5 Things Magellan Midstream Partners' Management Wants You to Know

Image source: Getty Images

Despite the declines across the oil and gas industry over the past couple of years, shares of Magellan Midstream Partners (MMP) have remained rather resilient. Much of that has to do with its business model. It owns the nation's largest network of refined petroleum product pipelines -- think gasoline and diesel -- and its fee based model of moving these products has helped it weather the storm in the energy market quite well.

As we look toward the next chapter of America's shale story, Magellan's management team has kept a pretty consistent strategy: Maintain modest growth while keeping a conservative balance sheet. The five quotes below from CEO Micael Mears and CFO Aaron Milford during the company's most recent conference call that should help give you a better picture of where the company is headed from here. 

Creeping debt level concerns?

An aspect that has made Magellan Midstream Partners so attractive as an investment compared to so many of its peers is that the company has kept a much more conservative balance sheet. Debt to EBITDA -- a metric that most credit ratings agencies look at -- is a great example of Magellan's more conservative approach.

Source: S&P capital IQ

Looking at the company's most recent finanical statements, though, the company's debt metric has started to increase. According to CFO Aaron Milford, this is slightly by design.

As mentioned in the fourth quarter call, as we move through 2016, we expect to see our debt-to-EBITDA ratio increase somewhat as our capital spending ramps up, but will remain well below 4x.

So far, Magellan's management has performed well enough over the years that they should at least be given the benefit of the doubt with this statement. However, it may be worth taking a deeper look if that debt level does start to creep closer -- or worse -- above that 4 times EBITDA mark.

Good guidance

Earlier in the year, management was expecting the operating environment to be a little worse than it actually was in the first quarter of the year. That, and the assumption that some new projects will come online this year, allowed CEO Michael Mears to announce that it was upping its guidance. 

Based on our solid start to 2016 and looking ahead for the rest of the year, we have increased our annual DCF guidance by $10 million to $910 million for 2016. You may recall that as part of our initial guidance for the year, we mentioned that each $1 per barrel change in the price of crude oil would result in a roughly $3 million impact to our DCF. However, based on the forward markets, the margin between gasoline and butane has not exactly tracked with its historical correlation this year. Therefore, even though our revised 2016 DCF guidance has increased, partly due to a higher commodity price forecast for the year, it has not increased as much as you might expect based on our historical crude oil price-to-earnings correlations.

We raised our quarterly cash distribution to $0.8025 per unit, which puts us on a trajectory to reach our goal of 10% annual distribution growth for 2016, all while maintaining distribution coverage of 1.2x and excess cash of more than $150 million for the year. We also continue to expect to raise our distribution by at least 8% in 2017 while continuing to maintain a 1.2x coverage ratio.

Seeing guidance getting upped should also help to ease any fears of the raising debt levels, if EBITDA and cash flow growth grow at a faster pace than debt, then those metrics will come down. This is also promising to hear that the company plans to keep its conservative payout policy in place that will help reduce the risk of a stagnant or lower distribution in the future. 

Acqusition update?

Magellan's management has been known to make an opportunistic purchase from time to time. So anyone listening in on the call will always be looking for any indication if the company is on the prowl for a deal. According to Mears, Magellan is likely going to be pretty quiet for a while:

As always, we remain active in the acquisition arena and have analyzed our bid on substantially all auctions that are in progress. As you might expect, the quality of those assets is varied and sellers still seem to expect a healthy price even in the current energy environment. However, we remain committed to maintaining our disciplined approach as ensuring that any acquisitions we pursue will benefit our investors in the long term.

If you're thinking that he is taking shots at asset sellers and telling them they think their assets are worth more than what they really are, you aren't the only one. 

Where do we go from here?

With three major capital projects coming to a close -- the saddlehorn crude oil pipeline, its Corpus Christi condensate splitter, and its Little Rock refined product pipeline -- much of the planned capital spending will be wrapping up. While the company hasn't given any major guidance as to its spending plans for 2017 or beyond, Mears wanted to reassure investors there are other opportunities in the wings.

As always, we continue to evaluate well in excess of $500 million of other potential organic growth opportunities with significant opportunities in all areas of our business. We remain focused on increasing our Gulf Coast marine capabilities, including additional refined products and crude oil storage in the Houston Ship Channel area and to further develop our Seabrook Logistics joint venture. We also recently announced the potential joint venture of refined petroleum products pipeline we are considering between Corpus Christi and Brownsville, Texas. 

We should expect to see some more details about capital spending in 2017 and beyond in the next quarter or two.

Contract issues with counterparties?

So much of a pipeline company's strength as an investment has been with its long term supplier contracts that set certain volume and fee rates for years to come. However, after a recent court ruling, those contracts are not as sacrosanct as they once were. One investor asked Mears whether the risk of its counterparties not being able to pay their bills. Here's his response.

There's really been no change since the detail we provided to you in the first -- in the call back in February. And just to highlight that, we feel, with one exception on our BridgeTex pipeline, that we have good credit quality with all of our counterparties. Certainly, we have a couple of trading entities that are counterparties, but we have no reason to believe at this point that those parties are presenting any kind of significant credit risk to us. And again, we have the one instance on BridgeTex, where we have a party that's not performing under the contract, and we don't expect them to do in any of our forecasts or guidance.

For the time being, this shouldn't be too much of a concern. Magellan's crude oil counterparties are in decent shape as Mears says, and its other segments are less at risk because of their position in the value chain for oil and gas. 

What a Fool believes

Very rarely do Magellan's conference calls or business updates come with many surprises, and this one was no different. No surprise announcements. No big changes to strategy. Just another quarter of strong performance coupled with a conservative business plan going forward. In many ways, that is the appeal to investing in Magellan: Slow & steady growth with a generous payout.

In the coming quarters, investors should watch 3 things: That its three major capital projects come online without a hitch, keeping management to its word about not passing that 4x debt to EBITDA threshold, and any further details about its capital spending for 2017 and beyond. These three things will like be the major factors in the company's profitability in the coming years.