Last year isn't one that investors in Magellan Midstream Partners (NYSE: MMP) will remember all that fondly, as the master limited partnership (MLP) declined in value. In fact, even after adding in the company's lucrative cash distribution, investors ended last year with a loss of 1.6%. That was well below the market, which delivered an unforgettable total return of 21.8%.
Here's a look at why Magellan underperformed last year and whether it can get back on track in 2018.
A solid but unspectacular year
On the one hand, last year was another solid one for the company. Distributable cash flow was on pace to come in at $1.02 billion, which would put it 7.7% ahead of 2016 and slightly better than Magellan's initial guidance. As a result, the company was able to increase its distribution to investors by 8%. Furthermore, Magellan secured several expansion projects, which will help fuel growth.
That said, last year wasn't without its share of challenges. In March the company noted that even though it secured a new contract for a recently completed expansion project, that deal would not bolster cash flow because commodity prices had fallen and would cut into its margins. Meanwhile, the company noted in the third quarter that Hurricane Harvey had disrupted its operations and would negatively impact distributable cash flow by $20 million. Due to these issues, distributable cash flow didn't grow as much as it could have last year, which weighed on the company's valuation.
Visible growth with upside
While 2017 had its share of ups and downs, it ended on a high note given that oil prices closed at more than $60 a barrel -- a 2.5-year high. So 2018 could be a much better year for the oil industry and Magellan. Those higher prices should incentivize producers to drill more wells, which would drive improved volumes across Magellan's oil pipelines. Meanwhile, 10% to 15% of the MLP's earnings comes from commodity-related activities, so the improvement in pricing should enable the company to make more money from these pursuits.
In addition to the potential benefits from higher oil prices, Magellan completed several expansion projects last year that will help drive growth in 2018. Plus, the company has more growth projects coming down the pipeline that should provide some incremental income this year. For example, its HoustonLink joint venture with TransCanada (NYSE: TRP) invested $70 million in building a new pipeline, which the companies expect to begin operations early this year. Furthermore, Magellan has a $125 million storage project that it plans to start up by the middle of 2018. Finally, it is building a new export dock that should be fully operational by the end of the year. These projects should drive distributable cash flow high enough this year to support another 8% increase in Magellan's distribution. While that's less than the 10% dividend growth planned by TransCanada, it's toward the higher end of Magellan's MLP peer group.
On top of this visible growth, Magellan has one of the strongest balance sheets among MLPs, which gives it the financial resources to pursue acquisitions. While merger and acquisition activity in the midstream sector was eerily quiet last year, it could pick up this year now that the industry finally seems to be back on solid ground. Furthermore, given that most MLPs lost value last year, companies might get the urge to merge so that they can boost valuations.
Everything is in place to quickly forget 2017
While last year wasn't one Magellan investors will remember fondly, the company completed several expansion projects and started several more that should begin generating earnings this year. Because of that, cash flow and the distribution will continue rising this year. Add to that the upside from higher oil prices and the potential for an M&A boost, and 2018 could be a much more memorable year for investors.
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