Magellan Midstream Partners, L.P.
Q2 2021 Earnings Call Transcript

Published: 29 Jul 2021

[Operator:]

Greetings, and good afternoon, everyone. Welcome to the Second Quarter 2021 Earnings Call. During the presentation, all participants will be in listen-only mode. Afterwards, we will have a question and answer session. As a reminder, this call is being recorded, Thursday July 29, 2021. It is now my pleasure to turn the call over to Mike Mears, Chief Executive Officer. Please go ahead, sir.

[Mike Mears:]

All right. Well, hello, and thank you for joining us today for our second quarter earnings call. Before we get started, I'll remind you that management will be making forward-looking statements as defined by the Securities and Exchange Commission. Such statements are based on our current judgments regarding the factors that could impact the future performance of Magellan, but actual outcomes could be materially different. You should review the risk factors and other information discussed in our filings with the SEC inform your own opinions about Magellan's future performance.

[Jeff Holman:]

Thanks Mike. First, let me mention that, as usual, I'll be making references to certain non-GAAP financial metrics, including operating margin, distributable cash flow, or DCF, and free cash flow and we've included exhibits to our earnings release that reconcile these metrics to their nearest GAAP measures. Earlier this morning, we reported second quarter net income of $280 million compared to $134 million in second quarter of 2020. Adjusted earnings per unit for the quarter, which excludes the impact of commodity related mark-to-market adjustments, was $1.38, which as Mike pointed out exceeded our guidance for the quarter of $1.15.

[Mike Mears:]

Thank you, Jeff. As part of this morning earnings release, we also reiterated our expectation to generate annual DCF of $1.07 billion during 2021. This guidance assumes contributions from the independent terminal through the remainder of the year, given the uncertain timing of the sales transaction. While we outperformed our guidance for the second quarter, some of the favorable impacts we enjoyed during the quarter are expected to be offset by higher costs during the second half of the year in part due the expenses that shifted from the second quarter to later in the year, as well as by lower commodity margins compared to the margins we expected when we increase guidance in April. We've now hedged approximately 80% of our gas liquids blending for the fall season. Blending margins compressed somewhat over the past few months, primarily due to higher costs for both butane and RIN, while future gasoline prices did not increase by similar amount. As a result, we are now expecting an average margin close to $0.35 per gallon for the year versus $0.40 previously announced. Additionally, we have also hedged about 80% of spring blending for next year as well at margins also around $0.35 per gallon. Turning to refined products demand, we expect refined product shipments to be in line with our previous estimates for the year with total volume still forecasted to be 13% higher than last year. By product we expect total gasoline shipments to be 13% higher, distillate 10% higher and aviation fuel 25% higher than our 2020 volumes. With overall current year refined product shipments still expected to be about 3% above the more normal demand year of 2019. Our estimates continue to project modest growth in demand associated with increased travel and economic activities, as well as increased contributions from our recent Texas expansion projects. Partially as a result of a customer recently completing a required connection that had encountered COVID related delays. We continue to see improvement in gasoline demand, especially during the peak summer vacation season and we have also seen continued improvement in distillate and jet fuel demand. Our estimates expect the improved level of activity will remain with people returning back to work in school in our markets and no additional lockdowns related to virus variants or otherwise. On the subject of our refined products pipeline, I'd like briefly mentioned the mid-year tariff changes that went into effect on July 1st. As expected we decreased the rates by approximately 0.6% in those markets subject to preferred index methodology, which historically have represented around 40% of our shipments. In the remainder of our markets we increased the terrorists by an average of more than 4% resulting in an overall average refined products mid-year tariff increase of nearly 3%. I also want to mention the due to increased movements on our recently expanded Texas pipeline segment, which is not governed by the FERC. We expect the overall percentage of our shipments subject indexation to decline through time with more volume being subject to market-based rate adjustments.

[Operator:]

Thank you very much. Our first question comes from the line of Spiro Dounis with Credit Suisse. Please go ahead.

