Like many stocks, Magellan Midstream Partners (NYSE: MMP) slumped in 2018. Overall, the midstream MLP's unit price declined 19.6% last year, though the company's high-yielding dividend did help cushion that blow a little bit by trimming the total return to a negative 14.9%. Driving that decline was a sell-off in the stock and oil markets amid fears of a slowing global economy.
While last year was a tough one due to market volatility, 2019 could be a much better one for investors. Here's why Magellan Midstream Partners could bounce back sharply this year.
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What happened in 2018?
If it weren't for the steep decline in its unit price, last year would have been considered an excellent one for Magellan Midstream Partners. That's because while volatility in the stock and oil markets weighed on Magellan's valuation, it didn't have any impact on the company's financial results. Quite the contrary -- the company was on pace to generate $1.12 billion in distributable cash flow (DCF), up 9.7% from 2018 and ahead of its initial guidance of $1.05 billion. What makes that outperformance even more impressive is that Magellan achieved it while selling a stake in the BridgeTex Pipeline, which gave it funds to reinvest into its growing backlog of growth projects.
That money will come in handy because Magellan added several new projects to its pipeline last year. One of those is a $500 million project to increase the capacity of its Texas refined petroleum products pipeline system from 100,000 barrels per day (BPD) up to 175,000 BPD, which should be in service and generating cash flow by mid-2020. In addition to that, the company is partnering with several energy companies to build a new long-haul oil pipeline out of the Permian Basin that should also start up by the middle of next year. With those projects, Magellan had about $2.5 billion of expansions under way at the end of last year.
Meanwhile, the company's rising cash flow and visible growth from expansion projects enabled it to increase its high-yielding distribution to investors by 8% last year. That increase, when combined with Magellan's lower unit price following last year's sell-off, pushed its current yield up to an attractive 6.5%.
What to expect from Magellan in 2019
Magellan Midstream Partners anticipates that it will continue growing because it's on track to complete several expansion projects this year, which, along with those finished in 2018, should provide a further boost to cash flow in 2019. One of the biggest is a joint venture with Valero Energy (NYSE: VLO) to construct a new marine terminal in Pasadena, Texas, which should start operations this month. Valero and Magellan are investing about $820 million into the two-phase project, with the second phase scheduled to be in service by next January. In addition to that, Valero and Magellan are spending $425 million to build a new refined products pipeline in Texas, which should start up by mid-year. Finally, the company has a smaller $60 million storage and export dock expansion in Texas that should start up in late 2019.
Because long-term, fee-based contracts underpin these expansions -- and more than 85% of the company's earnings overall -- they'll provide Magellan Midstream with a steady stream of cash flow when they come online over time. That leads the company to believe it can increase its distribution by another 5% to 8% this year even as it maintains a conservative coverage ratio of about 1.2 times cash flow. Meanwhile, it estimates that it has enough fuel in the tank to also increase its payout by that same rate in 2020. Adding further support to that view is that Magellan has one of the strongest balance sheets among MLPs, which gives it the financial flexibility to fund expansions even if market conditions continue deteriorating.
A high probability of a bounce-back in 2019
Magellan Midstream Partners lost nearly 20% of its value last year even though its cash flow rose about 10%. As a result, the MLP is much cheaper heading into 2019 as it currently trades at about 12 times cash flow versus 15.9 times at the start of last year. Because of that, the company has significant total return potential in 2019.
To put the upside into perspective, we'll consider two scenarios. First, if oil market conditions improve, Magellan's valuation could move back up to around 16 times cash flow, similar to where it was to start 2018. If that happens, it could deliver a more than 30% total return when adding in its 6.5%-yielding dividend. Meanwhile, even if its valuation multiple remains at the current level of around 12 times cash flow, Magellan could deliver a total return of 12% to 15% in 2019, assuming it grows its cash flow at the same rate it increases the distribution.
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