Even before this quarter started, Magellan Midstream Partners (NYSE:MMP) was in the midst of its most ambitious growth plan in the company's history. Between 2018 and 2020, management was expecting to spend $1.7 billion on a plethora of new projects, including multiple export facilities for crude oil and new pipelines for refined products. This past quarter, though, the crude-oil and refined-product logistics specialist announced that it was expanding the current plans for these facilities even further, and expects to spend even more money as a result.
So let's look at the company's most recent earnings results and what opportunities management sees on the horizon that have led to all this additional spending.
Magellan Midstream Partners' results: The raw numbers
|Metric||Q2 2018||Q1 2018||Q2 2017|
|Revenue||$644.1 million||$678.8 million||$619.4 million|
|Adjusted EBITDA||$338.6 million||$324.4 million||$323.9 million|
|Distributable cash flow||$266.6 million||$258.9 million||$250.4 million|
Magellan's quarterly results are so consistent that it's hard to tell one from another. Each quarter, the company delivers incremental gains in revenue and cash flow from new projects either starting up or ramping up to full capacity. This past quarter, all of its gains came from its crude oil segment as expansions of its Bridge Tex pipeline led to a 61% increase in volume. Those gains helped to offset modest operating-margin declines from its other two segments as higher costs and mark-to-market losses for its refined product and marine storage segments outpaced the incremental gains in volume and price increases.
Magellan's earnings reports frequently have these mark-to-market gains or losses on financial instruments. So it's a good time to explore what that is and how it applies to Magellan's results. A mark-to-market gain or loss is a term used in fair value accounting, a method commonly used by financial institutions that carry several financial instruments such as options contracts. In Magellan's case, it uses oil and refined product futures contracts for the small portion of its business that isn't a fee-based service to lock in a future sales price and ensure a steady cash flow stream from future contract sales.
A mark-to-market loss is when the value of those futures contracts declines before the expiry date of the contract. It is a non-cash loss because the contract hasn't expired and the company hasn't delivered oil or refined product under those contracts. Since Magellan is a master limited partnership, cash is king, and we as investors are more interested in the cash coming in the door when those contracts expire, the mark-to-market losses or gains aren't of great importance.
What happened this quarter?
- Management noted that it will be able to raise the tariffs on its fee-based refined product pipelines and services by 4.4% this year, starting in the second half of 2018. These tariffs, which are based on a price index model, increased by 2% the previous two years.
- Because of high demand from customers for the expansion of its West Texas refined product pipeline, management announced that it was increasing the scope of the project such that it will expand its capacity from 100,000 barrels per day to 175,000 barrels per day. The project will expand its capacity to deliver refined product from refining centers in Houston to Odessa and El Paso, Texas, to serve growing demand for diesel for the oil and gas industry in the Permian Basin as well as pipeline exports to Mexico.
- Magellan also announced that it gave the green light to expand its Seabrook logistics terminal with an additional 700,000 barrels of crude oil storage and a second ship dock that can handle Suezmax vessels. These two announcements mean that Magellan now expects to spend $2 billion on new projects between now and the end of 2020.
- While not yet official, management has also hinted that it could build an additional crude oil export terminal in Corpus Christi, Texas. If given the go-ahead from management, it would be another $700 million project that could have some portions operational as early as 2020.
What management had to say
As part of management's prepared remarks during its conference call, CEO Mike Mears hinted at the possibility that Magellan could be growing even more than what its current slate of projects suggests:
Even though we've already announced a few expansion phases to date, active discussions continue to further develop both our Pasadena and Seabrook Logistics joint ventures, even beyond yesterday's Seabrook announcement. Discussions also continue regarding new infrastructure investments in Texas for both crude oil and refined products service, including potential opportunities for additional pipeline, storage, and export capabilities. There is some industry chatter about our participation in various potential projects, so as related to this, we can confirm that we are in advanced discussions with multiple parties regarding potential projects. However, we are not prepared at this time to discuss the details of these discussions.
Part of those early discussions are likely related to this Corpus Christi project, but it could also include additional crude oil pipelines from the Permian Basin and Eagle Ford shale.
Historically, Magellan has maintained a distribution growth rate of 12% annually since its IPO in 2001. In a recent investor presentation, though, management noted that it expects distribution growth to be in the 5% to 8% range for 2018-2020. A deciding factor in this significant slowdown is the massive amount of capital spending Magellan is slated to do over the next two years. Slowing its distribution growth rate will free up more cash to go toward capital investment and make the company less reliant on the capital markets for funding.
It's too soon to tell whether this accelerated rate of spending continues beyond 2020, but there doesn't seem to be a lack of opportunities out there to expand the U.S. crude oil and refined product infrastructure. Either way, Magellan's business looks to be well positioned to grow over the next few years, even if it means that its payout to shareholders has to suffer slightly.