[Spiro Dounis:]

Hi, afternoon everybody. My first question just on asset sales and state of play of that market today, it's been another fairly active year for you again and realize it's hard to predict what M&A looks like going forward. But just curious is this a trend you think can continue at this pace? Or are you finding as you sort of prune these assets down little by little, that remaining portfolio starts to look maybe a little too core for you to part ways with and doesn't sort of lean you into maybe doing more of these joint ventures or optimizations that others have done as well. And if you could just maybe opine on interest levels in M&A right now as we stand in the year versus earlier this year as you're getting stronger or weaker about the same.

[Mike Mears:]

Well, let me address your first question. I mean, we have been active in asset sales, much more active than we've been historically. And that's been a process that we've routinely been engaged in is determining whether we have assets that are more likely to be more valuable somebody else and we think their present value is best. As we look forward, I want to comment specifically on anything we might do, but if you look at the assets we have sold, they've either been partial interest in joint ventures where we've retained an ownership or in the case of the marine terminals and the southeast terminals that – for reasons that are probably obvious. They're not really connected as part of a network on our refined products system or our crude oil system. So those are assets that are much easier to sell and not have any lingering negative impact on the remainder of the company. And you're right. I mean, if you look at the suite of our remaining portfolio, the number of assets that fall into that category, are smaller than before we sold these assets. But that doesn't mean that we don't consider and evaluate or won't continue to consider and evaluate assets, but we're not in the business of selling everything we own either. So we make those decisions from a strategic standpoint also and not just the absolute amount we can get from a transaction, but also what potential cost parts as they would have for the rest of the remaining system. So I'll just leave it at that. And I think your second question was with regards to whether there's been an uptake in M&A. And I think the – I mean the short answer at least from our view is it's still relatively slow. Obviously, we've been active in selling assets, but as far as assets that are in the market that we're interested in, we haven't been very active. And I would anticipate going forward that it's going to remain that way unless there's something very attractive to us that we think we can get at a reasonable price.

[Spiro Dounis:]

Got it. Very helpful. Thanks Mike. Second question just on MLP and tax and some of the uncertainty around that. I guess to the extent MLPs could eventually be taxed as C-Corp, just curious from your perspective, is that an automatic trigger for you to convert to a C-Corp? Or are there other considerations to keep in mind?

[Mike Mears:]

Well, if – clearly, if the MLP structure is no longer allowed, then yes, we will most likely convert. There's really no reason to remain a partnership without the tax advantages associated with it.

[Jeff Holman:]

Yes, the one caveat being is that in some permutations of proposals, there has been discussion of transition periods. It could be in the original back in the 1980s legislation, I think it was a 10-year kind of transition period, so sort of a long transition period. There will still be decisions about timing and what makes the most sense, but that will just be based on obviously facts and circumstances, the rules around that, how people are looking through to the ultimate situation versus do we see value and continuing to avoid a double taxation for a number of years, et cetera. So that's the only nuance probably that we would have to work around.

[Mike Mears:]

Yes, as you think about where we stand on that, I think three months ago it looked like it was more likely than not. We were going to have a requirement in new legislation to eliminate the structure. As we sit here today, it appears maybe it's a little less likely than it's going to happen. It's still a risk factor that's going to overhang the industry until there's uncertainty. And, as I said, I mean, it seems from week to week or month to month the likelihood that something is going to change moves around quite a bit. So it's kind of difficult to make any kind of long-term planning with regards to that. But we think at least at this point in time it looks like perhaps that legislation is not going to require, it looks like that's died down a little bit, but as everyone knows, I mean, things can change quickly in Washington, but that's what it looks like at the moment.

[Spiro Dounis:]

Got it. Understood. All right, I appreciate all the color. Thanks again guys.

[Mike Mears:]

You're welcome.

[Operator:]

Our next question is from Theresa Chen with Barclays. Please go ahead.

[Theresa Chen:]

Good afternoon. Thanks for taking my questions. First, Mike, I'd like to touch on the guidance you iterated, just in light of to beat this quarter and keeping it flat for that year. And I appreciate, all the color around it, just delving into this a little bit more related to the cost increases that or cost that were artificially suppressed this quarter have moved out to second half. How much was that? And what does that related to versus the lower expectations for butane blending in the fall, now that you've hedged the bulk of it? And was there any other moving part around full year guidance?

