Cash Rushes Through This Pipeline

10/17/2012 8:00 am EST

Focus: STOCKS

Net free cash flow is a key indicator to a company's ability to kick off reliable dividends, and this pipeline pick has it in spades, notes Lou Gagliardi of Cabot Global Energy Investor.

The lifeblood of a company’s financial strength is its ability to generate free net cash flow. For this reason, I look at operating cash flow before any investment decisions to get a truer picture of a company’s internal operational strength.

I then deduct capital spending to determine the company’s ability to re-invest in its operations (as well as possibly pay dividends and repurchase shares) using only its internal cash flow.

Drilling into my database of energy companies, one such company caught my eye: Magellan Midstream Partners LP (MMP), a pipeline Master Limited Partnership. Magellan has reported positive free cash flow each quarter since third-quarter 2009. Indeed, the second quarter of this year produced the firm’s highest NFC ever!

Magellan Midstream Partners has a $10 billion market capitalization with a 4.3% dividend yield. The firm engages primarily in the transportation, storage, and distribution of refined petroleum products in the United States. Magellan also owns and operates storage terminals that have capacity of approximately 36 million barrels.

Its financial strengths include growing EBITDA, exceptional free cash flow generation, a strong balance sheet with above-average EBITDA-to-interest expense coverage ratio, no general partner incentive distribution rights, and very low to insignificant short interest exposure.

I like Magellan’s outlook as an infrastructure player building pipeline capacity from main oil-producing regions like the Permian and Eagle Ford. The stock is registering positive momentum and resilient technical strength. It has an attractive dividend yield that provides a floor of support to the stock.

I recommend buying modest amounts, particularly on any stock pullbacks toward immediate support at $84.03. Place a firm stop-order limit at $79.10, and buy.

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