Magellan Ends Its Public Life as a Stand-Alone Partnership With Its Pending Oneok Merger

Sector Strategist

Stephen Ellis

Magellan’s refined product pipelines are high-quality assets that have contributed to earnings stability as well as steady increases in distributions over time. The pipelines connect refineries to end markets such as gas stations and railroads. As both supply and demand are remarkably steady over time, Magellan has been able to extract modest inflation-linked price increases, which also serves as strong protection against any future volume declines. However, investment opportunities have been more limited in the refined products segment. As a result, Magellan has invested more than $5 billion largely elsewhere since 2010 and has built up a respectable but ultimately more volatile and lower-quality crude oil pipeline, which now contributes about a third of operating margin. While the competitive intensity of the new businesses is higher than the core refined product pipelines, we’ve been impressed by Magellan’s capital discipline, as it has earned solid returns, and the partnership has sold off stakes at very attractive valuations. 

The Magellan-Oneok merger is likely to close in the third quarter. The shareholder meeting to vote on the deal is scheduled for Sept. 21. We continue to think the outcome remains an excellent one for the vast majority of Magellan unitholders and expect it to close on time. We acknowledge that about a fourth of Magellan unitholders will likely face a sizable tax bill, as Magellan distributions have reduced their cost basis over the years to a very low cost. However, we see this issue as mainly timing (a tax bill now versus later). Considering the premium above our stand-alone fair value estimate, we see Magellan unitholders as essentially realizing considerable upfront value today instead of some distant and more uncertain point in the future. The alternative, assuming the stock trades at our lower fair value estimate, would mean less realized value after taxes for Magellan unitholders.

Business Strategy & Outlook

Magellan Midstream Partners has a wide economic moat. 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%-14% 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.

New pipelines are typically constructed to allow shippers or producers to take advantage of large price differentials (basis differentials) between two market hubs because supply and demand is out of balance in both markets. Pipeline operators will enter into long-term contracts with shippers to recover the project’s construction and development costs, in exchange for a reasonable tariff that allows a shipper to capture a profitable differential, and capacity will be added until it is no longer profitable to do so. Pipelines are approved by regulators only when there is an economic need, and pipeline development takes about three years, according to the U.S. Energy Information Administration. Regulatory oversight is provided by the Federal Energy Regulatory Commission and at the state and local levels, and new pipelines under consideration have to contend with onerous environmental and other permitting issues. Further, project economics are locked in through long-term contracts with producers before even breaking ground on the project. If contracts cannot be secured, the pipeline will not be built. A network of pipelines serving multiple end markets and supplied by multiple regions is typically more valuable than a scattered collection of assets. A pipeline network allows the midstream firm to optimize the flow of hydrocarbons across the system and capture geographic differentials; use storage facilities to capture price differentials over time; and direct more hydrocarbons through its system via storage and gathering and processing assets, ensuring security of flows and higher fees. Finally, as an incumbent pipeline, it is typically cheaper to add capacity via compression, pumps, or a parallel line than it would be for a competitor to build a competing line.

To assess the strength of a midstream firm’s moat, we consider two factors: the location and quality of the firm’s assets and the strength of the firm’s contract coverage.

Magellan’s refined product pipelines (about 65%-70% of the enterprise) are an extremely attractive business that has served as a reliable cash flow generator for Magellan to expand elsewhere. The infrastructure is fundamentally better positioned than most if not all natural gas and oil pipelines for a few reasons. First, as the 9,800 miles of pipes across 15 states connects refineries to end markets such as gas stations via 54 Magellan terminals, demand is highly stable as it depends on consumer demand in terms of miles driven and fuel efficiency. Similarly, supply and thus flows are less volatile as it is aggregated by a refinery versus multiple gathering and processing units linked to levels of drilling activity. Second, with Magellan serving the midcontinent, which has benefited the most in recent years from an increase in light crude supply, Magellan serves some of the most profitable refineries in the United States, meaning it can easily boost prices 2%-3% annually in line with inflation with little pushback, as the costs are passed through to the end consumer. Third, we’d characterize the incremental fee opportunities from refined product storage terminals and butane blending as low risk and attractive, given the lack of volatility in Magellan’s end markets. Finally, given the completely stagnant demand outlook, virtually no new pipes are being constructed, meaning Magellan faces no new competitive threats from that angle.