[Mike Mears:]

Well, yes, let me kind of simplify it because there is obviously a lot of moving parts. We're going to just talk about the material ones. I mean, first of all, I think, there was some speculation that perhaps we had reduced significantly or refined product demand forecast for the remainder of the year. That hasn't happened. I can't tell you that we've tweaked it a little bit. Our internal forecast, we've lowered gasoline a little bit. We've increased diesel. The net of those is a slight reduction, but it's not a material contributor to the change in our forecast. So for the most part, our second half volume forecast is very close to what it was back when we visited with you in our last earnings call. The big changes that are reduced in the second half to offset the over performance in the second quarter is number one the commodity margins, which are lower than what we had anticipated. As you know, as we mentioned in the call last time, we had not fully hedged to the spring. Fortunately as time went forward, the margins compressed. And when we did reached a point of locking in the remainder of the volume, those margins came down. And so that is one of the significant changes in the second half of the year. The other is, as you mentioned, the cost, the timing of the cost. And I don't have the precise numbers here in front of me. I can tell you one of the big items is on maintenance capital that just through the timing, not in any intentional way, but just through the timing of how these projects unfold. We significantly under spent our expectations for maintenance capital in the second quarter, in the first quarter, quite frankly. And we're anticipating that we're still going to spend the same amount of maintenance capital by the end of the year as we originally planned. And so that has a negative effect on the second half of the year. So, those are the two primary elements. Again, there's noise around a lot of different individual line items, but those are the big items right there.

[Theresa Chen:]

Thank you. And I guess switching gears to your pending sale, independent terminals along the southeast, how's the FTC process going there? And do you expect the second request related to this?

[Mike Mears:]

Well, we have not yet received a second request and it's really hard for us to predict whether we will or not. The process is going well. I mean, we don't have any – there hasn't been anything that's been raised from the FTC desk that's caused us any concern on this. But whether we get a second request and how long the process is going to take, we really don't have anything to comment on that at this point. We think we're going to have a successful approval at the end of the day. I think, Theresa, it's more a question of how – when rather than if, but sometimes these processes go quick, sometimes they don't. We don't know which one of them is going to be on this one yet.

[Theresa Chen:]

Great. Thank you. And lastly I appreciate all the details you gave on the rates and the natural inflation exposure that many of your assets have. And as we look to 2022, given the current inflationary environment, can you just give us a sense of what your expectations are for total tariffs and fees increases mid-year next year, given that we have a lot of the data as is. And can you remind us how much of your assets are subject to caps and collars versus those that are not?

[Mike Mears:]

Well, I can tell you that on – so the index is going to be formula driven and I don't have what PPI is year-to-date, but it's very strong. And so, we would expect that our index rates are going to be – have a significant increase next year driven by the index and driven by the PPI. What we do in the market base rate locations? We haven't done that analysis and we typically wait until the spring and do a competitive analysis around our terminals to make a determination as to what those rate increases will be. I don't know what that will show yet. Obviously in a high inflation market, we would probably be more inclined to increase those rates more than we would in a low inflation market, but I don't have numbers for that yet, and I won't have numbers. We won't have a sense of that until we get into next year and start doing our planning for the tariff increases, which typically takes place in the late spring. And as far as the percentage of our volumes that are subject or revenue that's subject to index, I mean, right now it's around 40%, but as I mentioned, as time goes on, we expect that percentage to decrease. And it's not because we're losing volumes in that market, it's because we're increasing volumes in markets that are not subject to the index, particularly in Texas, which are intrastate rates. And so as those volumes grow than the percentage of our transportation revenue, the subject to the index will decline over time.

[Theresa Chen:]

Thank you.

[Mike Mears:]

All right, thank you.

[Operator:]

And our next question is from Shneur Gershuni with UBS. Please go ahead.

