Why Magellan Midstream Partners May Belong in Your Portfolio

With interest rates still at historically low levels, income-hungry investors should take a closer look at energy master limited partnerships, or MLPs. These tax-advantaged entities offer investors stable income and benefit from the growing demand for pipelines and other infrastructure needed to support continued growth in domestic hydrocarbon production.

Let's look at Magellan Midstream Partners (NYSE: MMP  ) , an MLP that offers limited direct exposure to commodity prices and solid distribution growth prospects, backed by a strong balance sheet and a highly capable management team.

Photo Credit: Wikimedia Commons.

Increasing share of fee-based revenues
Magellan Midstream Partners is primarily involved in the transportation, storage, and distribution of crude oil and refined petroleum products such as gasoline and diesel fuel. It owns the nation's longest refined petroleum products pipeline system, with access to nearly half of U.S. refining capacity, and has a storage capacity of more than 90 million barrels of petroleum products and crude oil.

Though Magellan derives the majority of its revenue from refined products infrastructure, the partnership is gradually expanding its crude oil presence to capitalize on the ongoing shift among upstream companies away from natural gas and toward oil. Of the $1.1 billion of expansion projects it is pursuing today, roughly three-quarters involve infrastructure to transport and store crude oil.

Two of these projects -- the Longhorn and BridgeTex pipelines -- will greatly expand the partnership's capacity in the Permian Basin, a high-growth, liquids-rich resource in West Texas, when they come online later this year. Longhorn's existing capacity will expand from 225,000 barrels per day, or bpd, to 275,000 bpd by mid-2014, while the BridgeTex pipeline, which Megallan owns 50%, will have a capacity of 300,000 bpd.

Crucially, volumes on these pipelines are supported by long-term, fee-based contracts, which provide a great deal of visibility into future revenues. As these and other fee-based projects are brought online, they will add further stability to Magellan's already highly stable business model. This year, the partnership expects fee-based, low-risk operations to account for 85% or more of its operating margin.

Strong distribution growth prospects
Though Magellan's yield of 3.2% is admittedly low compared to its peers, the company has a solid track record of distribution growth and even stronger prospects for future growth. Since 2001, Magellan's distribution has grown at a compound annual rate of 12%, which is especially impressive considering that this growth was funded by internally generated cash, as opposed to the issuance of new units.

Going forward, the partnership is targeting 20% distribution growth this year and is guiding for record annual DCF of $730 million, which will result in a 1.2 times distribution coverage ratio -- less than last year's 1.3 times but still nothing to be alarmed about. For 2015, management is targeting 15% distribution growth.

Part of the reason why Magellan has delivered such impressive per-unit distribution growth over the past decade is its attractive capital structure. As a 100% limited partner, it doesn't have to pay incentive distribution rights, or IDRs, to a general partner, which frees up more distributable cash flow for unitholders.

Peers MarkWest Energy (NYSE: MWE  ) , Enterprise Products Partners (NYSE: EPD  ) , and Genesis Energy (NYSE: GEL  ) also don't have general partners. As a result, the cash these companies have available for distribution is substantially higher than it would be if they had to pay IDRs to a general partner.

Risks to consider
While rising interests are certainly a risk factor for all MLPs, Magellan appears less vulnerable than most. The majority of the company's outstanding debt, which had a face value of $2.7 billion as of year-end 2013, doesn't mature until 2018 and beyond. For an MLP, longer-dated debt is generally more desirable since it gives the partnership additional time to generate cash to pay the bill.

Magellan also has an extremely healthy debt-to-EBITDA ratio of roughly 3.2 times, which should allow it to fund its current slate of expansion projects through debt financing, as opposed to issuing new units. An MLP's debt-to-EBITDA ratio is an important measure of its ability to repay its debts and is frequently used by ratings agencies in assigning credit ratings. A ratio under 4 times is generally viewed as healthy.

With a robust balance sheet, ample liquidity, healthy credit and leverage metrics, and strong distribution growth prospects, I think Magellan could be a valuable addition to any investor's income portfolio.

3 stock picks to ride America's energy bonanza
Magellan's strong distribution growth outlook is supported by the record oil production that's revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 


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Arjun Sreekumar

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.

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