Energy Transfer (ET 0.17%) has become a premium passive income producer in recent years. The master limited partnership (MLP) pays a significantly above-average cash distribution that currently yields 7.9%, compared with the 1.4% dividend yield of the S&P 500. Meanwhile, it has been steadily pushing that payout higher each quarter.
The MLP recently declared its latest distribution increase, pushing its payout 3.3% above the year-ago level. It should have plenty of fuel to continue growing its big-time payout in the future. That makes it an excellent option for those seeking a steadily rising passive income stream and who understand the potential tax implications of investing in an MLP.
The big reset is paying big dividends
Energy Transfer hasn't always been the most reliable income stock. The MLP cut its distribution payment in half during the pandemic to retain additional cash to fund expansion projects and debt reduction. That strategy has paid off. It was able to steadily chip away at its leverage ratio, driving it down to its 4.0 to 4.5 target range within the last year. That allowed the company to steadily bring its distribution back up to its pre-pandemic level, which it achieved early last year.
The pipeline company has since set a target of increasing its distribution at a 3% to 5% annual rate by steadily bumping the distribution payment up each quarter. It can easily support that growth. The MLP generates significantly more cash than it distributes to investors -- $3.6 billion in excess free cash flow after paying $4 billion in distributions last year. That gives it plenty of money to fund expansion projects, to the tune of $1.6 billion in growth capital expenses in 2023, while maintaining a strong balance sheet. It expects leverage to be toward the low end of its target range this year.
Energy Transfer's increasing financial flexibility allowed it to make two notable acquisitions last year. In November, it bought fellow MLP Crestwood Equity Partners for $7.1 billion and closed its $1.5 billion purchase of Lotus Midstream in May. The company structured those deals so they would have a neutral impact on its leverage ratio, ensuring it maintained its financial flexibility.
Ample fuel to grow value for investors
Those acquisitions will move the needle for the MLP this year. It expects its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to rise to a range of $14.5 billion-$14.8 billion, up about 7% at the midpoint. Energy Transfer should also get a boost from expansion projects and healthy market conditions. With earnings rising and it having strong financial metrics, Energy Transfer has plenty of capacity to increase its distribution this year.
The energy infrastructure company expects capital spending to rise to between $2.4 billion and $2.6 billion this year, well within its $2 billion-$3 billion annual target range. Those projects will help fuel earnings growth in the coming quarters. Meanwhile, that spending range means the company will continue to generate excess free cash flow to maintain its balance sheet flexibility.
It could use that capacity to repurchase units and continue consolidating the midstream sector. Unit repurchases would help reduce its outstanding units, enhancing its ability to increase its distribution per share. Meanwhile, Energy Transfer has a long history of making accretive deals that increase its cash flow per share. Either option would enhance its ability to continue expanding its distribution.
A premier passive income producer
Energy Transfer offers a high-yielding distribution that it should be able to continue increasing each quarter. While MLPs like Energy Transfer can affect an investor's taxes -- they send a Schedule K-1 instead of a 1099-DIV form each tax season -- they also have tax benefits. For example, distribution payments are often largely tax-deferred until the investor sells his or her units. Because of that, Energy Transfer is a great option for investors seeking a big-time income stream that should steadily rise in the future.