[Shneur Gershuni:]

Hi, good afternoon, everyone. Mike, I was wondering if I can just go back to the conclusion of your prepared remarks. I just wanted to make sure I heard everything correctly. It sounded like a special distribution is something of a lower priority from a capital return perspective. And so, if I understand correctly, it sounds like high return playing field CapEx opportunities is probably priority number one, but otherwise opportunistic buybacks to help improve your payout ratios and improve your coverage ratio is kind of the preferred avenue of incremental returns of capital. Just kind of wanted to understand that at this point,

[Mike Mears:]

I think you framed it exactly right. I want to make clear that we're not saying we'll never do a special distribution, but when we look at the playing field right now, it's low on our priority list and we're not planning on one at the current moment. So you're correct, high return capital investments and equity repurchases are our top priority right now.

[Shneur Gershuni:]

Okay, perfect. And then secondly, I just kind of wanted to revisit the PPI question that Theresa just asked. When I sort of think about your business, I would imagine that this PPI impacts the overall cost of your business this year into next year and so forth. When I sort of think of your base cost structure versus your revenue structure, is it fair to conclude even though not all the revenue is tied to regulated – to the regulated index that the revenue increase driven by PPI would be greater than anything that would happen on the cost side in terms of mining your business?

[Mike Mears:]

I think that that's generally true. I mean, if you look at or I should qualify that by saying to date that's been true. I mean, our largest costs on our pipeline systems are typically people and power and we haven't seen cost increases on those two line items consistent with what PPI has been year-to-date. Now, again, that could change going forward, but that's where we are currently. We are seeing cost increases particularly on maintenance projects and capital purchases, increases in steel costs and those sorts of things. So as we replace pipe, replace valves, do those sorts of things. We have seen significant cost increases, but we haven't seen it on our two biggest pieces. Now, again that's as of today we'll have to see how that plays out going forward. But I think – I think that's that on that one. Does that answer your question?

[Shneur Gershuni:]

Yes. No, it definitely does. I have a few more, but I'll go back into queue and respect the two questions.

[Mike Mears:]

Okay.

[Operator:]

And our next question is from Jeremy Tonet with J.P. Morgan. Please go ahead.

[Unidentified Analyst:]

Hi, this is John for Jeremy. Wanted to start kind of digging in more on the capital allocation and I guess buybacks specifically, you've talked about kind of like more regulatory certainty needed there, but also kind of completed 80 million or so in buybacks during the quarter. Kind of – can that pace continue without more regulatory uncertainty or was that kind of like considering the assets sales also? And how are you kind of thinking about that in general?

[Mike Mears:]

Well, I don't want to comment specifically on the pace of the buybacks, but I will say regulatory uncertainty has been an element in deciding when we execute and when we don't, and it will continue to be that way. I think at this moment we think the regulatory uncertainties died down a little bit. This is not gone away completely. If the proposed legislation of Washington continues on the porch where it is right now, where it doesn't look like this is going to happen. I mean, there's going to be a required conversion to a C-Corp then that puts us in a more comfortable position with regards to our equity pace, if that changes that can affect that.

[Unidentified Analyst:]

Okay. That makes sense. That's helpful. And then also wanted to ask quickly on kind of the legal expense for the quarter; do you mind expanding on what that was related to, and should we expect any continuing elevated legal costs or was that more one-time?

[Mike Mears:]

Well, what I will say, I don't want to talk about the specific cases involved, but there were multiple legal items that were all netted to the number you saw in the financial statements. It wasn't just one issue. And we expect those to be one-time deals. These are not recurring items. These are one-time resolution of lawsuits or other legal disputes that were resolved in the second quarter.

[Unidentified Analyst:]

Okay. Thank you very much. I'll stop there.

[Operator:]

Our next question is from Tristan Richardson with Truist. Please go ahead.

[Tristan Richardson:]

Hi, good afternoon guys. Just a quick question on the rationalizing capacity in the crude oil, I think you've noted that the contract portfolios and timing of expirations are always going to be a limiting factor. Can you talk about any progress on that front, either with peers or customers, but then also, I think you guys have talked in the past about looking at optimization opportunities that are outside the scope of doing something with a peer. Can you give us a sense of what that could look like?

