Magellan Midstream: Your Opportunity Is Knocking On This High Yielder

Summary

Magellan Midstream Partners operates a moat-worthy pipeline system of petroleum products in the U.S.

It has a best-in-class track record of earning high returns on invested capital, and maintains strong capital returns to unitholders.

MMP also has 20 consecutive years of distribution growth, and the recent share price weakness provides an opening for value seekers.

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DonNichols/iStock via Getty Images Good things come to those who wait, and the recent market volatility may just provide the opening that patient value investors have been waiting for. In practice, buying above-average companies at below-average prices is a winning strategy that many successful investors have employed. That’s why it pays to tune out the market noise and focus on high-quality players whose long-term growth theses are intact.

This brings me to Magellan Midstream Partners ( MMP ), which is a high-quality player in the midstream space that’s known for paying a reliable and growing distribution. I highlight what makes MMP an even more attractive buy after the recent drop, so let’s get started. Opportunity Knocks On This High Yielder

Magellan Midstream Partners is an MLP (note: issues schedule K-1) that operates pipelines and storage terminals across the Central and Eastern regions of the U.S. Its asset base includes America’s longest petroleum products pipeline system, covering 9,800 miles, 54 terminals, and 47 million barrels of storage capacity.

Notably, MMP can tap into nearly 50% of the nation’s refining capacity. Refined products make 71% of its operating margin, with crude oil making up the rest. What makes MMP’s income stream particularly durable is the primarily fee-based nature of its business. As seen below, just 9% of MMP’s operating margin is sensitive to commodity prices. (Source: Investor Presentation )

Morningstar assigns MMP a wide moat rating considering the aforementioned attributes, and the fact that MMP’s producers and end customers have few alternatives, as noted in its latest analyst report: “We expect Magellan will benefit from a particularly strong efficient scale moat source, given the lack of alternatives for its refined product pipelines (it provides more than 40% of refined products to 7 of the 15 states it serves), and with stable demand forecast, there’s zero incentive for new competing pipelines to be built. We forecast returns on invested capital to remain well ahead of Magellan’s cost of capital because of the minimal reinvestment needs of the refined product business. Even if we assume refined product pricing declines by 50%–an extremely unlikely scenario, given that pricing generally only moves a few percentage points annually– Magellan’s ROICs are around 11% (versus 13% in our base case), demonstrating the strength of the business. ROICs are also supported by strong capital allocation as well as the elimination of its incentive distribution rights in 2010, which lowered its cost of capital.” – Morningstar As noted above, Morningstar sees MMP as still having a low-teens return on invested capital even in a worst case and highly unlikely commodity pricing scenario. In a more likely scenario, MMP should be able to continue delivering ROIC in the mid-teens, given its strong business position. As seen below, MMP has achieved a 16% historical average ROIC, putting it ahead of Holly Energy Partners ( HEP ) and Enterprise Products Partners ( EPD ). (Source: Investor Presentation)

MMP continues to perform well, with distributable cash flow growing by 7% YoY, to $277 million in the third quarter. This was driven by increased refined products transportation volumes, including continued strong distillate demand across MMP’s entire pipeline system, as well as lower than expected expenses due in part to management’s continued cost optimization efforts.

What sets MMP apart from its larger peer, Enterprise Products Partners, is its aggressive capital returns program. Last year, MMP returned nearly $1.2B of value to unitholders through cash distributions and equity repurchases, and management expects to return $1.4B this year, including $750M worth of unit repurchases so far this year (through end of Q3).

Looking forward, I see continued robust capital returns, as management recently expanded its repurchase program by an additional $750M. At the current equity market capitalization of $10.14B, this would be enough to retire an impressive 7.4% of MMP’s outstanding units. Management also expects to spend $80M and $20M in 2021 and 2022, respectively, and anticipates a healthy 6-8x invested capital to EBITDA ratio (the lower the ratio, the better).

Risks to MMP include the nature of its transported products as they relate to environmental and worker […]

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