OKE - ONEOK: Captivating Dividend Yield And Secular Growth Potential

2023-06-20 06:08:48 ET

Summary

• ONEOK offers a compelling dividend yield of around 6.2%.
• Anticipated developments in the energy sector indicate a less cyclical nature for natural gas, driven by three significant factors.
• The shift from coal to natural gas power plants, the increasing preference for electricity to charge electric vehicles, and the rising power demands of artificial intelligence technologies.
• ONEOK endeavors to manage its debt and continue dividend payments. The outlook for future dividend increases remains uncertain, as achieving desired levels of debt reduction may hinder the capacity to raise dividends.

Investment Thesis

ONEOK's ( OKE ) dividend yield is around 6.2%, more than enough to entice investors, particularly once investors wrap their heads around the secular growth engines to higher natural gas prices.

Here, I'll start my analysis by describing why I strongly believe that going forward over the next few years, natural gas will be a lot less cyclical than it has been in the past few years. Indeed, I make the case that natural gas has 3 main significant drivers that one should be made aware of.

Then, I'm going to discuss the one thing all investors reading about OKE want to know about, its dividend, and some possible areas of concern for dividend investors.

Nevertheless, despite indicating these concerns, I'm very bullish on OKE stock.

Why Do We Need to Improve the Flexibility of Our Electrical Grid?

ONEOK charges a fee for natural gas (refined and processed) volumes transported over its pipelines and processing facilities rather than from the price of natural gas .

This is an important distinction that I'm not sure many investors remember. It's the volumes of natural gas that matter to this thesis. Not the price. That being said, they of course tend to largely tract each other.

Here are 3 reasons why natural gas demand will move higher over the next one to two years.

Firstly, as we seek to decarbonize our energy sources, this means that we are moving away from coal-powered energy plants to natural gas plants.

Secondly, as we seek to charge our EVs from our households, that will mean that electricity will be the preferred use of energy, rather than heavy oils.

Thirdly, AI is a revolution that will impact us all. Even if this statement sounds bombastic right now, it's no more bombastic than the internet was in the early 1990s.

Furthermore, AI is extremely power-hungry. The jump in power from a calculator to a PC is the same jump in terms of computing power to go from a PC to a cloud server. And it's a roughly equal jump again going from cloud servers to AI large language models. All the computing power and training, and cooling, will require significantly more electricity.

These 3 aspects lead to the increased use of natural gas. Now, it's not only natural gas, nuclear and renewables that will play a role too. Essentially, natural gas will be the bridge and destination fuel that will enable the renewable transition.

Why Invest in OKE?

ONEOK finds itself at a crossroads. The business is expected to acquire Magellan Midstream Partners ( MMP ). Even if there's mounting opposition , I don't believe that this opposition will succeed in gathering enough votes to stump the acquisition from going through.

What could happen is that this opposition could ultimately lead to a renegotiation of the acquisition price, but I don't believe that Magellan Midstream Partners' management will stop the acquisition from going through.

This is pure conjecture from my side. But I believe that MMP's management will have been offered a very attractive bonus to step aside, and from what I can discern from the outside, MMP's management does not appear to be putting up too much of a fight.

Consequently, for our purposes, I've assumed that acquisition goes through, even though I've left myself some margin of safety to assume that ONEOK's balance sheet could end up slightly more stretched than anyone had originally desired.

Above, we can see that the bearish concern facing ONEOK is that its balance sheet is mightily stretched (assuming the acquisition goes through).

Furthermore, as part of the deal, ONEOK will end with about 582 million shares outstanding. Therefore, given that its annualized dividend is around $3.82, this means that ONEOK's annual capital going out the door to finance its dividend will be around $2.2 billion.

Management makes the case that even after the dividend is paid, ONEOK will still have around $1 billion of excess cash flow to pay down each year, with the aim to deleverage its balance sheet back to 3.5x net debt to EBITDA.

However, even assuming that ONEOK does pay down its debt, 3.5x net debt to EBITDA close to the end of this decade, means that ONEOK may be unlikely to have the wherewithal to increase its dividend payout any time soon.

The Bottom Line

In summary, the investment thesis on ONEOK revolves around its enticing dividend yield of approximately 6.2% and the expectation of a less cyclical natural gas market.

This analysis highlights three significant drivers for natural gas demand: the shift from coal-powered plants to natural gas, the increasing use of electricity for charging EVs, and the power-hungry nature of artificial intelligence.

These factors position natural gas as a bridge and destination fuel for the renewable energy transition.

The impending acquisition of Magellan Midstream Partners adds complexity to the picture, with concerns over ONEOK's stretched balance sheet. While management anticipates sufficient excess cash flow for debt reduction, the ability to increase dividend payouts in the near future remains uncertain.

Altogether, there's a lot to be excited about ONEOK's near-term prospects.

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