Magellan Midstream Partners: Predictable (NYSE:MMP)

Magellan Midstream Partners (MMP) goes about its business without attracting much attention. This partnership issues a K-1 with outside directors elected by the public unit holders. Therefore, there is some accountability here that is lacking in much of the midstream industry.

The company debt is rated as investment grade. That is one of the highest ratings in the midstream industry. More importantly, this company brings off expansion projects while managing to stay out of the courts and, more importantly, away from any court cases that make the newspapers. The nice quiet dependability is desirable for many income investors.

Yet, Magellan has a long history of paying distributions while slowly increasing those distributions. Now that the coronavirus challenges are finally beginning to fade, the return to historical growth should be an added benefit to an already tantalizing distribution.

Returns

This midstream has a current price that anticipates a lot of bad news.

(Source: Seeking Alpha website, October 7, 2020)

The current yield is among the higher yields of this partnership. Generally, this partnership has steadily increased the dividends through the years. This year, the coronavirus demand destruction brought that to a halt.

Still, management noted that the coverage was considered adequate and it would improve next year.

Debt Profile

This partnership has one of the more conservative debt profiles.

(Source: Magellan Midstream Partners Virtual Investor Conference, August 2020)

This fiscal year could send the debt ratio up. That is especially true with some more coronavirus challenges ahead. However, this partnership is well prepared for some weak quarters by keeping debt low.

The investment grade credit rating gives this partnership access to lending rates that few other midstream competitors can match. It also lends credence to the management statement about maintaining the distribution. An investment grade credit rating generally leaves some leeway to borrow to maintain the distribution, should that be necessary. Unless the debt ratio above heads to about 4.5, there really should be no worries about the distribution. Only if management changes the priorities for expenditures would that distribution be a worry.

Return On Capital

The return on capital is also high. This enables management to borrow more for each project, while keeping the debt ratios conservative.

(Source: Magellan Midstream Partners Virtual Investor Conference, August 2020)

Slides put together by management can be suspect. Especially ones that show excellent profits like the one above. But the history of distribution increases as well as the low debt ratio tend to independently back up the claim above.

Compare this to the quarterly conference call, where Energy Transfer (ET) management called some of the SemGroup (SEMG) assets “priceless”. The frequent problem with priceless acquisitions is that you end up with the profitability shown above for Energy Transfer. In case the SemGroup acquisition was not convincing, then the fact that Shell (RDS.B) pulled out of the Lake Charles joint venture should be another indication of a lack of financial discipline when it comes to profitability and cash flow objectives.

Back in June, I noted (again) that cash flow just never seems to appear when Energy Transfer management forecast all that free cash flow. The fact is that if management chooses to pay more for “priceless”, then shareholders end up shouldering more risk of a project cost overrun causing below-average profits. As the chart above demonstrates, Energy Transfer has long not focused on profitability of assets. If that discipline does not change, there could be more cash flow disappointments ahead just based upon the chart above.

Safe Projects

This management has a habit of keeping projects out of the newspapers and out of court while bringing those projects in as budgeted or below budget. Should an accident happen and a project run over budget, the balance sheet can withstand quite a bit of trouble before any credit ratings would change.

(Source: Magellan Midstream Partners Virtual Investor Conference, August 2020)

This management expands by taking on low-risk projects. Texas, in particular, is known to favor midstream companies. This business environment allows companies like this one to expand without a lot of delays or lawsuits. The size of the state and the location of some major production fields are advantages to a partnership like this one. Intrastate projects frequently do not have the red tape associated with interstate projects.

Compare this to an Energy Transfer management that took on an out-of-state project known as DAPL. Management further took some risks, and now the appeals court just further warned the defendants:

(Source: Inforum article written by Adam Wills, August 5, 2020)

The court further “unburied the hatchet” with this follow-up:

“or that the district court abused its discretion in refusing to remand without vacatur pending the statement’s completion, see Allied-Signal, Inc. v. U.S. Nuclear Regulatory Comm’n, 988 F.2d 146 (D.C. Cir. 1993).”

(Source: Appeal Court ruling on August 5, 2020)

The court action has put a fair amount of shareholder money at risk. Whether or not management wins is as important as the fact that management was willing to risk losing and all that a loss possibly entailed. At the very least, a win would cost a fair amount of legal fees that could be used elsewhere. A loss could entail removal of the pipeline where the defective permit was issued, combined with repercussions from the partners.

Both companies at this time have investment grade debt. But the general business strategy of Magellan is far safer for income investors. Another noted comment was the investment grade level of customers. This is another choice to minimize potential problems ahead.

Crestwood Energy Partners (CEQP), for example, has Chesapeake Energy (OTCPK:CHKAQ) as a customer. Crestwood did take the time to renegotiate its contracts with Chesapeake before the bankruptcy to market rates. The stock price is being affected by the bankruptcy news, even though management took care to fix the contract before the bankruptcy.

Energy Transfer management has chosen to fight the motion to cancel the contract it has with Chesapeake. But the problem is that now rates are relatively weak, and a renegotiation now puts the company at a considerable disadvantage compared to the path taken by Crestwood Energy Partners management.

That bankruptcy court decision will be determined by the onerous burden of that contract. The bankruptcy court has always had the final decision in such matters. Now, the procedure to get there can have a lot of drama. Energy Transfer management intends to spend shareholder money to fight this motion when it could have proactively handled the situation with considerably less cost. This is another instance of management choosing a risky strategy (with a good chance of getting “burned”) that raises the legal costs of doing business. It is yet more support for the low profitability shown in the slide above.

Conclusion

Magellan Midstream partners is a “SWAN” investment. This conservative management will continue to do what it does best with an excellent discipline focus on profitability. Partnership unit holders elect a fair number of independent directors that provide accountability to the common unit holders seldom seen in midstream.

When compared to the risky strategies of Energy Transfer, Magellan Midstream is likely to return to a combined appreciation and distribution that is well above average over the long term. At the current price the well-supported distribution alone is at a rate that is above the total long-term return of the average investor. Once the coronavirus challenges fade, an appreciation return of 6% annually, when combined with the distribution, would provide a fantastic return for a midstream investment without all that upstream risk.

Energy Transfer management has engaged on a series of risky strategies that could cost the common holders the distribution and, possibly, the preferred holders as well. That risk is completely absent with Magellan Midstream, even though both companies have investment grade debt.

I analyze oil and gas companies and related companies like Magellan Midstream in my service, Oil & Gas Value Research, where I look for undervalued names in the oil and gas space. I break down everything you need to know about these companies – the balance sheet, competitive position and development prospects. This article is an example of what I do. But for Oil & Gas Value Research members, they get it first and they get analysis on some companies that is not published on the free site. Interested? Sign up here for a free two-week trial.

Disclosure: I am/we are long CEQP, RDS.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: I am not an investment advisor (or a lawyer), and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents, and press releases to see if the company fits their own investment qualifications.
I may initiate a position in MMP at any time without further notice.

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