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Magellan Midstream Partners: Distribution Growth Via Debt-Funded Unit Buybacks Cannot Last Forever

DT Analysis profile picture
DT Analysis


  • 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.

Several white storage tanks in a grassy field

JennaWagner/E+ via Getty Images


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

This article was written by

DT Analysis profile picture
I am no longer active, as I am taking a hiatus from finance to pursue business ventures in other sectors.  I hope that my analysis was helpful to investors across the years, thank you.

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.

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Comments (59)

This very year the GOP will almost certainly reassume control of the House and Senate. 2024 looks like a lock for the GOP. All of this puts MMP in the driver's seat, or at least his gas tank. The company took on debt when cash was almost free, which made sense. But now I would like to see MMP's debt start to shrink soon. The company seems pretty solid financially.
Ted Waller profile picture
I don't see that debt incurred during the worst economy in many years is an indicator of MMP's long term strategy. Their cash flow is quite adequate to manage capex and distributions in a normal year, as I showed in my recent MMP article: seekingalpha.com/... Also, I seem to recall they have committed to a self- funding model.
Grandpa in Tucson profile picture
In my humble opinion -- once the Biden administration gets it political Covid-foot off the throat of the American economy and the democratic controlled media recognize that electric vehicles will NOT dominate American roads for a long, long time, AND someone starts to listen to the scientists and engineers about where the electricity needed for EV's needs to be generated (Europe has already learned that wind and solar are NOT reliable), oil/petroleum products will have a resurgence......and that will put MMP in a very good position for a long time to come.
Bill Cunningham profile picture
@Grandpa in Tucson

" the democratic controlled media"

So. you've never heard of FOX or Newmax...(or maybe you work for them.. you're parroting their claims anyway ...)
Balthazar-B profile picture
@Bill Cunningham Would you agree that one major party's evident sway over both national and regional media organizations generally is significantly stronger than the other's? And that third parties have none to speak of?
michelf profile picture
I get the debt level has increased from the stock buybacks but if they can borrow money on the cheap, which I'm sure they can, then take some common stock out of the market they're having to pay a 9% dividend to would sound like a good move. I understand how this effects the balance sheet but net at the end of the day, it would appear to be a smart move. Any comments on if I'm wrong or right or neither...lol.
Bill Cunningham profile picture

"Any comments on if I'm wrong or right "

You're likely right; total earnings may go down but with stock buybacks, even if funded by (cheap) debt, earnings per share may go up...
As soon as I saw the headline I knew who wrote this article. Just as an aside Magellan is considered one of the best managed MLP's in the industry so I think they know what they are doing.
The distribution is around 9%, the buybacks eliminate the 9% obligation and substitute low cost debt. In the mean time income and demand is rising to service debt and increase buybacks and raise the distribution. It's a win win.
@Kurt Licherovsky spot on. I wish such analysis (capital allocation usage and value across all usages vs debt and other ratios mentioned) was included I the article
Only Dividend profile picture
@Kurt Licherovsky

This is a valid argument until it isn't. Debt has to be repaid. Dividends and distributions don't.

Not that I disagree with MMP as they're better informed about their company than I ever will be, but debt incurred without achieving real earnings growth can be a questionable use of capital.

Artificial eps growth through share count reduction is a trash way to achieve growth.

No hostility intended with my comments.
Charles Lieberman profile picture
"it remains undeniable that debt-funded unit buybacks cannot last forever since the additional debt incurred adds nothing to their earnings" This statement is glaringly and factually incorrect. If the company issues debt at a 4% yield to buy back shares yielding 8.9%, free cash flow increases rather nicely. Within just 2 years, they could pay down almost 10% of the debt they issue and the debt paydown would only accelerate from there. Debt issues to buyback shares can't be done without limit, or the company risks stress should the economy go into a deep recession and cash flows get crushed. But short of that situation, issuing debt to buy back shares is highly accretive to shareholders. And that extra cash flow can be used to retire debt, thereby derisking the balance sheet. With current prevailing interest rates so low, this is precisely the time for the company to issue debt to buy back shares.
@Charles Lieberman @ dani@Daniel Thurecht - can you refer to Charles point. I think he and Kurt above are spot on RE use of funds by MMP.
grbbiker profile picture
stockstudent111 profile picture
Won't they see FCF growth next year and if so, then can rise div or buy back more from that, no? Unless I missed it, the article only discusses the past, not the future.
Tuco's Child profile picture
An oddly composed article with this basis repeated :

"... in the age of electric vehicles"

We are a long long way off from EVs making an impact on oil consumption. In fact, from cradle to grave, EVs consume massive quantities of fossil fuel energy, and are more expensive to run without tax payer subsidies.

