This is the seventh in a series where I provide my example of "What is good due diligence for MLP (energy Master Limited Partnership) investors?" For many of you, this will appear to be hyper due diligence. You can opt to weed out some of the hyper diligence to arrive at the level that feels right to you. Prune prudently. For those who have read multiple articles in this series, it is time for you to be asking what - if any - part of my due diligence process should you omit in yours.
Before I begin with the Magellan specific numbers - let's review some sector data. MMP answers the question "What does good look like?" with most of its attributes. I want to provide more color on that.
For example, you may be asking what is a good DEBT/EBITDA ratio? To some degree, it is all relative. A good ratio is "well below the credit covenants". A more utilitarian answer would parse the 'mature' MLPs something like this: Great - under 4.1x; Good - 4.2x to 4.4x; OK - 4.5x - 4.7x; Trouble - over 4.8x; Big trouble - over 5.0x. But, those numbers are true when EBITDA expectations are stable. A falling EBITDA expectation can turn a good ratio into a troubled ratio. And when a newly constructed asset hits the balance sheet with earnings generation that is well below expectations, the same bad thing can happen.
What is "Interest Coverage" and why is it important? The ratio is EBITDA dividend by interest expense. It is a second way to answer the question of how manageable is the debt load. Good is over 6x. Bad is under 4x.
What is RRR? It is "Required Rate of Return". It is a 'dividend discount model' variable this is - for most brokerages - a part of the calculation of a target price.
To this investor, it is a valuation concept you should pick up via observation over the years. Why do "yield + CAGRs (analyst projections of forward Compound Annual Growth Rates of the distribution)" vary? Because of different levels of risk or 'regular oscillations' in a company's earnings. For REITs (Real Estate Investment Trusts) - the RRR is the portfolio cap rate. Why do MOB (Medical Office Building) heavy health care REITs sell at higher valuations (or lower yield + CAGRs) than REITs owning senior housing? MOBs have lower cap rates.
Why do senior housing REITs sell at higher valuations (or lower yield + CAGRs) than REITs owning skilled nursing facilities? Senior housing properties have lower cap rates.
Why do BDCs (Business Development Companies) with lower 'portfolio weighted average yields' sell at higher valuations (or lower yield + CAGRs) than BDCs with higher portfolio weighted average yield'? Lower yields exist due to lower default risks.
Why do MLPs with higher percentages of fee based income sell at higher valuations (or lower yield + CAGRs) than MLPs with higher commodity sensitive income? There is lower risk of extreme income oscillations.
What can one do to account for the expected variation in the "yield + CAGR" numbers? You set variable "Required Rates of Return" based on the risk level.
A really new investor might be asking if there is any evidence that concepts like CAGRs and RRRs have any influence on MLP valuations. Let's look at that MLP 'sector wide' data (meaning the coverage universe includes large cap, small cap, gathering and processing and refinery logistic MLPs) by parsing the data by the RRR related data point of credit rating:
For MLPs with corporate credit ratings of "BBB+ or BBB" - their average yield is 7.00%; CAGR is 5.65%; Price/DCF is 14.11; Analyst Rating is 2.39; and Accuracy Rating is 1.80.
For MLPs with corporate credit ratings of "BBB-" - their average yield is 7.18%; CAGR is 5.97%; Price/DCF is 11.46; Analyst Rating is 2.27; and Accuracy Rating is 2.17.
For MLPs with corporate credit ratings of "BB+, BB or BB-" - their average yield is 7.74%; CAGR is 5.10%; Price/DCF is 11.41; Analyst Rating is 2.36; and Accuracy Rating is 2.26.
For MLPs with corporate credit ratings of "B, B+ or B-" - their average yield is 10.53%; CAGR is 4.00%; Price/DCF is 8.09; Analyst Rating is 2.45; and Accuracy Rating is 3.38.
