Published by Bob Ciura on June 30th, 2017
After a significant rally to end 2016, crude oil has turned lower again over the first half of 2017.
It has taken a number of oil stocks down along with it, including Master Limited Partnerships like Magellan Midstream Partners (MMP).
The stock has declined 7% year-to-date, but investors are throwing the baby out with the bathwater.
Magellan’s cash flow is only modestly impacted by falling oil prices, thanks to its toll road style business model.
This allows the company to continue increasing its dividend, even during the oil downturn. Magellan is a Dividend Achiever, a group of stocks with 10+ years of consecutive dividend growth.
Even better, the dip in Magellan’s share price this year has pushed its dividend yield up to 5%.
Magellan is one of 416 stocks with a 5%+ dividend yield.
This article will discuss why income investors should consider taking advantage of the market’s irrational punishing of this high-quality MLP.
Magellan operates three core segments:
- Refined Products (58% of operating profit)
- Crude Oil (32% of operating profit)
- Marine Storage (10% of operating profit)
The Refined Products segment is Magellan’s largest, which includes 9,700 miles of refined products pipeline.
It also includes 53 connected terminals and another 27 independent terminals, as well as a 1,100-mile ammonia pipeline system.
Source: June 2017 JP Morgan Energy Conference, page 4
In addition, the Crude Oil segment includes 2,200 miles of crude oil pipelines, with storage facilities that hold capacity of 26 million barrels.
Lastly, Magellan operates five marine terminals, that also hold storage capacity of 26 million barrels. The Marine Storage segment enjoys long-term contracts, with utilization consistently above 90%.
Magellan’s business model provides the company with several advantages.
As an operator of pipelines and storage terminals, Magellan is heavily insulated against protracted declines in commodity prices.
The business model acts similarly as a toll road, in that Magellan receives fees based on volumes of products transported and stored through its network.
Only 13% of Magellan’s 2016 operating profit was derived from activities that are highly sensitive to commodity prices.
Approximately 85% of future cash flow is of the fee-based nature, which is very stable.
Going forward, Magellan’s high-quality assets and business model should continue to fuel steady growth in the years ahead.
Magellan has generated steady growth for many years.
In 2016, Magellan’s distributable cash flow increased 0.5% to $948 million. DCF-per-unit increased less than 1%, to $4.15. Annual distributable cash flow reached a record for the company.
The crude oil segment was Magellan’s best-performing business last year, with 17% growth in operating profit.
For companies that operate on the exploration and production side of the oil business, higher commodity prices are the major potential catalyst.
But for Magellan, its biggest catalyst is new projects.
Magellan invested $5 billion in organic growth projects and acquisitions over the past 10 years. For 2017 and 2018, Magellan expects to invest $600 million and $350 million, respectively, in potential growth projects.
One of its most important new projects is the Saddlehorn Pipeline.
Source: June 2017 JP Morgan Energy Conference, page 9
Magellan has a 40% ownership stake in the project, which will include a 600-mile pipeline, with a maximum capacity of 300,000 barrels per day.
The Saddlehorn project should be significantly accretive to Magellan moving forward. The project has an average earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple of 7.
Put differently, Magellan expects to generate an annual EBITDA yield of approximately 14% from this project.
Separately, Magellan, along with Plains All American (PAA), will expand their jointly-operated BridgeTex pipeline system, from 300,000 barrels per day to 400,000 barrels per day of capacity.
The Saddlehorn and BridgeTex assets helped fuel Magellan’s strong crude oil performance last year.
Magellan’s strong performance continued to start 2017.
First-quarter distributable cash flow increased 7.5% year over year. Earnings-per-share increased 7.7%.
The strongest growth was seen in the Refined Products segment, where operating profit rose by 29%, due to hedging activities, 4% shipment volume growth, and higher tariffs.
Growth from new projects will help the company continue to increase dividends moving forward.
Magellan is a rare stock, in that it offers investors a unique mix of a 5% yield, and high dividend growth each year.
It recently increased its dividend by 9%, compared with the same quarterly distribution last year.
Source: June 2017 JP Morgan Energy Conference, page 16
Magellan has increased its dividend 60 times since its initial public offering in 2001. Since then, Magellan has increased its dividend at an impressive compound annual rate, of 12%.
The company expects 8% dividend growth in 2017 and 2018.
A key factor that helps sustain Magellan’s dividend is that it has no incentive distribution rights. IDRs typically give the General Partner an increasing share of the MLP’s distributable cash flow.
Not having IDRs gives Magellan a simpler corporate structure than most other MLPs, which helps lower its cost of capital and provide more cash flow for distributions.
And, Magellan has a solid balance sheet, with a strong investment-grade credit rating of BBB+.
Source: June 2017 JP Morgan Energy Conference, page 17
The company has adopted a more conservative financing structure than many other MLPs, which served it well during the recent downturn in the oil market.
For example, Magellan maintains a leverage ratio below 4.0. Many MLPs that had to cut or suspend their dividends over the past year have had leverage ratios of 5.0 or higher.
Another key measure helping to secure Magellan’s dividend is that it generates more cash flow than it needs to pay the dividend.
For example, in 2016 Magellan had a distribution coverage ratio of 1.25, meaning it generated 25% more cash flow than it needed for dividends.
In 2017, Magellan expects its distribution coverage ratio to decline slightly, to 1.2, but this is still a healthy level of coverage.
The price of oil is sinking once again in 2017, which could bring up some bad memories of the 2015-2016 downturn, which led to several huge dividend cuts across the MLP space.
However, there is a big difference between the upstream, exploration and production MLPs—which are reliant on high commodity prices—and the midstream operators like Magellan.
Magellan’s distributable cash flow has held up remarkably well this year, and is poised to grow thanks to new projects.
As a result, Magellan is a best-in-class MLP. The stock is attractive for income investors, as well as dividend growth investors.