Everything is going according to plan for Energy Transfer (NYSE:ET). In fact, ET has recently reached a major milestone. On January 26, 2023, it announced that it is increasing its quarterly distribution by 15% to $0.305, or $1.22 on an annualized basis. This represents a substantial 75% increase compared to the previous year. For those who have been following ET, this marks a crucial milestone as the distribution has now officially returned to pre-Covid levelsmeaning that the post-Covid distribution restoration plan has now been completed.

It is important to note that management has consistently communicated this objective over the past couple of years, demonstrating a clear and unwavering focus on achieving this goal. For instance, the following quote is from one of many press releases that clearly state the goal:

Future increases to the distribution level will be evaluated quarterly with the ultimate goal of returning distributions to the previous level of $0.305 per quarter, or $1.22 on an annual basis, while balancing the partnership’s leverage target, growth opportunities and unit buy-backs.

Well, mission accomplished. Management successfully achieved their objective, and they deserve commendation. However, the question that arises is, what lies ahead? In the recent press release regarding the distribution increase, ET reiterated its target leverage ratio of 4.0x-4.5x debt-to-EBITDA, which has remained unchanged over the past few years, as well as its commitment to returning additional capital to unitholders.

This distribution increase represents another step in Energy Transfer’s plan to return additional value to unitholders while maintaining its target leverage ratio of 4.0x-4.5x debt-to-EBITDA. Future distributions will be evaluated, while balancing the partnership’s leverage target, growth opportunities and unit buy-backs.

I was one of the few proponents of ET during the dark days of Covid-19, when the first lockdowns were announced, and the world economy effectively shut down. I have published more than 15 articles in total about ET (excluding this one), of which 6 were written in 2020 after the Covid hit. Back then, the share price on many occasions was hovering around the $5 mark. Now, we are almost 3 times higher. Investors who were brave enough and purchased units back then have secured a yield on cost of approximately 25%. In other words, if one invested $100,000, the total income received from distributions (given that the $1.22 per unit annually has been restored) would be approximately $25,000. This is remarkable, and congratulations to those who managed to isolate the noise from critics who were focusing on doom and gloom predictions that the world was coming to an end or who exaggerated about the outcome of the Dakota Access Pipeline.

So, what to expect going forward? My thesis has remained consistent, and I believe it is more relevant than ever. The main argument in favor of investing in ET is that the Partnership has fully transitioned to a self-funded model. In the past, ET relied on the traditional toxic high-yielding, low distribution coverage MLP (Master Limited Partnership) model whereby virtually the entire profits were distributed to unitholders, and little was left to reinvest in the business. As such, ET had to rely on constantly raising new capital. However, when the energy crisis of 2015 hit, exacerbated by concerns around China, the unit price collapsed, resulting in a sky-high yield, which was prohibitive for raising new capital. As such, many MLPs slashed their distributions in an effort to retain capital since they were locked out of the equity capital markets. ET was one of the few MLPs that managed to survive the storm and retained its distribution. However, then Covid came, and management decided to go on ‘defense mode’ by slashing the distribution in half, albeit with a very well-defined plan to restore the distribution after paying down debt (as discussed above).

The good news is that ET not only does not rely on the capital markets now, it generates enough internally generated cash flow to satisfy a number of corporate priorities including maintenance CAPEX, growth CAPEX including M&A, distributions, paying down debt and putting cash aside for a rainy day. In other words, ET has turned to the high-quality business model adopted by the likes of blue-chip companies. This is the right way forward, and in my mind the only sustainable way forward. In other words, investors can sleep well at night knowing their distribution is very well covered and the Partnership can retain substantial levels of cash, net of distribution payments, to invest in itself and be successfully part of the energy transition. It is important to note that the vast majority of ET’s revenue backlog is fee-based and not a function of energy prices. The end result is that each quarter ET is left with around $1 billion after distribution payments, which equates to more than $4 billion annually, and this provides tremendous financial flexibility. As mentioned above, with the surplus cash, the Partnership can either acquire other companies, scale up CAPEX growth, deleverage, or even boost payouts to unitholders, including unit repurchases.

