There's a lot of uncertainty in the energy sector right now, including the long-term push toward clean energy and the near-term geopolitical situation. However, when you step back and look at the global energy market, change is really pretty slow moving on the demand front. And that's great news for high yielding master limited partnership (MLP) Magellan Midstream Partners (MMP).
What does it do?
Magellan is tightly focused on oil, with its business spread between the infrastructure that moves crude oil (28% of operating margin) and refined products like diesel (the rest). The vast majority of its operations are fee-based, with just 9% of operating margin tied to "commodity-related activities." In other words, most of the cash flow that the MLP generates isn't impacted by commodity prices, but by the demand for energy.
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So far, this has been a very good business model for income-focused investors, and Magellan has increased its distribution every year since its initial public offering in 2001. For full-year 2022 it expects to cover its distribution by roughly 1.25 times, which is right in line with management's long-term coverage goal. Meanwhile, Magellan has an investment-grade-rated balance sheet, providing a solid financial foundation.
While it is true that many of the MLP's peers have been increasing their coverage ratios and have more attractive growth plans ahead of them, Magellan isn't sitting pat. Recognizing that near-term capital investment opportunities are modest, it has been buying back units at a rapid clip since 2020. Fewer units helps to support earnings per share figures and lowers the absolute dollar value that needs to be paid out as distributions. And, when the investment environment shifts and Magellan can again invest at return levels it deems attractive, the cash it is returning to unitholders via buybacks and be shifted back toward capital investment projects that boost fee income.
Although rapid growth is unlikely, there's no particular reason to expect the distribution to be cut. Magellan's huge 8.3% distribution yield should be pretty enticing for investors looking to maximize the income they generate today. That said, there's the long-term issue of the global pivot toward clean energy to worry about.
Nothing is changing fast
Unless you completely ignore the news, you know that investing in the clean energy future is a global focus. And eventually, clean energy will dramatically reduce the demand for dirtier carbon energy sources. However, this is not likely to be a quick transition -- it takes time, and a lot of capital, to build energy infrastructure.
In fact, the International Energy Agency actually expects demand for older carbon fuels like oil and natural gas to increase all the way up to 2040. And after that point it's highly likely that demand declines slowly over time. So Magellan should have years of demand ahead for the vital energy infrastructure that supports its cash flows.
The driving force here is important because you may not actually see it. In developed nations, where population growth isn't material, shifting to clean energy is a priority and captures headlines. In developing nations, however, the priority is increasing access to energy so countries can continue to climb the socioeconomic ladder. Energy is easily one of the most vital aspects of that climb, and all sources will likely be put to work. If that means continuing to use oil, that's what will happen. Note, for example, the continued investment in coal, one of the dirtiest fuels, in China.
Magellan's business remains on solid ground as long as the world needs carbon fuels like oil and diesel. And at this point, there's no reason to believe these key energy sources are going away anytime soon.
A contrarian play
If you can look past the headlines and see the bigger trends taking shape worldwide, then you shouldn't ignore Magellan Midstream Partners and its huge distribution yield. Yes, you'll be taking a position that seems counter to the mainstream zeitgeist, which may be uncomfortable for more conservative types, but there's no reason to expect Magellan's distribution to succumb to the clean energy shift for many years to come. If you are looking to boost the income you generate, this is a unique and focused energy MLP worth a deep dive today.
