Magellan Midstream Partners (MMP) has obliterated the return of the S&P 500 over the past decade, delivering a total return of more than 400% while the market has merely doubled an investor's money. Fueling that outperformance is Magellan's ability to invest in high-return growth projects that deliver needle-moving cash flow, enabling the company to grow its distribution to investors at a brisk pace.
The company expects that growth to continue in the years ahead, with plans to deliver 8% annual increases to its distribution in 2017 and 2018, thanks to the $950 million of high-return projects it has under construction. That said, I still can't believe that the company sanctioned the building of a new $335 million marine terminal in Pasadena, Texas, as the expected return is almost 50% below what it anticipates earning from other projects in its backlog.
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Drilling down into Magellan Midstream Partners' backlog
Magellan Midstream Partners has several high-return projects underway. For example, the company is a 40% partner on the Saddlehorn Pipeline, which it's constructing with Plains All American Pipeline (PAA 0.17%) and Anadarko Petroleum (APC). The system will move oil produced by Anadarko Petroleum and Noble Energy (NBL) in the Rockies to America's oil hub in Cushing, Oklahoma. Overall, Magellan expects to invest $220 million for its share in the project, which -- thanks to the long-term contracts from Anadarko and Noble -- should enable it to earn a seven times earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple on its invested capital. To put it another way, its $220 million investment should collect more than $31 million in annual cash flow, or about a 14% yield on capital.
That return is similar to what the company expects to earn from others in its backlog. In another example, the company anticipates earning a seven times EBITDA multiple on the $330 million it invested in completing a condensate splitter in Corpus Christi. Meanwhile, its $115 Galena Park dock expansion should earn it around nine times EBITDA. These returns are relatively consistent with what rivals can make on new projects. For example, ONEOK (OKE 0.47%) expects to earn multiples of five to seven times EBITDA on its backlog, many of which are small, high-return projects. Meanwhile, Kinder Morgan (KMI 0.99%) expects to earn around 6.7 times EBITDA on its growth projects.
Given those returns, it's still hard to believe that Magellan Midstream Partners sanctioned the construction of a new marine terminal in Pasadena. While a long-term customer commitment fully supports the company's initial $335 million investment in the project, Magellan only expects to earn a 12 times EBITDA multiple on the initial phase, which includes 1 million barrels of storage capacity, a marine dock, and pipeline connectivity to its existing Galena Park facility. To put that return in perspective, Magellan would only collect about $28 million in annual EBITDA from the project, or about an 8% yield on its investment, which is almost half the return it expects to earn on its investment in Saddlehorn.
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Making sense of this decision
On the one hand, an 8% unlevered yield is still a pretty solid investment. Furthermore, given the slowdown in the oil market in recent years, the company's ability to lock up any new growth projects is a positive. That's because this project should help Magellan Midstream Partners continue growing its distribution past 2018 since it won't start up until early 2019. Still, it won't move the needle for investors as much as the others in its backlog, which suggests that the distribution growth rate starting in 2019 could slow considerably.
That said, the primary driver of Magellan Midstream Partners' decision to sanction this project wasn't the returns it can earn on the initial $335 million investment. Instead, the company sees this terminal as a strategic platform to drive future growth. That's because the company believes that it could expand the facility in the future to include up to 10 million barrels of storage and five docks. While those expansions would cost the company about $1 billion, it believes that those investments could earn an eight times EBITDA multiple. In other words, Magellan chose to sanction this project because it's willing to take lower returns now to get this terminal started so that it can potentially earn much higher returns in the future on subsequent expansions.
Investor takeaway
At first glance, Magellan Midstream Partners' strategic decision to sanction the construction of a new marine terminal doesn't make sense because the returns are much lower than a typical midstream expansion project. However, it's a decision that could pay off down the road if the company can secure more customer commitments and expand the terminal to its full potential, as those projects would earn much higher returns. While it's a bit of a risky bet, it's one that could pay off handsomely over the long term.
