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This 6.3%-Yielder Thinks Its Stock Is Getting Too Cheap

By Matthew DiLallo - Jan 22, 2020 at 10:19AM

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Magellan Midstream Partners is joining a growing number of its midstream peers in launching a repurchase program.

Magellan Midstream Partners (MMP 0.67%) has a long history of rewarding income-focused investors. The master limited partnership (MLP) has increased its distribution an impressive 71 times since its initial public offering in 2001, which has helped grow its yield up the current level of 6.3%. The company announced its latest raise this week, boosting the payout by 1% from its prior level, helping fuel full-year growth of 5%. 

Usually, consistent dividend growth enables companies to generate market-beating total returns. Magellan, however, hasn't beaten the market in recent years due to all the negativity in the energy sector. Overall, its units are down 12.6% over the past three years, even though it continued growing its earnings and distribution. The MLP's valuation is at a historically low level, and that's leading the company to launch a repurchase program so it can start taking advantage of its cheap price. 

A roll of cash next to a calculator and a sticky note with the word dividends.

Image source: Getty Images.

Adding optionality

Magellan Midstream isn't like most MLPs. Instead of funding growth through a combination of new debt and equity sales, the midstream company has financed the bulk of its expansion via retained cash after paying its growing distribution. It has issued equity only once in the past decade, selling $260 million of additional units, even as it has invested $5.8 billion on expanding its operations. Meanwhile, it covered the remaining amount with non-core asset sales and debt while maintaining one of the strongest balance sheets in the sector. At the moment, it has a low 2.8 times debt-to-EBITDA ratio, which is well below its sub-4.0 target. 

As a result, it currently has tremendous financial flexibility, especially after recently agreeing to sell three marine terminals to Buckeye Partners for $250 million. That even stronger financial profile comes as growth spending is on track to decline this year as it finishes several major projects. This increasing financial flexibility puts Magellan in the position to return even more cash to its investors above the current distribution level.

While the company could use that flexibility to accelerate its distribution growth rate, it instead launched a $750 million unit repurchase program. That's enough money to retire about 5% of its outstanding units at the currently low price, though it likely won't repurchase that many since the program will last through 2022. That gives Magellan the option to return additional capital to investors through a repurchase program when conditions permit.

Following the leaders

Magellan's unit repurchase program shares many similarities to one launched by large-scale MLP Enterprise Products Partners (EPD 0.96%). Last spring, Enterprise authorized a $2 billion unit repurchase program to give it another option in growing shareholder value. It went on to repurchase about $81 million in units through the third quarter of last year. On the one hand, it would make sense for the company to quicken its repurchase pace given how cheap its units are these days. However, because it has such a large pipeline of high-return expansion projects, it's currently using the bulk of its excess cash after paying its growing distribution to finance growth.  

Meanwhile, pipeline giant Kinder Morgan (KMI 2.49%) also authorized a $2 billion repurchase program. It's a bit further along, with the company repurchasing about $525 million in stock since December of 2017. That number could grow significantly this year since Kinder Morgan has about $1.2 billion of additional financial flexibility after funding its current growth program and dividend. If it uses all that money to repurchase shares this year, it could nearly double its per-share growth rate from 3% to 5%-6%. 

Magellan Midstream will likely follow in the footsteps of these two leaders and slowly use its repurchase program. That will give it the flexibility to keep funding growth as well as increasing its payout while conserving capacity in case there is a major sell-off that makes it even cheaper.

Drawing a line in the sand

Investors continue to avoid energy stocks, which is causing the valuations of top-tier names like Magellan Midstream to fall to historically low levels. That's leading the MLP to follow in the footsteps of its peers by authorizing a repurchase program. That will give it the flexibility to start buying back some of its cheap units so that it can create more value for its dividend-focused investors over the long-term.

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Stocks Mentioned

Magellan Midstream Partners, L.P. Stock Quote
Magellan Midstream Partners, L.P.
$47.84 (0.67%) $0.32
Enterprise Products Partners L.P. Stock Quote
Enterprise Products Partners L.P.
$24.22 (0.96%) $0.23
Kinder Morgan, Inc. Stock Quote
Kinder Morgan, Inc.
$16.89 (2.49%) $0.41

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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