The 7.5% Yield on MLP ONEOK Makes the Risk Worthwhile

01/23/2015 4:31 pm EST

Focus: MLPS

Jim Jubak

Founder and Editor,

Today, following up on yesterday's energy sector dividend play, MoneyShow's Jim Jubak looks at another energy sector MLP that has been hit hard during the energy selloff, to determine if the risk is still worth the reward.

Yesterday, I took a look a one energy sector dividend play—Hi-Crush Partners (HCLP)—and the so-far, so-good story on dividend payouts for this supplier of fracking sand during the current plunge in oil prices. (See that post here.)

Today, I'm going to take a look at another energy sector dividend play; midstream pipeline master limited partnership ONEOK Partners (OKS). Like Hi-Crush, this MLP has been hit hard during the energy sector selloff, dropping from $59.44 on August 29 to $42.79 at the close on January 22. Like Hi-Crush, though, ONEOK has recently raised its quarterly payout, raising quarterly distributions per unit to 79 cents from 75 cents, a 5.3% increase, on January 15.

But as reassuring as ONEOK's decision to raise distributions may be, it's surely not the end of the story for income investors. Part of the appeal of energy sector MLPs has certainly been their relatively high yields during a period when yields on many income vehicles are extremely meager. But another part of the appeal, an important part, has been the record of these MLPs in growing distributions every year.

How likely is that going forward, especially in the near-term? For an income investor, the answer to that question is more important than the current high 7.54% yield on these units, since prospects for annual distribution growth are a big factor in the market's decision of where to set the price of an MLP.

ONEOK has two big advantages during the current energy rout.

First, about 70% of the revenue from the MLP's pipeline network comes from fee-based contracts. In the near-term, at least that gives the MLP's revenue stream significant shelter from shifts in the price of oil, natural gas, and natural gas liquids. Which is a very good thing since the price of natural gas liquids, the raw materials for the chemical and other industries and the focus of ONEOK's network, has plunged along with oil. And, for the same reason: Rising production from US shale geologies has resulted in a significant surplus in supply. For example, the price of ethane, which makes up about 40% of ONEOK's natural gas liquids flows, tumbled to 17 cents a gallon in December from 27 cents a gallon in July 2014.

Second, ONEOK's network of pipelines and processing plants reaches deep into underserved shale geologies such as North Dakota's Bakken. The company characterizes the areas it serves as the core of the core in the shale energy boom. Analysts estimate that because of the high productivity in these areas, all-in break-even costs for production companies are around $45 a barrel for oil. These producers will be among the last in the shale sector to cut production.

All this doesn't mean that ONEOK doesn't face challenges to reaching its target of 6% to 8% annual distribution growth. Some Wall Street analysts are predicting that distribution growth could slow to 3% or so-although-that seems a very low-ball estimate given the recent 5.3% increase in the quarterly distribution. Other analysts are holding their projections in the neighborhood of 7% annual growth.

It's this uncertainty that has sent the unit price down from $59 in August to $42 now. That same uncertainty has pushed the yield up to 7.54% currently. (The record date for the quarterly payout is January 30 with the payout itself on February 13.)

I think the risk of a period of lower distribution growth is real, although I'm with those analysts who think that 6% to 8% target is still reasonable. We'll get a better sense of that when the MLP reports revenue and earnings on February 23.

My read of the risk and reward on this income play is that I'd certainly hold here and that I'd recommend the units as a buy for income investors who can afford a bit of risk and who have the discipline to hold though any near-term price declines.

Like Hi-Crush Partners, ONEOK is a member of my Dividend Income portfolio

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