What Happened?
Energy Transfer Partners (NYSE:ETP) is up 12% in the past two weeks on relatively no material news. The rally has been fast and furious.
Source: Finviz
We selected ETP as the second pick in our High Yield Income portfolio on Discovered Dividends on 3/28, when the units were trading for $16.29.
Source: Discovered Dividends
We are up nearly 12% in less than a month with yield on cost at 14%. At this time, the units have broken through resistance at the 50-day SMA with a remarkable trajectory, and are now sitting 3% above the 50-day. The units are now testing resistance at the 200-day SMA at present. If the units can break through the 200-day SMA with the same force, it could be off to the races for another 12% gain to $20.50. So what is driving the rally? The following are my thoughts on the subject.
Short-covering
About 16% of the float is showing as short from the last update.
Source: ShortSqueeze.com
Usually, the start of many rallies in oversold stocks begins with a short-covering rally. Short-covering rallies often behave just as the recent rally in ETP units has - a fast and furious burst off the lows of $16. The question is, why are the shorts covering? My first blush intuition was that the algos made a big mistake. Let me explain.
A case of the baby being thrown out with the bathwater
ETP units were vastly oversold in March already. Then, news broke that the FERC announced it will no longer allow MLPs to recover an income tax allowance in cost of service rates. This caused MLP unitholders to sell first and ask questions later. This created an excellent buying opportunity in the units, as the majority of pipelines in the U.S. are not FERC-regulated. In fact, Energy Transfer Partners stated the MLP would have no material impact.
The following is the company’s response to the new FERC regulations:
“DALLAS - (BUSINESS WIRE) - Mar. 15, 2018 - Energy Transfer Partners, L.P. is aware of revisions the Federal Energy Regulatory Commission (“FERC”) is proposing to its 2005 Policy Statement for Recovery of Income Tax Costs, which if adopted after a public comment period, would no longer allow interstate pipelines owned by master limited partnerships to recover an income tax allowance in the cost of service. These revisions are not expected to have a material impact to ETP’s earnings and cash flow. Many of ETP’s rates are set pursuant to negotiated rate arrangements or rate settlements that it believes would not be subject to adjustment, or would be limited in terms of adjustment. In addition, many of its current transportation services are provided at discounted rates that are below maximum tariff rates, many of which it believes would not be impacted by a change in the maximum tariff rate.”
I posit this was the initial catalyst for the units to rally. What’s more, the stock was resting just above major long-term support at $16. On top of all this, the units are trading at steep discounts to historical and relative values. Here is why.
ETP units vastly undervalued
After I published my piece on ETP, another Seeking Alpha author had some additional info to add to my bull thesis. I really appreciated the additional thoughts and info and want to ensure everyone is aware.
SA author Western Reserve Strategies stated the following in regard to ETP’s valuation:
The chart shows the extreme discount in valuation in units of ETP versus the rest of the MLP sector. The great thing Western Reserve Strategies did after that was take a look at ETP bonds to see if the smart money had the bonds in dire straits as well. What the author found made his jaw drop. See the chart below:
Western Reserve Strategies" statement regarding bonds:
“My jaw hit the floor. The bond market is long-known to represent the "smart money". That Energy Transfer Partner’s units yield 2-3x more than its peer pipeline operators while its bonds trade right in line with those of these same peers can only mean one thing: either the bond investors are seriously underestimating Energy Transfer’s ability to meet its future obligations or (2) shares are drastically undervalued.”
I am going to have to agree with the smart money and the author - ETP units are current still undervalued by a wide margin.
The Bottom Line
My perception regarding the units at this point is they represent an excellent buying opportunity for long-term high-yield income investors looking for capital gains as well as income. One of my favorite quotes from investing icon Sir John Templeton is:
"Invest at the point of maximum pessimism."
Templeton is known as a contrarian investor. He referred to his investment philosophy as "bargain hunting." His guiding principle was:
"Search for companies that offered low prices and an excellent long-term outlook."
I feel this statement perfectly illustrates where ETP units lie at present.
Source: TD Ameritrade
The reward far outweighs the risk at the time. There is still a wide gap between the bullish sentiment level regarding ETP and the natural gas and energy sectors. The stock may have already bounced off the point of maximum pessimism, yet that only increases the margin of safety for investors opening a new position.
When I first recommended the stock, I caught a bunch of flak for not waiting for a trend reversal to occur. That would have reduced the risk. The good thing for those investors who are risk-averse is there is still time to get in on this investment. ETP"s newly combined assets have created a strong foothold in the most prolific producing basins for the MLP. This should augur well for organic growth for years to come.
The over 12% yield, coupled with adequate coverage ratio of better than 1, establishes a solid margin of safety. The ETP is under-owned and oversold presently. I still see 30% upside in the stock. If we can break through resistance at the 200-day SMA, we could be off to the races. Those are my thoughts on the matter. I look forward to reading yours!
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Disclosure: I am/we are long ETP.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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