Despite this high-quality business model, the distribution yield still remains elevated, almost 10%. Let’s be honest; how many companies can one find with such robust metrics that have this elevated yield? Very few is the answer. Moreover, my conviction is that given ET’s cash flow generation, one can lock in the high distribution today and also enjoy substantial capital gains. We have well passed the $10 per unit mark and are now heading towards the $15-20 range, which in my view is the fair value (more on this below). While I avoid making price predictions, this is a function of simply ET catching up with peers. ET is mistakenly viewed as a highly indebted MLP. While this has been the case in the past due to aggressive M&A-driven growth, the Partnership has changed its style, and leverage has been brought down over the past few years as a result of the aforementioned change in the business model relying on internally generated cash flow and a high distribution coverage. In other words, every year ET is in the fortunate position to generate substantial amounts of free cash flow to use as it sees fit.

In fact, my confidence in ET has grown further given the stellar Q4 2022 earnings results, which were released last week. In simple terms, ET continues to fire on all cylinders, breaking one record after another. Specifically, ET achieved new records in NGL fractionation and transportation volumes, the single-day fractionation throughput at Mont Belvieu reached more than 1 million barrels for the first time in the Partnership’s history, the Nederland Terminal set a new record for ethane exports, and also new records were broken for Midstream volumes. This translates to very strong cash flows with FY 2022 delivering Adjusted EBITDA of $13.1B, a new partnership record, DCF (Distributable Cash Flow) of $7.4 billion, and excess cash flow after distributions of $4.4 billion. Let’s put things into perspective. The DCF yield remains a whopping almost 20%, and the excess cash flow yield (after distributions), remains more than 10%. This is a clear indication that ET is undervalued, especially when taking into account that the debt levels are now conservative and continuing to be reduced while at the same time the business continues to grow.

This sets the foundation for even stronger performance going forward and more record-breaking years. The guidance for this year 2023 is strong, namely Adjusted EBITDA is expected to be between $12.9 billion and $13.3 billion versus expected growth capital of between $1.6 billion and $1.8 billion. Importantly, maintenance CAPEX is also negligible. As a result, this will result in substantial free cash flow generation.

The Partnership’s strength is also reflected in its senior unsecured debt rating, which is now on a positive outlook from all three rating agencies. This is not a coincidence, but the result of bold actions taken by the partnership when it decided to cut the distribution by 50% after the Covid hit, in order to prioritize deleveraging. Energy Transfer is now within its 4-4.5x target leverage ratio range, and with the recent distribution increase, the distribution level is now restored to the rate paid in the first half of 2020.

I am a cash flow guy. Cash is king, and ET is one of the best-positioned companies on this front. I believe this is evident from the style of my articles. But what is also clear is that ET is undervalued by a wide margin compared to its peers. In fact, ET is becoming unusually attractive relative to its peers, as evidenced by browsing the table below.

ET is cheap by any means, whether on an EV to EBITDA basis, Price to Cash Flow basis, or most other metrics. Should ET converge to the average valuation metrics of its peers, its unit price should be around $18-20. In such a scenario, the distribution yield would compress to around 6%-7%, which I consider fair for such a quality business model and setup. It is worth noting that the likes of Kinder Morgan (KMI) and Enbridge (ENB) already trade at such yields today, as illustrated below.

As such, based on the above, the only logical explanation is that undervaluation is a result of a highly indebted company or a company that has a substantial disadvantage relative to its peers. But this is clearly not the case. For starters, as discussed above, ET is breaking one record after another in terms of volumes. This indicates the fundamentals of the underlying business are doing well and the Partnership is well positioned for future growth. Moreover, debt is certainly not that big of an issue (as many incorrectly believe), especially since the Partnership has fought hard to address this issue. For instance, in one of the most widely used metrics, Net Debt to EBITDA, ET has the same debt as MPLX LP (MPLX) but has lower debt than KMI and ENB.

In any event, I think that my point is clear. The distribution has now officially returned to pre-Covid levels (signifying that the post-Covid distribution restoration plan has now been completed), ET has one of the best yields in the market, the distribution yield is around 8 percentage points higher than the S&P 500 dividend yield, the distribution coverage is healthy (around 2x), the Partnership is also investing in renewable energy via its Alternative Energy Group, and insider ownership continues to be the highest compared to its peers (approximately 14%). I continue to remain very bullish on ET, despite pounding the table when it was trading around $5 per unit during the dark days of the pandemic. The Partnership is way healthier right now as it has fully transitioned to a self-funded model, which generates enough internally generated cash flow to satisfy a number of corporate priorities. My preference is for ET to continue focusing on a balanced approach by investing in growth, continuing to pay down debt, but also to embrace buybacks more actively since the distribution yield remains close to double digits, which is rare to find in a company with such robust metrics.