The Alerian MLP ETF is roughly 45% off of its 2014 highs. That's a pretty good representation of the pain that's currently being felt in the midstream energy space. However, that decline has led to notable yields in the sector. But with a slew of distribution cuts in the space, you'll want to focus your attention on some of the better companies to profit from this downturn and get paid while you wait for better days -- partnerships like Magellan Midstream Partners, L.P. (MMP) and Spectra Energy Partners, LP (SEP).
1. Slow and steady
Magellan Midstream Partners is one of the most conservative oil and gas midstream companies in the industry. For example, its debt to EBITDA ratio is a modest 3.45, easily at the low end of the industry. It also boasts a generous distribution coverage ratio of 1.2 times. In fact, it recently announced that it was pulling back slightly on its distribution growth targets in 2019 and 2020 (going from 8% to 10% growth to 5% to 8%) to ensure that its distribution coverage stays robust. The midstream partnership has also been stingy with dilutive unit issuances, effectively issuing no new units over the last five years.
Image source: Getty Images.
You can easily find midstream companies that offer more than Magellan's generous 5.3% yield. However, it is hard to find a more conservatively run midstream player. Note, too, that Magellan has increased its distribution every single quarter it has been public, dating back to its 2001 IPO.
That said, you might be tempted to take the drop in the distribution growth target as a sign of weakness. It's not; management had originally planned to let its distribution coverage ratio fall to the 1.1 range, but based on the current market environment, chose to shift gears to assuage the concerns of investors worried about distribution cuts in the sector. Instead, the partnership will allow its debt to EBITDA levels to inch into the 4 times range -- which will still sit at the low end of the industry -- while it invests $1.4 billion over the next two years in new assets and expansion projects to grow its business. These projects either have customers lined up or are at facilities where demand indicates the need for expansion.
Magellan is a rock-solid option in the midstream space. Still down 20% from its 2014 highs, it's worth a close look for more conservative investors looking to benefit from the midstream downturn.
2. Complicated, but strong
Spectra Energy Partners' story is a bit more convoluted. The partnership's general partner was acquired last year by Canada's Enbridge Inc. (ENB -1.23%), which controls two other partnerships. That's led to some speculation that Enbridge will merge the three midstream partnerships into one big entity, which wouldn't be a bad thing for investors. Enbridge is a supportive parent, and a combined partnership would have industry clout.
It's worth noting that Enbridge recently agreed to exchange its incentive distribution rights for Spectra partnership units, meaning it gets treated just like any other unitholder. This is good for unitholders because it lowers the partnership's cost of capital. That said, Enbridge now owns around 80% of Spectra, effectively giving it total control over the partnership if it wants to make any changes.
The complexity of the Enbridge family of companies is part of the reason Spectra Energy Partners yields a robust 8% today. That said, as a stand-alone entity, it possesses some compelling attributes. It has a target of 1.1 to 1.2 times distribution coverage over the next three years. Distribution growth, meanwhile, is projected to be about 7% in 2018 before dropping down to roughly 5% in each of the next two years. Driving that distribution growth is roughly $2.5 billion worth of capital projects, the vast majority of which have customers lined up already. And, like Magellan, Spectra has a long history of distribution growth, with 42 consecutive quarterly increases under its belt.
A list of the projects in Spectra's backlog. Image source: Spectra Energy Partners, LP.
Generally speaking, Spectra's core portfolio is made up of long-haul natural gas pipelines. These are increasingly important assets as natural gas becomes a more dominant part of the domestic power grid. The story is pretty compelling so far. However, Spectra's debt to EBITDA is higher than that of Magellan's, hitting 5.7 times on a recent increase in the partnership's debt to help fund its expansion efforts. But as Spectra's current round of investments come online, they should help bring leverage down again. In the meantime, investors can jump on a high-yield partnership that's around 45% off of its 2014 highs.
Although not as conservative as Magellan, more aggressive investors will be well rewarded by Spectra's higher yield. However, with a slew of growth projects under way, solid distribution coverage, and a supportive parent, despite the complexity that involves, there's no reason to think Spectra's payout is at risk today.
Two ways to play the downturn
If you're seeking out high yields, the downtrodden midstream sector is a good place to be looking. However, you'll want to focus on stronger players with long histories of rewarding investors. Magellan is among the most conservative partnerships in the space and is suitable for just about any investor. Spectra Energy Partners is a more aggressive option, but it has a long history of rewarding investors, solid growth plans, and a supportive parent. More aggressive investors should find it a rewarding long-term opportunity despite the recent uptick in debt.
