Magellan Midstream Partners: The Best MLP In America Is Trading At A Discount

Mar.12.14 | About: Magellan Midstream (MMP)

Summary

Magellan Midstream Partners operates refined petroleum product and oil pipelines as well as marine storage terminals.

Management is the best in the business at organic growth and is very disciplined at not over paying for acquisitions.

Industry leading efficiency with net margins of 31%, almost 8x the industry average.

Magellan bought out its General Partner so 100% of distributions flow to limited partners which means higher distribution growth. Distribution growth has been 12% CAGR since 2001.

Management raised the distribution 16% in 2013 and is guiding for a 20% increase in 2014 and 15% in 2015. Investors can expect 18.2% CAGR returns through 2018.

While researching high yield stocks for my experimental real world portfolio I've started researching Midstream MLPs. During my research I came across one that took my breath away. In terms of the quality of the management, the consistent distribution growth and total returns over the years this MLP deserves to be hailed as the king of all MLPs.

Partnership Overview:

Magellan Midstream Partners (NYSE:MMP) is a pipeline partnership that operates in 3 segments:

  • Refined Products: 9,600 miles of Diesel and Gasoline pipelines, 53 terminals and a combined 41 million barrels of storage capacity
  • Oil pipelines: 800 miles of pipes with 15 million barrels of storage capacity. Includes one of the largest storage facilities in Cushing, Oklahoma, home terminal for West Texas Intermediate oil.
  • Marine Storage Terminals: 26 million barrels of storage capacity in five terminals in New Haven, Connecticut, Wilmington, Delaware, Marrero, Louisiana, Galena Park, Texas, and Corpus Christi, Texas. 90% of storage capacity is currently leased through long-term contracts.

According to the most recent investor presentation, 85% of Magellan's revenue is fee based guaranteed through long-term contracts. The remaining 15% of revenues is derived from different blends of gasoline. This high proportion of contract based fees means very predictable cash flows and allows the partnership to pay a medium sized, rapidly growing distribution.

From 2001-2012 Magellan's distribution rose at a compound annual growth rate of 20.8%. In 2013, it grew 16% with management guiding for 20% growth in 2014 and 15% in 2015. This would represent an 18.81% CAGR over 14 years resulting in a 1018% increase in the distribution. It was also made possible by Magellan buying out its General Partner in 2009. This freed up 100% of DCF to go to limited partners has greatly aided distribution growth. Not only does a lack of a GP aid in distribution growth but Magellan Midstream made the purchase on the cheap at just 8x EBITDA. This is a bargain compared to the 26x rival Buckeye Partners (NYSE:BPL) paid for its GP.

MMP Dividend Chart

This astounding distribution growth has been made possible by the best management in the Midstream MLP industry. Proof of this can be seen in the incredible margins of the partnership, along with its industry smashing ROA and ROE. The data below is from Morningstar.com.

Company

Yield

3 year revenue growth rate

3 year EPS growth rate

ROE

ROA

Operating Margins

Net Margins

Debt/Equity

MMP

3.38

6.8

23.1

12.6

36.8

37.2

30.7

1.5

KMP

7.23

15.8

35.6

8.8

23.3

25.8

26.2

1.2

PAA

4.6

17.7

39.2

4.9

13.5

4.1

2.3

0.9

EEP

7.88

-2.7

na

-0.9

-2.4

6.2

-1.7

0.8

EPD

4.17

12.3

100.8

6.8

18.3

7.3

5.4

1.1

ETP

6.68

99.4

-9.6

-0.2

-1

3.3

-0.2

1.4

BWP

3.07

-2.6

4.3

3.2

6.5

34.4

21

0.9

Ind Avg

25.4

27.4

2.4

8.8

8.2

3.4

1.5

Click to enlarge

As seen from the above table Magellan's operating metrics are:

ROA: 5.25x industry average

ROE: 4.2x industry average

Operating Margins: 4.55x industry average

Net Margins: 9x industry average

While MLPs are known for growing through acquisitions, Magellan's management is famous for organic acquisitive and being very disciplined with acquisitions. Where other MLPs may overpay management is firm in its dedication that each acquisition is immediately accretive to EBITDA and DCF.

