Magellan Midstream: What's Next After A Stellar Second Quarter

Summary

• Magellan Midstream had an excellent quarter in the 2Q2019.
• Operating profit at its flagship business segment - refined products - grew 24% year over year.
• In spite of an asset divestment, the crude oil segment was still up 3.7% over one year ago.
• Organic growth projects progress as expected, to contribute to 2019-2020 growth.
• I expect cash distribution to be raised in each of the following two quarters, to deliver a 5% annual increase as promised by the management.
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On August 1, 2019, Magellan Midstream Partners, L.P. (NYSE:MMP) reported the 2Q2019 results, beating Wall Street estimates across the board.

Below, I'd like to present a review of these results, hoping to shine some new light on the investment thesis which we presented here, here, here, and here.

Operations

Refined products: The refined product business segment generated a revenue of $489.90 million, up 10.7% over the 2Q2018 and 15.9% sequentially (Fig. 1).

• Transportation and terminals revenue increased by $15.2 million, due to higher average transportation rates following the 2018 mid-year tariff adjustment of 4.4% and to longer haul shipments on the Mid-Continent pipelines, which move at a higher rate.
• The refined product volume on the South Texas portion of the system dropped in the quarter, causing (1) a decrease of about 1% in the overall refined products volumes and (2) the fluctuations in the overall product mix as South Texas saw higher distillate and aviation volumes and lower gasoline volumes, as compared with the 2Q2018. Because volumes on the South Texas portion of the system move at rates much lower than the average tariff rate, so the lower volumes of these shorter-haul movements cause the overall average tariff rate per barrel to increase. Excluding South Texas, refined products demand across the rest of the system was relatively unchanged, in spite of the flooding that occurred in many of its markets during the 2Q2019.

Fig. 1. Quarterly revenue of the refined product business segment by sources. Source: Laurentian Research, based on company 10Q and 10K.

Total segment operating expenses increased by $2.5 million due to higher spending on asset integrity as a result of lumpy maintenance work schedule and less favorable product overages, which reduce operating expenses. However, the segment's operating margin still reached $224.1 million, up 17.1% over the 2Q2018 and up 30.3% sequentially (Fig. 2); measured in percentage, the operating margin was 45.7%, at approximately the average level for the six quarters since 2018.

Fig. 2. The quarterly revenue, operating margin, and operating profit for the refined products segment, shown with operating expenses. Source: Laurentian Research, based on company 10Q and 10K.

The segment's operating profit reached $158.33 million, up 24.0% over the 2Q2018 and up 45.7% sequentially (Fig. 2).

Crude oil: The crude oil segment pulled in a revenue of $164.51 million, up 6.1% from the 2Q2018 and 4.9% from the previous quarter (Fig. 3). It is worth emphasizing that the crude oil segment attained such performance in spite of the partial divestment of the BridgeTex Pipeline.

Fig. 3. Quarterly revenue of the crude oil business segment by sources. Source: Laurentian Research, based on company 10Q and 10K.

• The average crude oil transportation tariff actually decreased from the 2Q2018 to 2Q2019, as a result of (1) significantly high volume on the Houston distribution system moving at a much lower rate and (2) lower average committed rates on the Longhorn pipeline, effective in the 4Q2018.
• Transportation and terminals revenue increased by 12.8% year over year and 5.6% sequentially. Major positive factors include (1) fees earned from new storage and dock services and leased capacity from the Seabrook Logistics, (2) higher transportation volumes at Seabrook export facility, which started up in August 2018, (3) volumes on Longhorn actually increased to 275,000 bo/d in the quarter from a little over 270,000 bo/d in the 2Q2018, with the pipeline running essentially at or near the capacity for the entire quarter, and (4) increased contribution from the Saddlehorn Pipeline JV due to recent incentive tariff arrangements that attract incremental volume and increased volume in a step-up in contractually committed volumes since September 2018, with the Saddlehorn throughput increased from 65,000 bo/d to 145,000 bo/d. However, the positive impact of these factors was mostly offset by a sharp decrease (from 195,000 bo/d to 127,500 bo/d) in contribution from the BridgeTex Pipeline JV, in which Magellan's interest dropped from 50% to 30% in October 2018 as a result of partial divestment.

Operating expenses increased by $6.0 million due to (1) fees paid to Seabrook for leased storage and dock services and (2) higher maintenance costs for the condensate splitter at Corpus Christi during the 2Q2019. Non-cash derivative agreement adjustments caused an additional $6.1 million in operating expenses.

Fig. 4. The quarterly revenue, operating margin, and operating profit for the crude oil segment. Source: Laurentian Research, based on company 10Q and 10K.

The operating margin for the crude oil segment was $160.3 million, increasing by $8.3 million over the 2Q2018 to a quarterly record. Operating profit for the segment increased to $130.4 million, up 3.7% year over year and 16.1% sequentially (Fig. 4).

