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Summary

  • Very strong 1Q14 results; high DCF coverage ratios; no material differences between reported and sustainable DCF.
  • Growth in DCF per unit far exceeding growth in distributions.
  • Flip side of extraordinary results - greater portion of EBITDA generated by activities with commodity price exposure.
  • Favorable structure: no IDRs, low leverage.
  • Projections of 20% increase in distributions in 2014 and 15% in 2015 may be conservative; Premium price vs. other MLPs justified.

Magellan Midstream Partners L.P. (NYSE:MMP) recently reported its results of operations for 1Q14. This article analyses some of the key facts and trends revealed by this and prior MMP reports, evaluates the sustainability of MMP's Distributable Cash Flow ("DCF") and assesses whether MMP is financing its distributions via issuance of new units or debt.

MMP is engaged in the transportation, storage and distribution of refined petroleum products and crude oil. Its 3 operating segments are:

  1. Refined products: This segment primarily transports gasoline and diesel fuels, and includes an 9,500-mile refined products pipeline system with 54 terminals, 41 million barrels of storage, as well as 27 independent terminals not connected to MMP's pipeline system, and its 1,100-mile ammonia pipeline system;
  2. Crude oil: This segment is comprised of ~1,100 miles of crude oil pipelines and storage facilities with an aggregate storage capacity of approximately 18 million barrels; and
  3. Marine storage: This segment consists of 5 marine terminals located along coastal waterways with an aggregate storage capacity of approximately 27 million barrels.

Operating margin by segment for recent quarters and the trailing twelve months ("TTM") ended 3/31/14 and 3/31/13 is presented in Table 1 below. Operating margin is a key metric used by management to evaluate performance of its business segments. Following very strong results in 4Q13, MMP reported outstanding results for 1Q14:

(click to enlarge)Table 1: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings

The Refined Products segment accounts for the bulk of the increases in 1Q14 over 1Q13. This segment benefited from strong demand for gasoline and distillates, resulting in ~10% higher volumes. Average tariff increased $0.22 per barrel from approximately $1.14 to $1.36, partly as a result of a 4.6% tariff increase in mid-2013, but mostly due to longer haul movements. Significant butane blending (on which margins are strong) typically boosts fourth-quarter performance. Performance in 1Q14 also benefited from additional blended product carried over from 4Q13 blending activities and from more blending opportunities, in part due to higher gasoline demand. The butane blending margins seen in 1Q14 were exceptional and management is not incorporating these higher margins into its forecasts.

Operating margins generated by the Crude Oil segment also increased significantly in 1Q14 over 1Q13. This is largely due to the commencement of Longhorn operations in April 2013. Longhorn (the $375 million conversion of a large portion of the partnership's Houston-to-El Paso pipeline to crude oil service) is an expansion project of particular note. The reversed pipeline system transports 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 averaged 185,000 barrels per day ("bpd") in 4Q13 and ~200,000 bpd in 1Q14. MMP received regulatory approval to increase the capacity of the pipeline to 275,000 bpd, and expects to average approximately 240,000 bpd during the second quarter of 2014 and 250,000 bpd during the second half of 2014

Approximately 28% of the $348 million total operating margins in Table 3 was generated by commodity-related activities (mostly butane blending sales less costs of sales). The balance was generated by fee-based transportation and terminal services. Commodity-related activities are a more volatile source of operating margin and account for a significantly higher portion of the total in 1Q14. They accounted for ~20% of total operating margin in both 1Q13 and the TTM ended 3/31/14.

Higher operating margins drove 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). They also drove increases in earnings before interest, depreciation & amortization and income taxes (EBITDA), and in Adjusted EBITDA, as shown in Table 2 below. Adjusted EBITDA is another key metric used by management to evaluate its financial results. The adjustments include adding back equity based compensation, impairment charges and derivative gains or losses on commodity transactions.

(click to enlarge) Table 2: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.

MMP's definition of DCF is presented in an article titled "Distributable Cash Flow". The article also provides definitions used by other master limited partnerships ("MLPs"). Based on this definition, DCF reported by MMP for the TTM ended 3/31/14 was $799 million ($3.52 per unit), up from $538 million ($2.37 per unit) in the corresponding prior year period. Growth in DCF per unit has far exceeded growth in distributions in the latest quarter and TTM periods, as shown in Table 3 below:

(click to enlarge)

Table 3: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.

