Magellan Midstream Partners: Distribution Growth Via Debt-Funded Unit Buybacks Cannot Last Forever
Summary
- Magellan Midstream Partners has restarted distribution growth after a nearly two-year hiatus.
- It was positive to see their cash flow performance recovering after a weak start to 2021, although this was not necessarily the reason for their higher distributions.
- The primary driving force behind restarting their distribution growth was their unit buybacks but these cannot last forever given their reliance upon debt-funding.
- Their leverage ratio is already close to their self-imposed limit and thus limits their ability to continue these debt-funded unit buybacks.
- Whilst this may sound rather bearish, I still believe that my previous bullish rating is appropriate given their high 9% distribution yield remains safe.
JennaWagner/E+ via Getty Images
Introduction
Whilst the high distribution yield of 8.94% from Magellan Midstream Partners (NYSE:MMP) survived the turmoil of 2020, it nevertheless remains near the ceiling in the age of electric vehicles, as my previous article discussed. A follow-up analysis is provided within this article that reviews their subsequently released financial results and also considers the outlook for their recently restarted distribution growth via debt-funded unit buybacks.
Executive Summary & Ratings
Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.
Image Source: Author.
*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and also best captures the true impact upon their financial position.
Detailed Analysis
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Thankfully their cash flow performance has improved significantly after the previous analysis that followed the first quarter of 2021, which at the time saw their operating cash flow down 37.54% year-on-year, as my previously linked article discussed. When reviewing their latest results for the first nine months of 2021, their operating cash flow is recovering well with their result of $879.1m representing an increase of 4.64% year-on-year versus their equivalent result during 2020.
Despite this recovering cash flow performance and continued relatively low capital expenditure of only $112.1m during the first nine months of 2021, their distribution coverage was only 111.07% and whilst adequate, it nevertheless provides little scope to safely fund distribution growth. This stems from their distribution payments consuming a very sizeable portion of their operating cash flow, which drains the vast majority of their cash inflows even before considering their capital expenditure requirements, as was discussed in detail throughout my previously linked article. Despite this obviously inhibiting their short to medium-term distribution growth prospects, it was interesting to nevertheless still see distribution growth restart after a two-year hiatus thanks primarily to their unit buybacks, as per the commentary from management included below.
"The $391 million of units we repurchased during the quarter, at an average unit price of $48.50 per unit brings our total repurchases for the year to $473 million and complete the initial $750 million program authorized by our board over a year before the end of that programs three year term. The cumulative units repurchased today equals 15.1 million units or about 6.7% of total units previously outstanding."
"The reduction in total ongoing distributions resulting from these repurchases will increase distribution coverage going forward, which was an important factor in our decision to reinstate small distribution increase this quarter."
- Magellan Midstream Partners Q3 2021 Conference Call.
Even though their unit buybacks have removed a handy 6.70% of their outstanding units, they have nevertheless still come at a cost of higher debt because the $473m spent during the first nine months of 2021 clearly exceeds their $75.8m of excess free cash flow after distribution payments. Whilst investors can debate whether debt-funded growth capital expenditure is positive or negative, it remains undeniable that debt-funded unit buybacks cannot last forever since the additional debt incurred adds nothing to their earnings, thereby guaranteeing higher leverage.
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Following their use of debt to fund their unit buybacks, it was no surprise to see their debt continued increasing higher since the previous analysis with it now surpassing $5b for the first time, which is 2.52% higher than their $4.966b at the end of 2020. Whilst this only represents a relatively small increase, it obviously cannot continue forever as previously discussed with the timing depending upon how their subsequently discussed leverage is performing. Meanwhile, their cash balance of $12.6m remains very low and effectively almost non-existent and as a result, pulls back on their subsequently discussed liquidity.
