OKE - ONEOK Is Benefiting From A Gassier Bakken

2023-03-23 22:52:07 ET

Summary

• ONEOK has a nice tailwind coming from the Bakken as drilling activity is strong and wells in the basin are becoming gassier.
• OKE's balance sheet is in good shape with leverage near 3.5x, and the dividend is growing.
• The stock is a solid "Hold" for income-oriented investors.

ONEOK ( OKE ) is a solid player in the midstream space that should benefit from strong drilling in the Bakken and a rising gas-to-oil ratio in the basin.

Company Profile

OKE is an integrated midstream operator. The company has approximately 40,000 miles of natural gas and natural gas liquids ((NGL)) pipelines. It operates in three segments.

Its largest segment is its Natural Gas Liquids ((NGL)) segment, where it provides gathering, fractionation, transport, and marketing services around NGLs. Its operations span various basins including the Bakken, Powder River Basin, Niobrara, Permian, Barnett, and Scoop/Stack, among others.

The segment is projected to account for over 60% of its 2023 EBITDA. Over 90% of the segment’s earnings are expected to be fee-based in 2023.

OKE’s Natural Gas Gathering & Processing segment, meanwhile, consists of gathering pipelines and processing plants primary in the Bakken, Powder River Basin, and Mid-Continent. The segment is expected to account for about 25% of its 2023 EBITDA. Over 75% of the segment’s earnings are estimated to be fee-based in 2023, with the company’s contracts generally having some percent of proceed ((POP)) component to them.

The Natural Gas Pipeline segment comprises its intrastate natural gas pipeline and storage assets located in Oklahoma, Texas and Kansas. Over 95% of the segment’s EBITDA comes from fee-based sources, including firm and interruptible services. The segment is anticipated to make up over 10% of OKE’s EBITDA in 2023.

Opportunities and Risks

As a primarily fee-based midstream operator, the volumes running through its systems are the biggest factor with regards to OKE’s operational performance. While primarily dealing with natural gas, OKE is largely operating in oil basins dealing with associated natural gas that comes from oil drilling. Thus when looking at energy pricing, oil prices play a much bigger role in the activity surrounding its assets.

In fact, high oil prices and lower natural gas prices can benefit it, as its customers' drilling activities revolve around crude prices, but low nat gas prices can spur petchem demand. That, along with China reopening is beneficial to OKE. Strong ethane prices compared to nat gas prices also leads to more ethane recovery, which helps OKE fractionization volumes.

On its Q4 earnings call, CCO Kevin Burdick said:

“On our system, we expect the Permian Basin to stay in high ethane recovery in 2023, and for the Mid-Continent to be in partial recovery as natural gas prices fluctuate seasonally. We also expect to continue to see opportunities to incentivize ethane recovery in the Rocky Mountain region this year. We are on track to complete our 125,000 barrel per day MB-5 fractionator in Mont Belvieu early in the second quarter of 2023. And we recently announced MB-6, which we expect to be complete in the first quarter of 2025.”

High oil prices have led to strong drilling around OKE’s assets. But another dynamic that OKE is also taking advantage is higher gas-to-oil ratios, particularly on its gathering system in the Bakken. This means that the new wells getting drilled are gassier. In fact, natural gas volumes in the Williston have tripled since 2014, while the rig count has fallen -80%. Part of this is improve drilling and completion technology, but the gas-to-oil ratio has also increased by 80% since 2016.

OKE is benefiting from the increased volumes coming out of the Bakken, as well as a desire to flare less gas. The company said it only needs 15 rigs to keep gas volumes flat, and that over 20 rigs are currently on its system. So the combination of more drilling and gassier wells in the Williston are nicely benefiting OKE.

On its Q4 conference call, Burdick said:

“Producers remain committed to the region, and we anticipate a few more rigs will return as we move into spring. At our guidance midpoint, we expect to connect 500 wells in the region this year, a nearly 40% increase compared with 2022. We've already connected nearly 90 wells through February and have remained steady at more than 20 rigs operating on our dedicated acreage. Additionally, there remains a large inventory of around 500 DUCs basin-wide with approximately half on our acreage. Keep in mind that in the Bakken, producer economics are driven by crude oil and our customers are some of the largest and most well-capitalized in the country. This means recent fluctuations in commodity prices and specifically lower natural gas prices have not had an impact on producer activity levels on our acreage.

“We also expect gas-to-oil ratios to remain strong and continue to trend higher in the future, which can drive volume on our systems even without increased producer activity. In the Mid-Continent region, we continue to see positive activity with approximately 10 rigs currently operating on our acreage and more than 50 across the region. We expect process volumes to grow 12% at our guidance midpoint compared with 2022, and average more than 700 million cubic feet per day in 2023. Rig activity across the basin will also continue to drive additional NGLs to our system.“

Outside of volumes and energy prices, there is a risk of the midstream industry overbuilding. A lot of fractionation capacity has been coming online near Mont Belvieu, as noted by Wells Fargo Michael Blum on OKE’s Q4 call. Overcapacity can hurt utilization and rates, but volumes are usually contracted out.

Its exposure to the Bakken and other northern basin also exposes it to weather risks. Winters in these areas can be harsh and will often times lead to slowdowns in activity because of inclement weather.

Meanwhile, last July OKE had a frac plant destroyed by an explosion in Medford, Oklahoma. The company will receive $930 million in insurance payments, and build a new fractionator costing $550 million to replace it. The new frac facility should be completed in early 2025.

Valuation

Turning to valuation, OKE trades at 8.8x the 2023 EBITDA consensus of $4.6 billion. The company does have $593 million contribution from the insurance settlement in there, which if taken out would be about a 10x 2023 multiple.

Based on the 2024 EBITDA consensus of $4.2 billion, it is valued at 9.6x.

The stock has a free cash flow yield of about 10% based on my 2023 projections calling for $2.7 billion in normalized FCF.

The stock trades towards the high-end of other larger midstream players.

Conclusion

OKE’s balance sheet is in solid shape, with year-end 2022 leverage of 3.7x, or about 3.5x after the insurance settlement. Its dividend coverage ratio is about 1.5-1.6x (OCF-Maintenance CapEx/Dividend Payout), which should allow it to continue to pay down debt, increase its dividend, and invest in growth projects. OKE stock currently yields around 6.2% and it has never cut its dividend in 25 years.

Its 10x multiple, however, is towards the high end of where midstream companies currently trade, and you can get companies with better assets at lower valuations such as Enterprise Products ( EPD ) or Energy Transfer ( ET ). (However, you have the benefit of no K-1, unlike those two.). That said, it has some nice tailwinds and I think midstream companies are undervalued in general. As such, I think it is a solid stock to “Hold” and you can be a buyer on any pullback.

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