The Strategist

What is the secret a company with total revenue of 2630%?


08/30/2017 - 09:00



Are you interested in shares whose dividends grew 61 times since the IPO in 2001? Who overwhelmed all the market forecasts? It is unlikely that any of the investors will say "thank you, do not", after hearing about such a proposal. The mentioned company is called Magellan Midstream Partners, and it does not work in any of the fastest growing industries. Magellan seems to be an ordinary pipeline company engaged in transportation of gasoline and diesel fuel in the US with a total income of 2630%. How do they manage to get such an exceptional profit for years? Let's see how Magellan conducts its business - and what an investor, who is going to invest money in this company, needs to know.



pixabay
pixabay
It is difficult to understand how a company engaged in such risk-free activities as transportation and storage of oil products manages to receive such incredible income - especially given that the annual growth in demand for products since the company's IPO was only 0.6%. Magellan’s success can be explained by a variety of factors, among which there are three main points: the business model, the organizational structure of the enterprise and management. 

Let's start with the business model. In recent years, the demand for petroleum products has not grown too much, but it is still stable. Magellan supplies these products under contracts with a pre-determined price, so it is not frightened by volatility of raw material prices. This means that the company’s existing assets bring a steady income. In addition, many Magellan pipelines serve areas where there is no other energy supplier; therefore, a significant part of the company's assets is subject to laws for public utilities, which guarantees a fixed rate of return. Pipelines and terminals for storing petroleum products are expensive, but their maintenance costs are low, so every quarter the company earns a bunch of cash that it can distribute to its shareholders. 

Now, let’s talk about the company’s organizational structure. Magellan is a limited partnership, that is, a tax-optimized company whose income comes primarily from shareholders. Many companies are organized in this way, but Magellan has one feature that distinguishes it from everyone else: it does not have a major partner with rights to receive incentive payments (this is something like a management fee that allows the main partner to receive a certain percentage of the available cash).Thus, if there are no incentive payments, then all cash is evenly distributed among ordinary shareholders. This also means that the cost of raising capital in Magellan is less than that of most of its competitors. 

However, the main reason to invest in Magellan is its management, which knows exactly how to use the above factors to generate outstanding profits for many years. Although the cost of raising capital is low, Magellan invests money only in those projects that promise a high income and increase cost of the existing transport and logistics system of the company. According to the latest presentation for investors, the EBITDA value for all projects under construction is less than 7. The only exception to this rule are two terminals for oil exports, and their profitability is lower because this is the first stage of a long-term project, which in the future will necessarily bring high profits. Magellan’s management not only uses the right strategy to attract capital, but also intelligently manages financial activities. Unlike many other limited liability partnerships that pay all shareholders cash at the end of each quarter, Magellan retains a portion of these funds to pay for expansion costs. It seems that this goes without saying, but there are enough managers that believe that it will be enough for them to expand their business only to external capital (equity and/or borrowed). Due to all these factors, Magellan was able to ensure that since the IPO, payments to shareholders have increased annually by 12%, and all points to the fact that in the future the company is enjoy the same success.

The only reason why investors can refrain from investing in Magellan is that the company is a limited liability partnership. Since LLP is already a tax-optimized company, paying dividends to distributors is not a dividend, but distribution payments, which means that you are responsible for paying income tax on these revenues (which is calculated at your individual tax rate). In addition, you may have problems if the share in the private limited company is part of your pension investment, since the income from it is the income from the non-core activities. So due to the special organizational structure of Magellan, you will have to seriously bother with your tax return.

For many years, Magellan's activities have been unobtrusive for ordinary investors. The company rarely made major acquisitions and almost did not get into the headlines. It just grew steadily, and its leadership saw its main task to receive high income and prudent management of financial activities. This simple approach explains why the company has consistently demonstrated success for almost 20 years. Today, Magellan's shareholder's earnings per share are 5.5%, so if you are ready to invest in this company, now is the right time for it.

source: fool.com




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