An Underperforming MLP to Avoid and 2 Alternatives

As an income investor I am drawn to MLPs because of the attractive yields they offer. Because of this there are four main things that concern me: yield, distribution growth, distribution safety, and valuation. When analyzing an MLP, I am not only trying to help the average investor better understand these metrics in the context of a single company but how that company compares to its rivals. Investing is never done in a vacuum, and tough choices must be made when deciding where to invest. For this reason I recommend investors stay away from Buckeye Partners (NYSE: BPL  ) and instead consider Magellan Midstream Partners (NYSE: MMP  )  and Kinder Morgan Energy Partners (NYSE: KMP  )

There are three main reasons I feel investors would be better served investing in Magellan Midstream and Kinder Morgan: better access to faster growing energy markets, better operating results, and better valuation. 

Pipeline locations
The first reason can be explained by the old adage, "location, location, location." Buckeye Partners' 6,000 miles of pipelines are primarily located in the Midwest and Northeast. It has access to the fast-growing Marcellus and Utica shale formations but is missing out on the fracking booms in the Gulf Coast and the Permian Basin of Texas. It has minimal exposure to the Eagle Ford shale area and none in the North Dakota Bakken formation or Alberta Tar sands region. 

In contrast Magellan Midstream's assets are optimally located to take advantage of the oil boom in Texas, as well as North Dakota's Bakken formation. 

Meanwhile, Kinder Morgan Energy Partners has the largest natural gas network in North America. Its pipelines are located not only in the Marcellus and Utica shales but also in Texas, North Dakota, the Gulf Coast basin, and the Alberta Tar Sands.

In the coming decades, the majority of oil and gas exploration and production will come from areas that Buckeye's competition has better access to, as well as more resources to exploit. This brings me to my second reason for staying away from Buckeye: relative operational underperformance. 

Better management

Company

Yield

ROE

ROA

Operating Margins

Net Margins

MMP

3.38

12.6

36.8

37.2

30.7

KMP

7.23

8.8

23.3

25.8

26.2

BPL

5.8

2.5

5.9

9.5

3.2

Ind Avg

4.2

2.4

8.8

8.2

3.4

Data from Morningstar

As seen in the above table, Buckeye Partners is about even with its industry when it comes to operational efficiencies and profitability. However, Kinder Morgan's net margin is nearly eight times higher than the industry average, and Magellan's net margin is an incredible 800% greater than the average midstream company's. In addition to better operating metrics, Buckeye's competitors also have a better history of acquisitions (the bread and butter of midstream MLP growth). 

Both Magellan and Buckeye have bought out their general partners, thus greatly increasing the amount of distributable cash flow available to limited partners (the average investor). However, Magellan did so in 2009 during the financial panic at eight times EBITDA. Buckeye Partners on the other hand did so in June of 2010 at 26 times EBITDA. To understand just how much Buckeye overpaid for this acquisition consider this: Right now Buckeye Partners is trading at its all-time high. The price/EBITDA is 14.07, nowhere close to 26.

In addition to overpaying for its general partner, Buckeye had to write down $170 million in goodwill as an impairment charge due to its failed $440 million 2007 acquisition of Lodi gas storage. This was in the third quarter of 2011, but the company has discontinued operations at the California storage facilities and is planning on divesting the assets in 2014. 

Contrast this with Magellan's far wiser recent investments in its BridgeTex joint venture pipeline with Occidental Petroleum. This pipeline will pay for itself in only eight years, and the Longhorn pipeline reversal will pay for itself in three. Both projects are coming online in mid 2014, are fully contracted, and will greatly increase Magellan's distributable cash flows. This is why Magellan's management is guiding for distribution growth of 20% in 2014 and 15% in 2015. 

The final reason that investors should consider investing in Kinder Morgan or Magellan Midstream over Buckeye Partners is valuation.

Company EV/EBITDA
MMP 21.82
BPL 19.41
EPD 17.71
WZP 15.08
PAA 13.03
KMP 11.43

Data from Yahoo Finance

Bottom line
As seen above, Buckeye Partners has one of the highest enterprise value/EBITDA ratios (measure of business valuation/operating cash flows) in its industry. Given the sup-optimal location of its assets and its industry average efficiencies and profitability, this high valuation is unjustified. Investors can find higher yield, faster distribution growth, and better long-term growth prospects from Kinder Morgan Energy Partners.

In Magellan Midstream Partners investors can find one of the fastest growing distributions, industry-leading profitability, and a management team with a track record of acquisition and organic investing success. Each of these superior Buckeye competitors is trading either at a justifiable premium (Magellan) or is undervalued (Kinder Morgan). To put it more simply, why overpay for hamburger when steak is on sale? 

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Read/Post Comments (11) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 01, 2014, at 12:34 PM, arbtrdr wrote:

    Strange - BPL has absolutely the best assets in the Carribbean. KMP has acknowledged its growth is slowing and "hope" to have a 5% growth CAGR going forward.

    BPL certainly is not the best of the best but KMP is a step sideways - not up. Lots of other choices better in the next 12-24 months than KMP.

  • Report this Comment On April 01, 2014, at 1:13 PM, AdamGalas wrote:

    Keep in mind that BPL is likely to grow its distribution by 4% annually. KMP has guided for 5% and has a track record for meeting or bearing it's distribution projections, (12 of last 13 years).

    Rule of thumb for total returns for MLPs is:

    (Yield+ distribution growth)x yield

    This takes into account income, capital gains, (fueled by distribution growth) and distribution reinvestment.

