Written by Jonathan Weber for Sure Dividend
Investors have incurred a double hit this year due to the surge of inflation to a 40-year high. Not only have their stocks declined in the ongoing bear market, but the real value of their portfolios has declined as well.
Master Limited Partnerships are great candidates for the portfolios of income-oriented investors in the current investing environment. They offer exceptionally high yields, which offset inflation and can help investors wait patiently for the ongoing bear market to come to an end.
In this article, we will discuss the prospects of three high-yield MLPs, namely Magellan Midstream Partners (MMP), MPLX (MPLX) and Enterprise Products Partners (EPD), which offer above-average distribution yields with a wide margin of safety.
Magellan Midstream Partners
Magellan Midstream Partners has the longest pipeline system of refined products in the U.S. It has a pipeline network that is linked to almost half of the total U.S. refining capacity. The transportation and storage of refined products generates about 65% of total operating income of the MLP while the transportation and storage of crude oil generates the remaining 35% of operating income.
Magellan is one of the highest-quality MLPs in the investing universe thanks to some key characteristics. Most MLPs carry high debt loads, post poor free cash flows due to their hefty capital expenses and dilute their unitholders to a great extent on a regular basis. They also tend to have payout ratios near or above 100%.
Magellan is superior in all these aspects. It has a strong balance sheet and has posted positive free cash flows for more than 10 consecutive years. In addition, it has a healthy payout ratio and does not dilute its unitholders. In fact, since the onset of the pandemic, the stock has become remarkably cheap and thus the MLP has begun repurchasing units at a meaningful pace. All these attributes are testaments to the quality and the discipline of its management, which invests only in high-return projects.
Many investors avoid the energy sector due to its high cyclicality. However, Magellan is one of the most resilient oil companies to recessions thanks to its robust business model. The company charges its customers fees, which are proportional to the volumes transported and stored throughout its network. Even better, there are minimum-volume requirements. In other words, if its customers transport lower volumes than normal, they still have to pay high fees to Magellan. This is a key feature of the contracts, which render Magellan resilient to downturns.
The merits of the defensive business model of Magellan have been evident in every downturn of the energy sector. In 2014-2016, when the price of oil plunged 70%, Magellan incurred just a 3% decrease in its distributable cash flow (DCF) per unit. In 2020, all the major oil producers and refiners incurred excessive losses due to the unprecedented lockdowns imposed in response to the pandemic. Magellan proved one of the most resilient oil companies, as its DCF per unit dipped only 18% in that year.
Even better, Magellan enjoys markedly strong business momentum right now. Thanks to the sanctions imposed by the U.S. and Europe on Russia for its invasion in Ukraine and the aggressive production cuts of OPEC, the U.S. is the only major oil producer in the world that can replace most of the lost barrels. As a result, U.S. oil production has rebounded close to pre-pandemic levels and is likely to remain on the rise in the upcoming years. Magellan will greatly benefit from this trend, as higher volumes of crude oil and refined products will go through its network.
Thanks to its rock-solid business model, Magellan has exhibited an exceptional distribution growth record. It raised its distribution for 70 consecutive quarters at a 12% average annual rate, until the second quarter of 2020, in which it froze its distribution due to the pandemic. It froze its distribution for seven consecutive quarters and resumed raising it in late 2021 thanks to the recovery of the energy market. Overall, Magellan has raised its distribution for 22 consecutive years, at a 10% average annual rate.
The stock is currently offering an 8.3% distribution yield with a payout ratio of 81%. While this payout ratio is somewhat high, it is reasonable for a company with such a reliable business model. Given also its solid balance sheet, Magellan is likely to continue raising its distribution for many more years. The only caveat is the slow growth of the MLP, which should result in modest distribution growth in the upcoming years.
MPLX
MPLX is a somewhat diversified MLP that was formed by Marathon Petroleum (MPC) in 2012. MPLX operates in two segments: Logistics and Storage, which is related to the transportation and storage of crude oil and refined products, and Gathering & Processing, which is related to natural gas and natural gas liquids. The company generates about 65% of its EBITDA from its Logistics and Storage segment.
