OKE - ONEOK: Strong Asset Base And The Magellan Deal Add More Fuel

2023-10-12 06:00:09 ET

Summary

• ONEOK announced a merger with Magellan Midstream Partners, one of the largest deals in the energy sector, which will significantly increase OKE's EBITDA.
• The Company has consistently grown its EPS by 14% annually through acquisitions, and its yield above 5% makes it an enticing investment.
• Despite concerns about debt levels and achieving expected synergies from the merger, OKE's resilience and strategic ambitions make it a buy.

Investment Rundown

One of the more interesting companies to follow right now in the energy sector has to be ONEOK, Inc. (OKE). A company that created headlines when it announced the merger with Magellan Midstream Partners (MMP). The deal is one of the largest in the sector and will add a significant amount of EBITDA to the income statement of OKE.

OKE may exhibit a premium to the rest of the sector, but I find this justified as OKE has been growing the EPS by 14% annually over the last decade. This has come from significant amounts of acquisitions over the years and expecting it to continue I think is reasonable. The market likes consistency and OKE has shown plenty of it. Besides, the company also has a yield above 5% which I find enticing enough to invest in right now. This all results in a buy being issued by me for OKE.

Company Segments

OKE is a significant player in the natural gas industry, boasting a substantial market capitalization of $30 billion. The company's strength lies in its remarkable portfolio of natural gas midstream assets, which consistently contribute to substantial volume growth. This formidable presence in the midstream sector positions OKE as a key player in the energy market, with the potential for significant impact and growth.

Despite some volatility in the commodity markets the company has consistently been raising the EBITDA through a plentitude of acquisitions over the years. Most recently the deal that merged OKE with MMP. This addition boasts the portfolio of OKE's significance and has been a key reason for the uptrend recently in terms of the share price. Investors are anticipating OKE being able to raise the top and bottom line even further and maintain the double-digit EPS growth it has compounded annually over the last decade.

In May 2023, OKE made a strategic move by announcing its intention to acquire MMP. This acquisition was structured at a valuation of $67.50 per share for MMP, offering a substantial premium compared to the stock's trading price, which was hovering around $55 per share at the time. The market's initial reaction to this significant development was notable, as OKE stock experienced a 10 percent decline on the day of the announcement. However, the company has since shown resilience, with its stock rebounding from the initial dip. This move reflects OKE's strategic ambitions and its commitment to expanding its presence in the energy sector. The EPS estimates suggest 2023 resulting in $5.63 per share and I would agree here as natural gas prices are finding their bottom and I think it will be heading far higher from here on out. Going into the winter months seeing an appreciation in the prices I find likely seeing as it faces more demand during those months when temperatures are lower. This should in Q1 FY2024 be positively reflected in the income statement from OKE.

Earnings Highlights

The last quarter for OKE I think showcased a lot of resilience. The company managed to raise the bottom line to $468 million, up from $414 million a year prior. The maintenance capital remained the same which I think is great news as it means operational costs are possible to keep down slightly. Going forward it seems like natural gas prices are finding their bottom and I would expect them to continue trending upwards into the winter months and spring next year. This period tends to be when prices are higher as the necessity of warm homes for example increases. For the coming quarters, I will mostly be looking at the company's ability to maintain the bottom line. This will add further fuel to the company's ability to raise the dividend .

On 31 October we are getting the next report from the company and this will include Magellan Midstream which makes investors very keen on seeing the impact of it, myself included. I think that we will see a positive beat on both the top and bottom lines, around $5 billion and $1.1 EPS respectively. I think that the share price will likely start appreciating more in value as a result of this. Speculating about where OKE may trade on a p/e and p/s I think something along 10 - 12 and 1.5 - 2 is fair. Perhaps if the acquisition is shown to show even greater impacts on OKE growth then a higher multiple may be applicable.

Risks

My main concern is with OKE and the impending acquisition. If there is not the immediate and large impact of the acquisition that investors are seeking then I think the share price may be due for a correction. Lacking growth prospects could warrant a lower valuation to reflect that. Firstly, their current debt levels are a significant worry. Additionally, there's a considerable risk associated with not achieving the expected synergies from this upcoming merger. Let's delve into these concerns in more detail.

OKE is presently grappling with a substantial debt load, as evidenced by its staggering debt-to-equity ratio of 177.6%. This stands in stark contrast to its peers, who maintain a significantly lower ratio of 62.6%. The sheer magnitude of OKE's debt is a cause for concern, with its total debt amounting to $12 billion. Moreover, the impending acquisition entails issuing an additional $5.1 billion in notes, along with assuming a net debt of $5 billion from Magellan. These factors collectively elevate OKE debt to an estimated $23 billion, further intensifying the debt-related apprehensions. If the interest rates remain elevated for a prolonged period I think that the earnings of OKE are going to be heavily suppressed. The company needs to divert more earnings to pay it down and get into a reasonable range of leverage in my opinion. But it seems the market is not too concerned about this as it continues to trade at a premium based on earnings to the sector median. In the coming 12 months though the company has a very small amount of debt due, just around $4 million. This should be no problem paying down given the EBITDA of the business. As for the interest expenses for the company it sits close to company highs at $678 million, and I would assume that in 2024 it will rise given the fact that it's taking on $5 billion in debt following the deal. This could weigh on the bottom line for the short term or however long the Fed decides to keep rates higher.

Furthermore, the company has consistently been raising the shares outstanding in efforts to raise capital. I find this to be a concern over the long term. However, if the recent acquisitions prove to provide significant amounts of additional EBITDA then the rate at which shares are diluted may decrease. This would be a very bullish signal and the introduction of a buyback program could send shares even higher I think.

Industry Comparison

In comparison to another natural gas pipeline operator, we have Kinder Morgan, Inc. (KMI). Right off the bat, I can spot that the valuation of KMI is higher both on an earnings basis and a p/s ratio. Now, these are quite subjective ratios and metrics as they are dependent on strong commodity prices. The last couple of quarters have been volatile for natural gas, but as I said previously, I expect it to recover quite well going into the winter months of this year.

As for the profitability of the two, OKE has managed to gather up a far better ROE right now at 36%, in comparison to KMI with just over 8%. I think this adds more shareholder value as OKE can raise the dividend more efficiently and faster as well. With KMI the payout ratio is also over 100% right now which of course is unstable in the long term. For this reason, I also find it more likely that KMI will cut or stop raising the dividend before OKE.

Final Words

The prices for natural gases have been quite volatile in the last quarters and I would expect it to continue somewhat like that. However, the long-term still looks positive for natural gas as we as a society are still heavily dependent on it. The acquisitions that OKE has done throughout the years have proven very profitable and I think this is adding a lot of value to the business and what investors are getting. A yield of over 5% and a historical EPS growth of 14% each year are optimistic about how the future might look for OKE. The addition of MMP will add further EBITDA and distribute capital and I am in for the ride, rating OKE a buy.

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