Magellan Midstream Partners: Still Generating 9% Passive Income

Summary

• Magellan Midstream Partners is attractive for its dividend and is also focusing on share buybacks right now.
• The company was growing in double-digits in the past two decades, but growth rates will probably slow down in the years to come.
• Even when assuming only low growth rates, the stock seems to be undervalued.

MikeMareen/iStock via Getty Images

Recently, I published an article about AT&T (T), which is interesting for its high dividend yield. Another company that is interesting due to a similar high dividend yield is Magellan Midstream Partners (NYSE:MMP). The problem remains that I am not allowed to purchase MMP as my broker in Germany doesn’t allow for me to purchase any “limited partnership” due to the higher risks associated with these types of businesses (the potential of losing more money than the original amount). And although I can’t purchase any shares, I still can look at the company to provide an update and discuss if it would have been a good investment.

In the following article, I will look at the last quarterly results, and then I will focus on the bigger picture. We will focus on the dividend, the balance sheet, realistic growth rates, and finally, we will calculate an intrinsic value.

Quarterly Results

When looking at the third quarter results, Magellan Midstream Partners could not only beat expectations for revenue (by $9.7 million) as well as for earnings per share (by $0.09 in the case of GAAP earnings). The company also raised guidance for fiscal 2021: net income per unit is now expected to be $4.43 compared to a consensus of $4.23 and free cash flow is projected to be $1.29 billion for the full-year 2021 (or $384 million after dividend distributions).

In the third quarter of fiscal 2021, Magellan Midstream Partners generated $639.1 million in revenue, and compared to a total revenue of $576.4 million in the same quarter last year, this is an increase of 10.9% year-over-year. Operating profit also increased from $259.7 million in Q3/20 to $277.7 million in Q3/21 – resulting in 6.9% year-over-year growth. And finally, diluted net income per share increased by 14.9% from $0.94 in the same quarter last year to $1.08.

Dividend

In case of Magellan Midstream Partners, the dividend is an important aspect in the decision whether to buy the stock or not and therefore we must pay close attention to the dividend. In October 2021, the company announced it will increase the quarterly dividend from $1.0275 to $1.0375. And while this is only an increase of 1%, it is still a good sign that investors can expect growing dividends in the years to come and Magellan Midstream Partners is continuing its streak of 20 years of increasing dividends and while dividends grew with a CAGR of 4.89% in the last five years, MMP increased the dividend 690% since the IPO in 2001.

(Source: MMP Investor Overview)

The current quarterly dividend is resulting in an annual dividend of $4.15, which is resulting in a dividend yield of 8.73% right now. When looking at the trailing twelve months results ($4.11 in earnings per share), we get a payout ratio above 100%, which can’t be sustainable for any business. However, when using the guidance for fiscal 2021 ($4.43), we get a payout ratio of 93.7%, which is acceptable for a master limited partnership.

(Source: MMP Investor Overview)

Aside from the focus on the dividend, Magellan Midstream Partners is also focusing on share buybacks in the recent past. Between 2011 and 2018, the number of outstanding shares increased slightly from 226 million to 229 million, but in the recent past, MMP reduced the number of outstanding shares to 218.8 million in the third quarter of fiscal 2021. Especially in the last quarter, Magellan Midstream Partners spent a lot of money on share buybacks - $390.7 million for which it repurchased about 8.1 million of its common units.

And together with the increased dividend, MMP also announced additional funds for share repurchases:

The partnership’s board of directors has also approved a $750 million increase in Magellan’s authorized equity repurchase program, to a total of $1.5 billion, and extended the program through 2024.

Considering the high amounts MMP is spending on dividends and share repurchases, we also must take a closer look on the financial health of the business and the balance sheet.

Balance Sheet

As Magellan Midstream Partners is not only paying out a huge part of its generated free cash flow but will also use a lot of cash for share buybacks in the foreseeable future, we must take a closer look at the balance sheet and the financial health of Magellan Midstream Partners. On September 30, 2021, Magellan Midstream Partners had $5,103 million in long-term debt on its balance sheet. Compared to a total partner’s capital of $1,914 million, this leads to a D/E ratio of 2.67, which is a much higher D/E ratio than I like to see. Additionally, we can compare the total debt to operating income Magellan Midstream Partners could generate in the last four quarters ($925 million) and it would take about 5.5 years to repay the outstanding debt, which is a rather long time. With these amounts of debt and metrics, we don’t have to fear bankruptcy – but it is also a balance sheet to which we should pay close attention.

