Magellan Midstream Partners: A Much Misunderstood Partnership (NYSE: MMP)

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(Note: This article originally appeared in the June 26, 2022 newsletter and has been updated as needed.)

Magellan channel partners (NYSE: MMP) is a very strong partnership with one of the highest financial strength ratings in the industry. Like enterprise products The partners (DEP), this company is also rated investment grade. But unlike Enterprise Products Partners, this company transports refined products and does a lot of petroleum-related business. The market does not make the link here with the green revolution that is happening with natural gas products. Yet petroleum-based products find their way into our lives in so many ways that the future remains bright even if demand for fuel disappears tomorrow.

Some of the more unexpected products made from petroleum include aspirin, thread, pencils, lotion, and petroleum jelly. In fact, one would be surprised at all the beauty products (like lipstick) made from petroleum, coal, and coal tar. In addition, oil has carbon-hydrogen chemical bonds that are easier to break than the oxygen-hydrogen bonds in water. If ever the day came when natural gas became too expensive to serve as a feedstock for the growing hydrogen market, then oil would be another possible place to make hydrogen (though not the only one). from afar).

Meanwhile, oil, like natural gas, is slowly making its way into the green revolution. This part of the industry has done much less to tout the progress made in helping the market find these green end products. Nevertheless, the dependence on non-renewable resources will have to change first before we ever lose that dependence. It involves an ingrained habit change that is unlikely to be a quick process. For this reason, many still show the need for oil and natural gas in the future.

Magellan Midstream is heavily involved in the “first stage”. This first step largely involves getting products to and from refineries

Magellan Midstream Refined Products Distribution and Storage Map

Magellan Midstream Refined Products Distribution and Storage Map (Magellan Midstream August 2022, corporate presentation)

The company wants to be a “one-stop shop” for its main customers. The whole activity is largely paying. The convenience of dealing with a major carrier of these types of cargo is obvious. The partnership has competition “everywhere” but has a competitive advantage simply because its large size provides its customers with many convenient alternatives.

Magellan Midstream Breakdown of Paid Activities

Magellan Midstream Breakdown of Paid Activities (Magellan Midstream August 2022, corporate presentation)

The business is largely fee-based and is further insulated from industry cycles by long-term take-or-pay contracts. This business will show something cyclical in nature. But it won’t be anything close to the cyclical upside swings that investors constantly see.

Still, Mr. Market doesn’t like the negative earnings comparisons that come with any cyclical nature. Despite the stability of this business and good financial strength, these units will often follow upstream companies down whenever the upstream experiences a cyclical downturn. More often than not, the cushion provided by financial strength usually makes this business a good deal whenever the upstream industry suffers from low commodity prices.

Magellan Midstream Long-Term Profitability Comparison

Magellan Midstream Long-Term Profitability Comparison (Magellan Midstream August 2022, corporate presentation)

Despite some cyclical trends in the business, management has kept the profitability of the partnership in an excellent range. Good profitability also offers some protection against investment downturns, as the market respects decent profits and the cash flow that comes with those profits.

One of the side issues with many “history stocks” and “new industry pioneers” is the tendency to report earnings without cash flow. This occurs when depreciation and other cost allocation methods are insufficient to actually record the amount of expenses needed to cover revenue.

Investors should remember that accountants win new clients through a competitive process. This competitive process puts pressure on them to “soften” their normal conservative tendencies. Accountants are notorious for adjusting cost allocation guidelines after an issue has made headlines. This is due to this competitive pressure which limits the amount of revenue and therefore the time spent finding outright fraud as well as aggressive accounting which is unlikely to be allowed in the future.

Investors can counter this trend toward public accounting by looking at the cash received from reported earnings. At some point, even growing businesses will have cash flow from operations. Investors need to keep “executives under fire” to ensure cash hits the bottom line and deadlines aren’t pushed back.

Magellan Midstream Record Money Return to Investors

Magellan Midstream Record Money Return to Investors (Magellan Midstream Aug 2022 Investor Presentation)

Magellan Midstream has a long tradition of returning excess cash to shareholders. The profitability presented above makes it possible to maintain this record while maintaining a low leverage effect. Note that in the early stages of an industry recovery, midstream capacity continues to fill from the previous downturn. So the need for a lot of expansion just isn’t there.

Free cash flow will change as the industry recovery gathers pace and more midstream capacity is needed. The use of share buybacks has allowed this partnership to have a track record of attractive long-term distribution growth. Management wisely did not increase distribution quickly during this period of record free cash flow. Some of this free cash flow will be needed as demand for more capacity increases cyclically as in the past.

Magellan Midstream Leverage Ratio History and Financial Strength Rating

Magellan Midstream Leverage Ratio History and Financial Strength Rating (Magellan Midstream Aug 2022 Investor Presentation)

Magellan Midstream has maintained leverage ratios at some of the lowest levels in the industry for a major independent midstream company. The result is that rare investment grade rating for a mid-tier company. Management has the necessary level of leverage to be able to fully fund future expansions with debt if this proposition is profitable enough or if management chooses to increase the leverage ratio.

Any top quality company has more than adequate access to debt markets at reasonable rates. Additionally, the company has long been self-financing, so no adjustments were needed when the market clamped down on competitors who raised capital to help fund future expansion projects. The resulting periodic stock dilution was largely absent here.

A well-run midstream like this will provide some appreciation combined with a generous cast. The total return should be in the teens. Units can be held by investors until the story changes or until the stock price becomes so outrageously high that it would take years of growth to justify the price. It’s so unlikely in an industry that isn’t considered part of the green revolution that it’s not worth worrying about. As a result, most investors can buy it at any pullback and likely hold it “forever” as long as there are no adverse management changes or changes in the “steady state” story. and as you go.” This stock will appeal to a wide range of investors.

(Note: This company issues a K-1. Investors should be fully familiar with all aspects of a K-1 before investing).

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