Is Magellan Midstream Partners A Good Investment?

May.20.14 | About: Magellan Midstream (MMP)

Summary

The growth in the cash distributions and distributable cash flows has been extremely impressive for the partnership.

Fee-based services business model protects the partnership from the volatility in the commodities market.

Growth projects in the Permian will add to the short-medium term growth in revenues as well as cash flows.

Magellan Midstream Partners (NYSE:MMP), a Master limited partnership, is engaged in the transportation, storage and distribution of refined petroleum products. The company has no international business operations and the U.S. business operates in three segments: petroleum pipeline system, petroleum terminals and ammonia pipeline system. The partnership has acquired some assets over the last few months which will allow it to enhance its revenue and cash flows. Magellan was able to increase its revenues at an average annual rate of 17% over the last five years with a 367% increase in its cash distributions since IPO - at the moment, the partnership distributes $2.45 per unit to its unit holders, yielding over 3%. The stock gained 34% in the last year and is up 24% year-to-date.

No Obligations to the General Partner

Magellan is different than many of the well-known MLPs and has a competitive advantage in its structure. Most MLPs have separate general partners that take a sizeable fee for running the partnership known as IDR [incentive distribution rights]. The partnership acquired its general partner in September 2009, which means that there are no incentive distribution rights for the general partner. IDR fees can consume a big chunk of cash flows, which gives Magellan a significant edge over other MLPs. This also means that the partnership can return more cash to the unit holders, instead of sending it to the general partner.

Moreover, the relatively stable business model of Magellan hedges the company from price fluctuations in the customer tariffs. The partnership has a well-diversified customer base, with no customers accounting for more than 10% of the total revenues. Further, fee-based services are expected to generate 85% of operating margin in the current year - having a larger portion coming from the fee-based services will shield the partnership from the volatility in the commodity prices.

Growth in Cash Distributions

For a partnership to maintain healthy growth in its cash distributions, it is vital to have strong growth in distributable cash flows. Magellan reported distributable cash flows of $670 million in the last year, showing an increase of 24% compared to the previous year. The partnership has increased its cash distributions for each of the last 17 quarters with a 367% increase since IPO. The company has also invested heavily in future growth projects that will make certain the future growth in distributable cash flows for its unit holders. Moreover, Magellan has $550 million worth of expansionary projects underway in the current year, along with potential expansion projects of more than $500 million, which are in the initial stages and ensures a strong growth in operations in the near future.

The impressive growth in cash distributions has been due to the solid segmented performance of the partnership. Magellan has mainly three businesses: transportation of refined products and crude oil, and marine storage. However, the refined products represented a major portion of the company's earnings in the last year. The partnership owns the longest common carrier pipeline system for refined products extending approximately 9,500 miles covering 15-states across the U.S. The image shows the revenue mix over the last two years.

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Source: SEC Filings

The increase in transportation and terminals revenue in the last year is mainly due to a 3% increase in transportation volumes and higher tariff rates. The average rate per barrel increased due to the mid-year 2012 and 2013 tariff rate increases of 8.6% and 4.6%, respectively. Further, the increased demand for gasoline and distillates also contributed towards the increased revenue.

Low profit margins in natural gas production forced energy sector companies to shift their focus towards liquids - which proved to be high-margin and less volatile in terms of price over the last few months. The shift in the strategy from the oil and gas companies allowed the midstream companies to reap substantial benefits. The crude transportation revenues of Magellan showed an increase of 93% in the last year, which is mainly due to the Longhorn pipeline. The Longhorn pipeline started its operations in 2013 and has averaged about 125,000 barrels per day since its start.

Positives and Possible Negatives

The aforementioned rise in crude transportation revenues has prompted the management to shift their capital expenditure towards crude infrastructure to take benefit of the expected increase in transportation volumes. The recent Permian Basin pipeline, Longhorn and BridgeTex are expected to be completed in mid-2014, and are expected to add increased pipeline capacity of 1,072 barrels per day in the Permian region, which will be a key growth driver for the partnership in the coming years.

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Source: UBS MLP One-on-One Conference, Utah, Jan 2014

Moreover, the first quarter earnings recognized another strong year start for the partnership with revenue of $346 million, up 66% from the same period last year and increased 17% compared to the last quarter. The refined products segments again recorded the biggest increase quarter-over-quarter due to the strong persistent demand for gasoline and distillates, resulting in approximately 10% higher volumes in the period. Further, the average tariff increased $0.22 per barrel from $1.14 to $1.36 mainly due to the longer-haul movements to meet the increased demand.

Conclusion

Magellan has one of the best cash distribution histories in the sector - the partnership does not have any obligation to the general partner, which leaves more cash for the limited partners and expansion projects. The fee-based business model of the partnership will allow it to continue growth in its revenues as well as cash flows as the volatility will be lower for Magellan. Further, the expansion projects in the Permian and BridgeTex will add to the revenues and cash flows of the partnership over the next few months. Magellan looks well positioned to grow in the short-medium term, and it will be a solid investment for income as well as growth investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.