One of the biggest reasons for buying units of Magellan Midstream Partners (MMP) was its distribution, which has been increased annually since its 2001 IPO. But something major changed in 2020 and it is having a major impact on the partnership's business. Is it time to worry about the distribution?
Hitting the pause button
Magellan has increased its dividend annually for a very long time, but within that streak was another one, with quarterly hikes since the start of 2010. That smaller streak ended in 2020, with the master limited partnership's distribution sitting at $1.0275 per unit since the fourth quarter of 2019. To be fair, because of earlier increases in 2019 Magellan was able to notch another year of annual increases last year, so the yearly streak is still alive. However, an early warning sign of trouble on the dividend front is often when a company stops following its traditional dividend paying patterns.
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In fact, Magellan has already telegraphed an end to the annual streak. It has stated that it intends to maintain the current $1.0275-per-unit dividend through the end of 2021, which would mean no increase this year. But there's another problem in this commitment from the midstream name's first-quarter earnings release: "Management does not intend to provide specific financial guidance beyond 2021 at this time but expects to target annual distribution coverage of at least 1.2 times once refined products demand returns to more historical levels."
The expectation is that the distribution will be covered by around 1.17 times in 2021. So there's a reason to believe that Magellan will be able to keep supporting the current payout, assuming things do, indeed, return to "more historical levels." However, the goal of 1.2 times coverage is far from a statement that the distribution is secure.
Changing things around
And then there's the fact that Magellan has been selling assets. In April it sold a stake in a terminal joint venture for $270 million. To be fair, it retains a 25% interest and remains the operator of the asset, so it hasn't exactly jettisoned this investment. However, it followed that up with the sale of 26 independent terminals for $435 million in June. Basically, the partnership is circling the wagon around its oil (34% of operating margin) and refined products (66%) pipeline operations.
According to the June news announcement, "Magellan intends to use the proceeds from this transaction consistent with its stated capital allocation priorities." It said a similar thing about the April deal, though specifically noted that unit repurchases were a possibility. In a June investor presentation, the partnership outlined its capital allocation priorities as "a disciplined combination of capital investments, cash distributions and equity repurchases."
MMP Dividend Per Share (Quarterly) data by YCharts
The second capital allocation (distributions) is fairly obvious and is the main focus of the broader discussion here. The first and third are a bit more problematic. For example, the current capital investment plan for 2021 is a scant $75 million, which will fall to just $15 million in 2022. Building new assets from the ground up has been a core growth driver in recent years, with capital spending in 1999 totaling nearly $1 billion. That fell in 2020, as you might expect given the pandemic backdrop, but clearly, at this point, Magellan doesn't have any material growth prospects on the construction front. So don't expect increasing cash flows from newly built assets to save the day here.
Unit buybacks, meanwhile, are always open ended, given that the partnership doesn't actually have to follow through on any commitments it makes. That said, with the asset sales, if it doesn't buy back enough units to offset the reduction in cash flow from the sales, it will likely have a problem maintaining the distribution at its current level. With no growth projects in the works, buybacks should probably take on an increased importance for dividend investors. Indeed, repurchases could be the difference between Magellan's holding the line on the distribution or not in 2022.
Yes, there's reason for concern
There's no way to tell what the future holds for Magellan or its distribution. However, the partnership has clearly walked back its commitment to quarterly and annual increases. And without any specific target for 2022 beyond a distribution coverage goal, investors have to be thinking that a distribution cut is a real possibility. An acquisition could change the math here, as would unit repurchases, so investors should start to pay very close attention to management's comments as the year unfolds. The truth, however, is very clear: While Magellan is still a well-run midstream partnership, it may not be the reliable income option it once was.