The "analyst rating" comes from Yahoo Finance - where the lower the rating, the better the rating. The "accuracy rating" is my "historical DCF projection accuracy rating" - which has been fully explained in prior articles. On average, MLPs with better credit ratings sell at lower yield and higher Price/DCF valuations. There appears to be a high correlation between the accuracy rating and the credit rating. This is evidence that credit ratings are based on more attributes that credit metrics alone. If one closely reads the updates by the rating agencies, then you are already aware of that. I also see a correlation between credit rating and analyst rating.
Let's look the at sector wide data by parsing the data by my CAGR projection:
For MLPs with CAGR projections over 8.5% - their average yield is 5.11%; Price/DCF is 15.13; Analyst Rating is 2.19; and Accuracy Rating is 1.94.
For MLPs with CAGR projections under 8.5% but over 5.9% - their average yield is 5.78%; Price/DCF is 12.40; Analyst Rating is 2.26; and Accuracy Rating is 1.56.
For MLPs with CAGR projections under 6.0% but over 3.5% - their average yield is 7.59%; Price/DCF is 10.45; Analyst Rating is 2.28; and Accuracy Rating is 2.73.
For MLPs with CAGR projections under 3.5% - their average yield is 10.81%; Price/DCF is 9.49; Analyst Rating is 2.62; and Accuracy Rating is 3.14.
On average, MLPs with higher CAGR projections sell at significantly lower yields and significantly high Price/DCF valuations. I also see some correlation between the CAGR projection and the analyst rating.
One last question: What is the difference between an RRR assessment of 10.0 and 12.5? Or put differently, does such an assessment difference matter? The answer - it matters a lot. Let's say you are comparing two MLPs with roughly equal CAGR projections with two different risk assessments of 10.2 and 12.5. By my penning a specific number on my risk assessment, I have effectively said that the lower risk option merits selling at 250 bps lower of a yield. I also generate different constants in my Price-implied CAGR formula (a metric discusses in prior articles) for those different risk levels.
Let's look at the year to date numbers and pry loose their message on MMP:
MLP Midstream 6-17-16
The consensus Distributable Cash Flow or DCF projections were last updated on 5-30-16. The distribution Compound Annual Growth Rate or CAGR projections were updated 5-30-16. Yields are based on the Q2-16 distribution. Under the 'year to date' header, the change in the distribution is the change since Q2-15 - or the change over the last twelve months. The change in the target, EPS and DCF is the percentage change in the consensus 2016 projection that has happened since the beginning of 2016. The Dist/DCF number is the ratio of the Q2-16 distribution to the 2016 DCF projection. The 2016 DCF projection is an adjusted average of eleven DCF projections from the major brokerages covering MLPs. The CAGR is intended to be the percentage change in my CAGR projection since the beginning of the year - but I lack confidence that I have the timing of this stat right. The target prices and EPS projections are from Yahoo Finance.
Large Cap Midstream
|Current||Distrib/||Q2 Dist||Dist/dcf||Dist/dcf||Year-to-Date Percent Change|
|Buckeye Partners, L.P.||(NYSE:BPL)||69.12||1.1875||6.87||89.79||86.84||4.79||8.39||0.24||-2.19||0.38||3.26||0.00|
|Enable Midstream Partners||(NYSE:ENBL)||14.34||0.3180||8.87||102.58||100.16||55.87||62.78||-4.88||6.55||-10.79||1.76||-97.50|
|Enbridge Energy Partners, L.P.||(NYSE:EEP)||21.99||0.5830||10.60||105.52||100.95||-4.68||0.37||-40.34||-28.99||-3.07||2.28||-86.84|
|Enterprise Products Partners L.P.||(NYSE:EPD)||27.72||0.3950||5.70||77.83||74.18||8.37||11.45||-6.85||-5.09||-2.87||5.33||-3.64|
|Energy Transfer Partners, L.P.||(NYSE:ETP)||38.56||1.0550||10.94||107.93||91.94||14.32||20.58||-62.76||-19.96||-18.71||3.94||-66.10|
