This article analyzes the most recent quarterly and the trailing twelve months ("TTM") results of Magellan Midstream Partners, L.P. (NYSE:MMP) and looks "under the hood" to properly ascertain sustainability of Distributable Cash Flow ("DCF"). The task is not easy because the definitions of DCF and "Adjusted EBITDA", the primary measures typically used by master limited partnerships ("MLPs") to evaluate their operating results, are complex. In addition, each MLP may define these terms differently, making comparison across MLPs very difficult. Nevertheless, this is an exercise that must be undertaken to ascertain what portions of the distributions being received are really sustainable.
Revenues, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) reported by MMP for 1Q13, 1Q12, and the TTM ending 3/31/13 and 3/3/12 are summarized in Table 1:
Operating income, net income and EBITDA increased by 8-9% in the TTM ended 3/31/13 vs. the prior year results. Net income in 1Q13 was up 20% vs. 1Q12, but that is primarily due to hedging activity (1Q12 was negatively impacted by $16.3 million of losses, while 1Q13 benefited by $4.9 million from hedge gains). Absent this activity, net income between periods was comparable.
In 1Q13, MMP completed a reorganization of its reporting segments undertaken, in part, to reflect the increasing importance of crude oil activities to MMP's business. The newly defined reporting segments are:
- Refined products: this segment includes an 8,800-mile refined products pipeline system with 49 terminals, as well as 27independent terminals not connected to MMP's pipeline system, and its 1,100-mile ammonia pipeline system;
- Crude oil: this segment is comprised of ~800 miles of crude oil pipelines and storage facilities with an aggregate storage capacity of approximately 15 million barrels; and
- Marine storage: this segment consists of marine terminals located along coastal waterways with an aggregate storage capacity of approximately 26 million barrels.
Segment operating margins and income are shown in Table 2 below:
The previously mentioned hedging activities account for ~61% of the operating margin increase in the Refined Products segment in 1Q13 over 1Q12. The balance of the increase is principally due to higher volumes shipped and higher tariff rates. The bulk of the operating margins seen in Table 2 are generated by fee-based transportation and terminals services, with commodity-related activities contributing ~20% MMP's operating margin in 1Q13 and ~19% in the TTM ending 3/31/13 (vs. ~15% and 20% in the prior year 3 and 12 months periods, respectively).
MMP's definition of DCF and a comparison to definitions used by other MLPs are described in one of my prior articles. Using that definition, DCF in the TTM ending 3/31/13 was $538 million ($2.37 per unit), up from $469 million ($2.07 per unit) in the prior year period. As always, I first attempt to assess how these figures compare with what I call sustainable DCF for these periods and whether distributions were funded by additional debt or issuing additional units. Given quarterly fluctuations in revenues, working capital needs and other items, TTM numbers tend to be more meaningful than the quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows; however, I look at both.
The generic reasons why DCF as reported by the MLP may differ from sustainable DCF are reviewed in an article titled Estimating Sustainable DCF - Why and How. Applying the method described there to MMP generates the comparison outlined in Table 3 below:
Table 3: Figures in $ Millions
The differences between reported and sustainable DCF in the periods under review are not material. Based on results to date and the strong coverage ratios shown in Table 4 below, it appears that management will hit its $580 million DCF target in 2013. The 10% distribution growth targets for both 2013 and 2014 also appear achievable.
The simplified cash flow statement in Table 5 below gives a clear picture of how distributions have been funded in the periods under review. The table nets certain items (e.g., debt incurred vs. repaid) and separates cash generation from cash consumption.
Simplified Sources and Uses of Funds
Table 5: Figures in $ Millions
The numbers indicate solid, sustainable, performance. Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-partners exceeded distributions by $234 million in the TTM ended 3/31/13 and by $89 million in the prior year period. MMP is not using cash raised from issuance of debt and equity to fund distributions. The excess enables MMP to reduce reliance on the issuance of additional partnership units or debt to fund expansion projects. The $221 million of cash balances at 3/31/13, although down from $328 million at year-end, still represents an extraordinarily high level relative to past periods. Given the importance of certain expansion projects discussed in a prior article, management believes it prudent "to keep a bit more cushion to allow these large-scale projects more than adequate time to come online safely and reliably".
Of these projects, Longhorn (the conversion of a large portion of the partnership's Houston-to-El Paso pipeline to crude oil service) is of particular note. At $375 million, this is the largest organic growth project ever undertaken by MMP. The reversed pipeline system will transport crude oil from Crane, Texas, to refiners or third-party pipelines in Houston and Texas City, Texas. Deliveries of crude oil began in mid-April 2013 and are expected to average ~90,000 barrels per day through the end of 2Q13. By 3Q13 deliveries should increase up to Longhorn's full capacity of 225,000 barrels per day. The reversed pipeline is expected to have a materially favorable impact on MMP's results of operations.
MMP spent $199 million and $365 million on acquisitions and growth projects during 2011 and 2012, respectively. It currently expects to spend ~$900 million in 2013 on projects now underway, with additional spending of approximately $320 million in 2014 to complete these projects. The $200 million increase in projected 2013 spending on acquisitions and growth projects (vs. what was expected as of 4Q12) reflects the agreement (announced in February 2013) to acquire approximately 800 miles of refined petroleum products pipeline from Plains All American Pipeline, L.P. for $190 million.
MMP's current yield is at the lowest end of the MLP universe. A comparison to some of the MLPs I follow is provided in Table 6 below:
As of 6/7/13:
Magellan Midstream Partners
Plains All American Pipeline (NYSE:PAA)
Enterprise Products Partners (NYSE:EPD)
El Paso Pipeline Partners (NYSE:EPB)
Targa Resources Partners (NYSE:NGLS)
Kinder Morgan Energy Partners (NYSE:KMP)
Buckeye Partners (NYSE:BPL)
Williams Partners (NYSE:WPZ)
Regency Energy Partners (NYSE:RGP)
Energy Transfer Partners (NYSE:ETP)
Boardwalk Pipeline Partners (NYSE:BWP)
Suburban Propane Partners (NYSE:SPH)
In over two years (since 3Q 2010), MMP has not issued additional partnership units (excluding units issued in connection with compensation arrangements), a significant accomplishment and rare achievement in the MLP universe. This is all the more so given that MMP has done this while keeping its leverage low (3x EBITDA on a TTM basis). Also, MMP's net income per unit exceeded distributions per unit in the TTM ended 3/31/13 ($2.01 vs. $1.96 per unit). That too is unusual for an MLP. Based on 1Q13 results, management increased its 2013 DCF target by $10 million to $580 million and noted there was a potential upside to the 10% distribution growth per unit projected for 2013.
Given these factors, its performance track record, a management team that is disciplined and unwilling to pay the premiums that other MLPs have been paying for acquisitions, an impressive portfolio of growth projects, advantageous structure (no general partner incentive distributions), ability to generate significant excess cash from operations, and proven ability to minimize limited partner dilution, MMP's premium price may be justified.