    BPL has a 5.8% yield and likely 4% distribution growth rate,(my model uses formula of 20% 10 year distribution cagr, 30% 5 year cagr and 50% 1 year).

    Thus BPL investors who reinvest distributions can expect 10.4% total returns. 1871-2013 stock market average performance is 9% cagr, 9.2% with dividend reinvestment.

    So BPL will continue to beat market in the long-term, but KMP will do even better, 13.3% cagr total returns.

    Remember that investing isn't done in a vacuum. BPL is like a Mitshubishi, a fine car. But KMP is like a Lexus, and right now you can buy this Lexus for less than the Mitshubishi. Since you can only drive one car at a time you might as well drive the nicer car, especially if it's cheaper.

  • Report this Comment On April 03, 2014, at 8:15 PM, algray123 wrote:

    Thanks for the wrong advice. I sold bpl on your advice and the price has been going up ever since. Nice call, NOT.

  • Report this Comment On April 04, 2014, at 2:26 PM, AdamGalas wrote:

    I'm sorry you feel that my advice led you astray. Please keep in mind that my article's thesis was based on 3 premises.

    1. BPL was overvalued relative to its likely growth prospects.

    The price has indeed increased since my article was published but now BPL is even more overvalued.

    Just because a stock is overvalued doesn't mean it will decline in the short-term.

    2. BPL is overvalued relative to its competition, such as KMP which is undervalued at the moment. The rise in price only strengthens this argument.

    3. KMP and MMP are fundamentally better companies than BPL and that is what foolish investing is all about. Investing in companies, not stocks.

    My time frame is long-term, meaning a minimum of 5 years, but more like 10-15. Come back in a decade and see how BPL has done relative to MMP and KMP.

    I'm very confident that you won't feel the same way then.

  • Report this Comment On April 08, 2014, at 1:12 PM, sklarb wrote:

    BPL is up about 60% over the last 4-5 years not counting the dividend. They have pipelines in California, Texas and from the west end of Iowa through to NY state, where they supply jet fuel to NYC airports. I think you should look at their company page again and reassess your opinion of this company. I own KMP as well- both will do fine as 640 billion of new pipeline projects are planned. What about BORCO in the Bahamas? That's an important terminal.

  • Report this Comment On April 08, 2014, at 1:19 PM, sklarb wrote:

    I've been in the stock market learning on my own for 22 years. As far as the person who sold BPL based on the advice from someone at Motley Fool, you are much better off considering advice from various sources and then making your own decisions. I don't believe anyone on CNBC either except for Art Cashin because everyone has an agenda- Cramer, Gartman, whoever- they try to sell newsletters or get you to buy what they will be selling or vice versa. They are wrong as often as they are right. Bloomberg is a much better station because it's not so US-centric and they aren't trying to get you to time the market and jump in and out, making money for managers and the exchanges. I consider all of these sites, Seeking Alpha, Motley Fool, CNBC, whatever as infotainment.

  • Report this Comment On April 09, 2014, at 10:45 PM, AdamGalas wrote:

    Thank you Sklarb for a very good point. Any single article should never be used as the basis for an investment decision.

    As to your point about BPL doing well, I believe it will. However, I still believe that KMP, with better management and better situated assets will do even better. My argument was based purely on relative merits.

    Thank you for your comments though, its always good to get a good debate going.

  • Report this Comment On April 10, 2014, at 5:16 PM, algray123 wrote:

    My point was to show that the author of this article had no right to say that BPL was to be avoided. How many other people did the same as I and sold on his alarm. Or was he just selling news? It is for sure that Mr. Galas's comments will be treated like salt, worthless or used to raise your blood pressure.

  • Report this Comment On April 10, 2014, at 11:03 PM, AdamGalas wrote:

    I apologize if I have caused any offense. "raising your blood pressure" was certainly not my intent.

    However, I must respectfully disagree with you. My opinion is my own and I have every right to it. I laid out my case as clearly as I could and I stand by my argument.

    I did not raise an alarm about BPL, did not call for anyone to sell it or short it.

    I simply laid out my argument that I believe that, though an "ok" partnership, there are better investments based on both business fundamentals and valuation.

    My claim that BPL is underperforming is based on its relative operational results as well as my interpretation of its future growth prospects.

    If you wish to counter my argument then please state your counter points. I am more than willing to consider alternate view points and if proven wrong I will happily admit it.

    My goal is to help investors learn about general investing and the energy sector in particular. I am always striving to expand my fund of knowledge and if you believe you know something that I do not then please share it with the rest of us.

  • Report this Comment On April 14, 2014, at 6:09 PM, ferdiefor wrote:

    MMP fundamentally is a superior company to KMP. When higher interest rates finally arrive and are here to stay the KMP emperor will find its clothes are a bit tattered.

    KMP's cost of equity will be too high to allow for much of its future capex to remain viable. My concerns about KMP are being realized as they move into vessels and more CO2 projects. EPD is better able to make money from CO2 because it retains so much of its dcf versus KMP that pays it all out thus the need for more debt and equity issuance.

    EPD is a far superior pick to KMP in the mega-cap MLP space.

  • Report this Comment On April 23, 2014, at 10:55 PM, AdamGalas wrote:

    I actually have an article coming out next week that addresses this issue.

    KMP's higher cost of capital will eventually be taken care of by a merger with KMI. At the present time KMP is not having trouble growing at a decent clip but as you said a time will come when IDRs simply make the partnership uncompetitive.

    In that case management has stated they would be willing to consider a buyout of KMI by KMP via unit issuance or merely the buyout of IDR rights. This would leave KMI a holding company for KMP (and EPB) units.

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