[Mike Mears:]

Well to your first point, I don't have an update to give you, I can't tell you we are actively and continue to actively look at opportunities but I'm not in a position to give you an update on any developments there. As far as other optimization opportunities and we've executed on a number of things to improve our cost profile. With regards, if your discussion is specifically with regards to optimization around assets, again I don't really have an update to give you. There's some things we're doing that are going to lower our costs but they're probably not material things that are worth talking about at this point. So I guess the takeaway you should have here is, this isn't something we evaluated and put on a shelf. It's a very active process for us. And we do believe asset rationalization; especially in the Permian would be a good thing. If all of the relevant parties can find a way to create incremental value through such an action and we'll continue to evaluate and pursue it.

[Tristan Richardson:]

Appreciate it Mike. And just a quick follow-up, I think in the past you've been asked about opportunities on the renewable fuel side, and I think you've talked about – there might be potential initiatives out there to pull that blending activity backward into the value chain. So that there will be more of an opportunity for Magellan. Just curious, is that something you guys continue to look at or are there other potential updates there, or maybe some case studies that we should think about?

[Mike Mears:]

Well, we're very active in that regard. You know, I mentioned in our notes that we are adding biodiesel blending at some facilities in Kansas and Missouri, but we're doing a number of other things. We have started test movements for biodiesel blends in the pipeline, they've been successful. We've got a number of areas that we're targeting to start doing particularly biodiesel blending at hub locations and then transported by pipe. I would caution you that it's probably going to be more of a gradual process rather than a system-wide process all at once. I would also tell you it's in the – in an ideal situation; it's going to be something that we can do with very low capital. So we're not going to be adding hopefully a lot of capital cost to do this. But it's evolving and we're very positive on it. And we think we're on a path to be able to talk about it more in the future, but we are moving the ball on it.

[Tristan Richardson:]

Appreciate it. Thanks Mike.

[Mike Mears:]

Sure.

[Operator:]

And our next question is from Keith Stanley with Wolfe Research. Please go ahead.

[Keith Stanley:]

Hi, good afternoon. First, I just wanted to ask on refined products volumes. So you're sticking with the guidance for the year to be 3% above 2019 or normal levels. When I look at the first half of the year, you're already up 3% versus the first half of 2019. So this is probably overly simplified, but wouldn't that imply, you're not really assuming any incremental recovery in volumes in the second half in the guidance, and kind of assuming the same level of recovery in the second half of the year to be 3% above 2019 that you already saw in the first half of the year?

[Mike Mears:]

Yes. If you look at our volume forecast for the second half of the year, they're fairly consistent with what we actually saw in the second quarter. So on an absolute basis, and it's different by products, but on absolute basis, we're not expecting a tremendous volume growth from the second quarter of this year that just saw some tremendous growth. If you're comparing that to future period, I mean, past periods, you're still going to have in each of those quarters, a growth percentage because those previous quarters were depressed. But just comparing what we're expecting for the third and fourth quarter versus the second quarter of this year, it's relatively flat. But again, that's still when we do the math works out to about a 3% growth over 2019.

[Keith Stanley:]

Okay. That makes sense. Second question. I just wanted to clarify, I think – I think you said 80% of spring blending is now hedged as well. If I'm not mistaken that might be a little earlier than you typically do it. So just any thoughts on, I guess, why you decided to lock in more of the spring blending at an earlier point?

[Mike Mears:]

Well, I don't know that it's materially earlier than when we would have done it previously. When we – as you might expect, knowing when the precise time to hedge and lock in a forward margin, there's some science behind it and there's some art behind it. And these markets have been very volatile as you can imagine with butane prices and gasoline prices, not necessarily moving in tandem and RIN prices being extraordinarily volatile. And so I really don't have another answer for you other than taking all those things into consideration, we taught it was appropriate to lock in the margins. And as with any hedging program, you can second guess it after the fact you're always subject to that, whether you don't hedge and you made the wrong decision, or you do hedge and you make the wrong decision you have to make a decision. And when we looked at everything going forward into the spring, we just made the decision to lock that in. So I don't have any more detail other than that.

