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Magellan Midstream: High Quality, High Yield

Fears that OPEC has lost control of the oil market stems from U.S. shale producers are now running leaner and meaner.

Magellan Midstream Partners LP (MMP) is a conservatively managed MLPs that did a superior job of weathering the energy sector’s downturn, observes Ari Charney, editor of Investing Daily’s Utility Forecaster.

Recently, energy commodities have been selling off due to fears that OPEC has lost control of the oil market now that U.S. shale producers are running leaner and meaner.

The continuing glut of production has certainly put a ceiling on energy prices. The question now is whether $40 per barrel is the floor, or whether volatile commodity markets could push crude prices even lower.

Nevertheless, such uncertainty gives us another opportunity to pick up a high-quality, conservatively managed master limited partnership at a more reasonable price: Magellan Midstream Partners LP.

A key part of Magellan’s financial strength is its lack of incentive distribution rights (IDRs). Management had the foresight to eliminate the IDRs and acquire the general partner in a simplification transaction back in 2009.

Without IDRs, Magellan has been able to maintain a comfortable 1.3 times coverage of its quarterly distribution, while growing its payout 14% annually over the past three years.

Magellan also has one of the strongest balance sheets in the industry. Net debt to EBITDA (earnings before interest, taxation, depreciation, and amortization) for many MLPs averages around 4.5 times, while Magellan keeps its leverage at just 3.6 times.

In addition to prudent financial management, Magellan also benefited from having a largely demand-facing business amid a supply-induced crash.

The MLP owns the longest system of gasoline and diesel pipelines in the U.S., with 9,700 miles of pipelines complemented by 53 storage terminals and 42 million barrels of storage.

This infrastructure is concentrated in the middle third of the U.S., giving Magellan an absolutely commanding market share throughout much of the Midwest.

In recent years, management has been diversifying into newer areas for the partnership, including crude oil pipelines and marine terminal storage. While such moves could create execution risk, these are core areas for many midstream operators, and we trust management to get it right.

The overall investment package is very compelling. As such, we’ve wanted to add Magellan to one of our portfolios for a while. Now that the MLP is firmly in correction mode, this seems like the right time to do it.

Of course, you have to pay up for quality. Based on its trailing-year distributable cash flow (DCF), Magellan is one of the more expensive names in the MLP space, with a multiple of 16.4 compared to a sector average of 10.9.

In this case, however, we think the premium is warranted. With a forward yield of 5.0%, Magellan is a new addition to the Income Portfolio and a buy below $78.

Ari Charney is the chief investment strategist for Utility Forecaster, an analyst for Canadian Edge, and managing editor of Jim Fink’s Options for Income.

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