Better Buy: Magellan Midstream Partners vs. Crestwood Equity Partners

Energy has been one of the best performing sectors this year as oil demand and prices recover from their pandemic-driven low last year. However, despite the bounce back, many energy stocks still trade at low valuations. As a result, some have high dividend yields.

That's certainly the case for energy master limited partnerships (MLPs) Magellan Midstream Partners (MMP) and Crestwood Equity Partners (CEQP). Both currently yield about 9%, mainly because of their bottom-of-the-barrel valuations. Here's a closer look at which one is the better buy right now.

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Drilling down into their financial profiles

The first thing an investor should do when analyzing income-focused investment options is to look at their financial profiles. Here's how these two MLPs stack up against each other:

Data source: Crestwood Equity and Magellan Midstream.  

As that table shows, Magellan and Crestwood both yield 9% and generate relatively steady cash flow backed primarily by fee-based contracts or regulated rates. However, there are two notable differences between the two. Magellan has an investment-grade balance sheet -- and one of the highest ratings in the midstream sector -- backed by a lower leverage ratio. Meanwhile, Crestwood has a much more conservative dividend payout ratio of around 50% of its cash flow.

Digging a little deeper, investors will discover that Magellan's payout is on rock-solid ground despite its high dividend payout ratio. That's because the company expects to generate about $100 million in excess cash this year, which is enough to cover its remaining expansion projects (about $75 million for 2021) with room to spare. That leaves it with some money to buy back its beaten-down units.

Likewise, Crestwood expects to generate enough cash to fund its big-time distribution and remaining expansion-related spending with room to spare. It therefore plans to pay down debt and repurchase more of its dirt cheap units this year.

Drilling down into their valuations

Another essential factor to consider when comparing two companies in the same sector is their valuations.

Magellan Midscream expects to generate slightly more than $1 billion of distributable cash flow this year, somewhat less than last year's level. With a current market capitalization of $10.2 billion, Magellan sells for about 10 times its cash flow. That's relatively cheap for an investment-grade company that generates lots of stable cash. 

Meanwhile, Crestwood expects to produce about $360 million of distributable cash flow this year at the midpoint of its guidance range, also slightly less than last year's level. However, the much smaller Crestwood only has a $1.75 billion market cap, implying it trades at less than five times its cash flow. 

There's no good explanation as to why Crestwood sells for a 50% lower valuation than Magellan. While it has a weaker balance sheet, it's generating stronger cash flow as it grew more than 15% last year while Magellan's declined because of the outsize impact the pandemic had on its refined products-focused business. That deeply discounted valuation recently led Crestwood to buy out a former strategic investor, taking on debt in the process because it was too good a price to pass up.

Same high yield, even cheaper price

Magellan and Crestwood both pay monster 9%-yielding distributions because their valuations haven't fully recovered from last year's oil market downturn. However, Crestwood trades at a 50% discount to Magellan's valuation for no apparent reason other than it doesn't have investment-grade credit. So it looks like the better buy between the two for income investors since it has even greater upside potential as the oil market continues recovering.