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Yield-Chasing in Reverse

By Ari Charney on May 19, 2017

I hate overpaying for my favorite stocks. So I’ve been watching Magellan Midstream Partners LP’s (NYSE: MMP) four-month slide with great interest.

Magellan is one of a handful of conservatively managed master limited partnerships (MLP) that did a superior job of weathering the energy sector’s downturn while continuing to cover its quarterly distribution.

In addition to prudent financial management, Magellan also benefited from having a largely demand-facing business—the MLP owns the longest system of gasoline and diesel pipelines in the U.S.—amid a supply-induced crash.

As such, I’ve been wanting to add Magellan to one of the Utility Forecaster portfolios for a while now.

But the problem is that with each decline I assume that I’ll have an opportunity to pick up Magellan at an even lower price, at which point, the MLP inevitably reverses.

In addition to being fixated on value, I’d love to lock in a yield above 5%. Right now, Magellan has a forward yield of 4.7%, which is definitely enticing. And it’s boosted its distribution almost every quarter since its initial public offering back in 2001.

Still, there’s something psychologically compelling about breaking the 5% threshold, even though the MLP is just three-tenths of a percentage point away from it at current levels.

However, a chart of Magellan’s forward yield over the trailing five-year period reveals that it’s probably worth locking in a yield of 4.7%. For one, that’s well above the MLP’s average yield of 4.1% during this period.

And it’s not all that far away from Magellan’s yield at the bottom of the energy sector’s bear market, at which point its units yielded around 5.5%.

While the energy sector isn’t out of the woods yet—prolific U.S. shale producers are in an epic battle with OPEC—odds are that last year’s low was the bottom for this cycle.

But if the trend is our friend, then Magellan’s units could extend their run to the downside. Indeed, they seem to be mirroring the performance of the MLP space as a whole.

Since Magellan’s trailing-year high in late January, the MLP has dropped 8.9% on a price basis, which is only slightly worse than the Alerian MLP Index’s 7.8% decline.

Other high-quality MLPs, such as Enterprise Products Partners LP (NYSE: EPD) and Spectra Energy Partners LP (NYSE: SEP) have fallen less, by about 6.7% and 5.5%, respectively, over that same period.

They also yield more. EPD has a forward yield of 6.1%, while Spectra has a forward yield of 6.4%.

Obviously, both EPD and Spectra are worthy holdings. But as risk-averse income investors, we like Magellan’s lower leverage and stronger distribution coverage.

Of course, you have to pay up for quality. When looking at an MLP’s valuation, we compare the current unit price to its trailing-year distributable cash flow (DCF), which is the relevant profit metric for these yield-oriented securities.

On a price-to-DCF basis, Magellan is one of the more expensive names in the MLP space, with a multiple of 17.4 compared to a sector average of 11.8.

Because the calculation of DCF can vary from MLP to MLP, we also looked at Magellan on a price-to-EBITDA (earnings before interest, taxation, depreciation, and amortization) basis. On that score, Magellan also ranks among the most expensive names in the space, with a multiple of 14.4 compared to a sector average of 9.8.

Although we’re pretty stingy, we’re certainly willing to pay a premium for quality. But we’d like that premium to be just a bit smaller than it is presently. Perhaps this time around, the market will abide.

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