[Keith Stanley:]

Now, that makes sense. It's certainly been volatile. Thank you very much.

[Mike Mears:]

Sure.

[Operator:]

And our next question is from Gabe Moreen with Mizuho. Please go ahead.

[Gabe Moreen:]

Hey, good afternoon. Maybe if I could just follow up on Keith's question, just in terms of – can you just put into context sort of the RINs expense for this year relative to historical levels and also whether you had some of that exposure, I guess for 2022, at this point?

[Mike Mears:]

I don't have the number on what our actual expense is in front of me. If I'm being told that the average is about $0.13 a gallon is what our cost is, I don't know on an absolute basis what that works out to. We don't typically hedge the RIN independent of walking in the margin. So typically what we do when we lock in gasoline to butane margin. We also by the RIN associated with that. So we're not exposed at least on our hedged production to the RIN price, but we typically don't hedge RIN beyond that on a speculative basis.

[Gabe Moreen:]

Got it. Thanks Mike. And then maybe if I can ask, there's obviously been a lot of media reports about smaller markets running out of various refined products due to lack of truckers and whatnot. I'm just wondering to what extent that may or may not be impacting any of your markets. And I guess whether there's any opportunity for some smaller projects to come out of that?

[Mike Mears:]

Well we have – where we've seen some stress on supply is in the in the Front Range, Denver front range, and part of that is just due to their rapid recovery in demand. Part of that's due to the conversion of the Cheyenne refinery that's taken supply out of the market. We have already initiated some projects to get more supply up there. We're evaluating additional projects to get more supply up there. We think we're going to have a few of them. There are going to – that we're going to be able to execute on. These aren't transformational projects. They're maybe adding 5,000 barrels a day in that kind of range to the market, but they're highly – but they're relatively low capital, and if they're high return projects for us. So we're looking at that. We're also looking at some rail capability to rail more barrels into the market, into some of our facilities. So there are opportunities there. They're not quick fix kind of opportunities. They do require time and capital investment. But we do anticipate we're going to have more throughput and some high return projects to supply more barrels to the Front Range.

[Gabe Moreen:]

Got it. Thanks Mike.

[Mike Mears:]

Sure.

[Operator:]

And the next question is from Michael Lapides, Goldman Sachs. Please go ahead.

[Michael Lapides:]

Hey guys, thanks for taking my question. Just a quick one here on the growth CapEx outlook for next year, that's a pretty small number. Is that a placeholder at this time of the year, meaning little more than halfway through 2021? Or that, hey, we've gone to our customers, we've kind of talked it through and there really isn't a whole lot they need from us from an infrastructure standpoint, and it kind of is what it is. And is it too early to even have a view on kind of what that could be for 2023 or are you getting indications now already for 18, 20 months out?

[Mike Mears:]

Good question. I mean, first of all, the $15 million number, just to be clear on what that is. That is – that is on projects that have already been approved and are under construction. And so that $15 million is just what's rolling over in the next year to finish those projects. We do anticipate we're going to have incremental projects approved before the end of this year and into early next year. So that, that number will come up. I think to be realistic, it's hard to see based on what we have in front of us, that that number for a full year for 2022 would be above $100 million, but we could get up, if a lot of these projects we're working on actually happened, we could get up close to that number for the year, and it's too early for us to forecast anything for 2023.

[Michael Lapides:]

Got it. Thank you, Mike. Much appreciated.

[Mike Mears:]

Sure.

[Operator:]

And Mr. Mears, I’ll turn the call back over to you.

[Mike Mears:]

Alright. Well, thank you everyone for your time today and your interest in Magellan, and we will talk to you soon,

[Operator:]

Ladies and gentlemen, that does conclude our conference call for today. We thank you all for your participation. Have a great rest of your day. You may disconnect your lines.