As a dividend growth investor, I am constantly on the lookout for additional opportunities to buy income-producing assets. Sometimes, I analyze stocks I already own and consider increasing my position, while on other occasions I focus on new positions that can fit my portfolio. The current volatility may offer new opportunities as stock prices are down significantly.
During the pandemic in 2020, energy companies suffered the most, and I took advantage of the situation to buy shares in leading supermajors as well as some MLPs. In the MLP sector, I bought shares in Enterprise Products Partners (EPD), MPLX (MPLX), and Magellan Midstream (NYSE:MMP). In this article, I will revisit the latter.
I will analyze the company using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier for me to compare analyzed stocks. I will look into the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.
According to Seeking Alpha’s company overview, Magellan Midstream Partners, L.P. engages in the transportation, storage, and distribution of refined petroleum products and crude oil in the United States. It operates through Refined Products and Crude Oil segments. The company operates a refined products pipeline that transports gasoline, diesel fuel, aviation fuel, kerosene, and heating oil to wholesalers, retailers, traders, railroads, airlines, and regional farm cooperatives; and to end markets.
Sales of Magellan have increased by almost 50% over the last decade. The sales growth pattern is evidence of how volatile growth is despite being consistent. Sales growth comes from increased volumes as well as new projects coming online. The combination of both supports long-term revenue growth. Going forward, the consensus of analysts, as seen on Seeking Alpha, expects Magellan to keep growing sales at an annual rate of ~6% in the medium term.
The company’s EPS (earnings per share) has grown at a much faster pace, and over the last decade, it has more than doubled. The DCF (distributable cash flow) has grown at the same pace over the last decade. The company expects lower DCF and EPS in 2022 due to divestitures it did as it keeps steering the company and focusing on lucrative projects. Going forward, the consensus of analysts, as seen on Seeking Alpha, expects Magellan to keep growing EPS at an annual rate of ~2% in the medium term.
Magellan is on track to become a dividend aristocrat. The company has raised the annual payment for 20 years in a row. The current dividend yield is attractive at 8.65%, and despite the challenges, the company has raised the dividend by a CAGR of 4%. The payout ratio based on EPS is 97%, but it is more accurate to use the DCF for the payout ratio, and DCF based payout ratio stands at 81%, which is manageable for MLPs.
The number of shares outstanding has declined over the last decade. The company saw a slow increase in the number of shares as share issuance is needed for employee compensation, but not for growth funding. A lower share count is always a plus as it means that the company doesn’t dilute its shareholders and returns more capital. The reason for the opportunistic buybacks was the decline in the share price during the pandemic and it offered an attractive “self-investment”.
The company’s P/E (price to earnings) ratio is below 11 at 10.89 when taking into account the 2022 EPS forecast. This is roughly the average valuation over the last year. When using the DCF the company is trading for roughly 10 times the 2022 DCF given by the company in its outlook during the last earnings call. The company seems to trade for a fair valuation for a blue-chip with such a long track record of execution.
The graph below from Fastgraphs shows that the current price is fair indeed. Over the last two decades, the company’s average P/E was closer to 17. Right now it’s around 11. However, during the last two decades, the company has also shown a CAGR of almost 11%. The current expectations for the medium term are not as promising. Therefore, I believe that the discount even if a little bit too deep, is justified.
To conclude, Magellan is a blue-chip MLP. The company enjoys steady growth in sales, EPS, and DCF. It uses its DCF to fund its dividend and even lower the number of shares outstanding as the company doesn’t rely on equity to fund its growth, but rather focuses on manageable debt load and its cash flow. This solid package comes at a valuation of roughly 10 times DCF and 11 times EPS, which is more attractive than the average valuation.
The American market is less receptive to electric vehicles. The adoption of EVs in the United States is significantly slower than in Europe where some countries already see more than 90% of new cars sold being electric cars. This slow adoption is an opportunity for Magellan to keep enjoying its massive cash flow and slowly build its non-oil-oriented business. A faster shift would have made it harder to adapt.
Another advantage and opportunity for Magellan is its scale which allows it to be more efficient and competitive. The company has a massive pipeline network. This experience and knowledge can be used and replicated for other projects. Moreover, the profits come from diversified businesses mainly transportation and storage. Diversification and scale allow the company to lower costs and invest in various businesses depending on the demand.
Magellan is a highly profitable company with more than $1B in DCF annually. It means that the company can raise debt and equity and combine it with its cash flow for investment. The company is aware that it needs to follow the energy transition trend and is already working in that direction. It has published what it believes can serve as potential long and short-term opportunities that are not oil-related.
Changing sentiment toward oil may slow the growth of Magellan in the medium and long term. As the economy strives to become carbon-neutral, and Magellan is planning to join the trend, its core business will suffer a blow. Less oil transported through its pipeline will have an impact on the top and bottom line, and the company must allocate funds very wisely to replace those revenues with new green projects.
Adoption of electric vehicles while slow in the United States still serves as a prominent risk for Magellan. The company has to adapt and prepare for this significant change in consumer taste that will affect the oil demand. Magellan will have to change at least some of its value proposition and it will have to start investing soon.
The third risk and some may say the largest risk is the regulation. We have already seen the federal government blocking the Keystone XL pipeline that was planned by TC Energy (TRP). The political atmosphere today is negative towards fossil fuels, and it probably won’t change. Therefore, while there are politicians who will resist limitations on energy, additional regulation is a significant risk.
Magellan is a solid investment, and it’s no coincidence that the company has successfully increased the dividend annually for 20 years. The company’s valuation is fair at the moment, and it has several growth opportunities that should support sales, EPS, and DCF growth in the medium and long term despite some risky headwinds.
The company is not going to grow extremely fast like some growth stocks, but with a dividend yield of almost 9%, it is enough to show decent returns. These returns come with modest growth that will help investors gain a solid 10%+ total return. Therefore, I believe that the company is a good addition to the dividend growth portfolio even though it probably won’t beat the S&P 500.