When looking at the asset side, the biggest part of Magellan Midstream Partners’ assets are property, plant, and equipment ($5,932 million) and goodwill is only $50.1 million, which is good. But Magellan Midstream Partners also has only $12.6 million in cash and cash equivalents – a rather low amount that is putting question marks behind liquidity. Similar to the debt levels, I don’t expect troubles right away, but we should pay close attention to the balance sheet.

Growth

By nature, Magellan Midstream Partners is the kind of business we are expecting slow growth rates from as most companies from the energy sector are not really showing high growth rates. We are also expecting stability and consistency from utility companies as the demand for energy (electricity, oil, or gas) is rather stable, and while MMP is delivering on aspects like stability and consistency, it is also growing at much higher rates than we might expect.

Since the IPO, earnings per share grew with a CAGR of 11.34% and we can see that the 10-year EPS CAGR fluctuated above 10% during the last decade. At this point, MMP is presenting itself not as a low-growing utility company, but rather a high-growth company.

(Source: Author’s work)

And while we could make the argument that Magellan Midstream Partners can grow at a high pace, we also must acknowledge that the business was rather stagnating in the last few years. When looking at the 5-year CAGR, we see only 0.17% annual growth and we must consider the possibility of MMP growing at a rather low pace. But as we will see in the following section, MMP does not have to grow at a high pace in order to be fairly valued right now.

(Source: MMP Investor Overview)

And although we have to consider the possibility of lower growth rates in the years to come, we must point out the high historical return on invested capital of more than 16% for Magellan Midstream Partners, which is not best-in-class, but also a rather high RoIC in absolute numbers.

Intrinsic Value Calculation

I already mentioned above that Magellan Midstream Partners does not have to grow at a high pace in order to be fairly valued. And when looking at some simple valuation metrics, we also get glimpses of MMP’s “cheap valuation”. Right now, Magellan Midstream Partners is trading for a price-earnings ratio of 11.27, which is one of the lowest ratios of the last decade and clearly below the 10-year average of 18.23. And when looking at the price-free-cash-flow ratio, Magellan Midstream Partners is trading only for 10.86 times free cash flow, which is clearly below the 10-year average of 29.57.

Data by YCharts

When looking at the P/E as well as P/FCF ratio, Magellan seems to be extremely cheap. Not only is Magellan Midstream Partners trading for one of the lowest valuation multiples in the last 10 years, a valuation multiple in the low-double-digits seems extremely cheap for a business that could grow with a solid pace in the last decade (see section above).

Aside from these simple valuation multiples, we can also calculate an intrinsic value by using a discount cash flow analysis. For such a calculation, we need to make several assumptions. In the last two decades, MMP could grow in the high-single-digits or even low-double-digits, but let’s be very pessimistic and assume only 0% growth for the years to come. As a basis for our calculation, we can take management’s own guidance for fiscal 2021 ($1.29 billion in free cash flow). When using these assumptions as well as 218 million outstanding shares and a 10% discount rate, we get an intrinsic value of $59.17.

And while zero growth for the foreseeable future seems to be too pessimistic, the free cash flow of $1.29 billion might be exceptionally high and not a good basis for our calculation. In the last four quarters, the free cash flow was $957 million and, in fiscal 2020, free cash flow was $668 million – and this was already one of the highest amounts in the last few years. The reason for this high free cash flow can be found in the low capital expenditures in the last few quarters. In the last four quarters, MMP spent only $189 million, which is the lowest amount in the last 10 years. But the average capital expenditures in the last five years were $634 million and we must assume that Magellan Midstream Partners will have similar high capital expenditures again as we are dealing with a capital-intensive business.

However, MMP seems to be undervalued nevertheless – even when taking much lower free cash flow amounts as a basis. When taking the free cash flow of 2020 (which was only $668 million), MMP must grow 4% annually on average in order to be fairly valued right now – and considering past growth rates, this seems realistic and achievable.