Currently, Magellan has $1.1 billion in expansion investment underway with an additional $200 million in acquisitions in 2013.

Those acquisitions included:

- July 1 acquisition of 250 miles of New Mexico pipeline for $57 million.

- November 15 acquisition of the Rocky Mountain pipeline system consisting of 550 miles of pipeline and 4 storage terminals with 1.7 million barrels capacity. This cost $135 million.

According to the 4th quarter conference call, these acquisitions are going so well management is in discussion with regulators and counter parties about expanding capacity on both systems.

The combined efforts of management at disciplined and efficient growth with an incredible dedication to a consistently fast growing dividend has resulted in stunning unitholder returns.

MMP Total Return Price Chart

When dividend reinvestment is included Magellan Midstream returned a total of 28.1% CAGR over the last 13 years. Compare this to 4.68% for the general market and you can see that Magellan Midstream did 6x better than the market.

Valuation and Future Performance:

Past performance is not what current investors care about. They want to know what is Magellan Midstream worth today and what kind of returns can they expect moving forward.

When valuing a high yield MLP a good rule of thumb is to add the yield (present income) and the projected CAGR of the dividend (capital gains). Then, multiply the sum by the expected average yield (distribution reinvestment).

Normally I would use the five-year distribution CAGR to model forward growth, however, in this case management has issued guidance. In 2014, they are projecting a 20% increase in distribution with 15% in 2015. I assume a 12% in 2016-2017 which is Magellan's long-term historic norm.

This means that over the next five-years I am modeling a 94% increase in the distribution. This amounts to 14.2% CAGR. Add this to the current yield and assume a 3.4% continued yield (to account for strong investor demand for the growing distribution) and my model assumes 18.16% CAGR total return. How does this compare to other Midstream MLPs?

Company

Yield

Dividend CAGR (7 year)

Dividend CAGR (5 year)

Dividend Growth 1 year

Avg 5 yr yield

Predicted 5 year Total Return CAGR

3.38

10.96

10.51

16

1.049

18.16

(NYSE:KMP)

7.23

7.68

5.31

3.03

1.063

13.33

(NYSE:PAA)

4.6

8.22

6.33

4.68

1.056

11.54

(NYSE:EEP)

7.88

2.33

1.89

0

1.071

10.46

(NYSE:EPD)

4.17

6.69

5.24

2.94

1.054

9.92

(NYSE:ETP)

6.68

4.63

0.58

2.94

1.074

7.78

(NYSE:BWP)

3.07

-19.6

-17.41

-81.22

1.076

3.16

Click to enlarge

As seen in the above table, Magellan Midstream is expected to continue leading its peers in total returns over the next 5 years and by a wide margin.

To determine a fair value for the units I use the projected 5 year total return to project the price in 2018. 18.16% growth over 5 years results in 133% growth. To discount this I compare this growth to the market's historical 1871-2013 CAGR of 9%. Including dividend reinvestment this becomes 11.1% CAGR over a period of 142 years.

This means that if an investor parks his/her funds in a cheap index fund and reinvests the dividends over the very long-term they are likely to earn 11.1% CAGR. Investing in individual securities is only logical if one can outperform the market. Thus 11.1% is the target to beat by which all potential investments should be judged.

The fair value is the price at which a stock will return one's hurdle rate. The fair price I calculate is the price at which investors can expect to match the market's long-term 11.1% return.

In five years an 11.1% return equals a 69.2% return. So to find the fair value I multiply Magellan's current price by 133% to yield a projected five-year price of $158.03. Discounting by 69.2% I get:

Fair Value: $93.4

Discount to Fair Value: 26.5%

Rating: Strong Buy

Conclusion:

With the recent disaster at Boardwalk Pipeline Partners the importance of industry best management, asset diversification and distribution growth is paramount to successful MLP investing. I strongly feel that Magellan Midstream Partners represents the gold standard of Midstream MLPs and should be under strong considering by all income investors. A discounted distribution analysis indicates that Magellan Midstream is likely to massively outperform both its peers and the market in general. Its deep discount to fair value makes it a strong buy at the current price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.