Better Buy: Magellan Midstream Partners vs. NuStar Energy

Last year was a brutal one for the oil industry. The COVID-19 outbreak clobbered demand for oil and refined products, causing prices to tumble. That affected the volumes flowing through pipeline systems, affecting the cash flows of most master limited partnerships (MLPs).

However, with vaccines rolling out and Saudi Arabia recently giving the oil market a big shot in the arm by reducing its production, 2021 appears poised to be a much better year for oil stocks, meaning beaten-down MLPs like Magellan Midstream Partners (NYSE:MMP) and NuStar Energy (NYSE:NS) could bounce back sharply in 2021. Here’s a look at which seems like the better buy right now.

Petroleum storage tanks with the sun setting in the background.

Image source: Getty Images.

Comparing their financial profiles

While energy market conditions are improving, the industry remains on a fragile footing. That means investors need to make sure an energy stock can survive the current turbulent period so it’ll be around for the recovery. With that in mind, here’s a closer look at the financial profiles of these two midstream companies:

Data source: Magellan Midstream and NuStar Energy.

As that table shows, Magellan has a much stronger financial profile than NuStar. It has an investment-grade credit rating — it’s one of the highest-rated midstream companies — backed by a relatively low leverage ratio. It has the financial strength to endure the current turmoil since it can more easily borrow money at lower rates than its financially weaker rivals. For example, the company issued $300 million of 30-year notes in December at 3.95%, giving it the funds to refinance other debt, finance capital projects, and repurchase some of its units. 

On the other hand, NuStar has junk-rated credit, so it has much higher borrowing costs. That was evident in its recent debt financing. It issued $600 million of five-year notes at a 5.75% interest rate and $600 million of 10-year bonds at a 6.375% rate to help refinance other debt. 

Given its current credit situation, NuStar’s primary focus has been on improving its balance sheet. The company has done that by selling assets — it sold its Texas City terminals for $106 million in December — while also slashing its growth-focused spending. It will likely continue to focus on repaying debt in the near-term to bolster its financial flexibility.  

A look at their valuations

NuStar Energy’s weaker financial profile has weighed on its unit price over the past year. Its unit price has tumbled 45% over the past year compared to a nearly 30% decline for Magellan. 

On one hand, that steeper decline has it trading at a lower valuation these days. NuStar currently expects to generate between $690 million to $730 million of adjusted EBITDA in 2021, about flat with last year’s level. With a current enterprise value (EV) of $5.2 billion, it trades at an EV/EBITDA ratio of 7.3 times at the midpoint of its 2021 forecast.

Meanwhile, Magellan currently expects to generate about $1.325 billion of Adjusted EBITDA in 2020 and should be able to produce around that much this year, if not more. Given its current enterprise value of $14.9 billion, it trades at 11.2 times its EV/EBITDA. 

What’s ahead for these two MLPs 2021

Because of its stronger financial profile, Magellan Midstream has a lot more flexibility this year. As a result, the company plans to maintain its current distribution level, using its excess cash to fund expansion projects and continue repurchasing its beaten-down units. That buyback, along with improving market conditions, could help boost its unit price this year.

Meanwhile, NuStar’s priority remains on reducing debt. It plans to reduce its growth spending even further this year, using the savings to repay debt. As it reduces leverage, that should lift some of the weight holding down its unit price.

High risk/high reward vs. high-quality

While Magellan and NuStar are MLPs that operate infrastructure to transport and store crude oil and refined products, they have vastly different risk/reward profiles. NuStar’s weaker balance sheet makes it much higher risk, though its cheaper valuation suggests it has more upside. On the other hand, Magellan is a much lower-risk investment, though with less upside potential.

As a result, Magellan is the better buy for income investors right now since its payout is on a more sustainable foundation than NuStar. Meanwhile, investors willing to take on more risk might want to consider NuStar’s greater upside potential.

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.

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View more information: https://www.fool.com/investing/2021/01/11/better-buy-magellan-midstream-partners-vs-nustar-e/

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