The natural upside to any midstream operation is the strong cash flow, a resource which if well used can help finance an important capital investment. Most importantly, the assets built can then be sold to oil and gas producers in order to reward those who trusted management with initial investments. That's it. There is not much of a secret behind midstream oil and gas companies. Hence, from this analyst’s point of view, the key element to success is quality leadership. Such a characteristic allows the business model to identify market trends, and transform synergies into real growth. Magellan Midstream (MMP) may just be the case that exemplifies the argument. However, gurus have not been too enthusiastic about the stock and trading volumes remain low. Let us see why, and if you should take a position.
Rolling Down the River
Last February, Magellan Midstream presented the full year report for 2013. In it one can find the overall improvement achieved during the year. Performance indicators for refined products and crude oil pipeline shipments, net income, total assets and cash distributions have all seen improvements. However, average utilization of crude oil and marine terminals have both experienced a small decline. Nonetheless, the report highlights the record performance achieved during the past year and resulting consolidated financial strength.
Magellan Midstream has also been given approval by financial institutions. Fourteen institutions have reported on the stock throughout the year’s first quarter, and only one downgraded the stock from “Buy” to “Neutral.” Out of the remaining 13, seven have gave the stock a “Buy” rating, while four gave it a “Neutralm” while the remaining three boosted the target price, resulting in a consensus “Buy” rating and $75.54 consensus price target. Additionally, the company owns the longest refined petroleum products pipeline system in the country, with a storage capacity of more than 90 million barrels of petroleum products.
Two recent announcements fuel growth prospects for Magellan Midstream: first, reopening of the open season to solicit capacity commitments from shippers to transport refined petroleum products to Little Rock, Ark. Up to 75,000 barrels per day of gasoline, diesel fuel and jet fuel are expected to flow through the pipeline. The second is the construction of a 50,000 barrel a day plant by the second half of 2016 to process ultra-light oil into fuels at Corpus Christi.
Some Things to Keep in Mind
Throughout the last five years, Magellan Midstream has achieved what many industry peers can only dream of: steady growth. Revenues and net income increments secured the model a wide operating margin. True, debt level has risen to questionable levels, and has the potential to affect the business by substantially increasing indebtedness and liabilities levels. The risk associated with such development is the inability to integrate the new operations effectively and dilution of limited partner shareholders.
Magellan Midstream’s growth prospects are based primarily on an attractive portfolio of energy infrastructure assets that generate stable and recurring fee and tariff-based revenues. The company is expanding capacity through the upgrade of current assets and construction of new ones. And although acquisitions have and will continue to be the main growth driver in the business model, partnerships are common too. Most important, credit ratings provide a competitive advantage in accessing capital at a reasonable cost, and long-term investors were rewarded through a consistent distribution growth.
Currently trading at 28.6 times its trailing earnings, Magellan Midstream carries a 28% discount to the industry average. However, net income growth and revenue growth through the last three years is below the industry average, a phenomenon deeply related with integration costs of acquisitions. Hence, it is recommended to follow Chuck Royce (Trades, Portfolio)’s long-term approach to the stock, after integration is complete.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.