Both Magellan Midstream Partners (NYSE:MMP) and MPLX (NYSE:MPLX) are top Master Limited Partnerships that have tumbled lately. Both the stocks are trading at monumental distribution yields. Crude oil production in the US is being affected by demand destruction due to coronavirus in an oversupplied market. Midstream operators, including Magellan and MPLX, are sure to face some heat in such a scenario. While neither can be said to be 100% safe from a distribution cut, one of the two certainly has much better odds.
Balance sheet strength
The importance of a conservative leverage profile cannot be overemphasized today. With an outstanding debt of just $4.8 billion at the end of 2019, Magellan has a conservative debt-to-EBITDA ratio of slightly above 3 times. In comparison, MPLX has an outstanding debt of roughly $20 billion and a debt-to-EBITDA ratio of more than 5 times.
As of their most recent earnings reports, both Magellan Midstream and MPLX have a strong distribution coverage of around 1.4 times. However, a more conservative balance sheet places Magellan Midstream on a far stronger footing than MPLX if earnings fall. This financial discipline has allowed Magellan Midstream to raise its distributions 71 times since the company's IPO in 2001. Magellan has kept its first-quarter distribution unchanged from the previous quarter, despite a strong balance sheet, in line with its principle of stringent financial discipline.
Impact of low oil and gas prices
Low demand, excess supply, and the resultant low commodity prices are expected to affect both Magellan Midstream's and MPLX's earnings. While both transport and store crude oil and refined products, MPLX also has gas gathering and processing operations. In an investor update in late March, Magellan Midstream expected a 25% drop in gasoline and aviation fuel demand in the entire second quarter. That may not be too far off the mark based on the U.S. Energy Information Administration's data. . Further, the company assumes a month of transition, after which demand resumes to its pre-COVID period.
If this happens, the company estimates a reduction of $180 million in its 2020 distributable cash flow guidance of $1.2 billion. In this case, Magellan will have a distribution coverage of around 1.1 times for 2020. Even if the demand doesn't pick up as fast as Magellan has assumed, the company looks to have the wiggle room to maintain its payouts.
In comparison, MPLX's earnings may be slightly more affected due to its gas gathering and processing operations. Cheap gas is severely affecting Appalachia producers where MPLX has a lot of gathering and processing infrastructure. Credit ratings of several Appalachia producers were downgraded recently due to concerns relating to lower demand and prices. This exposes midstream operators also to counterparty credit risk and lower volumes.
MPLX too is exposed to volume reductions, more so if any of its customers goes bankrupt. A slight positive for Appalachia gas producers could be a possible market share gain as gas production from associated wells, which produce both oil and gas, falls in response to oil market dynamics. However, that doesn't protect MPLX much, which has significant assets in associated gas areas as well.
Another factor that increases MPLX's risks is its exposure to a limited number of key customers. For the year 2019, two of the company's key customers each accounted for around 14% of its gathering and processing segment's operating revenues. MPLX's earnings may be significantly affected if any of its key customers witness significant volume reduction or go bankrupt.
Similarly, MPLX generated 91% of its 2019 logistics and storage revenue from parent Marathon Petroleum (NYSE:MPC). MPLX's liquids logistics and transport volumes will fall as demand for products remains low.
The better buy is...
Both MPLX and Magellan Midstream are facing headwinds. Both may see volume reductions, especially in the near-term. However, Magellan stands better due to its conservative leverage and diversified customer base. MPLX's gathering and processing operations may also add volatility to its earnings.
If things become normal soon, and oil and products demand return to pre-COVID-19 levels, both the companies may fare fine. However, if demand remains depressed for a little longer, Magellan Midstream looks better positioned to face the crisis, while maintaining its payouts.