|Kinder Morgan, Inc||(NYSE:KMI)||18.04||0.1250||2.77||23.26||21.83||20.91||22.59||-6.67||-3.75||-5.70||-73.96||0.00|
|Magellan Midstream Partners LP||(NYSE:MMP)||74.43||0.8025||4.31||80.05||72.46||9.55||11.91||-5.69||-0.48||1.01||11.85||-10.11|
|Oneok Partners, L.P.||(NYSE:OKS)||37.92||0.7900||8.33||100.32||96.93||25.85||31.10||13.20||13.05||3.28||0.00||50.00|
|Plains All American Pipeline, L.P.||(NYSE:PAA)||26.75||0.7000||10.47||137.93||112.45||15.80||21.86||-31.67||-24.07||-24.54||2.19||-96.67|
|Spectra Energy Partners, LP||(NYSE:SEP)||46.27||0.6338||5.48||81.00||74.56||-3.00||-0.34||6.73||1.53||10.99||3.85||7.69|
|Sunoco Logistics Partners L.P.||(NYSE:SXL)||27.22||0.4890||7.19||87.32||72.99||5.91||9.72||-23.26||37.98||-3.03||16.71||-2.11|
|Williams Partners L.P.||(NYSE:WPZ)||32.54||0.8500||10.45||90.67||85.00||16.84||22.94||-48.65||0.00||-2.34||0.00||-33.33|
|Large Cap Average||7.67||90.35||82.52||14.21||18.61||-17.55||-2.12||-4.62|
|The Alerian MLP index ETN AMJ is 6.21% and with dividends is 8.06%.|
|The S&P500 index ETF SPY is 1.30% and with dividends is 1.81%.|
|The Russell 2000 index ETF IWM is 1.28% and with dividend is 1.57%.|
MMP has a year to date "Price plus Distribution" of 11.91% - which is well below average for this MLP sub-sector. The current yield is 4.31% - which is significantly below this grouping's average. MMP has under performed while having smaller than average declines in its EPS projection, a smaller decline in the price target, an increase in its DCF projection, and a moderate fall in its five year forward distribution CAGR projection as a result of company guidance.
MMP is one of seven MLPs in this grouping that does have a 2016 DCF projection that is higher than their current distribution. One of those seven have current yields that are higher than 10% - which is WPZ, a stock facing increased uncertainty due to WMB being in parent or general Partner.
With the WTI rising, 2016 has been a "risk on" year. MMP is built to outperform in risk neutral and risk off years. While MMP is losing to the average large cap midstream stock, it is till beating the Alerian MLP index.
The spreadsheet that follows summarizes key metrics in the income statement and balance sheet since Q1-13:
|MMP Operating Margin|
Magellan Midstream Partners metrics: 57% Refined Products; 34% Crude; 9% Marine Storage. 85% fee based.
|2016 Guidance: EBITDA of $1.166 billion and DCF of $910 million|
|Long Term Debt||3,800,000||3,400,000||3,407,114||3,326,936||3,183,750||2,982,895||3,303,707||2,910,496||2,435,316||2,435,316||2,486,715||2,390,021||2,391,718|
|For MMP, even the credit facility expense is included in the long term debt numbers|
|In March of 2015 MMP issued $250 million of 3.20% notes due 2025 and $250 million of 4.20% notes due 2045|
|In March of 2014 MMP issued $250 million 5.15% notes due 2043|
|In October of 2013 MMP issued $300 million of 5.15% notes due 2043|
Since the beginning of 2014, LTM (last twelve month) EBITDA numbers are up (1,172.935/865.488) 35% while the unit (MLPs call their "shares" units) count has grown 0.3% and interest payments on a growing amount of debt has fallen. If you are reading this series of article and have not read the ones on ETP and PAA - you should pause and do so. That last set of metrics was amazing.
DCF/unit growth and EBITDA growth depends on your start date. DCF is basically flat when compared to the quarters since Q4-14. The DCF is up big over the last three years. Distribution growth has been consistently good.
What can we learn from these numbers?
1. I have verified the DCF/unit (or Distributable Cash Flow per unit) calculations with the DCF numbers from three different brokerage analysts. The DCF calculation is simple - there are no adjustment to the DCF dollars. Adjustments for 'normalization' have not been needed.
