Share of energy transfer will almost double in 5 years

Most investors are interested in Energy transfer (NYSE: ET) attracted by its high yield, which currently stands at around 7.9%. The company currently pays a quarterly dividend of $0.32 and aims to increase this by 3% to 5% per year in the future.

That’s attractive in itself, but I also think the pipeline operator’s shares could nearly double over the next five years.

This would happen through a combination of growth projects and modest multiple expansion. This is when investors assign a higher valuation metric to a stock.

Let’s take a look at why I think Energy Transfer shares can more than double over the next five years.

Growth opportunities

Energy Transfer is one of the largest midstream companies in the U.S., with an extensive integrated system that spans the entire country. It is involved in almost all aspects of the midstream sector, transporting, storing and processing various hydrocarbons in its systems. The size and breadth of its systems provide it with many opportunities for expansion projects.

This year, the company plans to spend between $3 billion and $3.2 billion in growth capital expenditures (capex) on new projects. If the company spends between $2.5 billion and $3.5 billion in growth capital expenditures per year in the future, it can pay its distribution and have money left over from its cash flow to pay down debt and/or buy back stock.

Given this and the early opportunities Energy Transfer sees in power generation due to increased demand for energy from data centers as a result of the rise of artificial intelligence (AI), it’s likely safe to say the company can spend around $3 billion per year on growth capital investments over the next five years.

Most midstream companies are looking for at least 8x build multiples for new projects. This means that the projects will pay for themselves in about eight years. For example, a $100 million project with an 8x multiple would generate an average return of $12.5 million in EBITDA (earnings before interest, taxes, depreciation and amortization) per year.

Based on that type of return on growth projects, Energy Transfer should be able to see its adjusted EBITDA increase from $15.5 billion in 2024 to about $17.4 billion in 2029, if the company continues to spend $3 billion per year on growth projects.

Multiple expansion options

From a valuation perspective, Energy Transfer is the cheapest stock among its master limited partnership (MLP) midstream peers, trading at 8x on a forward enterprise value-to-adjusted EBITDA basis. That metric takes into account a company’s net debt while factoring in noncash items and is the most widely used way to value midstream companies. At the same time, it’s trading at a much lower valuation than it has historically been.

The story continues

MLP midstream stocks averaged an EV/EBITDA multiple of 13.7x between 2011 and 2016, so the industry as a whole has seen its multiples decline. However, with demand for natural gas rising due to AI and demand for electric vehicles declining, the transition to renewables appears to be taking much longer than expected. If this is the case, these stocks should be able to command a higher multiple than they do now, as this reduces fears that hydrocarbon demand will decline significantly in the coming years.

How Energy Transfer’s Stock Nearly Doubled

If Energy Transfer grows its EBITDA as expected, the stock could hit $30 by 2029 if it can achieve a 10x EV/EBITDA multiple. That’s higher than the 8x forward and 8.7x trailing multiple it currently achieves, but it’s still well below where the MLP midstream space has historically traded.

* Enterprise value is based on 3.42 billion shares outstanding, $57.6 billion of debt, $3.9 billion of preferred stock, $3.9 billion of investments in unconsolidated subsidiaries and cash, and $11.6 billion of non-controlling interests.

However, Energy Transfer and several other midstream companies appear to be very well positioned to be stealth AI winners due to increasing demand for natural gas. Energy companies and data centers have already approached Energy Transfer for natural gas transmission projects, and a natural gas volume boom could be on the horizon. Given this growth opportunity, coupled with the company’s strengthened balance sheet and consistent distribution growth, I would expect Energy Transfer’s multiple to expand modestly over the next five years, with the stock nearly doubling.

But even if the multiple doesn’t expand, investors can still make a very solid return on their investment through a combination of distributions (currently $0.32 per unit per quarter) and more modest price appreciation. With no multiple expansion and more than $7 in distributions between now and the end of 2029 (assuming 4% annual growth), the stock would still generate a return of over 75% over that period.

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Geoffrey Seiler has positions in Energy Transfer, Enterprise Products Partners and Western Midstream Partners. The Motley Fool recommends Enterprise Products Partners. The Motley Fool has a disclosure policy.

Forecast: Energy Transfer Stocks To Nearly Double In 5 Years was originally published by The Motley Fool