Magellan Midstream Partners (NYSE:MMP) and Kinder Morgan (NYSE:KMI) are both well-respected names in the midstream energy sector. However, 2020 may have been a major turning point in the industry. While both should survive the shift, one is likely to fare better over time. And it’s not the name that I would have historically preferred. Here’s what’s going on, and why changing times have led to a change in my outlook.
As the world turns
The key headwind for midstream stocks in 2020 was the steep decline in demand for oil and natural gas, a drop-off that upended the energy sector. However, those were not the only headline-grabbing issues in the energy industry. Last year also featured a wider recognition of the need for the world to refocus its energy infrastructure around cleaner alternatives. That has left a material cloud hanging above midstream entities, which make their money by helping to process and move oil and natural gas around the world.
To put some numbers on how things have changed in the midstream space, Magellan spent roughly $1 billion on capital projects in 2019. That number fell to around $355 million in 2020. And in 2021, the partnership is expecting to spend just $75 million. Its growth plans have, basically, come to a screeching halt. Historically, midstream players have grown by building new assets from the ground up, so this is a major issue for investors to consider. The problem is that, longer term, if demand for oil is set to go flat or decline, those new investments just won’t be as necessary.
Kinder Morgan hasn’t been immune from this either. For years, the company talked about the massive backlogs of projects it had, with the figure pegged at $3.6 billion in the early days of 2020. However, when it reported its full-year 2020 results, the word “backlog” didn’t even make it into the company’s news release, and it only mentioned about $800 million in capital spending plans for 2021. And while $800 million is a lot larger than the $75 million Magellan is talking about, Kinder Morgan is nearly four times larger — it needs to spend more to support its core business.
To be fair, both Magellan and Kinder Morgan own assets that would be difficult, if not impossible, to replace. And the pipelines, storage, and processing assets they own are likely to remain important for many years to come. However, the opportunity to grow by building just doesn’t look quite as robust as it has in years past. That suggests that existing assets will be increasingly valuable, but also that the midstream industry may be shifting into a new phase that could include increased acquisition activity.
On that front, Magellan’s balance sheet is in great shape and ready to be put to use buying competitors or individual assets. Its financial-debt-to-EBITDA ratio stood at a healthy 3.7 at the end of 2020. That’s toward the low end of the range in its industry, which is pretty much the norm for the company. Kinder Morgan, meanwhile, chimed in with a financial-debt-to-EBITDA ratio of 7.1. It’s normally at the high end for its industry, and doesn’t have the same amount of financial leeway.
However, scale matters when you’re talking about acquisitions. Magellan is materially smaller than Kinder Morgan, so it won’t be able to take on the types of deals that its larger peer could easily absorb. Moreover, Magellan is highly focused on just two areas — oil pipelines and refined products pipelines. That further limits what assets it could pick up. Kinder Morgan, with its larger and more diversified portfolio, can venture into more areas and take on bigger targets. That includes swallowing up smaller competitors.
In fact, Magellan’s strong balance sheet and niche focus might actually increase the chances that someone looks to acquire it. In contrast, because of Kinder Morgan’s size and scale, few, if any, would be able to attempt to buy it out. So, despite the trust issues I have with Kinder Morgan because of its dividend history, I have to believe that it has a better growth outlook right now than Magellan.
When times change, you have to change along with them, like it or not. So, if investors are weighing a choice between Magellan and Kinder Morgan, it seems like Kinder Morgan might be the better long-term option at this point. However, that doesn’t mean it is the best choice in the midstream sector. In fact, there are other equally large industry players with solid long-term prospects (and better dividend histories) that investors might want to consider first.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/04/02/better-buy-magellan-midstream-partners-vs-kinder-m/