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This High-Yield Stock Could Have Something Special in Store for Its Investors

By Matthew DiLallo - Feb 9, 2020 at 10:17AM

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Magellan Midstream Partners is looking at alternative ways to return cash to investors in addition to growing its high-yielding distribution.

Magellan Midstream Partners (MMP 1.59%) has routinely rewarded its investors by sending more cash their way. Since its initial public offering in 2001, the master limited partnership has increased its cash distribution 71 times. All those raises have helped push its yield up to 6.8%. 

The company plans to continue growing its payout this year, even though it will be a more challenging one for the MLP. It can easily afford to do so, given its financial profile, which continues to grow stronger. Now it's contemplating whether to send back even more cash to its investors, which was a central theme on the fourth-quarter conference call.

A person holds out a handful of hundred dollar bills.

Image source: Getty Images.

In tip-top financial shape, with further improvement forthcoming

Last year was an exceptional one for Magellan Midstream Partners. "Magellan closed out the year with another strong quarter, generating record DCF [distributable cash flow] for both the quarter and the year," according to comments from CEO Mike Mears on the fourth-quarter call. He further noted that "annual distribution coverage was higher than usual for our Company at 1.4 times, generating nearly $370 million of excess cash flow." That gave the MLP a large portion of the funds needed to cover its $1 billion capital program.

Magellan financed the rest with debt. However, even with those incremental borrowings, the company ended the year with a leverage ratio of 2.8 times debt-to-EBITDA, which was well within its sub-4.0 target, giving it significant financial flexibility this year. Not only is it on track to produce $240 million of excess cash after accounting for its planned distribution increase, but it also expects capital spending to decline to about $400 million. It also recently agreed to sell three marine terminals to Buckeye Partners for $250 million and 10% of its interest in the Saddlehorn pipeline to Noble Midstream Partners for $77.5 million. Magellan's leverage ratio is on track to fall even further this year.  

The potential to do something special with its flexibility

While the company could retain its financial flexibility so that it can capture future expansion opportunities, it currently believes that the energy sector has entered a period of low expansion potential. It's considering alternative ways to return additional capital to investors above its current distribution.

One of those is potentially repurchasing units. The company's board recently authorized the repurchase of up to $750 million of its units through 2022. Meanwhile, Mears noted another potential option on the call. He said that "we also believe that payment of a special distribution, while not talked about much in the midstream space, could make a lot of sense as well, returning cash to investors immediately in a very tax-efficient way."

Mears said the company plans to continue evaluating both options "using a deliberate long-term value-focused approach, taking into account our outlook for capital spending, our liquidity, our leverage position at the time, and our valuation."

As such, the payment of a special distribution will be dependent on two main factors. The first one is if it's unable to secure too many more expansion projects. The company noted that it's evaluating more than $500 million of projects. If it moves forward with several of those expansions, then it might opt not to return more cash to investors.

The other factor is valuation. If Magellan's unit price tumbles, it might take that opportunity to repurchase some units rather than pay a special distribution.  

However, if capital spending is on track to decline again in 2021, and its unit price holds up, then a special distribution might be a good way to reward investors in a low-growth environment.

Keep an eye out for something special

Magellan Midstream Partners has a long history of sending an increasing supply of cash to its investors. That trend appears likely to continue in 2020. Not only has the MLP already said it plans to keep raising its distribution each quarter, but it has also authorized a unit repurchase program and is considering a special dividend. That extra payout would be a nice bonus for the company's income-focused investors, which makes it something to keep an eye out for in the coming year.  

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Magellan Midstream Partners, L.P. Stock Quote
Magellan Midstream Partners, L.P.
$51.64 (1.59%) $0.81
Noble Midstream Partners LP Stock Quote
Noble Midstream Partners LP

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