The energy industry has been hit hard by low oil prices, which have been nearly as painful for midstream players as they have for exploration and production companies. While drilling for oil and moving it are two very different businesses, they are still tied at the hip.
That helps explain why Magellan Midstream Partners (NYSE: MMP) and NuStar Energy (NYSE: NS) have fallen 30% and 40%, respectively, so far in 2020. Is this an opportunity for long-term investors to pick up a good midstream name — or even two — or is there more to the story for these high-yielders?
1. Old versus new-ish
Master limited partnerships Magellan and NuStar have both been around the midstream space for a long time. Magellan is basically a slow and steady player that’s long focused on a mixture of pipeline and storage assets. After recently selling some storage assets, management has decided to break its operations down into two segments. One handles the transportation and storage of refined products (about two-thirds of 2019 operating margins), and the other the transportation and storage of crude oil (the remainder). Roughly 85% of its top line is fee-based, meaning that it largely gets paid for the use of its assets, with the price of the commodities going through them having less of an impact on its performance. Despite the new business breakdown, Magellan is basically doing the same thing it has been doing for a very long time.
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Not too long ago, NuStar was focused almost exclusively on storage. After running into some issues with that model, which required it to cut its distribution in 2018, the partnership shifted gears and now has a mix of pipelines (roughly 60% of revenue) and storage (the remainder) in its portfolio. About 60% of the company’s business is derived from refined products, and 40% oil. And, like Magellan, it is largely paid for the use of its assets, though it doesn’t provide a breakdown of its fee-based income. Still, there are some broad similarities between the two partnerships today. That said, NuStar doesn’t have as long a history behind it as it exists today.
2. What about the distribution
Master limited partnerships are basically designed to pass cash through to unitholders. On that score Magellan is one of the most consistent names in the midstream space, providing investors with a distribution increase every single year since its initial public offering in 2001. Because of the troubles in the energy sector, which have depressed demand and impacted the 15% of the top line that isn’t fee-based, the board has chosen to hold the distribution steady at the first-quarter rate all year. However, that will still extend the partnership’s streak by another year. It expects to cover the distribution by around 1.1 times in 2020, below its target of 1.2 times. Not ideal, but not terrible.
NuStar cut its distribution by 45% in 2018, as noted above, as it was remaking its business. With the current issues facing the energy sector it has decided to trim the payout again, this time by a third. The unit price decline has kept the yield high at roughly 10%, but income-focused investors have clearly not been well served by an investment here. Magellan, which yields around 9.2%, has provided far greater consistency. Notably, NuStar’s logic for the current cut was to “protect our balance sheet.” That’s a good reason for a dividend cut, but not exactly a reassuring one for the business.
3. A matter of leverage
With that segue, Magellan stands out from NuStar in another important way as well: leverage. Magellan has long focused on maintaining a strong balance sheet. At this point, financial debt to EBITDA is roughly 3 times. That compares to NuStar’s 6.8 times. To be fair, an asset write down impacted that figure for NuStar, but it has historically had higher leverage than Magellan. At the end of 2019, for example, NuStar’s financial debt to EBITDA ratio was around 5 times versus Magellan’s 3. Basically, this is a long-term trend, with Magellan’s fiscally conservative nature giving it more leeway to deal with industry headwinds — a fact that’s obvious from the recent distribution cut at NuStar.
An easy win
NuStar has made good progress in diversifying its business, but that has yet to translate into the type of consistency that Magellan has provided investors over time. Basically, there’s more work to be done before NuStar can put itself in the same league as Magellan. For most investors looking at this pair of midstream partnerships, the extra yield on offer from NuStar doesn’t appear to be worth the added risks. Magellan, an old hand that’s basically sticking to what it does well, is an easy win here.
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