MPLX has a business model that is very similar to that of Magellan. It has a fee-based model, which involves charging fees for the volumes of products transported and stored throughout the network of the MLP. MPLX has minimum-volume contracts with its customers and thus it enjoys reliable cash flows even during downturns, in which its customers transport and store lower volumes than usual.
MPLX greatly benefits from the multi-year contracts it has signed with its parent company, Marathon Petroleum. Thanks to these contracts, MPLX has a strong position in the Marcellus / Utica region, one of the most prolific regions in the U.S., and enjoys resilient cash flows even during rough economic periods.
The resilience of MPLX was clearly reflected in its performance in 2020. Due to the pandemic, most oil companies incurred excessive losses in that year but MPLX posted just a 9% decrease in its DCF per unit. Moreover, the company has fully recovered from the pandemic, with record DCF per unit in 2021 and 2022. Furthermore, just like Magellan, MPLX is likely to maintain strong business momentum thanks to the aforementioned tailwinds from the sanctions of western countries on Russia and the production cuts of OPEC, which have led the U.S. to ramp up its production at a fast pace.
MPLX has a short history, as it was formed in 2012, but it has a decent performance record, as it has never cut its distribution. It is currently offering an exceptionally high distribution yield of 9.6%, which may lead some investors to think that a distribution cut is imminent. However, the company has a solid payout ratio of 63% and a healthy leverage ratio (Net Debt to EBITDA) of 3.5. Given also its defensive business model, MPLX is likely to be able to defend its distribution for many more years.
Enterprise Products Partners
Just like Magellan and MPLX, Enterprise Products Partners is a midstream MLP, with an immense network of pipelines and storage tanks. The difference is that Enterprise Products Partners is focused primarily on natural gas. The network of the MLP includes nearly 50,000 miles of pipelines of natural gas, natural gas liquids, crude oil and refined products. The network of Enterprise Products Partners also includes storage capacity of more than 250 million barrels.
Enterprise Products Partners has a fee-based business model, which includes minimum-volume requirements and hence it is very similar to that of Magellan and MPLX. Thanks to its defensive business model, Enterprise Products Partners incurred just a 15% decrease in its DCF per unit in 2020, in one of the fiercest downturns in the history of the energy market.
Enterprise Products Partners is currently facing a headwind from the ongoing shift of most countries from fossil fuels to renewable energy sources. However, due to the growing consumption of energy, this shift has proved harder than initially expected and hence it is likely to take much longer than initially anticipated to materialize. In addition, natural gas is considered a much cleaner fuel than oil products and coal and hence environmental policies do not aim to reduce the use of natural gas. This is undoubtedly positive for Enterprise Products Partners, which is focused primarily on natural gas.
Enterprise Products Partners has raised its distribution (in CAD) for 24 consecutive years. The stock is currently offering an 8.0% distribution yield, with a solid payout ratio of 55%. Moreover, the MLP has one of the strongest balance sheets in the MLP universe, with a BBB+ credit rating from S&P and a Baa1 rating from Moody’s. Thanks to its healthy payout ratio, its strong balance sheet and its robust business model, Enterprise Products Partners can easily continue raising its distribution for many more years.
The only caveat is the slow growth of the MLP. Enterprise Products Partners has grown its DCF per unit by 2.5% per year and its distribution by 4.1% per year on average over the last decade. Therefore, it is prudent for investors to expect modest distribution growth in the upcoming years.
Final Thoughts
Magellan, MPLX and Enterprise Products Partners are among the highest-quality MLPs in the investing universe. They offer exceptionally high distribution yields with a wide margin of safety while they have also proved remarkably resilient to recessions and downturns of the energy sector. Given also the tailwind from the ongoing global energy crisis, which has rendered the U.S. a key oil and gas producer for the global energy market, the three MLPs are ideal holdings for high income in 2023.