From a contract coverage perspective, we consider Magellan’s position to be weak, but the maturity and stability of the refined product market has lent itself to a niche where long-term contracts are less frequently used than in nearly all pipeline markets. Magellan only seeks long-term contracts when further investments are needed to ensure recovery of its capital, so only about 40% of its refined product shipments were subject to term commitments (usually involving reduced fees) with about three years until expiry. Given the refined products markets is demand driven, customer credit is not usually relevant, as if one customer lowers utilization, another one steps in. With the market being demand driven and the high stability and security of pipeline flows and limited alternatives to Magellan pipelines, there is lower risk than average for Magellan.

Magellan’s portfolio of crude oil pipelines and terminals is a no-moat business now, in our view. The most important asset is the Longhorn pipeline, which transports 275,000 barrels per day to Houston from the Permian Basin. Magellan’s other important crude oil assets are mainly joint venture activities, such as the BridgeTex pipeline (30% owned by Magellan), which transports 440,000 bpd to Houston from the Permian Basin, and Double Eagle (50% owned by Magellan), a 100,000 bpd pipeline that delivers Eagle Ford condensate to Magellan’s Corpus Christi terminal. These pipelines have taken sizable fee declines of more than 50% over the last few years with the Permian long-haul oil pipeline market expected to be oversupplied likely until the end of the decade. The pipelines are also not ideally located to serve export markets, which has contributed to utilization declining from the 90%-plus levels they have historically earned. Magellan's major crude oil pipelines are largely contracted (75%-87%) under contracts that have an average remaining life of between four and seven years.

Material environmental, social, and governance exposures create additional risk for midstream investors. In this industry, the most significant exposures are greenhouse gas emissions (from upstream extraction, midstream operations, and downstream consumption) and other emissions, effluents, pipeline spills, and opposition and protests. In addition to the reputational threat, these issues could force climate-conscious consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as production limits, removal of existing infrastructure, and perhaps even direct taxes on carbon emissions.

Midstream emissions are relatively low in the lifecycle of oil and gas, and midstream firms have relatively lower risk than upstream and downstream firms from carbon taxes. Canadian firms already pay carbon taxes on their carbon emissions, most of which are generally passed to their shippers and other customers. Spills represent a major threat and have created great resistance from environmentalists, Indigenous groups, and other climate-conscious persons. Examples of the opposition are seen in President Joe Biden’s revocation of the Keystone XL presidential permit and the legal challenges with the Dakota Access Pipeline system.

Magellan has yet to lay out any material ESG targets.

Wide

Economic Moat

Magellan Midstream Partners

Magellan Midstream Partners LP engages in the transportation, storage, and distribution of petroleum products. It operates through the following segments: Refined Products and Crude Oil. The Refined Products segment consists of an approximately 9,800-mile refined petroleum products pipeline system with 54 terminals and two marine storage terminals. The Crude Oil segment consists of approximately 2,200 miles of crude oil pipelines, a condensate splitter and 39 million barrels of aggregate storage capacity, of which approximately 29 million barrels are used for contract storage. The company was founded in August 2000 and is headquartered in Tulsa, OK.

Revenue

Cost of revenue

Gross profit

Operating expenses

SG&A

Other

Operating income

EBITDA

Net income

Earnings per share

Total assets

Current assets

Cash & equivalents

Receivables

Inventory

Non-current assets

Net PPE

Intangibles

Total liabilities

Current liabilities

Short term debt

Income tax payable

Non-current liabilities

Long-term debt

Total equity

Stockholders equity

Minority interest

Total liabilities & equity

Total debt

Net debt

Book value per share

Cash from operations

Funds from operations

Change in working capital

Cash from investing

Capital expenditure

Purchase/sale of investments

Purchase/sale of business

Other sources

Cash from financing

Change in stock

Change in debt

Cash dividends paid

Cash from other sources

Net change in cash

Free cash flow

Magellan Midstream Partners LP engages in the transportation, storage, and distribution of petroleum products and crude oil. It operates through the following segments: Refined Products and Crude Oil. The Refined Products segment consists of an approximately 9,800-mile refined petroleum products pipeline system with 54 terminals and two marine storage terminals. The Crude Oil segment has approximately 2,200 miles of crude oil pipelines, a condensate splitter, and 39 million barrels of aggregate storage capacity, of which approximately 29 million barrels are used for contract storage. The company was founded in August 2000 and is headquartered in Tulsa, OK.

Arbor Realty Trust

Enterprise Products Partners

Meredith

Tanger Factory Outlet Centers

These stocks have yields over 6.5% that are well covered by earnings and low price-to-earnings ratios, making them clear buys for investors looking to cash in on dividends.
The post 5 Cheap High-Yield Dividend Stocks Set to Grow Their Dividends appeared first on InvestorPlace.

