Sometimes, it's reassuring that a company knows exactly what it is and doesn't try to be anything else. Magellan Midstream Partners (MMP) fits that description quite well. It's a business that focuses on developing transportation and logistics assets with consistent fee-based revenue that can fuel future growth and steady distribution increases.
Management has stuck to this game plan for years and, based on its statements, will keep at it for some time. That said, there are signs that much larger projects are on the horizon. Here are comments from the most recent earnings conference call that give investors the impression that things are changing.
Image source: Getty Images.
Sticking to the plan
It has to be incredibly tempting for pipeline and infrastructure companies to spend big money right now. Production in the Permian Basin is booming, and large producers continue to say they intend to increase production considerably for several years into the future. That kind of backdrop could get some chief financial officers to place a greater emphasis on growth rather than capital discipline. However, Magellan CFO Aaron Milford wants to keep the balance sheet and capital funding time for the foreseeable future:
Our net debt to EBITDA ratio at December 31, 2017 was approximately 3.3 times. We continue to maintain $1 billion credit facility which also supports our commercial paper program. We do have any borrowings outstanding under this facility at year end 2017. We also continue to maintain a $750 at the market equity program and we do not issue any units during the quarter and not issued any units since putting the program in place.
As we stated in the past, the ATM [at the market equity program] is a tool we plan to use to manage our leverage ratio to approach our four times limit. As has been the case for some time, given our current economic estimates we believe we can fund our current state of growth projects without needing to issue any equity, but we do expect our leverage ratio to continue to rise closer to our 4 times target as we fund our growth projects throughout 2018.
Magellan opting to not use its equity issuance program to raise capital is a large part of its value proposition to shareholders, actually. Typically, master limited partnerships use equity to fund part of their capital spending. Most companies are able to do so while still being able to raise their payout, but growing without diluting shareholders has allowed Magellan to maintain one of the best distribution-per-share growth rates in the business.
MMP average diluted shares outstanding (quarterly). Data by YCharts.
Giving investors a sense of ease
I think it's fair to say that investors are a little nervous when it comes to pipeline companies and others with a lot of debt. One of the most significant reasons for this is potentially higher interest rates. Buying a stock like Magellan's is largely predicated on the company's ability to provide steady, growing dividends for the foreseeable future. So, in this spirit, CEO Michael Mears gave an outlook for the next few years.
I am sure you've also noticed that we've provided our view of 2019 and 2020 as well in this morning's release. We have continued to hear from our long-term investors the strong distribution coverage remains important to them especially considering the performance of the energy markets and MLP space over the last few years, as a result we intend to manage our business in a way that maintains a coverage ratio of 1.2 times for the foreseeable future.
Maintaining this level of distribution coverage is a bit more conservative than what management's guidance in previous years. Here's why Mears is making that change now.
With regards to the 1.2 times coverage, we feel -- we've historically talked about being comfortable going down the 1.1 times coverage. Quite frankly, we think our business is healthy at 1.1 times coverage, but we also think that it is prudent to maintain a higher coverage and trend more toward a self-funding model than a full distribution of available cash flow. So, we are going to target 1.2 times at least for the foreseeable future.
Self-funding -- or, more specifically, self-funding the equity portion of its capital plan -- seems to be the new buzzword for management teams in this industry. By not having to go to the market for funding, cost of capital is lowered and management is given a wider array of projects in which it can invest.
No change on acquisitions
Historically, Magellan used acquisitions as a crucial growth lever. However, the company hasn't made a significant asset purchase since 2015. While there has been a confluence of factors that likely kept management from making a purchase -- valuations, high levels of organic growth spending, etc. -- Mears indicated that they are still on the lookout for the right kind of acquisition.
On the topic of acquisitions, we remain active in analyzing the opportunities available on our space as always price and risk profile are key considerations and Magellan intends to maintain its disciplined approach when evaluating not only potential acquisition opportunities. but also construction projects. Our preference continues to be to pursue opportunities to expand our asset portfolio with fee-based activities and long-term committed volumes from credit worthy counterparties.
Just about every company in this industry is looking for fee-based activities with long-term committed volumes and creditworthy customers, so it's hard to find assets like this selling at a discount. Plus, with so much organic growth in the pipeline, one has to imagine that the hurdle for an acquisition is incredibly high.
Green light for its big projects looking better by the day
In prior conference calls and press releases, Magellan's management had spoken extensively about some investment projects that called for much larger spending compared to previous ones. One of them, an export terminal in Pasadena, Texas, was set up as a two-stage project where phase one was a rather modest-sized endeavor and phase two would be a $1 billion-plus investment.
Magellan has yet to make a final determination on investing in phase two of this project, but based on Mears' comments, it's looking more and more likely. He also talked about some of the expansion possibilities at its Seabrook Logistics terminal.
[W]ith regards to Pasadena, we're already in active discussions with a number of parties for further expansion of Pasadena. Just as a reminder, we can build another 5 million barrels of storage there and 3 additional docks. The expectations for increased refined product exports are very strong. So there's interest in the capabilities of Pasadena. So those discussions are under way. On Seabrook, our next phase of expansion would include additional storage, actually at Seabrook, but also at Suezmax dock. Progress on that project has been moving pretty rapidly and I would hope that we'll have something to announce more definitive on that in the near future.
Backlog bigger than you might think
Magellan has a go-to line in all of its slide decks that says the company is advancing a potential project backlog "in excess of $500 million." For some time, that was an assurance that the company had plenty of work in the wings to maintain its double-digit annual distribution growth.
Well, Magellan is a $14 billion company now, so $500 million in project backlog isn't exactly a big number. However, Mears noted that some of the things the company is working on are significantly in excess of $500 million. Here's Mears giving some early details on its plan for another export terminal in Corpus Christi, Texas:
[J]ust to give you a sense, I won't quote for you an actual capital cost, but the scope of it that the capabilities we have with the land would include four docks and up to 10 million barrels of storage. So that should give you kind of the sense what kind of capital opportunity is there.
As a gauge of how much money is involved, the company's phase two for Pasadena is expected to cost more than $1 billion with three docks and 5 million barrels of storage. To say that this project is in excess of $500 million is really underselling its potential.
