Breaking Down the Alerian MLP Index: Magellan Midstream Partners

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 |  About: Magellan Midstream Partners, L.P. (MMP)
by: Mike Maher

Continuing our examination of the largest holdings of the Alerian MLP Index (a composite of the 50 most prominent energy Master Limited Partnerships) let's take a look at Magellan Midstream Partners (NYSE:MMP), which has a 4.5% weighting in the index.

Magellan owns and operates pipelines that are linked to petroleum refining in the US, as well as storage terminals and an Ammonia pipeline and related terminals. The partnership's pipelines connect to more than 40% of US refining capacity as well as having access to refined products imports, and bisect the country from Texas, to the Canadian border. The Petroleum Pipeline System is the largest asset for the partnership, and was responsible for 79% of operating margin in 2010. Petroleum Terminals were responsible for 21% of operating margin, and the Ammonia Pipeline System accounted for less than a percent of 2010 operating margin. About 85% of the partnerships revenue is fee-based, so there is some limited exposure to commodity prices. Based on the most recent distribution of $0.7575, MMP's annual distribution comes to $3.03, for a 5.1% yield. It is also important to note MMP has no GP, so there are no incentive distributions that must be paid.

Distribution growth has been strong for MMP, increasing 189% since the IPO in 2001. After growth stalled in 2009, distributions have increased for the past 4 quarters, ticking up by slightly more than a penny each quarter. Distributable cash flow set a quarterly record in Q4 of 2010, up an incredible 22% to 128.1 million. The partnership is forecasting DCF to increase from a record $399.8 million in 2010 to a record of $410 million in 2011, a 2.5% increase. Management is targeting to grow the distribution 7% in 2011, and based on current spending plans and results from recent acquisitions, thinks it can increase the distribution another 7% in 2012. Should that be achieved, that means at the end of 2012 the distribution will be at an annualized rate of $3.47.

The coverage ratio of MMP was 1.2 times the distribution exiting 2010, the level it was at in 2007 and 2008, before dipping to 1.1 times in 2009. Management is guiding for 2011 the coverage ratio to dip back to 1.1 times the distribution. This should be of no surprise, seeing that DCF is set to increase at less than the 7% projected distribution growth rate. Given the low coverage ratio on 2011 distributions, and management's guidance for 7% growth in 2012, management must be planning to see DCF growth accelerate over the next 24 months.

The partnership spent nearly $500 million of expansion projects and acquisitions in 2010, a respectable amount considering Magellan has a market cap of $6.6 billion. It acquired assets from BP in September 2010 that added 7.8 million barrels of storage capacity in Cushing, Oklahoma, as well as over 100 miles of petroleum pipelines in the greater Houston area. Management reported strong performance for those new assets in the final part of the year, which should only improve as they are fully connected and leveraged into Magellan's footprint. The Longhorn Pipeline, acquired in 2009, was connected to Magellan's E. Houston origin late in 2010, and should continue to ramp up volume into 2012. Magellan also currently has plans to construct 7 mm barrels of new storage capacity, with the possibility of adding to that amount. New storage will start to come online in Cushing by the end of 2011. Add to that a few small tuck in acquisitions, and Magellan's growth prospects look strong.

Magellan Midstream Partners is well positioned going forward. Without a GP, unit holders are not taking an instant haircut from incentive distributions paid out to the GP. A history of maintaining a strong coverage for distributions has allowed management to grow the partnership, both organically and through acquisitions, the benefits of which will be shown as MMP continues to increase its distribution. Should management hit its growth estimates and get the distribution up to $3.47 by the end of 2012, units would have to be approaching $68 a share to keep the yield at 5.1% The partnership's strong footprint serving the refiners in the US makes its assets nearly irreplaceable, and given MMP's relatively small size, there is plenty of room for further expansion.



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