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This High-Yield Stock Is Working Hard to Keep Its Dividend Growth Engine Well Fueled

By Matthew DiLallo - Nov 21, 2019 at 11:39AM

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Magellan Midstream is making sure it has plenty of fuel sources to continue increasing its 6.8% yield.

Magellan Midstream Partners ( MMP -0.88% ) has consistently rewarded its investors over the years. The master limited partnership (MLP) has increased its distribution an impressive 70 times since its initial public offering (IPO) in 2001. That steadily growing payout has richly rewarded dividend investors as the company has generated an eye-popping 2,810% total return over that time frame. That has obliterated the S&P 500's nearly 235% total return during that period.

The MLP is working to ensure it can keep growing its payout in the future, which was one of the major takeaways on its third-quarter conference call.

A man drawing a chart of rising dollar signs on a green chalkboard.

Image source: Getty Images.

A nice margin of safety

CEO Mike Mears spent some time on the call talking about the sustainability of the company's current 6.8%-yielding payout. He noted that the company recently "raised our quarterly distribution to $1.02 per unit, which is consistent with our plan to increase our annual distributions by 5% for 2019." Furthermore, he noted, "With our updated 2019 annual DCF (distributable cash flow) guidance of $1.26 billion, we now expect the 2019 full-year coverage ratio of 1.35 times, which results in more than $300 million of excess cash flow for the year. One of our objectives is to maintain a coverage ratio that ensures the reliability and safety of our quarterly cash distribution, especially as we enter a period of increased competitive pressure for long-haul crude oil pipelines in the Permian Basin."

Thanks to its strong results during the third quarter, Magellan is on track to produce $40 million of additional cash this year. Because of that, it will cover its growing dividend by a comfortable 1.35 times, well above its target of greater than 1.2 times coverage, enabling it to retain more excess cash to help fund expansions.

A stack of pipelines with a blue sky in the background.

Image source: Getty Images.

Taking steps to keep growing

Meanwhile, the company got some good news on the expansion front during the quarter as it now expects to invest $1 billion this year and another $400 million in 2020, which is a net $150 million increase from its prior view. Driving that increase was recently approved projects to expand Seabrook and Saddlehorn as well as some new oil storage capacity in the Permian Basin.

Those investments into expanding its systems should enable Magellan to continue growing its cash flow even as market conditions become more challenging in the future. As Mears noted, its Permian oil pipelines won't be as profitable because new ones are starting to come on line, which will steal some of the volumes it had been moving.

Those competitive pressures have also made it harder for the company to secure new expansion projects. It has already canceled a couple of projects in recent years, including an investment in another long-haul Permian crude pipeline. As a result, investors were starting to worry that the company's growth engine might be running out of fuel.

However, it has started easing those concerns. Not only did it approve an additional $150 million of new projects during the third quarter, but it has also taken steps to ensure another one moves forward.

It had been seeking shippers for the Voyager Pipeline but received lukewarm support as customers wanted a cheaper solution. Mears provided an update on its progress with this project by stating:

We have been actively working on this over the past few months with multiple parties and we have made significant progress. The project, as currently designed, will require a fraction of the capital that was originally contemplated and includes multiple value-adding components that have been negotiated with certain counterparties. But we still can't guarantee that the project will reach FID (final investment decision). We are significantly more optimistic that we will be successful with these new developments.

As Mears points out, the company has completely reworked its proposed Voyager pipeline to make it not only more attractive to shippers but also a higher returning investment opportunity. Consequently, it seems increasingly likely that it will move forward with that project, which would move oil from a major storage hub in Oklahoma to the Houston market. It's one of several additional expansions it has in development. Overall, it could invest more than $500 million into those projects. Success in securing that growth could give it the fuel to keep increasing its payout for the next few years.

Slowly refilling the tank

Competition in the pipeline sector has hit Magellan Midstream hard over the past year as it has had to cancel a couple of projects. However, it has slowly been refilling its growth engine by securing smaller expansions. In the meantime, it's reworking other projects to increase the probability of success. That's making it increasingly more likely that the company will have enough fuel to continue growing its dividend in the coming years.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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