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Author: Ron Hiram
Published: August 15, 2015
Summary:
- Operating margin, EBITDA and DCF increased in 2Q15 vs. 2Q14 both in absolute and per unit terms.
- There were no material differences between reported and sustainable DCF.
- Despite industry headwinds, 2Q15 coverage ratio remained among the strongest in the universe of midstream energy MLPs.
- The projected 15% increase in distributions remains intact and coverage for 2015 is projected at a strong 1.3x. MMP also projects a 10% increase in distributions per unit in 2016.
- Investors looking to increase their exposure midstream energy MLPs should strongly consider MMP.
This article analyses some of the key facts and trends revealed by 2Q15 results reported by Magellan Midstream Partners L.P. (MMP). It also evaluates the sustainability of the partnership’s Distributable Cash Flow (“DCF”) and assesses whether MMP is financing its distributions via issuance of new units or debt.
MMP is engaged in the transportation, storage and distribution of refined petroleum products and crude oil. Its 3 operating segments are:
- Refined Products: this segment primarily transports gasoline and diesel fuels and includes an 9,500-mile refined products pipeline system with 52 terminals, 42 million barrels of storage, as well as 27 independent terminals not connected to MMP’s pipeline system, and its 1,100-mile ammonia pipeline system;
- Crude Oil: this segment is comprised of ~1,600 miles of crude oil pipelines and storage facilities with an aggregate storage capacity of approximately 21 million barrels; and
- Marine Storage: this segment consists of 5 marine terminals located along coastal waterways with an aggregate storage capacity of ~26 million barrels.
Operating margin by segment for recent quarters is presented in Table 1 below. Operating margin is a key non-GAAP metric used by management to evaluate performance of its business segments. It includes revenue from affiliates and external customers, operating expenses, cost of product sales and earnings of non-controlled entities.
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Table 1: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.
Commodity-related activities within the Refined Products segment include butane blending and fractionation. Operating margin generated by these activities are, relative to fee-based activities, far more volatile. Product margin (i.e., commodity-related margin) as a percent of total operating margin dropped to 5.4% in 2Q15 from 10.8% in 2Q14 and is at its lowest level in at least 5 years. It stands at 16.8% for the trailing twelve months (“TTM”) ended 6/30/15, down from 18.6% in the corresponding prior year period.
Total operating margin increased $22 million vs. 2Q14 (see Table 1), while earnings before interest, depreciation & amortization and income taxes (EBITDA) increased by $30 million and Adjusted EBITDA increased by $35 million:
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Table 2: Figures in $ Millions (except per unit amounts and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.
Adjusted EBITDA is another key metric used by management to evaluate its financial results. The adjustments include adding back equity based compensation and impairment charges, deducting derivative gains, and adding back derivative losses on commodity transactions.
MMP derives DCF by deducting interest expense, maintenance capital expenditures and provisions for taxes from Adjusted EBITDA. DCF reported by MMP and distributions for the periods under review are presented in Table 3:
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Table 3: Figures in $ Millions (except ratios and % change). Source: company 10-Q, 10-K, 8-K filings and author estimates.
These are outstanding results. Coverage ratio remained very strong in 2Q15 despite industry headwinds. The excess cash retained constitutes a significant source of capital for MMP and enables it to reduce reliance on the issuance of additional partnership units or debt to fund growth projects.
The generic reasons why DCF as reported by an MLP may differ from what I call sustainable DCF are reviewed in an article titled “Estimating sustainable DCF-why and how“. MMP’s definition of DCF and a comparison to definitions used by other MLPs are described in an article titled “Distributable Cash Flow”.
The comparison between reported and sustainable DCF presented in Table 4 indicates no material differences between reported and sustainable DCF for the TTM periods under review:
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Table 4: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Table 5 below presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded:
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Table 5: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Net cash from operations, less maintenance capital expenditures, exceeded distributions by $390 million and by $284 million in the TTM ended 6/30/15 and 6/30/14, respectively. Clearly, MMP is not using cash raised from issuance of debt to fund distributions. On the contrary, the excess cash generated constitutes a significant source of capital for MMP and enables it to reduce reliance on the issuance of additional partnership units or debt to fund growth projects.
Based on 2Q15 results, MMP slightly increased its 2015 guidance for both Adjusted EBITDA and DCF (by $10 million to $1,115 million and $880 million, respectively (vs. the $1,082 million and $880 million actually achieved in 2014). The projected 15% increase in distributions remains intact and coverage for 2015 is projected at a strong 1.3x. MMP also projects a 10% increase in distributions per unit in 2016.
Based on the progress of expansion projects already underway, MMP is increasing its expansion capital spending by $200 million to approximately $1.4 billion, with $850 million of that spending in 2015 and $550 million in 2016. MMP expects its investments in expansion projects to average 6-7x EBITDA. Based on that, EBITDA would increase by ~$200 million once the full $1.4 billion is placed into service. This is an 18% increase from the current level (i.e., from EBITDA in the TTM ended 6/30/15).
Table 6 provides selected metrics comparing the MLPs I follow based on the latest available TTM results. Of course, investment decisions should be take into consideration other parameters as well as qualitative factors. Though not structured as an MLP, I include KMI as its business and operations make it comparable to midstream energy MLPs.
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Table 6: Enterprise Value (“EV”) and TTM EBITDA figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates.
Note that BPL, EPD, KMI, MMP and SPH are not burdened by general partner incentive distribution rights (“IDRs”) that siphon off a significant portion of cash available for distribution to limited partners (typically 48%). Hence multiples of MLPs without IDRs can be expected to be much higher (see Table 4, column 5). In order to make the multiples somewhat more comparable, I added column 6, a second EV/EBITDA column. I derived this column by subtracting IDR payments from EBITDA for the TTM period. Other approaches can also be used to adjust for the IDRs of the relevant MLPs.
Even after adjusting for IDRs, the gap between MMP’s multiple and that of some of the other MLPs remains substantial and MMP appears pricey when measured solely by that metric. On the other hand, MMP has a disciplined management with an outstanding track record, superior distribution coverage, lower leverage, an ability to generate significant excess cash from operations, and good growth prospects.
On top of that, MMP should receive top marks for minimizing limited partner dilution. In over four years (since 3Q 2010), MMP has not issued additional partnership units (excluding units issued in connection with compensation arrangements), a significant accomplishment and rare achievement in the MLP universe. Nor does management anticipate needing to issue units in the foreseeable future. This is all the more impressive given that MMP has kept its leverage much lower than most MLPs (currently 3x Adjusted EBITDA on a TTM basis). Another impressive performance metric is MMP’s net income per unit. Unusual for an MLP, it exceeded distributions per unit year-to-date in 2015, as well as in 2014 and in 2013. Not only that, it did so by a wide margin.
Given these factors, I would favor MMP for investors looking to increase their exposure midstream energy MLPs.