After decades of rather consistent growth, Magellan Midstream Partners (NYSE:MMP) seemed to hit the ceiling in 2016:
Driving that decline is the company's direct exposure to commodity prices, which were weak in 2016. That said, prices are on the mend, which, when combined with the slew of growth projects Magellan Midstream Partners has in the pipeline, positions the company for a stronger showing in 2017. In fact, it could be the company's best year yet for adjusted EBITDA and distributable cash flow.
What went wrong in 2016
Magellan Midstream Partners entered 2016 expecting it to be a down year. After producing $1.172 billion in adjusted EBITDA and $942.9 million in distributable cash flow in 2015, the company's initial 2016 guidance for adjusted EBITDA was $1.154 billion, while it saw distributable cash flow slipping to $900 million. However, the MLP steadily increased its guidance throughout the year thanks to stronger-than-expected performance. As a result, it now expects to produce $1.193 billion in adjusted EBITDA and $925 million of distributable cash flow. While that would push adjusted EBITDA to a new record, distributable cash flow would still fall short of 2015's record level.
The primary culprit causing cash flow to slump is the company's refined products segment, where year-to-date operating margin has declined 7.2%. Driving that decline is the partnership's commodity-related activities, which have been under pressure because of weaker commodity prices in 2016. In addition to that, Magellan's marine storage segment has been under some pressure this year because of part to lower ancillary customer activities.
More fees on the way
This past year would have been a whole lot worse if it weren't for the fact that 85% of Magellan Midstream Partners' operating margin comes from fee-based activities. In fact, one of the company's goals is to increase the percentage of its operating margin that comes from fee-based activates to reduce its direct exposure to commodity prices even further. That's why it has invested $850 million in organic growth projects in 2016, which should supply growing fee-based cash flow in 2017.
One of the largest projects is the Saddlehorn Pipeline, which Magellan is building with Plains All American Pipeline (NASDAQ:PAA) and Anadarko Petroleum (NYSE:APC). Both Plains All American Pipeline and Magellan own 40% of the project, which puts their total investment at $230 million apiece. They expect the project to be fully operational early next year, which is noteworthy given its robust first-year economics. Magellan estimates that it will earn eight times EBITDA on the capital deployed, or roughly $28.8 million in annual EBITDA apiece for Magellan and Plains All American Pipeline on their investment.
In addition to that, Magellan has a $300 million condensate splitter nearing completion. The economics of this project are even better at six times EBITDA on invested capital, or roughly $50 million per year of EBITDA.
The steady fee-based earnings from these and other projects in the pipeline alone could push Magellan's adjusted EBITDA and distributable cash flow to new records in 2016.
An improving market
In addition to the new fee-based assets going into service in 2017, Magellan should also benefit from an improving commodity price market. OPEC's recent decision to step in and support oil prices should at least stabilize crude oil prices in 2017 -- if not push them higher -- which should cause crude production in the U.S. to rebound. This improving oil market will benefit Magellan's crude oil segment by reversing the lower transportation and storage volumes the company experienced in 2016 due to weaker U.S. oil production resulting from low oil prices.
Likewise, the company's refined products and marine storage segments also stand to benefit from an improving oil market. Not only should Magellan earn higher margins on its commodity-related activities as a result of improving prices, but it should experience stronger demand for services. These improvements should drive a recovery in the operating margin of both segments, which should push distributable cash flow higher in 2017.
Weaker commodity prices marred Magellan Midstream Partners' results in 2016 because its direct exposure to those prices cut into distributable cash flow. However, the company has several large fee-based growth projects nearing completion, and there is growing reason to believe that an improving commodity price market is on tap for the year ahead. These catalysts could push the company's adjusted EBITDA and distributable cash flow to a new record in 2017, making it the company's best year yet.