This year has been a tough one for pipeline stocks, with even top-tier names Enbridge (ENB 0.74%) and Magellan Midstream Partners (MMP +0.00%) sharply selling off due to a variety of worries. Shares of Canadian oil pipeline giant Enbridge have tumbled 18% since the start of the year while units of oil and refined products master limited partnership Magellan have declined more than 12%. Those sell-offs came even though both companies reported solid results to end 2017 and expect cash flow to head higher in 2018.
While the lower prices make both pipeline companies more attractive to income seekers, one clearly stands out as the better buy right now.
Image source: Getty Images.
Drilling down into their balance sheets
One of the most important factors to consider when comparing two companies is their financial situation. However, in the case of Enbridge and Magellan Midstream Partners, both boast solid financial profiles.
|
Company |
Dividend Yield |
Credit Rating |
Debt-to-Adjusted EBITDA |
Projected 2018 Dividend Payout Ratio |
% of Cash Flow Fee-Based or Regulated |
|---|---|---|---|---|---|
|
Enbridge |
6.7% |
BBB+/BBB/Baa2 |
More than 5.0 times |
About 65% |
96% |
|
Magellan Midstream Partners |
5.9% |
BBB+/Baa1 |
Less than 4.0 times |
About 80% |
More than 85% |
Data source: Enbridge and Magellan Midstream Partners.
In this case, though, Magellan has a slight edge since it has a lower leverage ratio and one of the best credit ratings among MLPs. Enbridge's leverage ratio, on the other hand, is elevated at the moment because the company is building 22 billion Canadian dollars ($17.5 billion) in expansion projects. It's also working to address that concern by planning to sell CA$3 billion ($2.4 billion) of assets in 2018, which should get leverage down to its target level of 5.0 times debt to EBITDA by year-end. Meanwhile, the incremental earnings from its current slate of expansions should push leverage down to an even more comfortable 4.5 times by 2020.
It's also worth noting that Enbridge gets a much larger percentage of its earnings from predictable sources like fee-based contracts and it pays out a smaller portion of cash flow to support its lucrative dividend. However, in an industry where investors highly value having strong credit, Magellan scores the point in this round.
A look at their growth prospects
Enbridge might not have the best credit in the industry, but it's strong enough to help fund one of the largest backlogs of expansion projects in the sector. Those growth projects position the company to increase cash flow per share at a 10% compound annual growth rate through 2020, which should enable the pipeline giant to raise its already high-yielding dividend at a similar pace. While that's not the fastest dividend growth rate in the sector, it's above the 9% average of its peer group.
Magellan Midstream, on the other hand, expects to grow its payout at a below average rate. The company currently forecasts an 8% distribution increase this year, followed by 5% to 8% annual increases in 2019 and 2020.
Enbridge's faster-paced growth through 2020 is a difference maker. That's because investors who buy its stock now stand to earn a much higher yield on that initial investment over the next three years, and that's even if we assume Magellan increases its payout at the high end of its guidance range.
| Company |
Implied Yield in 2018 |
Implied Yield in 2019 |
Implied Yield in 2020 |
|---|---|---|---|
|
Enbridge |
6.7% |
7.4% |
8.1% |
|
Magellan Midstream |
6.2% |
6.7% |
7.3% |
Data source: Magellan Midstream and Enbridge.
It's also worth pointing out that investors will collect that larger income stream even as Enbridge only pays out about 65% of its cash flow each year while Magellan's payout will consume around 80% of its annual cash flow.
There's cheap, and then there's this
Typically, faster-growing companies like Enbridge trade at a premium valuation versus slower growing rivals like Magellan. However, that's not the case here. Enbridge currently sells for about 9.3 times distributable cash flow, which is well below the 11.9 times average of its pipeline peers. Magellan Midstream, meanwhile, trades at a premium value to both Enbridge and its peer group at around 14 times cash flow. While Magellan does have a lower leverage ratio than Enbridge and most other rivals, that's not enough to justify such a large premium.
It's not even close
Enbridge is one of the cheapest pipeline stocks around these days. Add that bargain-basement price to its improving financial profile and stronger growth prospects, and it's a no-brainer buy over Magellan right now. Not only should it supply more income to investors over the next three years, but it could potentially deliver a much higher total return if its valuation reverts closer to the peer group average.
