With yields of roughly 10%, Enterprise Products Partners (NYSE:EPD) and Magellan Midstream Partners (NYSE:MMP) are certainly offering a level of income that will attract dividend-focused investors. But a high yield alone doesn't tell the whole story. Is one of these two historically conservative midstream players better than the other, or are the high yields signs of brewing trouble? This quick primer will help you decide.
Energy is ugly
The first big question for investors is whether Enterprise and Magellan are even worth looking at, given that oil is in the doldrums. The answer is yes. Both of these master limited partnerships generate the lion's share of their operating margins (85% or more) from fee-based businesses. That means they get paid for the use of their assets; the price of what's moving through the midstream assets they own isn't the most important factor.
This is important, because it means their top and bottom lines tend to be fairly resilient in the face of energy price volatility, as we're seeing today. To put a number on that, Magellan's distributable cash flow fell about 3.5% in the first quarter, while Enterprise's dropped 4.5%. That's a modest decline, given that oil prices have been hovering at historically low levels. There's a host of reasons for the energy sector's malaise, many of which remain in play -- but the point is that, unlike oil drillers, Magellan and Enterprise have fairly resilient business models.
There will be an impact
Although unlikely to be hit as hard as exploration and production names, which are increasingly seeking out bankruptcy court protections, Magellan and Enterprise will see an impact from the energy market's current woes. The first quarter was evidence of that, and it will continue. Demand for these energy sources is still there, but it is relatively weak today compared to historical norms. That means that less oil and natural gas could be flowing through these midstream companies' assets. Moreover, it means there will be less demand for new assets, and both are pulling back on capital spending plans. That will lead to slower growth in the near term.
That said, these midstream partnerships have rock-solid balance sheets. For example, financial debt to EBITDA at Magellan was roughly 3 at the end of the first quarter. Enterprise's number on that metric was about 3.5. (For reference, peer Kinder Morgan had a financial debt to EBITDA ratio of around 5.5.) Both are at the low end of the midstream space, which is pretty much where these conservatively run partnerships usually find themselves. See the chart below.
Where there's a notable difference, however, is in the distribution. Magellan is expecting distribution coverage to be roughly 1.1 times this year. That's a little tight when you consider that Enterprise's distribution coverage was a pretty robust 1.6 times in the first quarter. From that perspective, income-focused investors should be far more comfortable in Enterprise's ability to support its distribution should things get even worse in the energy patch.
Spreading things around
The biggest points of difference between Magellan and Enterprise, however, are probably scale and diversification. Magellan's market cap is around $9 billion, and it operates two main businesses, refined products and crude oil. Both, however, are largely pipeline- and storage-based operations. Enterprise, on the other hand, has a market cap of $38 billion, and operates pipelines, storage, processing facilities, transportation, and ports. That's a quick overview, but Enterprise is truly one of the largest and most diversified midstream players in North America. It definitely gets the nod for more conservative investors who believe in spreading their eggs across as many baskets as possible.
Neither is bad, but one stands out
At the end of the day, both Magellan and Enterprise are conservative and well-run midstream partnerships. However, with the energy industry facing substantial headwinds, Enterprise comes out ahead in this matchup because of its broader diversification and more material distribution coverage. You probably wouldn't be making a mistake if you bought Magellan, but if you had to pick here, Enterprise looks like the better option today.