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 DCF. The task is not easy because the definitions of "Adjusted EBITDA" and Distributable Cash Flow ("DCF"), 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. In an article titled "Distributable Cash Flow" I present MMP's definition and also provide definitions used by other MLPs.
MMP is engaged in the transportation, storage and distribution of refined petroleum products and crude oil. In 1Q13, MMP completed a reorganization of its reporting segments undertaken, in part, to reflect the increasing importance of crude oil activities to its business. It now has 3 operating segments:
- Refined products: this segment includes an 8,800-mile refined products pipeline system with 49 terminals, as well as 27 independent 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.
Revenues, operating margin, operating income, net income and earnings before interest, depreciation & amortization and income tax expenses (EBITDA) reported by MMP for 3Q13, 3Q12, and the TTM ending 9/30/13 and 9/30/12 are summarized in Table 1 below. Given the seasonality of the businesses of some MLPs and given quarterly fluctuations in working capital needs and other items, a review of TTM numbers tends to be more meaningful than quarterly numbers for the purpose of analyzing changes in reported and sustainable distributable cash flows. However, I present both:
Table 1: Figures in $ Millions
Operating margin is the key metric used by management to evaluate performance of its business segments. Growth in operating margins has driven improvements in operating income (operating margin differs from operating income in that it excludes expense items, such as depreciation and amortization and general and administrative expenses), as well as in net income, EBITDA and DCF.
Of course, there are additional factors at work. For example, when MMP physically sells products that it has economically hedged, and when such hedges are designated as hedges for accounting purposes, MMP includes in its calculations of operating margin the full amount of the change in fair value of the associated derivative agreement. In 3Q13 a gain in fair value accounted for ~$32 million of the $84 million improvement in operating margins vs. the prior year period. The very favorable comparison of operating margins, Adjusted EBITDA and DCF for the 3 and 12-month period ending 9/30/13 over the corresponding prior year periods is also due to the fair value losses incurred in the 3 and 12-month period ending 9/30/12.
Growth in operating margins was principally driven by the Refined Products and Crude Oil segments, as shown in Table 2 below:
Table 2: Figures in $ Millions
Excluding the ~$32 million gain in fair value referred to above, Refined Products operating margins increased ~$19 million vs. the prior year period. In 3Q13 and the TTM ended 9/30/13 the Refined Products' operating margin benefited from higher volumes, higher rates and the New Mexico pipeline acquired on July 1, 2013, from Plains All American Pipeline, L.P. (NYSE:PAA) for $57 million (and funded with cash on hand). Crude Oil operating margins in these periods benefited from the placing into service of the Longhorn pipeline and commencement of crude oil deliveries in mid-April 2013. In addition, Longhorn volumes ship at a much higher rate compared to MMP's rate at the Houston-area distribution system ($2.35 per barrel vs. $0.34 per barrel in 3Q13). Marine Storage's operating margins benefited from an ~$8 million non-recurring expense reduction resulting from a reversal of a 2012 accrual related to potential air emission fees at the Galena Park, Texas facility.
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% of MMP's operating margin in the TTM ending 9/30/13 (vs. ~14% in the prior year period).
MMP's reported DCF for the TTM ended 9/30/13 was $613 million ($2.70 per unit), up from $492 million ($2.17 per unit) in the prior year period. However, reported DCF may differ from sustainable DCF for a variety of reasons. These are reviewed in an article titled "Estimating sustainable DCF-why and how". An analysis specific to MMP is presented in Table 3 below:
Table 3: Figures in $ Millions
Table 3 indicates the differences between reported and sustainable DCF in the periods under review are not material.
Based on results to date, management slightly increased its 2013 DCF guidance (by $10 million to $640 million and by $0.05 to $2.82 per unit) from the levels provided after MMP reported its 2Q13 results. MMP's strong coverage ratios are shown in Table 4:
Table 5 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded
Simplified Sources and Uses of Funds
Table 5: Figures in $ Millions
Net cash from operations, less maintenance capital expenditures, less cash related to net income attributable to non-controlling interests exceeded distributions by $223 million in the TTM ended 9/30/13 and by $101 million in the prior year period. Clearly MMP is not using cash raised from issuance of debt and equity to fund distributions. On the contrary, the excess cash generated constitutes a significant source of capital for MMP and enables it to reduce reliance on the issuance of additional partnership units that dilute existing holders, or issuance of debt to fund expansion projects.
Of these expansion 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, as expected, averaged ~100,000 barrels per day in 3Q13 (generating ~$26 million of incremental revenues in that quarter). Management had expected that by 3Q13 deliveries should increase up to Longhorn's full capacity of 225,000 barrels per day. The pipeline has been capable of operating at full capacity since mid-October and is now expected to average ~190,000 barrels per day in 4Q13. Overall, the entire capacity is 90% subscribed (10% of capacity is set aside for spot shippers). MMP plans to expand the capacity of the Longhorn pipeline by 50,000 barrels per day, all fully subscribed. Subject to regulatory approval, the operating capacity of the Longhorn pipeline is expected to reach 275,000 barrels per day by mid-2014.
Another major project is the BridgeTex Pipeline Company, LLC ("BridgeTex"), a joint venture formed in November 2012 by MMP and affiliates of Occidental Petroleum Corporation for the purpose of constructing and operating a 400-mile pipeline capable of transporting 300,000 barrels per day of Permian Basin crude oil from Colorado City, Texas for delivery to MMP's East Houston, Texas terminal; a 50-mile pipeline between East Houston and Texas City, Texas; and approximately 2.6 million barrels of storage. Completion is expected in mid-2014 and MMP expects to spend a total of ~$600 million for its 50% stake in BridgeTex. Contracts already at hand are sufficient to generate an 8x EBITDA multiple on this investment, with a significant upside.
Through 9/30/13 MMP spent ~$415 million on growth projects (of which ~$181 million was invested in joint ventures, accounted for as an investment in non-controlled entities). In addition, it spent ~$80 million on acquisitions. It currently expects to spend ~$925 million in 2013 on projects now underway, including ~$192 million for the pipelines purchased from PAA (the New Mexico pipeline and the to-be-purchased Rocky Mountain pipeline). An additional $400 million to complete current projects will be spent in 2014.
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 11/04/13:
Magellan Midstream Partners
Enterprise Products Partners (NYSE:EPD)
Plains All American Pipeline
Targa Resources Partners (NYSE:NGLS)
Buckeye Partners (NYSE:BPL)
El Paso Pipeline Partners (NYSE:EPB)
Kinder Morgan Energy Partners (NYSE:KMP)
Energy Transfer Partners (NYSE:ETP)
Williams Partners (NYSE:WPZ)
Boardwalk Pipeline Partners (NYSE:BWP)
Regency Energy Partners (NYSE:RGP)
Suburban Propane Partners (NYSE:SPH)
In over three 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 much lower than most MLPs (currently 3.12x EBITDA on a TTM basis). Another impressive performance metric is MMP's net income per unit. It exceeded distributions per unit in the TTM ended 9/30/13 ($2.41 vs. $2.10 per unit. That too is unusual for an MLP.
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. 4Q13 performance is expected to be significantly better than 3Q13, partly for seasonal reasons (limited butane blending takes place in the third quarter vs. significant butane blending that takes place in the fourth quarter; blending margins on butane are strong). The other factor is the 4Q13 Longhorn ramp up previously discussed and, with far lesser impact, the Double Eagle joint venture ramp up.