There's been a lot of change swirling around midstream energy partnership Spectra Energy Partners, LP (SEP) over the last year, and it isn't over yet. Industry peer Magellan Midstream Partners, L.P. (MMP), on the other hand, has been chugging along slow and steady, just like it always has. But the truth is that both largely fee-based partnerships are very similar, and are set to get even more alike in 2018 because of the changes at Spectra. Magellan, however, will still have a slight edge over Spectra in my opinion. Here's why.
Not much has actually changed at Spectra Energy Partners itself, which is good news. In fact, the partnership recently reached the milestone of 10 years of consecutive annual distribution increases. However, there was a huge shift at the partnership's general partner, Spectra Energy. At the end of February 2017, Enbridge (ENB 0.89%) acquired Spectra Energy for roughly $28 billion.
General partners manage their limited partnerships. GP's receive fees for this effort and normally get incentive payments tied to distribution growth as well. So the shift in control to Enbridge was a notable change for Spectra Energy Partners, partly because Enbridge controls more than one partnership. And Enbridge has had a lot going on lately. That included cutting the distribution at Enbridge Energy Partners, L.P. (EEP) by a painful 40% in the second quarter. Spectra unitholders watching that change would have been right to worry, at least a little.
But that fate doesn't appear likely at Spectra at this point. Continuing distribution growth is one reason to breathe easy, but so is the company's $2.5 billion list of investment opportunities. Management believes its organic growth opportunities will support distribution growth in the 4% to 6% range, though it notes that acquisitions could increase that number. And it remains on fairly solid financial ground. Its Debt to EBITDA currently sits at around 3.6x -- Enbridge Energy Partners' debt-to-EBITDA ratio started 2017 at over eight times, which helps explain the distribution cut. With a yield of around 7%, Spectra is a worthwhile consideration for income investors.
And it's likely to get even better, with Enbridge recently offering to exchange its incentive distribution rights for additional partnership units. Getting rid of incentive distributions will actually help to reduce Spectra's cost of capital. That will make growth even easier to achieve over the long term, though near-term distribution costs will probably go up assuming that Spectra issues new units to buy Enbridge's incentive rights.
Been there, done that
This is where Magellan comes in. Magellan, which yields around 5.4%, doesn't have incentive distribution payments because it bought its general partner years ago, a transaction often called an internalization. With debt to EBITDA of around 3.5 times, you can start to see the increasing similarities between the two partnerships. That extends to the distribution, since Magellan has increased unitholders disbursements for 17 years running.
Magellan's growth looks good, too. It has roughly $1.15 billion in organic growth projects planned for 2018 and 2019. It's evaluating another $500 million beyond that. The partnership expects distribution increases to be around 8% over the near term. Like Spectra, acquisitions could lead to positive changes in those projections. Magellan is really a slow and steady performer that just keeps chugging along.
It's about control
But if Magellan and Spectra are so similar, why not go with higher-yielding Spectra? The first reason is distribution growth, which is slated to be higher at Magellan. Over time, higher distribution growth rates make a big difference. For example, Magellan's distribution has increased 80% over the past five years compared to Spectra's growth of 45%. Magellan's yield is lower, but over the long term, I believe investors will be well rewarded by the partnership's higher distribution growth rates.
The second reason is control. Magellan's management team is focused totally on its own midstream business. Spectra is now controlled by a company that divides its attention between multiple different entities. Spectra will likely benefit from its parent selling it assets, but it doesn't have as clean a business model as Magellan. Spectra could easily find that it isn't getting the attention it needs because other entities, like Enbridge Energy Partners, are taking up more of the general partners' resources.
Magellan may offer a lower yield, but that's a cost I'd be willing to pay for the partnership's mix of self-control and higher distribution growth.