The midstream sector was a casualty of the drop in oil demand in 2020, facing long-term financial implications as exploration and production companies dialed back on drilling. The share price declines that resulted have left some of the best-run names in the sector with incredibly high yields, including Magellan Midstream Partners (MMP) and Enbridge (ENB 0.20%), with yields of 9.6% and 7.1%, respectively. Before you jump at the prospect of those higher yields, however, you should dig a little bit deeper. Here are a few key things to consider as you weigh an investment in either of these two midstream options.
1. Dividends and distributions
Clearly, if all you care about is getting the higher yield, then Magellan has the edge here. But there's more to this story. For example, as a master limited partnership (MLP), Magellan unitholders have to deal with the complications of a K-1 at tax time, and the MLP structure doesn't play well with tax-advantaged retirement accounts. Enbridge, meanwhile, pays its dividend in Canadian dollars, so the actual cash that U.S. investors see will vary along with exchange rates. But these are just surface issues.
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Magellan last increased its distribution in the fourth quarter of 2019. It held the disbursement constant throughout 2020, which increased its streak of annual distribution hikes to 19 years. However, it has already announced that it intends to hold the distribution at the same level throughout 2021. If it doesn't change course and boost the distribution by the end of the year, that streak of annual increases will end. And that's exactly what it is telegraphing.
Enbridge, on the other hand, increased its distribution by nearly 10% at the start of 2020 and then announced another 3% hike in early 2021. Its streak is up to 26 years and counting. If dividend growth is important to you, then Enbridge looks better positioned right now. Notably, its dividend payout is within its target range of 60% to 70% of distributable cash flow, so it doesn't appear to be stretching to keep its streak alive.
2. Growth
One of the key ways in which midstream businesses grow is by capital investment, effectively building scale from the ground up. Magellan's capital spending plans are pegged at $75 million in 2021, down from $355 million in 2020 and roughly $1 billion in 2019. It looks like the partnership's growth efforts have basically ground to a halt.
Enbridge, by contrast, believes it can spend roughly $3 billion to $4 billion a year through at least 2023, if not longer. It expects that spending will drive its distributable cash flow up by 5% to 7% a year. Its dividend payouts should continue to increase along the way. Once again, Enbridge comes out ahead.
3. The long term future
Another key difference between Magellan and Enbridge is what they actually do. Magellan owns a collection of oil and refined products pipelines. These are reliable fee-based businesses, but ones that are very much tied to the health of the oil sector. Enbridge's business is about 50% oil pipelines, so it has notable exposure to that same market. However, roughly 30% of its business involves its natural gas pipelines, which have an East Coast focus. Natural gas is a key energy transition fuel, as utilities move away from dirtier coal, and the regions in which Enbridge's pipes are located are supply-constrained. Another 15% or so of the company's business is tied to natural gas utilities, which are also seeing growing demand as other heating options get displaced. The rest of the company's portfolio is centered around electricity, with a heavy focus on offshore wind power in Europe. Almost all of these businesses are fee-based or backed by long-term contracts.
Of the two companies, Enbridge clearly is the one with the portfolio better suited to society's shift toward a cleaner-energy future. In fact, that's management's long-term plan. The company is using the earnings from its cash-cow oil pipelines to help fund growth in new areas so that it can remain relevant as the world around it changes. That's another point for Enbridge, given that Magellan remains tied to the status quo.
4. Leverage
Now we come to a metric where Enbridge loses to Magellan. The Canadian midstream company's financial-debt-to-EBITDA ratio is around 6.3, while Magellan's is just 3.7. This dichotomy is the norm for the two companies -- Magellan's leverage generally sits near the low end among their peers, while Enbridge's lands on the high end.
ENB Financial Debt to EBITDA (TTM) data by YCharts
In this regard, Magellan looks like it has a stronger balance sheet. However, it is worth noting that Enbridge has long operated with more leverage and managed itself quite well. Note the 26 years of annual dividend increases. Other midstream players with significant leverage -- including industry bellwether Kinder Morgan -- haven't managed the same feat.
The final call
Although Magellan is a generally well-run midstream partnership, it should be fairly obvious at this point that Enbridge looks like the better option for investors. Yes, it makes more aggressive use of leverage, but its dividend history is stronger, it has more substantial growth plans, and its diversified business is better positioned to ride the energy sector's long-term trends. Magellan's yield is notably higher, but for long-term investors, Enbridge still comes out well ahead.
