This is getting a little ridiculous.
There’s an incredible amount of crude oil is gushing out of the Permian Basin — almost 2.5 million barrels a day. And that’s just one from spot. Overall U.S. oil production has just topped 10 million barrels per day for the first time since 1970.
That means pipelines are equally busy carrying all that raw crude into these refineries and then carrying out gasoline, diesel and other finished products. So you’d think these would be boon times for Magellan Midstream Partners (NYSE: MMP), which owns 10,000 miles of pipeline that connect with 50% of the nation’s refinery capacity.
Indeed, the firm’s crude oil and refined products transportation volumes both set new record highs last quarter, as did distributable cash flow (DCF). So how much has the share price risen this year? 5%? 10%?
Actually, it has plummeted almost 25%.
Magellan is widely regarded as one of the sturdiest master limited partnerships (MLPs) around, with an unparalleled collection of pipeline and storage assets whose fee-based income stream is so predictable it’s almost boring. Since its IPO in 2001, the company has raised dividend distributions for an impressive 63 straight quarters.
Despite all that, the mighty energy infrastructure giant has seen $3.9 billion in market value suddenly vanish over the past couple months. Has something calamitous happened to derail future profits? Nope. In fact, management just reaffirmed its outlook for distributable cash flows (DCF) of $1.02 billion this year — a record high.
And yet the stock has fallen off a cliff, declining in eight of the past nine weeks. Like I said, it’s ridiculous.
So what’s behind this selloff in MMP? That’s a good question. Actually, it’s not specific to Magellan. Its peers are down 14%, 15%, even 23%. It’s been a one-way trade in the wrong direction.
I’ve seen this before. This same group underwent a similar fate in 2015, before the market finally realized it had gone overboard. When bargain hunters stepped in, they pocketed easy gains of 50%-plus over the next several months.
We could be looking at a similar bounce on the horizon.
So What’s The Problem This Time?
Some of the selling pressure stems from President Trump’s steel tariffs, as most midstream pipeline materials are imported. But I don’t see this as a huge threat, as rising raw material costs will likely be recouped and passed along to customers.
There was also some consternation regarding corporate tax reform while differing House and Senate versions of the bill were being reconciled. Remember, these partnerships don’t pay federal taxes. They simply pass the liability along to investors, thereby avoiding the double taxation of ordinary corporate profits (first at the corporate level, and then as dividends).
Until now, MLPs have been able to recover some of the income taxes borne by shareholders via higher rates on their pipelines. This allowance was deemed a cost of service. Now, the Federal Energy Regulatory Commission (FERC) is disallowing the practice, which would lower the rates (or tariffs) these operators charge to transport oil, gas and other products.
The upshot is reduced earnings capacity from some pipeline systems. That sounds bad, which is exactly why the entire sector plunged on the news, with most of these stocks experiencing the biggest daily decline in two years on March 15. But once again, the kneejerk reaction came before any rational attempt was made to analyze the financial impact — which in many cases is nil.
First off, this new ruling does not affect gathering and processing lines, storage tanks, processing plants, export terminals and other midstream assets. Nor does it apply to intra-state pipelines that don’t cross state lines.
These aren’t regulated by the FERC.
The policy change only involves long-haul interstate pipelines that cross from one state into another. And even then, those with rates that are market-driven (rather than regulated) are exempt. When you take that into account, the new law is narrow in scope.
While companies could feel a pinch, many others were quick to issue press releases claiming “zero” material impact.
Plenty Of Upside
After the scale of the tax threat (or lack thereof) was made clear, buyers began to cautiously tiptoe back in. But there is still more upside in this sector than I have seen in the past few years. Take MMP, which is trading around $60 per share. Analysts have a consensus price target of $77 which would imply appreciation of more than 28%. Energy Transfer Partners (NYSE: ETP) is looking at upside of more than 50%.
That’s the result of a perfect storm of rising rates, protective tariffs, and changing tax policies. But again, all storms pass.
There are many fine contenders in this group with well-positioned assets. But given that the entire sector has been unfairly treated, your best option might be the fund that has a stake in all the nation’s top MLPs.
This fund’s $3.4 billion portfolio is spread among dozens of holdings. It is a bit top-heavy, as the top-10 positions soak up more than 70% of the assets. But that concentration is exactly what I’m looking for in this case, considering these companies own and operate the backbone infrastructure that gathers, transports, processes, stores and distributes the nation’s vast energy resources.
Now, the negative factors discussed above shouldn’t be dismissed. But they have been overstated and are baked into the share prices at this point. As a result, this fund is on sale at current prices, a wide discount of 25% from just a few months ago. This is a unique opportunity many investors won’t want to pass up.
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