Many master limited partnerships (MLPs) have struggled over the past year amid record-low oil prices. Although MLPs are well-known for their robust yields, investors need to ensure that these companies can actually maintain them.
Headquartered in Tulsa, Oklahoma, Magellan Midstream Partners LP (NYSE: MMP) is an MLP that transports marine fuels, refined products and crude oil. Its pipelines stretch across 15 states in the South and Southeast.
The company currently pays shareholders $1.0275 in distributions a quarter, or $4.11 a year. That’s a whopping 8.58% yield!
In November 2017, Magellan earned an “A” rating from SafetyNet Pro.
But can we depend on its strong distribution in the future?
Let’s look at Magellan’s ability to generate cash flow…
Typically, MLPs are less risky investments than other companies in the oil and gas industry. That’s because MLPs’ stock prices are not directly tied to their underlying commodity. Instead, MLPs are paid to transport oil and gas. They use long-term contracts to lock in revenue.
They are also required to pay out a percentage of their income to shareholders, which leads to large dividend yields.
Magellan’s cash available for distribution (a measure of cash flow for MLPs) declined 20% from 2019 to 2020. However, even with lagging cash flows, the company was still able to raise its distribution in 2020.
In 2020, the company had a payout ratio of 89.14%. For this year, Magellan projects a payout ratio of only 84.97% as cash flows begin to rebound. That means Magellan’s payout ratio is in line with SafetyNet Pro‘s MLP comfort level of 100%.
Yet the company’s net debt-to-earnings before interest, taxes, depreciation and amortization (EBITDA) ratio has grown over the past few years. In 2018, Magellan had a net debt-to-EBITDA ratio of 2.78.
That number increased to 3.87 in 2020 due to lower EBITDA and increased debt. However, this trend should reverse in 2021 and 2022, which will help minimize the company’s payout ratio and interest payments.
Magellan has raised its distribution every year since 2002.
However, management expects to keep the payout constant in 2021.
CEO Mike Mears said…
Magellan intends to maintain our quarterly cash distribution at the current level during 2021. Based on our DCF guidance of $1.02 billion, we expect to generate excess cash of approximately $100 million this year, resulting in distribution coverage of 1.1 times for the year.
If this occurs, Magellan will likely receive a downgrade based on its payout ratio next year.
Magellan’s lower cash flow and higher debt-to-EBTIDA level are only minor concerns for the company’s distribution. A low payout ratio and a history of distribution raises continue to ensure Magellan’s distribution safety for now.
Dividend Safety Rating: B
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