Marine storage: Marine storage revenue increased by 2.2% over the 2Q2018 but decreased by 3.7% sequentially, with more tanks available for contract storage than in the 2Q2018. The segment generated $30 million of operating margin in the current quarter, up 6.0% year over year but decreased by 22.1% sequentially. The first phase of the Pasadena JV terminal continues to ramp up.

Profits

Net income: On a segment-consolidated basis, the operating profit in the 2Q2019 comes to $300.74 million, up 13.0% year over year and up 23.2% sequentially. Thanks to the decrease in net increase expense, net income rose to $253.70 million in the quarter, up 18.3% year over year and up 22.2% sequentially (Fig. 5).

Fig. 5. The quarterly revenue, operating margin, and operating profit for Magellan. Source: Laurentian Research, based on company 10Q and 10K.

Earnings per unit: On a per limited partner unit basis, diluted net income was $1.11 in the 2Q2019 as compared $0.94 in the 2Q2018, up 18.1%. If excluding mark-to-market commodity-related pricing adjustments, the net earnings per unit were actually $1.20 for the 2Q2019, beating the $1.13 guidance provided by management in early May 2019.

Distributable cash flow, the amount of cash generated during the 2Q2019 that is available to pay distributions, was $314.8 million, compared to $266.6 million for the 2Q2018, up 18% year over year and, before adjustments on asset disposition, down 1.0% sequentially (Fig. 6).

Fig. 6. The quarterly net income, adjusted EBITDA, and distributable cash flow of Magellan. Source: Laurentian Research, based on company 10Q and 10K.

Magellan declared $1.0125 per unit cash distribution for the 2Q2019, an 0.75% increase from the prior quarter.

Outlook

Balance sheet strength: As of June 30, 2019, total long-term debt outstanding was $4.4 billion. The leverage ratio Net Debt/EBITDA was 2.3X at the end of the 2Q2019, well within the 4x leverage limit without needing to issue equity (see here).

Given that low leverage ratio, Magellan expects to be able to fund all of its current portfolio of growth projects with retained excess cash flow and access to the credit facility.

Expansion capital projects: Magellan has a number of major construction projects, completed, near completion or in progress:

• The expansion of the Galena Park, Texas marine terminal is now operational, with 5 docks for a combined capacity of 750,000 bo/d. The completion of the project was slightly delayed due to ship channel disruptions.
• The East Houston-to-Hearne refined products pipeline in Texas is in the final stages of completion and testing, aiming to begin operations at end-August 2019 as originally scheduled.
• Phase 2 of the Pasadena, Texas JV marine terminal is nearing completion, with an additional 4 MMbo of storage, supporting dock and pipeline infrastructure still expected to be in service by end-2019.
• At Seabrook, construction of additional storage and export capabilities is progressing, with completion expected to be in early 2020.
• The West Texas refined products pipeline expansion and new Midland terminal are now underway, service start-up expected in mid-2020.
• The expansion of the Saddlehorn pipeline by an additional 60,000 bo/d, expandable to 100,000 bo/d, is anticipated to be operational by late 2020.

Based on the progress of these projects, Magellan expects to spend $1.1 billion in 2019 and $150 million in 2020 to bring them to completion. Additional organic growth projects are being evaluated, including the proposed Voyager crude oil pipeline.

Guidance for 2019 - Encouraged by the basis differential between WTI-Midland and Houston and the depressed butane prices, the management is increasing its annual distributable cash flow guidance by $40 million to $1.22 billion for 2019, which will give 1.3X the amount needed to pay projected cash distributions for 2019. It remains to be committed to its stated goal of increasing annual cash distributions by 5% for 2019 and targeting distribution coverage of at least 1.2 times for the foreseeable future.

Given the actual results so far this year, net income per unit is estimated to be $4.20 for 2019, with the 3Q2019 guidance of $1.03, excluding future mark-to-market adjustments on commodity-related activities.

Investor takeaways

Magellan clearly had another stellar quarter in the 2Q2019. The operating profit at its flagship business segment - refined products - grew 24% year over year, while that at the crude oil segment was up 3.7% over one year ago, in spite of the partial divestment of the BridgeTex Pipeline. On the partnership level, net income expanded by 18.3% and distributable cash flow by 18.0%. Organic growth projects progress as expected. The management has done a superb job in steering the ship.

In the quarter, the partnership increased the quarterly cash distribution by 0.75%. I expect it to increase cash distribution by another 0.75% in each of the next two quarters, to bring the 2019 distribution to $4.0635 per unit, thus fulfilling the stated goal of raising cash distribution by 5% per year.

The current unit price at $66.64, as compared with our estimated intrinsic value, offers a margin of safety of 18%, which is sufficient for a wide-moat company such as Magellan (Fig. 7).

Fig. 7. Stock chart of Magellan, cash distribution back-adjusted. Source.

Disclosure: I am/we are long 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.