Conclusion

In my opinion, MMP is a very good pick for long-term investors that are focused on passive income. Its almost 9% dividend yield seems very attractive – especially in this low-yield environment we are currently in. And although we should not expect high dividend increases in the years to come, we can assume that MMP will increase the dividend in the years to come and continue its 20-year streak of rising dividends. Of course, we should pay very close attention to the balance sheet and the high debt levels, which are anything but great and could be a problem for Magellan Midstream Partners in the years to come.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

Comments

[Doggywag]

MMP, a well-managed and financially sound company (for an MLP) yielding 9.25%, is laughably undervalued from a certain perspective. One reason is the MLP structure, which is highly complex and poorly understood by most investors (including me). Another is that fossil fuels are in sharp disfavor among investors and are likely to remain so (for good reason). Thus, I'd be surprised if MMP's stock price ever rose much from here (same as EPD and others, which are solidly stuck in the doldrums pricewise). The current yield, if maintained, will probably keep the stock roughly where it is for quite some years yet, because enough people are greedy or needy enough (again, like me). I think of MMP and EPD as sin stocks much like tobacco stocks, which have long outlived predictions of doom despite every bad thing the universe could throw at them. There's a mountain of hypocrisy out there about energy that will prop up fossil fuels for a fairly long time. For example, news organizations like the NYT have an anti-fossil-fuel stance but run worried articles about the state of jet travel during the pandemic, and lots of travel ads. Modest positions in these stocks make sense for income-oriented investors, especially retirees, who will probably croak before the companies do.

[Coach Baker]

@Daniel Schönberger Great case for MMP and fully agree with your findings. Further, was glad to see a boost in the distribution as well as other advocates like @brad@Brad Thomas. MMP has been my "Dog of the Dow" for the mlp segment of my portfolio. Is the D/E the principle reason the price has been flat?

[Incomeiam]

Made my first purchase at $44 today. Hard to pass up the dividend when I’m so close to retirement.

[abbaman32]

@Incomeiam You will be OK. I, on the other hand, having bought my units at $62, will never recover.

[abbaman32]

Another day another beat down.

[abbaman32]

Take a look at the MMP chart. Nothing but a downhill ski slope.

[jaylee_9899]

MACD is about to crossover and head up I am buying . At support heading back to 47/48 soon !

[abbaman32]

@jaylee_9899 It is under $44 now. There is no support for MMP. Down huge 7 of past trading weeks and continues to fall. This is an MLP for chumps.

[Overfished]

@abbaman32
I view this as a buy to hold for long term dividends.
I never intend to sell my shares, just live off of the dividends they provide.

price movements are irrelevant noise, which I view as buying opportunities.

this is what makes the market.

Fish

[A Serious Man]

This is an LP and its distributions are NOT dividends. The author needs to be much clear on that.

[abbaman32]

Just another down day. Nothing new.

[Kurt Licherovsky]

MMP earns 85% from renting their pipes and storage to other energy producers and participants. Fluctuations in energy demand is a buying opportunity from fluctuating share prices. The CASH FLOW or PROFITS doesn't change because of share price fluctuations.
I'm buying in the 44's, 45's, and 46's believing I'm doing the same thing as management and that the share price will rise above the 50 price level upon release of this quarter's earnings and profitability.
Don't buy MMP if you are worried about LOW COST net debt increasing or EBITDA not increasing enough. EBITDA is NOT a generally accepted accounting principle, some people call it CRAP_IDA and worse. If you don't like MMP's EBITDA then sell.
I like MMP's management and their credit metrics. If you don't, then sell. The company is buying in the mid 40's and many others are rushing to buy in the 44's. MMP's share price doesn't stay in the 44's for very long. Demand for MMP shares is abundant in the mid 40's and not so much in the low 50's when quarterly earnings and dividends are reported. I'm keeping my shares for the 9% dividend and selling my new acquisitions in the 50's for a 10% capital gain.

I could be wrong you should sell your MMP.

[PianoCat]

Net debt is increasing every quarter since the pandemic. EBITDA not so much, still below pre-pandemic levels. It appears that MMP is leveraging up its balance sheet to buy back stocks. I'm not sure whether that's a smart thing to do. Why are they so interested in pumping their own stocks at the expense of its balance sheet?

[Kurt Licherovsky]

@PianoCat The dividend is a 9% cost, every stock MMP retires they are earning a 9% savings in CASH, screw the balance sheet, the debt costs less than the dividend. I like what mgmt is doing, moreover fewer shares outstanding increases earnings per share and the dividend per share. What's the problem? MGMT just increased the dividend last quarter. Business is good.

SELL your shares if you don't like net debt and increasing EBITDA or hold on to your short position.

[houtex]

@Kurt Licherovsky
“ screw the balance sheet”
😳
We’ve come a long way, haven’t we?

[PianoCat]

@Kurt Licherovsky I have no position in MMP but when they stop pumping their stock maybe it will take a dive and I might buy some units.

I like MLPs that improve their balance sheet and pay good distributions.

