Magellan Midstream Partners' Management Sees 1 Hurdle in 2017, but Lots of Opportunity

By Tyler Crowe Markets Fool.com

As has been the case for several quarters in a row, Magellan Midstream Partners (NYSE: MMP) continues to produce strong quarterly results. One thing that's made this performance possible has been the absence of major issues or conflicts. The company is involved in a spat with one of its new customers, but aside from that, things are looking as good as ever for the company.

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To that end, management wanted to explain why investors should be optimistic about the company's future. Following are several quotes from the company's most recent conference call that encapsulates much of CEO Michael Mears' thinking for the coming year.

Image source: Getty Images

Great conclusion to 2016

While many other companies struggled throughout 2016 because of low commodity prices and a lack of volume moving through pipelines, Magellan posted its best year on record, in terms of profits and cash flow. As you might expect, Mears took a little bit of a victory lap in his opening remarks:

[W]e generated record quarterly distributable cash flow during the fourth quarter of 2016, closing out another strong year. The full year was also a record, generating DCF [discounted cash flow] of $947 million and successfully reaching our goal of increasing cash distributions to our investors by 10% for 2016 while achieving a coverage ratio of 1.25X. In addition, 2016 was an important year for us due to the completion of a number of significant growth projects. Most notably, we successfully started up our Little Rock pipeline during July and the Saddlehorn pipeline during September, and continue to hear positive industry feedback for their long-term strategic value.

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Issue with new asset

When Magellan announced earnings last week, it mentioned in its press release that the company was having a conflict with the customer for its new Corpus Christi condensate splitter. So Mears gave a brief update on the project without going into too many details, because the contract is now in the courts:

We also recently completed construction of our condensate splitter in Corpus Christi, which has been operating and generating products meeting market specifications. I'm sure you noticed in the earnings release this morning that we mentioned an emerging issue related to our splitter. Specifically, our customer provided notice to terminate its contract with us just a few days ago. In our opinion, this termination is not valid under the terms of the contract, and we have initiated legal action. While a legal dispute runs its course, we are in discussions with other potential customers for the splitter and are optimistic we will reach a satisfactory outcome to the situation.In our view, this facility has current and future economic value, especially with the expected growth of condensate production in the Permian and Eagle Ford basins.

Later on, Mears was asked about the confidence to get new customers signed up and the economics of the project without this major customer. Mears seemed pretty confident that management could make it work:

I mean, first of all, if you just look at the current, for lack of a better term, crack spread for the splitter, it's profitable to run even now. One would expect, as the abundance of condensate production is forecast in the Permian primarily and also the Eagle Ford happens, that that spread would get bigger. Secondly, we have started discussions with other potential customers, and those discussions are very early, but they're fairly positive at this point. So that gives us some confidence also. I mean, it's -- I mean, clearly, the worst-case scenario would be we don't run it. I think that the probability of that is extremely low. If there's value there, I think we'll find a way to extract it. And there is value there. But until we have a little bit more time -- and as I mentioned in my comments, this just happened last week, so we have not been talking to other customers until this week.

Not a lot of pricing growth in 2017

For better or worse, Magellan's pipeline network has sections that are in parts of the country that are deemed "non-competitive" because of a lack of other pipeline options. As a result, those pipeline tariffs are regulated by the Federal Energy Regulatory Committee (FERC). According to Mears, investors shouldn't expect large gains in fees from these particular assets in the coming year:

The other key component for our refined products pipeline is the average tariffs we charge. You are probably aware that the current FERC indexation methodology is based on the change in the Producer Price Index plus 1.23%. The preliminary change in PPI for 2016 is negative 1%, which will result in basically flat rates for those markets that follow the index. As a reminder, roughly 40% of our refined products system is deemed to be less competitive by the FERC so we follow the index in those markets, resulting in 40% of our refined tariffs remaining relatively flat in mid-2017.

This doesn't only apply to Magellan's FERC regulated pipelines, though. Mears also mentioned later that this pricing methodology affects some of its non-regulated assets:

Our Longhorn and BridgeTex systems have customer contracts that are correlated to the FERC index. As a result, we expect those rates to be flat between years.

Equity

One of the most important methods for master limited partnerships to raise capital has been through equity. That is, of course, if yields were low enough for a company to justify it. Magellan has been one of the companies in this industry that has been a little more prudent about raising capital through equity, but it looks like the company is preparing itself to raise equity if it were to need it. Here's Mears again:

[W]e do not anticipate any need to issue equity in the near future to finance the growth projects we are constructing at this time. As [CFO] Aaron [Milford] mentioned in his comments, we are in the process of establishing an ATM [at-the-market] program. But given what we see right now, we do not anticipate the need to use the program until material new organic projects are announced.

That ATM program is set up such that the company can raise $750 million when it needs it -- which suggests it may be spending on some big-ticket items in the near future.

Getting ready to make an acquisitionagain?

In years past, Magellan has been known to be a rather routine acquirer of assets. With so much organic spending going on over the past couple of years and high prices for assets on the market, though, Magellan has been rather quiet on the acquisitionfront. When asked if the company was looking at buying assets again, Mears was a little more specific than normal:

Well, the opportunity is, I think, significant. I think there's -- even though some Permian systems have transacted here in the last few months, there's still a number of those that are coming to market that we're interested in. But as we've said before, we're going tocontinue to evaluate those the way we've always evaluated assets, and whether we can be successful in this environment or not remains to be seen.

This is a little different from the typical "we're always looking, but will only make a good deal" response. It appears there are some things that Magellan's management has homed in on recently. Perhaps I'm reading into the tea leaves a little too much, but this could be a sign that we could see an acquisition rather soon.

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Tyler Crowe owns shares of Magellan Midstream Partners. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.