5 Cheap High-Yield Dividend Stocks Set to Grow Their Dividends

Magellan Midstream Partners is looking at alternative ways to return cash to investors in addition to growing its high-yielding distribution.

This High-Yield Stock Could Have Something Special in Store for Its Investors

Alerian MLP ETF

Plains GP Hlds

Investors should consider buying these three MLPs for awesome payouts. All of these companies offer great tax advantages and huge returns.

3 MLPs and a Rich ETF to Buy for Excellent Portfolio Padding

While Magellan Midstream's growth engine will sputter this year, its strong financial profile will give it the fuel to continue to reward dividend investors.

This Stock's High Yield Could Keep Going Up in 2020 Despite Headwinds

Magellan Midstream Partners LP (MMP) CEO Michael Mears on Q4 2019 Results - Earnings Call Transcript

Magellan Midstream (MMP) expects to generate distributable cash flows of $1.2 billion for the full-year 2020 and is targeting annual distribution growth of 3%.

Magellan Midstream (MMP) Q4 Earnings Beat, Revenues Miss

Chevron

NuStar Energy

Patterson-UTI Energy

Plains All American Pipeline

The latest Earnings Preview implies a 47.2% slump in the energy sector's fourth-quarter earnings from the year-ago reported number.

5 Oil & Gas Stocks Likely to Surpass Q4 Earnings Estimates

Growing transported volumes of gasoline, diesel and crude oil are likely to have contributed to Magellan Midstream's (MMP) Q4 Earnings.

Is a Beat in Store for Magellan Midstream's (MMP) Q4 Earnings?

The distribution hike on offer at Magellan Midstream (MMP) represents the firm's 71st payout increase since it went public.

Magellan Midstream to Sell 3 Marine Terminals, Hikes Payout

These picks offer high yields and reliable track records, too.

Top Dividend Stocks With Yields Over 4%

Magellan Midstream Partners is joining a growing number of its midstream peers in launching a repurchase program.

This 6.3%-Yielder Thinks Its Stock Is Getting Too Cheap

Crestwood Equity Partners

Enbridge

Phillips 66

These companies offer investors high yields and a whole lot more.

Looking for Yield? These 5 Top Stocks Pay More Than 5%.

Magellan has a 6.5% yield versus NuStar's 9%. Is bigger better, or is there something else going on that investors should know about?

Better Buy:  Magellan Midstream Partners vs.  NuStar Energy

Magellan Midstream Partners: Secure Dividend With Low Risk

Brookfield Asset Management

Energy Transfer LP Unit

Realty Income Corp

Simon Property Group

SPDR S&P 500 ETF Trust

STAG Industrial

I Put Half Of My Net Worth Into These Investments For 2020

The overall energy sector didn't have an excellent 2019, but these energy stocks and exchange-traded funds are great energy plays today.

The 4 Best Energy Stocks for Smart Investors

Magellan Midstream's (MMP) extended open season is for the shippers willing to carry oil through the to-be-expanded pipeline.

Magellan Gauges Shipper Interest for West Texas Pipeline

ONEOK

Williams

These stocks offer well-supported high-yielding dividends with a bit of upside sprinkled in for good measure.

5 Rock-Solid Dividend Stocks to Buy Yielding at Least 5%

Helmerich & Payne

These two energy industry players have yields of more than 6%, but the risks they face are vastly different

Better Buy: Magellan Midstream Partners (MMP) vs. Helmerich & Payne (HP)

Magellan Midstream Partners: Our First MLP Buy In A Long Time

Kinder Morgan

Exxon Mobil

The best dividends combine a top yield with good growth prospects.

3 Dividend Stocks That Pay You More Than Pepsi Does.

Magellan Midstream (MMP) outperforms the energy sector on the back of its strong midstream operations with more room to run.

Here's Why Magellan Midstream (MMP) is a Lucrative Choice Now

MPLX

Negativity in this sector has sent dividend yields soaring, making it a great place for income investors to find attractive yields this month.

6 Stocks Yielding 6% That Dividend Investors Won’t Want to Miss This December

Determining which pipeline company is the better dividend stock.

Better Buy: Kinder Morgan vs. Magellan Midstream Partners

Is  (MMP) Outperforming Other Oils-Energy Stocks This Year?

News for Magellan Midstream Partners Stock (MMP)