The Federal Energy Regulatory Commission (FERC) sent the midstream energy partnership sector reeling in March when it announced changes to the tax regime for interstate pipelines. So far this year, Magellan Midstream Partners, L.P.'s (NYSE:MMP) units have fallen 20%, dropping further lately by that FERC ruling. Far from a death knell, this appears to be an opportunity for investors to buy an over 6% yield backed by a conservatively run midstream partnership with a long history of rewarding investors well.
Magellan's enterprise value to EBITDA is the lowest it's been in five years. Equally interesting here is that Magellan's EV/EBITDA ratio has fallen below that of industry bellwether Enterprise Products Partners LP (NYSE:EPD). That's the reverse of the trend that was in place over most of that five-year period. Part of the reason for this shift is that Enterprise's units are down 15% so far in 2018, a less precipitous drop than Magellan.
Interestingly, though, neither of these two pipeline owners expects to see a material impact from the FERC ruling. The ruling essentially limited some tax benefits available to interstate pipelines, but Magellan's contracts are structured in such a way that it shouldn't be directly impacted by the change. The bigger issue is an investor sentiment shift regarding the midstream space, noting that Kinder Morgan Inc. (NYSE:KMI), a midstream company that is not structured as an LP, is down 18% so far this year. This appears to be an opportunity for investors to invest in well-run partnerships at relatively low prices.
What Magellan offers
Magellan is, indeed, a well-run partnership with a long history of being fiscally conservative. For example, Magellan's debt to EBITDA ratio of roughly 3.4 is well below Enterprise's 4.7 and Kinder Morgan's 6.5. This isn't a new trend; Magellan has historically operated with relatively low leverage relative to its midstream peers.
Then there's the issue of equity financing. The typical approach in the midstream partnership space is to sell additional units to help finance capital investments and acquisitions. However, over the past five years, Magellan's unit count has increased by less than 1%. Enterprise, for comparison, has increased its unit count by 18%. Industry giant Enterprise is actually shifting its approach so it will be more like Magellan, with an emphasis on self-funding.
Despite low leverage and little new unit issuance, Magellan hasn't skimped on growth spending. The partnership has dolled out $600 million or more in each of the last five years on capital projects and acquisitions. And it isn't pulling back, either. It has plans to spend $800 million in 2018, its highest level of spending over the past decade. For 2019, the partnership has roughly $350 million of projects lined up, with another $500 million under consideration. The current projects being worked on already have customers lined up, or are at facilities where demand justifies the spending, so they are low-risk investments.
The biggest proof of Magellan's success, though, comes to investors each quarter in the form of distributions. Magellan has increased its distribution every year for 18 consecutive years. However, within that annual streak is a quarterly streak that dates back to the partnership's IPO in 2001. The compound annual growth rate in the distribution over that span is an incredible 12%.
For 2018, Magellan is targeting 8% distribution growth, lower than the past but still nearly three times the historical rate of inflation growth. (For comparison, Enterprise's distribution is only expected to grow in the low single digits as it shifts its funding approach.) Meanwhile, the target coverage ratio is a robust 1.2 times, which provides ample protection for the distribution and even leaves room for further increases. Indeed, despite the broad midstream downturn and FERC ruling, it looks like little has changed at this partnership but investor perception.
Go your own way
Right now, the Wall Street crowd is negative on midstream companies. But it appears that the negativity is punishing even the best-run names in the space, like Magellan. It can be hard to go against the grain, but Magellan and its over-6% yield appear to be on sale today. This opportunity has presented itself despite the impressive operating and distribution history, and the strong prospects for future performance.