3 Reasons This High-Yield Oil Company Embraces Cheap Oil With Open Arms

By Markets Fool.com

Oil prices continue to crash, hitting a six-year low of $43 as of March 16. While the crude collapse has devastated the share prices of many oil-related stocks, Magellan Midstream Partners has held up relatively well.

Continue Reading Below

MMP Chart
MMP data by YCharts

In my opinion, there are three reasons Magellan has held up so welldespite oil's recent crash -- reasons to do with its superior business model any why all income investors should at least consider whether this MLP deserves a spot in their diversified income portfolios.

Oil storage business is booming

Source: Magellan Midstream investor presentation.

Continue Reading Below

Magellan Midstream owns five marine storage terminals with a storage capacity of 26 million barrels.

This allows Magellan to profit when oil prices crash because of what's known as the contango trade. When the spot price of oil is below that of oil futures contracts then traders and oil producers have a guaranteed future higher price they can sell at. They just need somewhere to store the oil in the meantime.

According to the Energy Information Agency, U.S. oil storage capacity now stands at 60%, up 25% from a year ago.

Note that the region with the lowest available spare storage capacity -- the East Coast -- is home to two of Magellan's storage terminals. As Magellan notes in its most recent 10-K, oil storage is an unregulated industry and the lease rates it can charge for such services are purely based on market forces.

With 88% of Magellan's oil storage capacity full at the end of 2014, and market prices for storage being driven up by increased demand to store cheap oil, Magellan's marine storage operating segment should have a very good year.

Don't get me wrong, Magellan's oil storage business, which accounted for 9% of its 2014 operating margin,isn't the main reason to invest in this MLP. I consider it merely a cherry on top of the two biggest reasons to love this fast growing midstream operator.

Cheap oil a benefit to growth
One of the reasons I like Magellan Midstream as a play on cheap oil is because the collapsing price of crude means better opportunities to buy new assets at attractive prices. For example, Magellan's management has a great track record of growth, both through organic growth and accretive acquisitions.

Source: Magellan Midstream investor presentation.

Not only does cheaper oil mean a chance to acquire new oil storage and transportation assets -- whose cash flows are often protected by long-term, fixed-fee, inflation-protected contracts -- at better prices, but an oil crash can also lower the price for completing organic investment projects already under way.

For example, Magellan's largest ever growth project, the 550 mile, $800 million to $850 million Saddlehorn Pipeline -- a joint venture with Plains All American Pipelineand Anadarko Petroleum--may come in under budget thanks to declining costs of pipeline steel and declining oil-related construction costs. Already, Magellan is anticipating the project -- of which they own 40% -- will pay for itself in just 10 to 11 years on an EBITDA or earnings before interest, taxes, depreciation, and amortization basis, based just on the contracts already in place. Magellan's management believes that the pipeline has significant profitability upside if it can fully subscribe the rest of its 400,000 barrels per day of capacity; and lower construction costs would only improve the economics of this, and other projects.

Distribution growth and safety
With a 3.7% yield, this MLP provides about twice the income of the S&P 500 and despite the crash in oil prices, is in no danger of having to cut its distribution. In fact, analysts expect Magellan to grow its distribution at a 13.7% compound annual rate over the next five years.

One of the reasons why Magellan is expected to grow its payout so quickly is because of itslack of incentive distribution rights, which gives it a competitive advantage over its peers. This advantage allows Magellan toboth lower its cost of capital and put 100% of marginal distributable cash flow, or DCF, straight to growing investors' distributions.

Magellan's exceptional management team has worked hard to ensure that its fast growing distribution is among the safest in the industry.

Source: Magellan Midstream Partners investor presentation.

This year alone the MLP expects to generate an excess $150 million of DCF,generating a distribution coverage ratio of 1.2, and 85% of operating margins are generated from fixed-fee, long-term contracts.Management's long-term goal is to maintain at least a 1.1 coverage ratio, allowing for a safe and sustainably quick growing payout that rewards long-term income investors even during times of energy price volatility.

Look beyond short-term oil prices and consider this proven high-yield winner
Energy investors are understandably nervous given how fast oil prices have crashed. However, Magellan Midstream Partners represents one of the best managed and fastest growing midstream MLPs in America with a generous payout that is well insulated from crashing crude. In fact, given its business model -- cash flows protected by long-term contracts -- I view the oil crash as a great chance for the MLP to benefit from rising demand for its oil storage services, cheaper construction costs for its new pipeline projects, and potentially more attractive acquisition prices.

The article 3 Reasons This High-Yield Oil Company Embraces Cheap Oil With Open Arms originally appeared on Fool.com.

Adam Galashas no position in any stocks mentioned, however, he does leadThe Grand Adventuredividend project, which owns Magellan Midstream Partners in several portfolios.The Motley Fool recommends Magellan Midstream Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.