Further, there is not enough lithium on the planet to replace even 25% of the ICE cars on the road.
@Tuco's Child You are incorrect on several points:
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.
Tuco's Child profile picture

Not sure I understand the exact gist of your response, but let me take a crack at it. You have engaged a retired chemist who worked in mining and minerals R & D at a major chemical co. in the NE USA.

1) The laws of thermodynamics hold. What you put in, is what you get out. Couch this in terms of the complete cradle to grave sequence in the total build and disposal of an EV.

2) The build of an EV depends on the coal and fossil fuel intensive mining of metals: their extraction, refinement, and reduction. Then transport and form fabrication and install. This is a fossil fuel intense battle to roll the ball uphill, look up the term "Gibbs Free Energy".

3) Lithium : let me term that "accessible lithium" . First you have to strip overburden and move that soil, then access preferably a lithium rich mineral deposit. If you are lucky you can mine an ancient salt deposit. Repeat this energy intensive destruction of the planets surface all over the world.

I am going to stop here. Respectfully, please read:

Mines, Minerals, and "Green" Energy: A Reality Check
Mark P. Mills
July 9, 2020
Energy & Environment Regulations

Too bad the author doesn’t analyze the growth potential of the basic business. Seems to me that it has bottomed and that volume growth and rate increases could drive higher cash flows.
BMW7 profile picture
I am interested to see what management does with the proceeds of the Buckeye terminal sale ?
Poor strategy… short term gains and long term pain…
Management team must have lots of stock options that pay at a slightly higher price.. Stay Away…
@AZ BOY ru shorting this stock.
Income4ever aka Cyclenut profile picture
I remain convinced that sooner or later MMP will be merged and folded into EPD so this will become a moot matter
Coach Baker profile picture
@Income4ever aka Cyclenut interesting prospect. Can you point me to where EPD considered this option?
Big Fat Dummy profile picture
@Income4ever aka Cyclenut You keep pushing this thesis, seemingly with little to no evidence.

EPD and MMP’s businesses have little overlap - why would EPD buy legacy assets? It makes little sense, and doesn’t match EPD’s growth trajectory centered on NGLs.
@Income4ever aka Cyclenut Wishful thinking. EPD grows organicly not through acquisitions.
Bill Cunningham profile picture
"it remains undeniable that debt-funded unit buybacks cannot last forever since the additional debt incurred adds nothing to their earnings"

The key question though is whether or not it adds anything to earnings PER SHARE...
OffSiteLocation profile picture
Looking at dividend history while recent years have been almost flat, they have not missed doing a small dividend increase each year.
rickevantodd profile picture
Excellent article. Very thorough and I appreciated the tables presented. I was a little surprised at how little a Company of this size had at the end of the qtr. it’s possible that the Companies distribution increase announced after 3Q was with the hindsight of being halfway thru 4Q. A modest increase in business should alleviate all the issues you raised. Long MMP.
Interesting article, esp. for a 'newbie' in the area of oil/gas pipelines in USA. I wonder if you have ever looked at TYG, as it is a CEF that holds many MMP 'lookalikes', and currently is the most discounted CEF out there, i.e. at 22.13% to NAV.
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'!
AspiretoRetire profile picture
@alpine I’m not the author, but I am not a fan of CEFs or ETFs in this space. There are only a few names worth an investment, and funds always buy many losers. MMP is one of those few good ones and the only one I hold or will buy in the future. Its conservative and skilled management team sets it apart; so many in this industry have wasted shareholder value over the years on untimely or uneconomical expansions, poor acquisitions, and too much debt. If MMP’s balance sheet gives you pause, you should look at some of its competitors.
Florida_Dreaming profile picture
@alpine This author does not respond to comments ever so don't waste your time.
OffSiteLocation profile picture
@alpine just look at any CEF MLP IN March 2020. That’s was these leveraged closed end funds did. They had to sell at the bottom making the bottom much worse because of leverage and calls on that leverage.
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.
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