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Ben Reynolds
Ben Reynolds
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Oneok: A Large-Cap With a High Yield and Growth Potential

A top-notch asset portfolio should provide continued growth and dividend

June 23, 2020 | About:

Since the Covid-19 outbreak, energy stocks have suffered massive losses as demand for oil and natural gas has collapsed, causing the sector to groan under the weight of its high debt.

Amid depressed prices in the sector, there are potentail opportunities for investors to grab some quality companies at a discount. We at Sure Dividend believe that ONEOK (NYSE:OKE) is an example of just such a stock.

This large-cap midstream company has been a consistent dividend payer for decades and is currently trading at around half its price from before the Feb. 19 stock market collapse. 

Business overview

ONEOK is an energy company that engages in the gathering and processing of natural gas. The company holds a world-class portfolio of natural gas assets, taking care of the liquid's storage and transportation.

In comparison with other energy companies whose operations predominantly revolve around oil, ONEOK's natural gas business is much more resilient and more capable of surviving a downturn, in our opinion, due to the cleaner nature of the fuel.

Earnings and dividend

The company has a consistent track record of growing its earnings and dividends. Up until recently, earnings had a five-year compound annual growth rate (CAGR) of 15%. As a result, management could comfortably raise the dividend, which saw a CAGR of around 9% over the same period. In fact, ONEOK has been consistently raising its dividend for the past 18 years. This is incredible for a company whose earnings are subject to commodity prices, which highlights its excellent asset base and skilled management. We expect that ONEOK's dividend growth is set to continue.

The recent market downturn and depressed natural gas prices should hit earnings in the short-term, but we expect a quick recovery. We estimate reduced Distributable Cash Flows per share for 2020 to be around $4.65. The current dividend per share of $3.74 is thus well-covered.

In regards to ONEOK consistently increasing its shares outstanding, some may find it worrying, as it dilutes value for existing shareholders. However, this is a common practice in the sector. Energy companies usually have a lower cost of equity in comparison to the expected ROI from the additional shares, therefore driving value with more issuance.

ONEOK grew its business at a steady pace in 2018 and 2019. Several new growth projects are expected to come online over the coming years, including pipelines and fractionation services in the Williston and Permian basins.

Valuation and future returns

According to our analysis, we expect that distributable cash flows per share and dividends per share will see CAGR of 5% and 6%, respectively. At its current price of $35.92, the stock is currently trading at 7.7 times its discounted cash flow. We believe that the stock's current valuation presents a significant opportunity, since it represents a decade low.

We expect a multiple expansion of around 10 times DCF, which is still below the stock's historical average. We understand that the low oil price environment has hurt many producers and their cash flow generation. Investors' reduced appetite for the sector and Wall Street's bearishness on it have caused us to lower our expected valuation from 13 to 10 times DCF. Along with our projected DCF and DPS, we come out with predicted CAGR returns of around 16% in the medium-term.

Risks

No matter a company's quality of assets and financials, every investment is subject to several risks. ONEOK recently announced a public offering of 26 million shares, representing 6.3% of shares outstanding as of the latest quarter. With the cost of equity being the underlying DPS and such a high yield, ONEOK's equity rise has been an expensive way to increase its liquidity.

Another risk to consider is ONEOK's ever-growing debt position. According to the company's most recent filings, its long-term debt amounts to a staggering $14.4 billion. This is almost as much as the company's current market cap of $14.8 billion. ONEOK's operating cash flow only covers interest payments by around 3.8 times, though we think this is still acceptable given the industry averages.

Investor takeaway

ONEOK is one of the many stocks whose price has suffered heavy losses amid Covid-19, but its asset quality and cash flows remain robust. Its track record of driving high-performance results has been consistent throughout the years. During the 2015-2016 oil and natural gas crash, the company kept increasing its distributions to stockholders. That's just one example of management's shareholder friendliness.

We believe that the dividend is well covered and expect it to continue in the medium term in-line with DCF. However, even a dividend cut wouldn't necessarily make the stock  unattractive for buyers.

We believe the future outlook is strong, which is why we rate the stock a buy for value and income investors who are not turned off by the risk.

Disclosure: No positions in any stock mentioned

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About the author:

Ben Reynolds
I run Sure Dividend, a website that finds high quality dividend stocks for long term investors using the 8 Rules of Dividend Investing.

Visit Ben Reynolds's Website


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