If you are watching the midstream oil and natural gas space, you've likely felt pretty queasy for more than a year. Just how upsetting has it been? Magellan Midstream Partners, L.P. (NYSE:MMP), one of the most conservative and well-run midstream energy partnerships, has seen its shares fall nearly 35% from peak prices in 2014. This year alone the units are down 22%. But CEO Michael Mears was still discussing Magellan's positive outlook when he spoke to investors and analysts during its most recent earnings conference call. Here are a few reasons the market may be too negative on Magellan's units today and why income investors should be paying close attention.
1. The partnership is doing fine
Mears was quite frank during the call when he spoke about 2017 results:
We're pleased to report our 2017 with strong operating and financial results delivering quarterly records to refined products transportation volumes, crude transportation volumes, and distributable cash flow, and solidifying 2017 as another record year for Magellan.
Without going into all the details, 2017 was perhaps a little less robust than previous years, but it was still a pretty good one for Magellan on both the operations and financial performance fronts. The fact that the unit price was so weak appears to have less to do with the partnership's underlying business than investors' negative opinion of the midstream space right now. That's a key issue to keep in mind since it suggests that investors might be a little too pessimistic here -- perhaps opening an opportunity for income seekers.
2. Magellan's still paying investors
The next notable comment from the CEO was about Magellan's distribution:
[W]e increased our cash distributions by 8% for the year, while generating a healthy 1.25 times coverage.
The partnership has increased its distribution for 18 consecutive years, with a hike every single quarter since it came public in 2001.
Magellan's current yield is about 6.2%, the highest level since roughly the turn of the decade. While investors might have been too optimistic when they pushed the yield down below 3% in the middle of 2014, the current yield appears to be very attractive given Magellan's solid performance and how committed the partnership has been to rewarding investors. Note that coverage of 1.25 times provides ample security for the current payout...and room for future distribution hikes.
3. Speaking of hikes
The CEO had something to say about future distributions, too:
[O]ur plan is to increase distribution by 8% again in 2018 consistent with previous guidance resulting in coverage of about 1.2 times for the year.
Mears went into a long list of growth projects and the expected operating performance of the partnership's various assets. But the end result is expected to be distributable cash flow of $1.05 billion in 2018, up roughly 3% from 2017.
This is where it's important to note the distribution coverage numbers again. In 2017, coverage was a robust 1.25 times, which is part of what's allowing Magellan to project a distribution increase of 8% in 2018. Despite a modest distributable cash flow boost of 3%, the partnership's robust coverage in 2017 gives it the leeway to support a larger increase this year.
4. Magellan will be more conservative from here
Mears highlighted the partnership's 2019 and 2020 outlooks, which call for distribution increases of between 5% and 8%. That's a more modest level of growth than in the past. He explained why:
We have continued to hear from our long-term investors that strong distribution coverage remains important to them especially considering the performance of the energy markets and MLP space over the last few years, as a result we intend to manage our business in a way that maintains a coverage ratio of 1.2 times for the foreseeable future.
With Magellan projecting 5% to 8% increases in distributable cash flow in 2019 and 2020, given what management knows today, it has no choice but to be a little more conservative with the distribution if it wants to maintain coverage of 1.2 times. But that will help ensure the safety of the distribution, which income investors should greatly appreciate.
When asked about the projections during the question and answer session, Mears said, "Quite frankly, we think our business is healthy at 1.1 times coverage, but we also think that it is prudent to maintain a higher coverage and trend more toward a self-funding model than a full distribution of available cash flow." Investors, then, shouldn't look at the slowdown as evidence of weakness, but rather as a statement about how important it is to Magellan's management team to run a conservative business for its unitholders.
5. But leverage will be going up a little
So being conservative with the distribution coverage is a wonderful thing, but note the comment about self funding. It's normal for partnerships to issue new units to help fund capital investments and acquisitions. However, Magellan isn't looking to fund its $900 million or so of 2018 investments in this way because new units would increase net unitholder distributions and be a headwind to its distribution coverage goals. The partnership intends to use debt, but don't get too alarmed. When asked about leverage, CFO Aaron Milford explained:
[L]everage will continue to creep up throughout the year in 2018. So, currently we're around 3.3 times debt-to-EBITDA at the end of 2017. We expect that leverage ratio to gradually increase throughout 2018 as we fund our growth closer to the four times level.
A debt-to-EBITDA ratio of 4, which is the partnership's target, is still fairly modest leverage, so Magellan isn't expecting to mortgage its future here. As such, you shouldn't get too upset as you watch the midstream partnership rely more on leverage this year -- it's just part of the bigger plan to ensure that the distribution is covered (and then some).
It won't excite, but it will keep paying
So 2017 was a record year, and management expects 2018, 2019, and 2020 to keep the records coming. The most important record for income investors is the distribution streak, which looks set to continue even if it's at a slightly slower pace for a couple of years. Note, however, that Magellan is fiscally conservative, and there could be upside to its figures if business goes well or if attractive investment opportunities present themselves. If you are an income investor, Magellan's high yield is worth a closer look today while the market is still downbeat on the midstream space.