Description

MMP is commonly thought to be one of the best run MLPs. The bet is that the refined products business is a gem and is worth almost the entire enterprise value at current prices. We believe the opportunity exists due to how out-of-favor the MLP space is; that MMP is a “baby being thrown out with the bathwater.”

We think the clearest way to demonstrate the opportunity is to compare the yield of the debt with the yield of the equity.

Debt/EBITDA is 3.2x. EV/EBITDA is 9.7x. MMP is an IG credit. 10 year unsecured paper issued in early May at 3.25% is trading at 109 for a YTW of 2.17%.

MMP is trading at 11x 2020 EPS and 10x 2021 EPS. The equity yields 9.8%.

Dividend coverage is ~1.25x. There are no IDRs.

We believe MMP is different than other MLPs in many positive ways. MMP does not rely on the equity markets to fund growth (see chart at bottom). Max leverage is 4x. It’s 15 year ROIC is >15%. Valuation is undemanding for a lower-but-steady growth business that is mostly demand-pull rather than supply-push. Indeed, we choose to value this business on EPS/FCF rather than EBITDA. How many MLPs can say that?

Given the coverage and quality of the cash flows, we believe the equity yield is too wide and should lead to an attractive total return over time.

Business

60-65% of MMP’s EBITDA is from their Refined Products segment while the remainder is from their Crude Oil segment.

Refined Products

The Refined Products pipelines deliver gasoline (54%), diesel (36%) and jet fuel (10%) from refineries in the central US to various terminals. It is the longest refined products pipeline system (9800 miles) in the US. The system has access to 50% of US refinery capacity. It is a critical component of US infrastructure. The major business driver is volume transported – gasoline/diesel demand (miles driven) is a very large component. A key differentiator of this system versus other MLPs is that volume is driven by end-market demand rather than how much supply is produced in a basin. The creates a much steadier need for product transportation which makes MMP’s pipes higher quality than supply-side pipes.

70% of the segment revenue is tariff-based. The other 30% is from other services, like storage, blending, etc. Of the 70% tariff-based, 40% of pricing is set annually by a FERC index. They have historically taken about 2% in pricing per year. The remaining 60% is competitive and MMP has taken market-based pricing of about 3-4% per year. Organic volume was down 1% in 2019. In total, this should lead to LSD organic revenue growth per year.

Key point:

The refined products transportation cost per gallon of gasoline is roughly 4c. When compared to the total cost at the pump, its negligible. If gasoline demand became critically impaired (e.g. electric vehicles, people structurally commute less due to WFH, etc), the FERC regulated pipelines should be able to increase prices to create a reasonable ROIC on the pipes. A 25% increase in price is only 1c/gal.

Crude Oil

MMP’s crude oil pipes are generally long-haul transportation pipes out of basins to Cushing and Houston. Longhorn and the Houston Distribution System are wholly-owned while the remaining are JV-owned.

There is substantial information about the various pipes in this March 2020 analyst day presentation. https://magellanlp.com/Investors/~/media/34E9268EBB6B4178BBEB028C552D4CAB.ashx

Information includes capacity, utilization, pricing and avg remaining contract life.

Much of this cash flow is from minimum volume commitments from IG counterparties.

As contracts renew, there will likely be price compression due to increased competition. That said, while we very much prefer the refined products segment to this one, these crude pipes are valuable. While remaining cognizant of false precision: even if we assign much lower long-term transportation rates, the net impact of the price compression offset by run-rate projects coming online in 2020 should be less than a $100mm impact to the segment EBITDA. We use a $150mm impact in our SOTP below.

COVID

The company provides enough granularity to do your own sensitivity analysis.

Within the context of the above update (provided in March 2020), the below US gasoline supply trends are encouraging:

Valuation

We believe the risk/reward framework is $35/$60 in a year. This includes a $4.11 dividend over that time. The biggest catalyst would be medium-term US gasoline/diesel demand becoming more clear.

MMP’s pre-COVID 2020 DCF guidance was 1200mm. 1200mm + 210mm interest = 1410mm unlevered free cash flow in a “normal” 2020.

Refined Products, assuming no long-term COVID impact: 700mm = 784mm 2019 segment EBITDA – 75mm MCX – 60mm lower normalized butane blending (likely very conservative) + 50mm remaining cash flow from Storage segment that was consolidated into Refined Products in 1Q20 after an asset sale. If volumes declines 1% (EIA estimate) and pricing grows at 2% (the more conservative of the FERC-based and market-based rates), cash flow should grow at ~1% annually. A 7% discount rate would imply a 6% yield in perpetuity. We believe a reasonable argument could be made that the discount rate should be lower than that. In sum, a 6% asset yield is arguably too high, but we use that in our target case.

Crude Oil segment: 710mm = MMP’s original 2020 cash flow guidance of 1410mm – 700mm from Refined Products. We then further adjust down the cash flow from the Crude Oil segment by 150mm to account for recontracting risk. 10-20% yield implies 5-10x cash flow.

Risks

The risks can be laid out as 2020-related and Long-Term-related.

2020: We shelter in place/WFH for a really long time and people stop driving. This creates tight EBITDA coverage (problems occur near ~1bn of EBITDA). The bonds are cov-lite and the 5x covenant is at the currently undrawn revolver. Maybe oil prices go so low that refineries need to shut in? Maybe there is so little demand for refined products that storage fills up and pipes back up to the well head? These are all things that need to be considered.

Long-term: crude pipeline counterparties shut in production due to low oil prices and their credit-worthiness/LT ability to hit commitments goes down. Other counterparties shut in and it creates an oversupply of longer haul pipe due to lower demand from E&P companies.  A lower oil price negatively effects the value of the crude oil pipes/assets. US production goes down. These assets end up being worth a significantly lower multiple.

Other

Catalyst

Time passing, gasoline demand recovering, the earnings power being better recognized by the market