A One-Two Punch of Yield and Growth

05/07/2009 10:54 am EST


Josh Peters

Editor, Morningstar DividendInvestor

Josh Peters, editor of Morningstar DividendInvestor, and analyst Jason Stevens like a pipeline company that throws off good dividends and offers capital appreciation, too.

As one part utility, one part pipeline general partner play, Oneok (NYSE: OKE) stands to provide utility-like yields with master limited partnership (MLP)-like growth.

Oneok adopted an attractive business model in 2006 that continues to drive growth for this otherwise steady-Eddie utility. By purchasing the remaining general partner stake of Oneok Partners LP (NYSE: OKS)—formerly Northern Border Partners—and selling its midstream natural gas assets into the partnership, Oneok simplified its operating structure and placed assets where they will do the most good for the firm.

Oneok Partners, which represents about 70% of Oneok’s earnings, operates a multistate natural gas gathering, processing, and long-haul transport system in the midsection of the country. Oneok owns 100% of the general partner of Oneok Partners, which gives it the right to collect incentive distributions for expanding the business and raising distributions at the master limited partnership.

We’re big fans of this aspect of MLPs and think incentive distribution rights closely align general partners’ and common unit holders’ interests. Oneok’s ownership of 47.7% of the MLP’s common units provides stable cash flows from distributions, and its incentive distribution rights allow Oneok to enjoy an increasing share of the pie as the MLP grows. This business gives Oneok a growth vehicle, which, in our view, the company sorely needs.

The economics of Oneok’s gas distribution business may be attractive, but its growth prospects certainly are not. Although it enjoys a narrow moat because of regulated rates of return and a monopoly presence in its service territories in areas of Oklahoma, Texas, and Kansas, the low growth of its markets is unappealing.

And though Oneok’s energy services segment offers better growth prospects, it is primarily a trading activity that is volatile by nature and faces stiff competition. In comparison, ownership and control of Oneok Partners provides Oneok with an increasing claim on the cash flows of a business that can expand through internal projects or attractive acquisitions.

We expect to see more dynamism stemming from Oneok’s midstream investments via Oneok Partners than from its other businesses, and with six dividend hikes in the last three years, we expect investors to enjoy rising shares of these returns.

Despite a series of acquisitions that added debt to the balance sheet and substantially reduced financial transparency, we think Oneok’s financial health is relatively sound. The company has substantially reduced its short-term borrowings, and we think its long-term debt load, though significant, is manageable.

Oneok has also maintained a conservative dividend payout ratio averaging 50%–55%, which allows room for variability in Oneok Partners’ gas gathering and processing businesses.

Given the growth potential for Oneok Partners and the boost to Oneok’s share in growth through the partnership’s incentive distribution rights, we estimate Oneok’s per-share earnings and dividend payments will rise at an average clip of 8% per year.

At Wednesday’s closing price of around $28, Oneok yields 5.7% and could generate total returns of 14%–15% annually.

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