1 High-Yielding MLP That Continues Doing Things the Right Way

Over the past five years, Magellan Midstream Partners (NYSE: MMP) has generated a total return of nearly 70%. That’s quite impressive considering that most master limited partnerships (MLPs) have lost value over that timeframe. One of the reasons the company has delivered such strong total returns is that it has steadily increased its payout even as rivals have either stopped raising their distribution, or cut it. Magellan has avoided this fate by investing within its means instead of stretching to grow at a faster pace.

Growing to create value, not build an energy infrastructure empire

Over the past decade, Magellan Midstream Partners has invested $5.4 billion in expanding its refined products and crude oil infrastructure business via targeted acquisitions and organic expansion projects. The company has largely funded this growth with retained cash flow and a modest amount of debt. Because of that, the company has only needed to issue $260 million of new equity (all in 2010), which represents a mere 5% of total spending. The company has also managed to keep its leverage ratio to less than 4.0 times debt to EBITDA (it’s currently just 3.3 times), which is why it has one of the best credit ratings among MLPs.

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Because Magellan Midstream Partners has lived within its means over the past five years, the average number of units it has outstanding is up less than 1%. Contrast that with rivals Buckeye Partners (NYSE: BPL) and Energy Transfer Partners (NYSE: ETP), which have a much more aggressive approach to financing growth because they typically pay out virtually all their cash flow to investors each quarter. That forced both to issue a boatload of new equity and debt to fund acquisitions and expansion projects. As a result, Buckeye’s outstanding unit count has surged 41%, while Energy Transfer’s is up a jaw-dropping 120% over the past five years.

Meanwhile, both have more highly leveraged balance sheets with debt-to-EBITDA ratios currently well above 4.0 times. While that new debt and equity has enabled both companies to expand the size of their infrastructure portfolios at a faster pace, investors haven’t benefited from this growth. Not only have both companies stopped increasing their payouts, but Energy Transfer Partners has delivered a total return of just 2% over the past five years, while Buckeye has produced a negative total return of 16%.

Sticking with what works

Magellan Midstream Partners currently has about $1.7 billion high-return expansion projects under construction that should enter service through 2020. Because of the company’s low leverage ratio and healthy distribution coverage, it can finance these projects without having to issue any equity. That ability to grow within its means gives Magellan Midstream the confidence that it can increase its 5.3%-yielding payout by 8% this year and at a 5% to 8% annual rate in 2019 and 2020, even as it maintains a healthy 1.2 times distribution coverage ratio and keeps leverage below 4.0 times. That steadily growing distribution should enable investors to continue earning outsized total returns.

At the same time as Magellan’s more conservative business model puts it on pace to continue growing value for investors, the more aggressive approaches of Energy Transfer and Buckeye could see them further erode investor value in the coming years. In Energy Transfer’s case, it’s searching high and low to find the capital it needs to finance the roughly $10 billion of expansion projects it has under construction. Because of its tight financial situation, its yield has risen into the double-digits, a sign that investors fear the company might need to cut the payout to get its finances on more sustainable footing. Buckeye Partners, likewise, has a double-digit yield because investors fear a cut is coming down the pipeline since the company has only covered it with cash flow by a worrisome 0.96 times over the past year, meaning it paid out more than 100% of its cash flow, which isn’t sustainable over the long term.

A great high-yield stock for the long haul

Magellan Midstream’s focus over the years has been on growing the value of the company, not building an energy infrastructure empire. The company’s more conservative approach has paid off by helping it create significant value for investors at a time when some rivals have destroyed value in their overly aggressive attempts to grow. Magellan’s differentiated business model is why it remains an excellent high-yield stock to consider holding for the long term.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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