OKE - ONEOK: A Smart 6% Yield To Have Your Cake And Eat It Too

2023-07-24 08:20:00 ET

Summary

• ONEOK is a promising stock for income investors due to its 6% yield and good growth prospects, as well as its long dividend track record.
• The company is well-positioned for future growth as demand for natural gas is expected to rise, and it has reduced its net debt by $1+ billion over the past year.
• Risks include uncertainty over its acquisition of Magellan Midstream Partners and potential execution risks, but its solid dividend yield and low price-to-cash flow multiple make it attractive.

Those who like sports know the importance of building a strong team around you, and not every team member needs to have the same attributes. For example, some stocks may have a lower yield today but may have the promise of outsized returns in the future, while other stocks may be high yielders that may not offer much in terms of growth.

Then there are those in the middle that may satisfy great income combined with growth. Such I find the case to be with ONEOK ( OKE ), which may be a good ‘goldilocks’ holding with a 6% yield and good growth prospects ahead. In other words, you can have your cake and eat it too.

I last covered OKE here back in February, highlighting its long dividend track record and insulation from commodity price volatility. In this article, I discuss recent business developments and why income investors may want to own this durable income generator for their portfolio.

Why OKE?

ONEOK is one of the largest midstream players in the U.S., with fully-integrated and strategic assets that connect NGL shale basins with key market centers. This includes connections in the prolific Mid-Continent, Rocky Mountain, and Permian regions.

What may also be attractive for ONEOK is that it’s structured as a standard C-Corp, meaning that investors don’t have to deal with Schedule K-1s come tax filing season.

ONEOK is well-positioned to play an increasingly important role as U.S. and global demand for natural gas is expected to grow in the coming years and decades. This is supported by its ability to invest in high-return organic projects, including a 125K barrel per day MB-5 natural gas fractionator in Mont Belvieu, a major natural gas hub in Texas where Enterprise Products Partners ( EPD ) also operates. OKE expects an MB-6 fractionator to be completed in Q1 of 2025.

Since 2017, OKE’s return on invested capital has improved by a robust 380 basis points from 11% to 14.8%. Adjusted EBITDA is set to grow materially this year by 26% through placement of assets into service, while Capex spending is expected to grow by just 14% at the midpoint, as shown below.

According to the Energy Information Administration, natural gas demand is expected to grow through at least the year 2050, as shown below, with demand growth stemming from exports and industrial (i.e. petrochemical feedstocks) use cases.

Meanwhile, OKE is seeing strong near-term demand, with natural gas processing volumes growing by 11% YoY during the first quarter, driving a 32% increase in natural gas gathering and processing segment EBITDA. In addition, natural gas pipelines segment EBITDA also grew by an impressive 17% compared to the prior year period.

This supports guidance for full year EBITDA growth. This would mean annual growth in every year over the past 10 years, with above 12% EBITDA CAGR in the 2013-2022 period, as shown below.

Looking ahead, OKE’s near-term growth is supported by the expansion of its natural gas storage capabilities in Oklahoma, allowing it to utilize and subscribe an additional 4 Bcf of storage capacity. 100% of this incremental capacity is subscribed through 2027 and 90% through 2029. Moreover, the Saguaro Connector Pipeline under evaluation would provide ultimate delivery to an export facility on the West Coast of Mexico would open up new avenues for growth.

Risks to OKE include uncertainty over its acquisition of Magellan Midstream Partners ( MMP ), with a notable shareholder of MMP protesting the deal over the deal value and tax considerations. While that may be an overhang, OKE would be a strong company with or without the deal. In addition, there are always execution risks when it comes to development projects and estimates.

Importantly, OKE has materially reduced its net debt by more than $1 billion since Q1 of last year, and it carries $680 million in cash on hand. It also has a very manageable net debt to EBITDA ratio of below 3.5x, sitting well within the < 4.5x range generally regarded as safe by ratings agencies.

The 5.8% dividend also remains well-covered at a 71% payout ratio. Notably, OKE has paid an uninterrupted dividend stream for over 25 years, and the dividend has a 5-year CAGR of 4.4%.

Lastly, OKE remains a good bargain at the current price of $66.49 with a price to cash flow of 8.1, which sits towards the low end of its 5-year range, as shown below. At this price, OKE could deliver market-beating returns over the long run with the near-6% yield combined with a modest 5% annual dividend growth rate supported by underlying cash flows.

Investor Takeaway

ONEOK offers an attractive combination of income and growth, with strong prospects in the near-term and long run. The company pays a solid 5.8% dividend yield that is well-covered by cash flows, while its price to cash flow multiple sits towards the lower end of its five-year range. OKE has also reduced its net debt over the past year and has a manageable debt to EBITDA ratio. All of these factors make ONEOK a potentially great option for income investors looking for a long-term holding that offers both yield today and growth potential in the future.

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