This Stock's High Yield Could Keep Going Up in 2020 Despite Headwinds

Magellan Midstream Partners (MMP) has increased its cash distribution to investors an impressive 71 times since its initial public offering in 2001. Last year alone, it boosted its payout in each quarter, for a jump of 5% overall. Fueling that growth was its surging cash flow thanks to its expansion projects as well as strong market conditions. 

Unfortunately, the master limited partnership (MLP) expects market conditions to soften this year, which will negatively impact its cash flow. However, the company still plans to keep increasing its payout.

Here's a look back at what drove its growth last year and why it has the confidence to keep increasing its payout in 2020.

A look at Magellan Midstream Partners' financial results

Data source: Magellan Midstream Partners.

Magellan Midstream capped an excellent year by producing strong fourth-quarter results as both earnings and cash flow soared by double digits compared to the prior-year period. The main driver was the crude oil segment, where gross margin jumped 17% year over year. The company benefited from higher transportation volumes on its Houston distribution system as more oil flowed to its Seabrook export facility. That helped more than offset lower volumes and rates on its Longhorn pipeline due to the start-up of new oil pipelines in the Permian Basin.

For the full year, Magellan generated nearly $1.3 billion in cash, up about 17% year over year. That was enough to cover the company's 6.6% yield by 1.4 times. This result was well ahead of its initial forecast for $1.2 billion in cash and covering its payout by at least 1.2 times. The main factor fueling the outperformance was higher-than-expected spot market shipments on its Permian oil pipelines (Longhorn and BridgeTex) due to the region's lack of pipeline space earlier in the year. 

Image source: Getty Images.

What's ahead for Magellan Midstream Partners  

With several new competing pipelines in the Permian Basin starting up over the last couple of months, Magellan has experienced a noticeable drop in spot shipments on Longhorn and BridgeTex. So, the company only expects to produce about $1.2 billion in cash flow this year, implying a roughly 7.5% decline from last year's record level. Also impacting cash flow will be the recently announced sale of some noncore marine terminals.

Despite that projected decline in cash flow, Magellan expects to continue to bolster its distribution this year, with a 3% raise as its target. Given its current cash flow projection, it will cover that higher payout by 1.25 times. Thought that's a solid level for an MLP, many peers are now aiming for coverage between 1.5 to 2.0 times.

One reason Magellan can afford to continue to increase its payout is that it has a top-tier balance sheet, including one of the highest credit ratings among MLPs, backed by one of the lowest leverage ratios in its peer group. That gives it the financial flexibility to keep increasing its distribution while also continuing to invest in expansion projects. Another factor is that growth-focused spending is on track to fall sharply this year, from $990 million in 2019 to about $400 million. With capital spending falling, Magellan has the financial flexibility thanks to its cash flow and top-tier balance sheet to increase its payout, fund expansion, and even allocate some capital toward repurchasing some of its units.   

While Magellan expects to invest less money on capital projects this year, that doesn't necessarily mean it's running out of opportunities to expand. The company noted that it's evaluating more than $500 million of additional expansion projects that it could green-light in the future if it gets enough customer support. Given its financial strength, it has the flexibility to move forward with more expansions this year while still returning more cash to investors.

An income stock to keep an eye on

Magellan Midstream Partners is coming off a record year, thanks to the impact of recently completed expansion projects and a strong market for pipeline shipments. This year, however, will be a different story as earnings are on track to decline because market conditions have softened. While the company has the financial flexibility to continue to strengthen its payout despite this headwind, there's some concern whether it can maintain its distribution growth streak beyond this year given its meager backlog and lower coverage ratio. As a result, dividend investors should keep a close eye on whether Magellan secures more expansion projects this year. If not, then it might eventually run out of the fuel needed to continue increasing its payout.