[abbaman32]

MMP is still heading south so I guess it is getting even more undervalued. I am now down 28%. One look at its chart can make one vomit.

[Kurt Licherovsky]

@abbaman32 very funny, I'm underwater too. MMP stock fluctuates. Looking backwards at the chart history, MMP fluctuates between 45 and 50 plus. NOW IS THE TIME TO BUY.

[abbaman32]

Take a look at the MMP chart. Since the end of October it resembles a downhill ski slope. And it is still declining. No wonder I am down 27% with this weakling. Yeah, higher distributions and buybacks are really working.

[Kurt Licherovsky]

@abbaman32 Very funny again, I earned the last dividend so I'm up 9% in CASH, I HOPE you are too. I'm underwater too but I'm adding in the 44's 45's and 46's. MMP will trade in the 50's again upon dividend declaration.

BUY LOW now SELL HIGH later. All stocks fluctuate for many reasons. Look at the reaction to OMICRON...learn that stocks are always a weak representations of actual value. Sell your shares if you are unhappy.

[abbaman32]

@Kurt Licherovsky It won't be long before we learn whether the lemmings will indeed be buying MMP and sending it skyward after the next dividend declaration.

[eatonbiz]

Thank you, Daniel, very helpful.

[Aricool]

nice analysis. thx. however, why take the debt vs growth risk of a single name like MMP, instead I just buy large amounts of MLPA & MLPX and get even higher divys & total return w/o the BK / debt risk. JMTC.

[Tony Naples]

@Aricool
The MLPA ETF is an interesting choice I have not previously explored.
In my prior analysis over a year ago, if I remember correctly, there seemed to be more risk with MLPX vs MMP. Will review again as MLPX does have similar distribution, albeit currently slightly higher 10%

[Derf]

@Daniel Schönberger Is the likes of MLPA or MLPX allowed by your German broker?

[abbaman32]

Still staring at a 25% unrealized loss.

[Tony Naples]

@abbaman32 Key point per Buffett. Unrealized loss. You own the same number of shares in a company with few shares because of buybacks. in other words you own a greater percentage of the company. Your unrealized loss is also decreased by a very real cash payment of distribution.
1. You can sell now and relieve your stress caused by unrealized loss.
2. You can hang tight and collect dividends which will eventually exceed the unrealized paper loss, netting you an actual gain.
3. You can buy more at this lower price ($44 today), thus averaging down your investment if you believe
a. the stock will continue to fluctuate and go back to $50 or more AND
b. MMP will continue to pay these distributions long into the future.
Make a decision you can live with so you will stop useless complaining.

[abbaman32]

@Tony Naples There is a difference between complaining and merely stating things as they are. Other MLPs are not faring as badly as MMP and I choose not to cheerlead. I think I will be heading for the door shortly and go with some of those better performers.

[rsmab01]

Has anyone looked at the price chart of MMP over the past decade? It is, in general, a downhill ski slope with a couple of moguls here and there (and this is pre COVID). My guess is anyone who has held this stock for this long is at best even with reinv of dividends. There is no amount of dividend that can be given to make up for such capital erosion. Any one just looking at yield without looking at stock performance is just kidding themselves

[bill h illify]

@rsmab01
Ok…I’ll bite…Dec 2011, buy at $32…now $46…plus the divs on top of that…could do worse.

[rhurry]

@rsmab01 This 10 year ago discussion is as lame as any discussion of 10 years from now. Find a new hobby.

[1papacobb]

@rhurry Should I live 10 years.

[Paperone75]

Only 44% of growth in 10 years? No, thank you. But I seldom have a look on this stock.

[grbbiker]

@Paperone75 Have you looked at the result with dividend reinvesting? You are selling MMP's performance short.

[Paperone75]

@grbbiker No I haven't, probably you have gained much more, doing so.

[Overfished]

@Daniel Schönberger I like the article thank you for your effort. You made note that as a foreign investor you can't invest in this because you run the risk of losing more than your original investment. Can you expand on this and how that is possible?

Fisch

[Akroma007]

@Overfished I am curious too, as far as I know the worst that can happen is the investment goes to 0.

[houtex]

@Akroma007
It may be concerning the tax impact of something like CODI but maybe not. I’m also curious what the author was thinking of.

[PianoCat]

@Overfished Foreign investors get a 37% withholding tax on dividend from a MLP. If the MLP is paying out dividend and depreciating in share price then you could end up losing money very easily because of that 37% tax.

[Income4ever aka Cyclenut]

Good commentary
Long MMP , EPD and ENB