Oneok (OKE -0.41%) made a bold move in May, agreeing to acquire Magellan Midstream Partners (MMP) in an $18.8 billion transaction. While Magellan isn't the greatest strategic fit since it focuses on oil and refined products while Oneok concentrates on natural gas and related liquids, the megadeal will significantly enhance Oneok's earnings and free cash flow. Because of that, the pipeline company could have lots of fuel to grow its dividend, which already yields an attractive 5.9%.
A model of stability
Oneok has been a solid dividend stock over the years. The pipeline giant has delivered over a quarter century of dividend stability and growth:
OKE Dividend data by YCharts
Oneok has maintained its dividend payment at a minimum while increasing it in most years. Overall, the dividend has grown at a 12% compound annual rate since 2000.
However, that pace has moderated considerably in recent years. The pipeline company kept its payout flat from the start of 2020 until earlier this year, when it provided investors with a modest 2% raise.
The main factor holding back dividend growth in recent years has been the company's heavy investments to expand its midstream systems. While those investments grew its earnings, its leverage ratio also increased. As a result, the company opted against raising the dividend to retain additional cash to help deleverage its balance sheet. Leverage has fallen from 4.6 times at the end of 2020 to 3.25 times by mid-2023. That combination of earnings growth and deleveraging put Oneok's high-yielding payout on a much more sustainable foundation.
Stomping on the gas
Oneok has increased capital investments in recent years. After spending about $1.2 billion on organic expansion projects last year (up from less than $700 million in 2021), the company plans to spend nearly $1.6 billion on capital projects this year (up from its initial range of $1.3 billion to $1.5 billion). Notable projects include initial activities to expand its Elk Creek Pipeline and fully loop its West Texas NGL Pipeline. The company is also pursuing the development of the Saguaro Connector Pipeline that would transport natural gas to the Mexico border. These investments will help grow the company's cash flow in the coming years, potentially giving it more fuel to increase the dividend.
Oneok is now enhancing its already strong growth profile by acquiring Magellan Midstream. The company expects that the deal will be accretive to its earnings per share starting next year, with it increasing to a range of 3% to 7% annually in the 2025 to 2027 timeframe. In addition, the midstream company expects the merger will increase its free cash flow per share by an average of more than 20% from 2024 to 2027. It expects to capture at least $200 million in cost savings and other synergies following the merger, which is a big factor driving that increase.
Overall, Oneok anticipates its free cash flow after funding dividends and growth capital expenses will be more than $1 billion annually over the first four years following the deal's closing. That will give it additional cash for debt reduction, incremental growth capital projects, or shareholder returns through share repurchases or a higher dividend. The company noted that it's targeting to grow its dividend following the merger. With the earnings accretion from the Magellan deal and the growing cash flows from organic expansions, Oneok could deliver brisk dividend growth in the coming years.
A potentially high-octane dividend stock
Oneok's dividend growth rate has slowed to a crawl in recent years as the company focused on deleveraging its balance sheet. However, it could reaccelerate over the next several years, primarily fueled by its pending acquisition of Magellan Midstream Partners. That makes it a potentially intriguing option for investors seeking a high-yielding payout with outsized growth potential.
