An Underperforming MLP to Avoid and 2 Alternatives

As an income investor I am drawn to MLPs because of the attractive yields they offer. Because of this there are four main things that concern me: yield, distribution growth, distribution safety, and valuation. When analyzing an MLP, I am not only trying to help the average investor better understand these metrics in the context of a single company but how that company compares to its rivals. Investing is never done in a vacuum, and tough choices must be made when deciding where to invest. For this reason I recommend investors stay away from Buckeye Partners (BPL) and instead consider Magellan Midstream Partners (MMP) and Kinder Morgan Energy Partners (NYSE: KMP).

There are three main reasons I feel investors would be better served investing in Magellan Midstream and Kinder Morgan: better access to faster growing energy markets, better operating results, and better valuation. 

Pipeline locations
The first reason can be explained by the old adage, "location, location, location." Buckeye Partners' 6,000 miles of pipelines are primarily located in the Midwest and Northeast. It has access to the fast-growing Marcellus and Utica shale formations but is missing out on the fracking booms in the Gulf Coast and the Permian Basin of Texas. It has minimal exposure to the Eagle Ford shale area and none in the North Dakota Bakken formation or Alberta Tar sands region. 

In contrast Magellan Midstream's assets are optimally located to take advantage of the oil boom in Texas, as well as North Dakota's Bakken formation. 

Meanwhile, Kinder Morgan Energy Partners has the largest natural gas network in North America. Its pipelines are located not only in the Marcellus and Utica shales but also in Texas, North Dakota, the Gulf Coast basin, and the Alberta Tar Sands.

In the coming decades, the majority of oil and gas exploration and production will come from areas that Buckeye's competition has better access to, as well as more resources to exploit. This brings me to my second reason for staying away from Buckeye: relative operational underperformance. 

Better management

Data from Morningstar

As seen in the above table, Buckeye Partners is about even with its industry when it comes to operational efficiencies and profitability. However, Kinder Morgan's net margin is nearly eight times higher than the industry average, and Magellan's net margin is an incredible 800% greater than the average midstream company's. In addition to better operating metrics, Buckeye's competitors also have a better history of acquisitions (the bread and butter of midstream MLP growth). 

Both Magellan and Buckeye have bought out their general partners, thus greatly increasing the amount of distributable cash flow available to limited partners (the average investor). However, Magellan did so in 2009 during the financial panic at eight times EBITDA. Buckeye Partners on the other hand did so in June of 2010 at 26 times EBITDA. To understand just how much Buckeye overpaid for this acquisition consider this: Right now Buckeye Partners is trading at its all-time high. The price/EBITDA is 14.07, nowhere close to 26.

In addition to overpaying for its general partner, Buckeye had to write down $170 million in goodwill as an impairment charge due to its failed $440 million 2007 acquisition of Lodi gas storage. This was in the third quarter of 2011, but the company has discontinued operations at the California storage facilities and is planning on divesting the assets in 2014. 

Contrast this with Magellan's far wiser recent investments in its BridgeTex joint venture pipeline with Occidental Petroleum. This pipeline will pay for itself in only eight years, and the Longhorn pipeline reversal will pay for itself in three. Both projects are coming online in mid 2014, are fully contracted, and will greatly increase Magellan's distributable cash flows. This is why Magellan's management is guiding for distribution growth of 20% in 2014 and 15% in 2015. 

The final reason that investors should consider investing in Kinder Morgan or Magellan Midstream over Buckeye Partners is valuation.

Data from Yahoo Finance

Bottom line
As seen above, Buckeye Partners has one of the highest enterprise value/EBITDA ratios (measure of business valuation/operating cash flows) in its industry. Given the sup-optimal location of its assets and its industry average efficiencies and profitability, this high valuation is unjustified. Investors can find higher yield, faster distribution growth, and better long-term growth prospects from Kinder Morgan Energy Partners.

In Magellan Midstream Partners investors can find one of the fastest growing distributions, industry-leading profitability, and a management team with a track record of acquisition and organic investing success. Each of these superior Buckeye competitors is trading either at a justifiable premium (Magellan) or is undervalued (Kinder Morgan). To put it more simply, why overpay for hamburger when steak is on sale?