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Their higher net debt has clearly pushed their leverage higher with their net debt-to-EBITDA increasing since the previous analysis to now sit at 3.88 versus its previous level of 3.70 that followed the first quarter of 2021, which is mirrored by their net debt-to-operating cash flow edging slightly higher to 4.34 versus its previous result of 4.19. Since this has further pushed into the high territory of between 3.51 and 5.00, it now seems reasonable to rate their leverage as high versus the previous rating of only moderate, despite their still otherwise favorable interest coverage of 4.82. Whilst this is not necessarily problematic nor endangers their distributions, it does not provide significant scope to continue funding their unit buybacks through debt, which remains the case even when utilizing their internally calculated leverage ratios, as per the commentary from management included below.
"Our leverage ratio at the end of the quarter was approximately 3.6 times for compliance purposes, which incorporates the gain we realized from the sale as part of our interest in Pasadena earlier this year. Excluding that gain, leverage would have been approximately 3.75 times."
"In particular, I'll note that we remain committed to our long standing 4 times leverage limit…"
- Magellan Midstream Partners Q3 2021 Conference Call (previously linked).
When considering the non-recurring nature of divestitures, it seems more apt to view their leverage ratio as 3.75 and thus they cannot see a sizeable increase to their debt without breaching their limit of 4.00, thereby limiting their debt-funded unit buybacks. Due to their lack of capital expenditure, it stands to reason that the earnings component of their leverage is unlikely to grow materially in the coming years and even if management were to relax their internal limit of 4.00, their unit buybacks and thus distribution growth cannot last forever.
Image Source: Author.
Whilst certainly not perfect, their liquidity still remains adequate despite their current ratio slipping back to 0.78 versus its previous result of 0.85 at the end of the first quarter of 2021. If not for their large operational size, this would have otherwise been rated as weak given their almost non-existent cash balance but thankfully, this advantage should ensure that they can continue accessing debt markets to provide liquidity and refinance debt maturities when required, which bolsters the $1b remaining available under their credit facility.
Conclusion
Whilst their unit buybacks helped reduce their outstanding unit count and as a result, see distribution restarted, this obviously cannot last forever given the reliance upon debt funding and thus their distributions remain near their ceiling due to their very large relative size. Despite my tone sounding rather bearish, I still believe that maintaining my bullish rating is appropriate since their high almost 9% distribution yield remains safe and thus a desirable way to generate income.
Notes: Unless specified otherwise, all figures in this article were taken from Magellan Midstream Partners' SEC filings, all calculated figures were performed by the author.
This article was written by
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (59)
There is plenty of Lithium in the earth’s crust. It’s very common. And the LiFP chemistry eliminates cobalt and nickel which are scarcer.
The US is way behind the curve in EV adoption, with one reason being the size of our country requiring range, but for every EV sold somewhere there is a drop in gasoline usage.
The cost of such new, Carola sized EVs from BYD in China now equal that of a comparable ICE, with far less operating and maintenance costs, and this is before govt incentives. The will quickly be cheaper to build as battery costs decline. You won’t be able to buy an ICE car after 2030, because all major car companies have said they won’t be building them.
This is the age of EVs with these cars a now being 30% of new car sales in China and parts of Europe. Read the projections from Goldman, Citi and others.
I do agree that we are 10 years(?) from seeing oil consumption drop but drop it will…it’s only a matter of when. I suggest NatGas will continue to replace coal and oil for energy generation and pipes are needed there, except MMP is heavy into distilled transportation, more than ET for example.
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Management team must have lots of stock options that pay at a slightly higher price.. Stay Away…
Like you (I can only guess), I thought it would be a 'safer' place to 'hide' for old retirees like me, who need regular income, as current lofty valuations of US stocks leave little room for dividend growth.
And you might be peripherally interested to learn that the EU is planning to shortly declare gas and nuclear fuels as environmentally 'friendly'!
They use leverage as a means to mask their high fees. When the market went down they were permanently crushed. I didn’t own any then, but many investors were killed. Hence the discount now.