Magellan Midstream: Pipeline profits

by Carla Pasternak, editor High Yield Investing

Magellan Midstream Partners (MMP), an MLP, owns the longest refined petroleum product pipeline system in the US; the 9,600-mile system connects refineries in the Gulf of Mexico and Midwest to wholesalers and industrial users from Texas to North Dakota.

Magellan was one of my first portfolio additions, bought in 2005 at $33.96. Since then, it has paid $17.71 per unit in distributions, and the price has more than doubled, for outstanding total returns of 165%.

The partnership has not missed a distribution since initiating payouts in 2001. In fact, distributions have been hiked every quarter, except for three quarters during the financial crisis when they remained stable.

During the past decade, the distribution has grown a remarkable 11% on average each year. Unlike many MLPs, Magellan's general partner doesn't have distribution incentive rights, and that leaves more cash flow for distribution to public partners like you and me.

The latest quarterly distribution of $0.815 per unit translates to $3.26 annually for a 4.5% yield.
And management is targeting 9% distribution growth in 2012 and a further 8% to 10% distribution growth in 2013.

Distributions are secured by stable fee-based businesses that account for around 85% of operating margins. The partnership is paid by volume handled in its pipelines, storage facilities and terminals.

Less than 15% of operating margins are tied to volatile commodity prices. That makes for steady cash flow and distributions. Plus, the partnership keeps growing. In the past seven years, Magellan has invested $2.3 billion in acquisitions and expansion projects.

As a result, earnings per diluted unit have grown an average 5% annually, despite a 60% increase in outstanding units over this seven-year period.

The company generated record results for 2011. Revenue rose 12% to $1.8 billion and net income climbed 33% to $413.6 million ($3.66 per diluted share), compared with $311.6 million ($2.85 per diluted share) in 2010.

Distributable cash flow (cash available for distributions) was a record $460.5 million in 2011, or 1.3 times the amount needed to pay 2011 distributions.

Looking ahead, management projects another record year in 2012, as expansion projects come online. It expects distributable cash flow to increase by 4% to a record $480 million and net income per unit by nearly 3% to $3.75, with first-quarter guidance of $0.98.

Growth will be driven by ongoing expansion projects, including a pipeline reversal, a pipeline expansion, and additional storage capacity.

To pay for this growth, Magellan typically uses a combination of internally generated cash flow supplemented by debt or equity.

At year-end 2011, the partnership had total debt of $2.1 billion at an average interest rate of 5.3% due between 2014 and 2037. Owner's equity of $1.5 billion gave a reasonable debt to equity ratio of 1.4 times.

The debt is easily affordable as interest expense of $105.7 million at December 31, 2011 was covered 4.9 times by earnings before interest and taxes (EBIT) of $521.1 million.

If history is any guide and corporate guidance can be taken at face value, Magellan Midstream Partners should continue to be a strong performer and provide investors a growing income stream.

The units are trading at their highest ever price levels, and new investors may wish to wait for a pullback. But given management's upbeat outlook and promised distribution hikes, this outperformance could continue for a while.

Learn more about this financial newsletter at Carla Pasternak's High Yield Investing.

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