Bearish on Energy Transfer Partners

On Feb 25, 2013, we downgraded Texas-based natural gas transportation and storage partnership Energy Transfer Partners L.P. (ETP - Analyst Report) to Underperform from Neutral, based upon a number of near-term challenges.

Why the Downgrade?

With natural gas prices likely to remain soft in the near- to medium-term, Energy Transfer Partners’ margins are expected to suffer in the next few quarters. The lack of fee-based contracts – which guarantee stable cash flows – has also been a negative. Furthermore, we expect units of Energy Transfer Partners to remain depressed until it raises its distribution, which has been static since 2008.

Causes for Concern

We believe that the overall picture for natural gas remain particularly weak, with storage levels remaining significantly above their five-year average. As such, we expect natural gas prices to stay low in the near future, thereby curtailing drilling activity around gathering systems and pipelines.

Gathering and processing partnerships such as Energy Transfer Partners are more sensitive to commodity prices compared to other partnership subgroups. As a result, collapsing energy prices have adversely affected their cash flow stability.

Though Energy Transfer Partners dishes out a healthy distribution yield of 7.6%, the partnership has not grown its payout since 2008. The lack of distribution increase has been a major impediment to a breakout in Energy Transfer Partners’ unit price.

Stocks that Warrant a Look

While we expect Energy Transfer Partners to perform below its peers and industry levels in the coming months and see little reason for investors to own the stock, one can look at McDermott International Inc. (MDR - Analyst Report), Helmerich & Payne Inc. (HP - Analyst Report) and Patterson-UTI Energy Inc. (PTEN - Analyst Report) as good buying opportunities. These energy equipment suppliers – sporting a Zacks Rank #2 (Buy) – have solid secular growth stories with potential to rise from current levels.