Demand for refined-petroleum products like gasoline and diesel fell off a cliff during the second quarter because of government-imposed travel restrictions to slow the spread of COVID-19. That had a significant impact on MLP Magellan Midstream Partners (NYSE:MMP), which operates the country's longest refined-products pipeline system. Its volumes and cash flow tumbled during the quarter, causing some concern about the sustainability of its nearly 10%-yielding dividend.

However, despite the turbulent market conditions, Magellan believes it will generate more-than-enough cash to maintain its payout. Here's a look at the quarter and what the MLP sees ahead.

Drilling down into Magellan Midstream Partners' second-quarter results

Metric

Q2 2020

Q2 2019

Change

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA)

$289.4 million

$378.3 million

-23.5%

Distributable Cash Flow (DCF)

$209.5 million

$314.8 million

-33.4%

DCF per unit

$0.93

$1.38

-32.6%

Distribution coverage ratio

0.9 times

1.36 times

-33.8%

Data source: Magellan Midstream Partners.

There's no way to sugarcoat things: The second quarter was an abysmal one for Magellan Midstream. Earnings tumbled nearly 24%, while cash flow fell by a third. Because of that, the company paid out more money via its distribution than it generated from operations.

Several issues impacted its results. In the refined-products segment, operating margin tumbled 31.7% to $171.4 million, due mainly to lower demand associated with travel and economic restrictions to slow the spread of COVID-19. The company also discontinued an ammonia pipeline late last year and sold three marine terminals in the first quarter of 2020, which cut into its revenue. Those negatives more than offset higher rates and the start up of a new pipeline late last year.

Meanwhile, the operating margin from crude-oil-related assets plunged 21.4% to $128.3 million. The main issue was lower volumes on its Longhorn pipeline because of weaker oil prices. The company experienced a similar problem on its jointly owned BridgeTex Pipeline and lost some income by selling a 10% stake in its Saddlehorn pipeline earlier this year.   

A closeup of a calculator with stacks of coins next to it.

Image source: Getty Images.

A look at what's ahead for Magellan Midstream Partners

States have started reopening their economies, fueling an increase in travel and economic activity from their lows in April. However, the pace remains uncertain, especially given the surge in cases across the Sunbelt region, which could force governments to reimpose restrictions. Because of that, the company slightly reduced the top end of its full-year guidance range. It now sees its distributable cash flow between $1 billion and $1.05 billion versus $1 billion and $1.075 billion in May.

On a positive note, that's enough money to cover the company's distribution by 1.1 to 1.14 times, leaving it with between $75 million to $125 million of excess cash. While that's below the company's long-term target range of at least 1.2 times, Magellan's top-tier balance sheet gives it the confidence to maintain its payout.

Magellan's balance sheet, which it has bolstered this year via asset sales, is providing most of the funding for capital projects. The company currently expects to spend $400 million on growth projects this year, most of which are nearing completion. Meanwhile, growth-focused spending is on track to decline to just $40 million in 2021. However, the company is evaluating more than $500 million of potential projects it could sanction.

Walking a tightrope

After a brutal second quarter, Magellan Midstream's dividend isn't as secure as it once appeared. However, the company believes it can maintain its current level, thanks to its balance sheet's overall strength. It has one of the top credit ratings in the MLP sector and a leverage ratio that should be in the range of 3.4 to 3.7 times debt-to-EBITDA at year-end, comfortably below its four times target. That gives it lots of cushion during these turbulent times.

As long as demand bounces back like Magellan expects, it should be able to maintain its payout in 2020 and beyond.