2. I have complete in confidence in my DCF calculation because my numbers always match those done by the professional analysts.
3. DCF/unit change since 2013 has been positive. Most MLPs have faced headwinds due to commodity price falls.
Let's move on to some attributes I know due to producing similar spreadsheets for many other MLPs. As you absorb the data from future articles in this series, you will have the data in which to arrive at similar assessments.
4. DCF/unit numbers by quarter are moderately volatile.
5. The 'annual' distribution coverage has been as strong as it gets. Coverage is both a safety and growth attribute.
6. The debt metrics for MMP are the role model of what good is. That produces a very low cost of debt capital.
7. In a low inertia environment, a good forward DCF projection will be close to the LTM (last twelve month) DCF number. For MMP, LTM DCF is (.90 + 1.13 + 1.01 + .98) $4.02/unit. 2016 EBITDA guidance of $1.166 billion is slightly below - but almost equal to - the LTM EBITDA of $1.173 - which tells us with certainty and clarity that earnings will be flat in 2016. The 2016 DCF guidance of $910 million results in a DCF/unit projection of (910,000/227,849) $3.99 - which almost replicates the LTM number.
I have 8 2016 DCF projections from the 12 brokerages I use to create a consensus number. The projections range from $3.95 to $4.14. The average for the projections is $4.01 - and 7 of the 8 projections are within ten cents of the average. The very small spread in the analyst projections comforts me. MMP has the highest grade I give on historical DCF projection accuracy. Once again - readers should compare this text just created on MMP to the text in same section for ETP and PAA. The difference - using popular phraseology - is huge.
Now that I have a very good DCF - let's move on the CAGRs - or a five year forward "Compound Annual Growth Rate" projection of the distribution.
Long term metric trends
The average calculation for growth is for ten years - for 2006 through 2015
The first average is the sum of changes for each individual year over ten year period - with that result divided by 10
The 2nd average is the difference between the current and beginning number, divided by the beginning number - with that result divided by 10
The distributions shown are annualized first quarter distributions
My median 2018 DCF projection for MMP is $4.68 and the median 2019 projection is $5.04. Presuming a 76% payout of the 2019 DCF of $5.04, the distribution would be $3.83 - and that would average (383/314 . . divided by 3 years) 7.32% growth per year. I show the high brokerage projection at 11.5% and the low one at 9.1%. I want conservative CAGRs. My 8% CAGR is pretty conservative. Given the current low yield, the market is putting a valuation (averaging my two PI-CAGRs of 5.99 and 12.69 to get 9.34%) on MMP that is over that projection.
Now that I have arrived at a growth projection with which I can have a fair amount of confidence - it is time to make a numeric risk assessment.
When it comes to historical DCF projection accuracy - MMP is as good as it gets. When it comes to credit ratings - MMP is as good as it gets. When it comes to credit metrics - MMP is as good as it gets. When it comes to distribution coverage - it is temporarily going from great towards average. The relatively low yield tells us a large percentage of the market's valuation of MMP is based on growth. I want to slightly increment the risk of owning MMP due to that attribute. Because of the sum of all attributes, I assess MMP with a 10.3% Required Rate of Return ("RRR" or risk assessment). Low RRRs are in the 10s and mainly go to BBB+ rated companies. Average RRRs for covered distributions are in the 11s and mainly go to BBB rated companies. Uncovered distributions result in RRRs in the 12s and mainly go to BBB- rated companies.
