Energy Transfer (ET) is becoming a passive income-producing machine. The master limited partnership (MLP) currently yields an eye-popping 9.7%. That prodigious payout will only get more attractive because the midstream company expects to increase it by 3% to 5% annually.

I want more of that massive and growing passive income stream in my portfolio. That’s why I keep padding my position. Here’s why I’m confident that the company can continue growing its big-time payout.

Mission accomplished
Energy Transfer has worked hard to improve the long-term sustainability of its distribution. The midstream giant made the difficult decision to slash its payout by 50% in 2020 to retain additional cash for debt reduction. That deleveraging strategy has been a success. The company recently achieved its targeted leverage ratio of 4.0 to 4.5. That has given it the financial flexibility to return its payout to its former peak, which it achieved in January.

It can easily cover that much higher payout level. During the first quarter, Energy Transfer generated $2 billion of distributable cash flow. That was enough money to cover its reset distribution with $965 million to spare. The company used that retained cash to fund its expansion program ($407 million of growth capital spending in the first quarter) and further strengthened its balance sheet by repaying additional debt.

Given its robust post-distribution excess free cash flow, Energy Transfer now expects leverage to be at the lower end of its target range going forward. That gives it additional financial flexibility to invest in new expansion projects and make acquisitions as opportunities arise.

The fuel to keep growing
Energy Transfer recently used some of its financial flexibility to acquire Lotus Midstream. It spent $1.45 billion, including $900 million in cash, to enhance its crude oil network in the Permian Basin. The company structured the deal so that it would be leverage neutral. Meanwhile, it will immediately boost its distributable and free cash flow, giving it incremental money to pay distributions.

The company also recently approved a project to expand its Nederland Terminal. It expects to invest about $1.25 billion into the project, which should enter service and supply incremental cash flow by mid-2025. That project and one associated with the acquisition of Lotus Midstream will increase the company’s growth capital spending to $2 billion this year (up from its initial $1.6 billion-$1.8 billion range), a level it can easily fund with excess free cash after paying distributions.

Energy Transfer has several other expansion projects under development. A notable one is a potential carbon capture and sequestration project with oil giant Occidental Petroleum (OXY). The companies are working to secure long-term contracts with carbon emitters in the Lake Charles, LA region. If successful, Energy Transfer would utilize existing pipelines and build new ones to connect those emissions sources to a sequestration site Occidental is developing. Carbon capture is one of several lower carbon energy opportunities the company is pursuing to repurpose existing infrastructure and invest in high-return expansions to improve margins and drive future growth.

The MLP’s financial strength and visible growth give it confidence it can grow its distribution in the future. It plans to increase its payout by $0.0025 per unit each quarter, implying roughly 3% to 5% annual growth. The company delivered that first raise in April, pushing its payout past its pre-pandemic peak.

A premium passive income producer
Energy Transfer has come a long way over the last few years. The MLP has transformed its balance sheet from a liability into an asset. It now has tremendous financial flexibility to continue investing in growing its operations while also increasing its already prodigious payout. I want more of this sizable and steadily rising passive income stream in my portfolio, which is why I continue padding my position in Energy Transfer.

— Matthew DiLallo

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Source: The Motley Fool