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Looking for Passive Income? Consider This Tried-and-True Energy Stock

ExxonMobil‘s stock recently clawed its way back to its all-time highs, pushing its yield down to 3.3%. Meanwhile, Magellan Midstream Partners (NYSE: MMP) is still 40% or so below its all-time highs and offering a huge 7.8% distribution yield. If you are looking for some passive income in the energy sector, Magellan’s fat yield should be of interest to you.

The main business

One of the main reasons why Exxon’s stock has rebounded to its high watermark is that its top and bottom lines are directly tied to the price of oil and natural gas. These commodities are highly volatile, and their prices have, over the past year or so, skyrocketed. Meanwhile, Magellan doesn’t really care too much about commodity prices. Its core business is collecting fees for helping to move oil and refined products. It gets paid so long as its system is being used.

The core of Magellan’s business is in the refined products space, which accounted for around 72% of operating margin in 2021. Essentially, this division helps to move things like gasoline and diesel fuel. The rest of its business is tied to moving and storing crude oil. A full 85% of its operating margin is fee based, which makes its business highly reliable even during energy downturns.

On top of that, Magellan has long focused on maintaining a strong balance sheet. Its financial debt-to- earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio is roughly 3.8. That’s just a touch higher than industry bellwether Enterprise Products Partners and at the low end of the broader midstream space. So the hefty distribution yield is built on a rock-solid foundation.

MMP Financial Debt to EBITDA (TTM) data by YCharts

The proof is in the pudding

That distribution, meanwhile, has been increased every single year since Magellan held its initial public offering (IPO). That was way back in 2001, so the annual streak is up to an impressive 20 years and counting. To be fair, the growth hasn’t been huge on an absolute basis, but it has been slow and consistent. Add that to the currently high yield, and Magellan is a worthwhile option for income investors.

The caveat is that Magellan’s target distribution coverage ratio is around 1.2. While that means that the master limited partnership’s cash flows can more than pay for its distributions, there’s been a shift in the industry. For example, Enterprise’s coverage ratio was 1.8 in the first quarter. While 1.2 used to be considered strong coverage, it isn’t anymore. 

But when you consider Magellan’s distribution history and historically strong balance sheet metrics, even conservative investors should probably be willing to accept this risk. That said, while you shouldn’t lose sleep over the 1.2 coverage target, it’s worth monitoring, just in case.

Lock it in

If your goal is to collect a passive income stream, Magellan might be a good pick for you. This master limited partnership isn’t exciting, but it is reliable. And while investors have dramatically bid up the prices of commodity-tied energy names, they have seemingly forgotten about Magellan and its toll-taker business.

With a 7.8% yield, a strong balance sheet, and a long history of annual distribution increases under its belt, you might want to buck the trend and take a look at Magellan today.

Reuben Gregg Brewer has positions in Enbridge. The Motley Fool has positions in and recommends Enbridge and Kinder Morgan. The Motley Fool recommends Enterprise Products Partners and Magellan Midstream Partners. The Motley Fool has a disclosure policy.

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