And with that - you should be sufficiently prepped for the ending spreadsheet that compares valuations:
Yield + CAGR Total Return Expectations
|Company||Q2-16||Consensus||Total||Bonds||DCF||My||Total Rtn||Consensus||Price Implied CAGR||Distrib||Price|
|Yield||CAGR||Return||Ratings||Accr||RRRs||- RRR||Ratings||RRR-Yld||P/DCF||/ DCF||/ DCF|
|Large Cap Midstream|
|Buckeye Partners, L.P.||BPL||6.87%||4.40%||11.27%||BBB-||2.50||11.00||0.27||2.1||4.13||3.82%||89.79||13.07|
|Enable Midstream Partners||ENBL||8.87%||0.10%||8.97%||BB+||3.00||12.50||-3.53||2.6||3.63||1.97%||102.58||11.56|
|Enbridge Energy Partners, L.P.||EEP||10.60%||0.50%||11.10%||BBB||2.00||12.00||-0.90||2.9||1.40||-0.09%||105.52||9.95|
|Enterprise Products Partners L.P.||EPD||5.70%||5.30%||11.00%||BBB+||1.30||10.00||1.00||1.7||4.30||3.06%||77.83||13.66|
|Energy Transfer Partners, L.P.||ETP||10.94%||2.00%||12.94%||BBB-||3.00||12.50||0.44||2.2||1.56||0.67%||107.93||9.86|
|Kinder Morgan, Inc||KMI||2.77%||6.00%||8.77%||BBB-||1.30||11.00||-2.23||2.4||8.23||-4.83%||23.26||8.39|
|Magellan Midstream Partners LP||MMP||4.31%||8.00%||12.31%||BBB+||1.00||10.30||2.01||2.1||5.99||12.69%||80.05||18.56|
|Oneok Partners, L.P.||OKS||8.33%||1.50%||9.83%||BBB||3.00||11.50||-1.67||2.9||3.17||1.00%||100.32||12.04|
|Plains All American Pipeline, L.P.||PAA||10.47%||0.10%||10.57%||BBB||3.00||12.50||-1.93||2.7||2.03||6.80%||137.93||13.18|
|Spectra Energy Partners, LP||SEP||5.48%||7.00%||12.48%||BBB||1.00||10.30||2.18||2.2||4.82||5.70%||81.00||14.78|
|Sunoco Logistics Partners L.P.||SXL||7.19%||9.30%||16.49%||BBB||1.10||12.00||4.49||2.1||4.81||3.98%||87.32||12.15|
"Total Return minus RRR" is my the buy, hold or sell number. Positive is buy - the stock is selling below what the valuation assessments suggest. Negative is sell - the stock is selling above what the valuation assessment suggest. Close to zero means the stock is correctly priced. In most sectors there is superior metric transparency compared to MLPs - and I produce TR - RRR numbers that are close to zero. Projected Total Return or "TR" = Yield + CAGR.
What does all of this math mean?
MMP is one of six MLPs where my "Yield + CAGR - RRR" numbers are higher than zero. Six out of six of those MLPs have Yahoo Finance sourced analyst "consensus ratings" that are lower (or better) than average. I may have low balled my MMP CAGR projection at 8% while my formulas are split on whether MMP is currently priced for a lower or higher projection. Based on the numbers, MMP is a buy.
This is a time where MLPs with superior safety attributes have relatively high valuations. One should expect some short to mid term under performance due to those valuations.
Conservative investors should want to invest predominantly in stocks where they have "faith and confidence" in the CAGR projections. That label fits MMP. That attribute should influence any weighting decision you would make on an MMP purchase.
One last comment: In my write-up on EPD, I provided the hyperbole that if you are retired or nearing retirement (my target audience) - and "if EPD, MMP and SEP (the large-cap MLPs with great balance sheets) are not your #1, #2 and #3 MLP holdings - you are probably doing something wrong. Or - if more than 30% of your MLP holdings have current yields over 7% - you are probably doing something wrong."
That comment was reader tested in a poll of comment likes at the end of the article. 82 readers agreed with that comment. 8 disagreed. Thus this site generated 90 reader poll participants out of the 10,313 that read the article. It may be the case that an internet site on investing skews towards a younger audience - thus phrasing the question for retirees assisted in a low response rate. Article like this could be too brain taxing - and reader fatigue contributed to a low response rate. But... I have the perception that my readers would have greater faith and confidence if the reader polls generated a response rate closer to 500. (And I think that most Seeking Alpha content should have polls that 'reader tests' the articles main thesis.) Can you make that higher participation rate happen?
Disclosure: I am/we are long EPD, MMP.
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.