Friday, February 17, 2023

Pipelines - Q4 2022 Earnings Season

Magellan Midstream Partners (MMP) reported results earlier this month. Highlights from the results and conference call

  • "[N]et income of $187 million for fourth quarter 2022, compared to $244 million for fourth quarter 2021. The 2022 results were negatively impacted by a $58 million non-cash charge for the impairment of our investment in the Double Eagle pipeline joint venture."
  • "Diluted net income per unit excluding mark-to-market (MTM) commodity-related pricing adjustments, a non-generally accepted accounting principles (non-GAAP) financial measure, was $1.06 for fourth quarter 2022, or $1.34 excluding the 28-cent negative impact of the Double Eagle impairment. These results exceeded the $1.22 guidance provided by management last fall primarily due to higher-than-expected refined products transportation revenues and improved commodity margin resulting in part from additional blending volumes during the quarter."
  • Distributable cash flow (DCF), a non-GAAP financial measure that represents the amount of cash generated during the period that is available to pay distributions, was $345 million for fourth quarter 2022, compared to $297 million for fourth quarter 2021. Free cash flow (FCF), a non-GAAP financial measure that represents the amount of cash available for distributions, additional expansion capital opportunities, equity repurchases, debt reduction or other partnership uses, was $324 million during fourth quarter 2022, versus $291 million during fourth quarter 2021.
  • "Magellan wrapped up the year with another solid quarter, supported by record refined products transportation volumes and financial results that exceeded our expectations. During 2022, we delivered over $1.3 billion of value to our investors via opportunistic equity repurchases and Magellan's attractive cash distribution, marking 21 years of continuous annual distribution growth," said Aaron Milford, chief executive officer.
  • Refined products operating margin was $303 million, consistent with the prior-year quarter, as higher financial results from this segment's core fee-based transportation and terminals activities were offset by unfavorable MTM adjustments on our commodity hedge positions. Transportation and terminals revenue increased $26 million primarily due to higher average transportation rates and record quarterly transportation volumes. The higher rates were largely driven by our 6% average tariff increase in July 2022. In addition, customers took advantage of the extensive connectivity of our pipeline system to overcome various supply disruptions in the Midcontinent and Texas regions during the current period, resulting in a higher proportion of long-haul shipments.
  • Annual DCF was $1,128 million in 2022, or 1.3 times the amount needed to pay distributions related to 2022, compared to $1,118 million in 2021. Annual FCF was $1,486 million during 2022 versus $1,316 million during 2021.
  • For the year, Magellan declared cash distributions of $4.17 per unit for 2022 compared to $4.13 for 2021, representing 21 years of uninterrupted annual distribution growth since our initial public offering in 2001. Recognizing that investors value steady increases to the cash distribution, management currently targets annual distribution growth of 1% for 2023, consistent with the increase provided over the last two years.
  • During fourth quarter 2022, we repurchased 1.9 million of our common units for $95 million, resulting in nearly 9.6 million units repurchased during 2022 for $472 million. Magellan has repurchased 26 million units for $1.27 billion under our $1.5 billion equity repurchase program over the last three years, representing an 11% reduction in units outstanding. 
  • Our 2023 DCF guidance of $1.18 billion would represent an increase of 13% over our DCF of $1.044 billion in 2020, the year we initiated unit repurchases. Assuming no additional repurchases in 2023, DCF per unit for 2023 based on our guidance would equate to approximately $5.80 per unit, an increase of 25% over 2020. Given management's current expectation that FCF after distributions will generally be used to repurchase units (subject to the considerations noted in "Capital allocation" above), DCF per unit is expected to continue increasing at a higher rate than DCF.
  • We plan to increase our annual distribution by 1% this year, similar to the past two years, which results in a yield of nearly 8% based on recent MMP trading prices. While we're not providing specific financial guidance beyond 2023 at this time, we expect DCF to continue to grow modestly over the next few years. Combining this modest underlying growth with our expectation to continue to repurchase units results in even higher growth potential for our distributable cash flow per unit as we have seen in recent years. For example, our DCF grew at an average annual rate of just under 4% between 2020 and 2022, while our DCF per unit grew at an annual average rate of just over 8% during the same period. This example, we believe, demonstrates the power in our capital allocation approach and our ability to create long term value for our investors through a healthy current distribution combined with the potential for capital appreciation as DCF per unit increases.

They shipped 145 million barrels of refined products in Q4 2022 versus 142 million in Q4 2021 and 131 million in Q4 2019. (Yet more evidence that the EIA is wrong about energy consumption.) Aviation fuel volume hit 9 million barrels this quarter, not quite back to the 11 million in Q4 2019, but a big recovery from 5 million in Q4 2020. Revenue per barrel of refined product shipped was $1.88 in the fourth quarter vs $1.66 in the fourth quarter of 2019.

