NuStar Energy (NS +0.00%) is offering a generous 8.9% yield today. Magellan Midstream Partners' (MMP +0.00%) yield is 6.1%, still notable but a lot lower. These two midstream oil and gas players will definitely entice dividend-focused investors. But dig a little deeper before you decide, because there's more to look at than just the distribution yields. Here are some key facts you need to know before you buy either of these master limited partnerships.
1. The distribution
Magellan covers its distribution by around 1.2 times. That's a long-term target and is a very healthy number in the midstream space, providing ample safety. NuStar is projecting its distribution coverage to be around 1.3 to 1.4 times in 2019. That's an even better number, but it comes with a caveat.
Image source: Getty Images.
Magellan has increased its distribution every year for 19 consecutive years. NuStar cut its distribution in 2018 by a painful 45%. Prior to the cut, the distribution hadn't changed since 2011. Those are vastly different records, with Magellan clearly coming out on top.
2. Changing versus staying the same
Magellan's distribution record really rests on its conservative approach. The partnership owns pipelines (roughly 90% of its operating margin) and storage assets (about 10%). It generally only spends money on capital investments when it has customers lined up ahead of time. And the vast majority of its top line is tied to fee-based contracts, which helps it avoid the ups and downs of the commodity products that flow through its system. This is the same game plan Magellan has used for years, and there's no intention of changing it today. If you like safe and boring investments, Magellan should be right up your alley.
NuStar is finally nearing the end of an effort to reduce the risk of its business. At the start of the decade, it was a mixture of storage and pipeline assets with a marketing business attached to it. It has since exited the volatile marketing business so it can focus on its core storage and pipes. It has been spending heavily of late on the pipeline side of its business to take advantage of the growth in U.S. onshore oil and natural gas production, including the 2017 acquisition of Navigator Energy Services for roughly $1.5 billion.
That said, NuStar is still making changes, recently selling a terminal asset so it could reduce leverage. While NuStar is working to reduce risk, this shift was also the reason for the distribution cut, as management has tried to simplify (it bought its general partner) and reposition the business. At the end of the day, it still looks like a work in progress to some degree.
3. Where things stand today
While NuStar's distribution and business are on much stronger ground at this point, there are other issues to consider. For example, Magellan's debt-to-EBITDA ratio is among the lowest in the industry at roughly 2.4 times. NuStar's ratio is a hefty 11 times, though to be fair, it reports debt to adjusted EBITDA brings that figure down to around 4.0 times. That's much better but still notably higher than Magellan. This is the norm, not the exception -- Magellan has always focused on maintaining a rock-solid balance sheet.
NS Financial Debt to EBITDA (TTM) data by YCharts.
Looking a bit deeper, Magellan's debt-to-equity ratio is roughly 0.3 times compared to NuStar's 1.2. And it shouldn't be surprising to see that Magellan covers its interest expenses by a robust 7.8 times. NuStar's coverage has been tight lately, hovering near 2 times in recent years. Once again, Magellan's approach is clearly focused on being fiscally prudent. NuStar has reduced the financial risks it faces, for sure, but Magellan still comes out on top when you look at each partnership's balance sheet.
4. Where to from here?
Magellan recently canceled a couple of projects, which has left investors worried that it won't have much in the investment pipeline after it completes roughly $1.1 billion worth of projects in 2019. In fact, at this point, it is only looking at around $150 million worth of capital spending in 2020. It prefers ground-up construction, which it believes leads to higher returns than acquisitions, and has around $500 million in projects under consideration. The thing is, $500 million is closer to the norm for Magellan than $1.1 billion, which is an unusually high rate of spending.
So while there's a little trepidation about the future, the partnership's long history of success and conservative approach suggest it deserves the benefit of the doubt here. Even a soft year for capital spending wouldn't be the end of the world or change the bedrock foundation on which Magellan is built. And, frankly, it wouldn't take too much to get from its current 2020 plan to one that was more in line with its historical spending levels.
NuStar is in the middle of a big spending boom of its own, with plans to invest as much as $550 million in capital projects this year. That number is projected to decline by about 40% in 2020 as the company works on smaller projects. Like Magellan, it isn't really talking about longer-term spending plans at this point, but there's no particular reason to doubt its ability to find new avenues for expansion as it looks to take advantage of U.S. production growth. The big takeaway, however, is that neither one of these partnerships stands out when it comes to capital growth plans.
Better but still a bit short
When all is said and done, NuStar has made a huge transition over the last decade. That process appears to be nearing its end, with the partnership on much firmer ground than it had been. The problem is that this process required a distribution cut along the way. Magellan, on the other hand, has simply done the same thing it always has, including maintaining an enviably unwavering financial foundation and consistent distribution growth.
While NuStar's higher yield might be enticing to investors looking to maximize the income their portfolios generate, Magellan's financial strength and long history of success make it the better energy stock of this pair. It's better to err on the side of safety if you like sleeping well at night.
