Published Feb. 25, 2017 by Bob Ciura
There is an old saying, that it is important to separate the wheat from the chaff. This is especially applicable when considering the oil and gas Master Limited Partnerships.
Investors typically buy MLPs for income. But as the past year proved, an MLP’s distribution is not guaranteed.
ONEOK Partners LP (OKS, Financial) navigated the recent downturn in natural gas prices well. It maintained its dividend, even as commodity prices crashed.
This speaks to the strength of ONEOK’s assets and business model.
ONEOK is a Dividend Achiever, a group of 272 stocks with 10-plus years of consecutive dividend increases.
You can see the full Dividend Achievers List here.
Plus, the stock has a hefty 6% yield.
Let's iscuss the key factors that allowed ONEOK to preserve its dividend through the crash, while so many other MLPs slashed their dividend payouts.
Business overview
ONEOK Partners LP is structured as a Master Limited Partnership. It has a general partner, ONEOK Inc. (OKE), which owns 41% of ONEOK Partners.
ONEOK Partners’ business model is based on storage and transportation of natural gas and natural gas liquids. It operates in the midstream segment of the energy sector.
The company has an extensive asset network, consisting of 37,000 miles of pipelines.
Source: UBS MLP Conference presentation, page 7
One of the core strategies for ONEOK in recent years was to reduce its reliance on commodity prices. It did this by tilting investment toward its fee-based assets.
By 2016, approximately 85% of the company’s earnings came from fee-based assets, up from 58% in 2012.
Source: UBS MLP Conference presentation, page 9
For the 10% of ONEOK’s earnings that still come from commodity exposure, the company mitigates this risk with hedging.
ONEOK’s repositioning came at the perfect time, as it allowed the company to fare much better during the downturn in oil and gas prices.
Growth prospects
The most important growth catalyst for a pipeline operator is new projects. Building and developing new pipelines creates revenue growth for ONEOK.
The company invested $9 billion from 2006-2016 in its infrastructure. This created strong growth, which the company seeks to continue moving forward.
One area the company emphasizes is further ramping up its Permian Basin assets.
Source: UBS MLP Conference presentation, page 17
ONEOK’s natural gas pipelines in the Permian have a total capacity of 1.9 billion cubic feet of gas per day.
The Permian is one of the premier oil and gas fields in the U.S. It is an oil and gas behemoth, that produces more than 2 million barrels of oil, and 8 billion cubic feet of natural gas, per day.
Higher production means greater demand for pipelines and storage terminals, and that means more cash flow for ONEOK.
Distributable cash flow, a non-GAAP financial measure frequently utilized by MLPs, rose 35% to $1.07 billion through the first nine months of 2016.
Natural gas volumes increased 15% over the first three quarters of the year, driven largely by continued volume growth in the Williston Basin.
Source: UBS MLP Conference presentation, page 22
In August, ONEOK completed an 80 million cubic-feet-per-day natural gas processing plant called Bear Creek.
Completion of the project spurred 45% growth in natural gas gathering and processing EBITDA through the first nine months of 2016.
The Bear Creek facility is 50% utilized. Continued ramp-ups should help volumes processed increase again in 2017.
Lastly, ONEOK pursued significant cost cuts to help grow distributable cash flow. For example, capital expenditures were reduced by 47% in the first nine months of 2016.
Dividend analysis
ONEOK has a current annualized distribution of $3.16 per unit. This works out to a 6% yield based on its recent share price.
ONEOK has increased its distribution by 98% since April 2006.
Importantly, the company carried a cash distribution coverage ratio of 1.11 over the first nine months of 2016.
The company has dramatically shored up its dividend coverage over the past year. Through the first nine months of 2015, ONEOK’s distribution coverage ratio was 0.80.
A ratio below 1.0 indicates the company is not generating enough distributable cash flow to cover its distributions. It is a red flag that the dividend is not sustainable, and could be vulnerable to a cut.
ONEOK’s volume growth and cost cuts helped the company get back above the 1.0 threshold. It currently generates approximately 11% more distributable cash flow than its distribution requires.
With continued growth of distributable cash flow, it could set the table for a distribution increase in 2017.
ONEOK maintains an investment-grade credit rating. S&P gives the company a BBB rating, with a stable outlook.
Keeping a manageable level of debt on the balance sheet helps a company keep its cost of capital low.
Source: UBS MLP Conference presentation, page 30
It also helps MLPs preserve their dividends when times get tough. Over-leveraged balance sheets were the main cause of so many dividend cuts in the MLP asset class over the past year.
This is why ONEOK took steps to lower its leverage.
Its debt-to-EBITDA ratio declined from 4.8 in 2013, to 4.3 last year. And, the company targets a ratio below 4.0 in 2017.
ONEOK’s improving balance sheet is a key reason why the company was able to maintain its distribution last year.
Final Thoughts
The crash in commodity prices caused many MLPs to cut their distributions over the past year. Some eliminated them entirely. Others went bankrupt altogether.
However, the most well-run MLPs continued to raise their distributions, even during the crisis.
By avoiding the debt binge in the years preceding the decline in oil and gas prices, ONEOK was spared, relative to many other MLPs that got hit much harder.
ONEOK’s hefty 6% yield appears to be sufficiently covered by distributable cash flow.
And, now that ONEOK has meaningfully cut costs and is ramping up processing capacity at several major growth projects, there is a chance the company could return to dividend growth in 2017.
In the meantime, investors are paid well to wait.
Disclosure: I am not long any of the stocks mentioned in this article.
