Why I Added This MLP to my Retirement Account
Based on several media stories lately, I'm probably in the minority for saying this. I am a big fan of Master Limited Partnerships for my retirement account. Not because I need the income today -- I'm pretty sure I'm quite a few years away from retirement -- but instead I like the idea of reinvesting those high distribution payments over time. This is one of the reasons that I recently added Magellan Midstream Partners to my retirement account.
Of course, the simple fact that Magellan is a MLP isn't the only reason I bought this company. There are several factors that made me decide to select Magellan over many of its peers. Let's take a look at the reasons I decided to purchase this company -- perhaps they will give you some information about the company that will help guide you in your financial decisions.
The 3 factors influencing my decision
There are lots of things that make Magellan a compelling company to buy, and the best way to categorize them is into three parts: The business model, the potential, and the corporate culture/structure.
The business model: Four of the largest master limited partnerships have specialties that gives them distinct competitive advantages: Enterprise Products Partners has natural gas liquids, Kinder Morgan Energy Partners has pure natural gas, Plains All American has crude oil, and Magellan Midstream has refined petroleum products. Each of them is the dominant American player in each respective space.
Like it or not, oil and gas will continue to be in demand for many years to come, and as long as that demand is there, we will need efficient infrastructure to deliver those products from the well to the pump. Over the several decades prior to the recent energy boom, the value chain for oil went something like this: Imported crude oil makes its way to coastal refineries where it is then transported as finished products across the U.S. This made Magellan Midstream an incredibly important factor in this value chain. It's near-10,000 miles of pipelines and storage terminals are designed to transport and store refined products from the Gulf Coast throughout the Midwest, Rocky Mountains, and Southeast United States.
But wait, we are in an oil production boom, and places like North Dakota are producing gobs of oil, Right? That is true, but the refining capacity in these parts of the country is much more limited. The Gulf Coast region of the U.S. has more than 50% of the nation's refining capacity. So unless there are some major investments to build new refineries across the United States -- not that likely considering costs and the highly technical term known as "not in my backyard" -- we will likely see much of that crude moved down to the Gulf Coast and then transported back to the rest of the country through refined product pipelines. Since Magellan has refined product pipeline connections to over 50% of the nation's refining capacity, it has a distinct competitive advantage in delivering oil and gas to gas pumps across the nation.
Also, since it is a Master Limited Partnership, investors should look for stable, predictable cash flows that won't be interrupted by things like changes in commodity prices. A majority of Magellan's revenue is based on volume pricing and fee based services -- approximately 85% of the company's operating income comes from activities that aren't based on commodity prices. So the biggest threat to the company's business would be a major downturn in gasoline demand. While this is certainly a long term threat, it will still take years before this actually happens. Magellan estimates that the total refined product demand in its serviced markets will decline by less than 0.5% within the next 10 years.
The possibilities: Even though Magellan has one of the more complete refined products pipeline networks, the real growth in the pipeline business is on the other side of the refinery: crude oil. Shale oil formations such as the Permian and Eagle Ford are growing in leaps and bounds. Even though rail has been there to cover the shortage of takeaway capacity from these regions, long term pipelines are the cheaper method of transportation. This is why Magellan's decision to dedicate 80% of its near $1 billion 2014-2016 capital budget to crude oil pipelines is such a positive. Between its newly operational Longhorn, BridgeTex, and Double Eagle pipelines, the company will have almost 700,000 barrels per day of crude-carrying capacity coming online between now and the middle of 2015.
A key focus of Magellan's growth strategy is focused on moving crude oil, and it has identified a niche: moving oil from regions like the Permian & the Eagle Ford to the gulf coast. Not only are these pipelines in great need, but the capital to get them off the ground is rather modest since oil gathering and distribution networks are already in place. Plains All American has thousands of miles of gathering pipeline in the Permain, and Magellan already has a well established network of crude distribution pipelines in the Houston region.
The corporate structure: Major financial media outlets such as Bloomberg have recently voiced their concerns over the master limited partnership space for two major reasons: the way they find growth and the complicated corporate structure. This is what makes Magellan and a very small set of Master Limited Partnerships unique.
Unlike most other MLPs, which are split into a general partner that manages the operations of the partnership and the limited partnership that owns the assets, Magellan doesn't have a managing general partner. Back in 2010 it bought out its general partner's stake. Not only does this make Magellan easier to understand as an investment because it is a stand-alone enterprise, but it isn't required to pay management fees -- also known as incentive distribution rights. There are multiple benefits to not having to pay these fees that go beyond just the cost of doing business, which are better explained here.
The absence of these management fees and the pressure to pay out all of its distributable free cash at any cost gives it the ability to grow its business with some organic capital rather than entirely from debt and equity issuances. Over the past 3 years, Magellan has generated cash flow of at least 30% in excess of its distribution payments. This excess cash has allowed the company to increase both its share count and total debt issued by the lowest amount of its peers, all of which have translated into better stock performance for the company. Since its buyout of its general partner it has outpaced its closest peer, Enterprise Products Partners, by 88%, and has nearly quadrupled the S&P 500 on a total return basis.
Of course, past performance doesn't predict future success, but the combination of a well integrated pipeline and storage network, strong growth opportunities, and a more transparent corporate structure make Magellan one of the top pipeline investments in my book.
As I mentioned, a decline of total gasoline consumption thanks to increasing fuel efficiency and alternative fueling options are probably a long ways off, but it is still a legitimate threat that is worth watching. Disruption of gasoline-fueled transportation has been difficult to achieve, mostly because of the massive infrastructure required for any viable alternative. One thing that can never be underestimated, though, is the ability of technology to rapidly change course, so any major technological advancements that could have an immediate impact on transportation will be watched closely.
One other critical element I will be watching is whether management continues its rather conservative growth and distribution policies. If the company's distribution coverage ratio starts to get thinner because of overaggressive distribution increases without major business growth, than I may need to revisit this position. After all, this is for a retirement account, and I don't have plans to retire any time soon.
Magellan Midstream's distribution yield of 3.2% might not wow investors like Kinder Morgan Energy Partners' 7.1% or Plains' 4.4%. However, Magellan has grown its distribution 12% on an annualized basis for 12 years running, and on a total return basis it has been one of the best performing MLPs since its decision to go General Partner-free. For a long term investment, Magellan seems to be pulling all the right levers, and that is why I have decided to add it to my retirement account. Is Magellan right for you? I can't say. The needs of your retirement account could be wildly different than the needs of mine, but it is hard to argue with the fundamentals of the business.
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The article Why I Added This MLP to my Retirement Account originally appeared on Fool.com.Tyler Crowe owns shares of Enterprise Products Partners L.P. and Magellan Midstream Partners, L.P.. You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.The Motley Fool recommends Enterprise Products Partners L.P. and Magellan Midstream Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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