The current market capitalization of Magellan is $10.9 billion and enterprise value is $16 billion. Their guidance of $1.18 billion of distributable cash flow for 2023 implies a shareholder yield of 10.8% on the current price. Units are trading for 10 times the Q4 annualized net income (excluding the impact of the non-cash Double Eagle impairment).

Over the three year period from December 2019 through December 2022, the CPI rose by 15%. Magellan's revenue per barrel of refined product shipped rose 13% - not quite as much. Corporate level general and administrative expense rose 34% (ouch). Operating expense for the refined product segment was flat and for the crude oil segment it rose 7%. As the company mentioned, above, the distributable cash flow has risen only 13% since 2020, a bit less than inflation.

Adjusted EBITDA for the full year 2022 was $1.43 billion, up only slightly from the 2021 level of $1.42 billion. (It is still below the 2019 level of $1.58 billion.)

We do have to keep in mind that Magellan sold 26 refined petroleum products terminals last summer for $435 million. That divestment would have reduced earnings somewhat, and the proceeds were used to buy back units, which is an example of something that has allowed Magellan's DCF/unit to grow faster than DCF alone.

Also, like many businesses, Magellan's ability to raise prices follows inflation with a lag. Prices are reset at intervals, contracts are renegotiated, and so forth. On this quarter's conference call, they said that they will raise their refined product rates an average of 8% this summer, an amount that will obviously exceed the current rate of inflation.

We want the earnings of our pipeline investments to grow faster than inflation. We can be patient and they will still work out nicely if there is a lag, but we want revenue to at least match inflation and earnings to grow faster than inflation.

Enterprise Products Partners (EPD) also reported results last week. Highlights from the results and conference call:

  • Enterprise reported net income attributable to common unitholders of $5.5 billion, or $2.50 per unit on a fully diluted basis for 2022, compared to $4.6 billion, or $2.10 per unit on a fully diluted basis for 2021. 
  • Distributable Cash Flow ("DCF") increased 17 percent to $7.8 billion for 2022 compared to $6.6 billion for 2021.
  • Adjusted cash flow provided by operating activities ("Adjusted CFFO"), increased 13 percent to $8.1 billion for 2022 compared to $7.1 billion for 2021. Enterprise’s payout ratio of distributions to common unitholders and partnership unit buybacks was 54 percent of Adjusted CFFO in 2022. Adjusted Free Cash Flow ("Adjusted FCF") was $3.0 billion for 2022. Excluding $3.2 billion used for the acquisition of Navitas Midstream Partners, LLC ("Navitas Midstream") in February 2022, the partnership’s payout ratio of Adjusted FCF was 71 percent for 2022.
  • Enterprise increased its cash distribution 5.4 percent to $0.49 per common unit with respect to the fourth quarter of 2022 compared to the distribution declared with respect to the fourth quarter of 2021.
  • Enterprise finished 2022 with a solid fourth quarter, reporting record total gross operating margin. Our quarterly results were driven by record total pipeline transportation volumes of 11.5 million BPD, on a barrel equivalent basis, higher NGL and natural gas pipeline transportation volumes, higher natural gas processing margins and increased fee-based gas processing volumes. 
  • Gross operating margin for the NGL Pipelines & Services segment increased 17 percent to $1.3 billion for the fourth quarter of 2022 compared to $1.1 billion for the fourth quarter of 2021.

These Enterprise results are clearly superior to those of Magellan, with earnings, cash flow, and distributions growing by much higher percentages (matching or exceeding inflation).

The current market capitalization of Enterprise is $57 billion and enterprise value is $86 billion. The $7.8 billion of distributable cash flow for last year implies a shareholder yield of 10.8% on the current price. Units are trading for just under 10 times the Q4 2022 (annualized) net income.

The November investor presentation had a great slide showing the growth in EPD's adjusted FCF per unit:

Their "adjusted" free cash flow metric excludes cash used for acquisitions, such as last year's $3.2 billion acquisition of Navitas Midstream. That is reasonable, since when we talk about free cash flow, we are interested in the amount of cash that is produced by the business and available for owners to reinvest. So, we deduct the expenses for maintenance that are necessary to keep the business running as-is, but we can add back what was spent expanding the business.

The November presentation also had a good discussion of the so-called "energy transition."

The EPD investor presentation even cites Vaclav Smil's book How the World Really Works (previously, on CBS) on one slide!

1 comment:

CP said...

Despite the impressive rally in 2021 and 2022, we believe that midstream equities still have upside potential, driven by a combination of attractive valuations, strong balance sheets, elevated commodity prices, and favorable asset class tailwinds during inflationary periods. This view is potentially supported by a few indicators.

One indicator is that MLP EV/EBITDA ratios remain low relative to historical averages, while cash flow has consistently increased since 2013.15 This positive trend may represent an attractive opportunity to invest in midstream equities. The continued execution of elevated cash flows, returning excess cash to investors through dividend increases and buybacks, can also provide additional support for the sector. Furthermore, the trend of generous shareholder returns is expected to garner attention and potentially drive demand for midstream MLPs within portfolios.