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". Applying the method described there to MMP's results generates the following comparison between reported and sustainable DCF:

(click to enlarge)

Table 4: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Table 4 indicates the differences between reported and sustainable DCF in the periods under review are not material.

MMP's strong coverage ratios are shown in Table 5:

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Table 5: Figures in $ Millions, except ratios. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Table 6 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

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Table 6: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.

Net cash from operations, less maintenance capital expenditures, exceeded distributions by $123 million in 1Q14 and by $305 million in the TTM ended 3/31/14 (vs. $231 million in the prior year TTM period). Clearly, MMP is not using cash raised from issuance of debt 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.

BridgeTex Pipeline Company, LLC ("BridgeTex") is one of MMP's major expansion projects. It is 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 by June 30, 2014 and commercial operations should commence by the middle of 3Q14. MMP expects to spend a total of ~$600 million for its 50% stake in BridgeTex (of which $374 million had been spent as of 3/31/14). Contracts already at hand are sufficient to generate an 8x EBITDA multiple on this investment, with a significant upside.

In 2013, MMP spent ~$773 million on growth projects, acquisitions and investments in non-controlled entities. The total amount to be spent on expansion capital in 2014 is currently estimated at $700 million, of which ~$550 million will be spent complete current projects. To complete its current slate of construction projects, MMP will spend an additional $325 million in 2015 and $75 million in 2016.

MMP's current yield is lower and its multiple of enterprise value to EBITDA is higher, relative to other MLPs:

As of 05/13/14:

Price

Current Yield

TTM

EBITDA

EV / TTM EBITDA

2014 EBITDA

Guidance

Buckeye Partners (NYSE:BPL)

$77.14

5.64%

627

19.0

710

Boardwalk Pipeline Partners (NYSE:BWP)

$15.96

2.51%

689

10.6

650

El Paso Pipeline Partners (NYSE:EPB)

$32.98

7.88%

1,115

10.1

1,200

Enterprise Products Partners (NYSE:EPD)

$73.03

3.83%

4,787

17.9

-

Energy Transfer Partners (NYSE:ETP)

$56.10

6.56%

2,970

12.1

-

Kinder Morgan Energy (NYSE:KMP)

$74.50

7.30%

5,428

9.9

5,900

Magellan Midstream Partners

$78.42

2.98%

979

21.0

1,011

Targa Resources Partners (NYSE:NGLS)

$61.99

4.82%

661

14.6

750

Plains All American Pipeline (NYSE:PAA)

$56.57

4.35%

2,168

12.4

2,150

Regency Energy Partners (NYSE:RGP)

$27.55

6.90%

477

19.1

-

Suburban Propane Partners (NYSE:SPH)

$45.29

7.73%

307

12.8

-

Williams Partners (NYSE:WPZ)

$52.37

6.82%

2,215

14.4

3,145

Table 7: Enterprise Value ("EV") and TTM EBITDA figures are in $ Millions; EPB, EPD, ETP, KMP and MMP TTM numbers are as of 3/31/14; others as of 12/31/13. Source: company 10-Q, 10-K, 8-K filings and author estimates.

It would be more meaningful to use 2014 EBITDA estimates rather than TTM numbers, but not all MLPs provide guidance for this year. Of those I follow, the ones that I have seen do so are included in the table.

It's not surprising to see MLPs that do not pay their general partner incentive distributions ("IDRs"), such as BPL, EPD and MMP, trade at higher EBITDA multiples. This is because IDRs siphon off a significant portion of cash available for distribution to limited partners (typically 48%).

Management recently raised its 2014 EBITDA guidance by $76 million to $1,011 million and its DCF guidance by $80 million to $810 million, primarily as a result of strong 1Q14 results. Distributions are projected to increase by 20% in 2014 and to be covered 1.35x by DCF. A further increase of 15% is projected for 2015.

MMP's current yield is the lowest of the MLPs I follow and its EV/EBITDA multiple is the highest (although after adjusting for IDRs the gap is not as glaring). On the other hand, MMP has 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, an ability to generate significant excess cash from operations, and a proven performance track record. On top of all that, MMP has been able to minimize limited partner dilution.

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 2.8x 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 3/31/14 and 3/31/13. That too is unusual for an MLP.

Given these factors, I consider MMP to be a high quality, core holding, MLP and would continue to accumulate on weakness.

Disclosure: I am long EPB, EPD, ETP, MMP, PAA. 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.