Source: ONEOK Partners
Thanks to the worst energy crash in 50 years the oil and gas industry is littered with high-yield dividend stocks, both high and low quality, that offering potentially tempting undervalued, long-term income opportunities. One such example is ONEOK Partners (OKS) and its sponsor and general partner ONEOK Inc. (OKE 1.22%), which have followed the rest of the MLP industry into a deep price collapse over the past year.
Of course the hard part for investors to determine whether or not ONEOK represents a great MLP trading at a very attractive price, or a subpar pipeline operator that's been understandably punished by Wall Street for some major flaws to its business model.
Find out three reasons from ONEOK's 2015 results why I believe ONEOK remains a high risk investment in 2016; one that is inferior to many of is higher quality competitors.
2015 results: solid volume growth BUT not good where it matters most
| Metric | 2014 | 2015 | Change |
| Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) | $1.559 Billion | $1.566 Billion | (0.4%) |
| Distributable Cash Flow (DCF) | $1.17 Billion | $1.137 Billion | (2.8%) |
| Distribution Per Unit | $3.07 | $3.16 | (2.9%) |
| Distribution Coverage Ratio (DCR) | 1.10 | 0.86 | (21.8% |
Sources: earnings release, Yahoo Finance
Thanks to new projects coming online in 2015 ONEOK was able to deliver a 44% and 12% increase in NGL and natural gas volumes, respectively. Unfortunately due to record low commodity prices this volume growth wasn't enough to prevent its DCF and coverage ratio from falling to unsustainable levels. This was partially due to the ONEOK Partners' need to raise $749 million in equity capital from ONEOK Inc. earlier in the year, which resulted in 11.2% investor dilution.
On the plus side in January of 2016 ONEOK Partners managed to obtain a $1 billion, three year unsecured loan. Combined with a one year extension of an existing $2.4 billion credit facility that has $1.8 billion in remaining borrowing power management believes will allow it to operate well into 2017 before needing to raise additional growth capital.
Distribution profile: management remains cautiously optimistic
- Yield: 10.3%
- 2016 DCR Guidance: 1.0+
- 5 Year Analyst Annual Distribution Growth Projections: 0.7%
As you can see ONEOK is currently priced as if its current distribution is at high risk of a short-term cut and analysts expect it to barely grow over the next half decade. Of course analyst forecasts can easily prove wrong, since Wall Street is notoriously short-term focused and often incorrectly assumes that short-term trends will continue for many years.
So what are the chances that the market is wrong about ONEOK's payout sustainability and growth prospects? Well ONEOK Partners offered guidance of 22% DCF growth for 2016, which assuming no further unit count growth, should be sufficient to secure its current distribution.
Source: ONEOK Partners investor presentation.
However, the oil crisis has shown that management forecasts must always be taken with a grain of salt, because they are based on certain energy price assumptions that can easily prove overly optimistic. For example, for 2016 ONEOK is assuming that oil prices will average $42.5 per barrel, which, despite oil's impressive rally over the last few weeks, might very well prove wrong.
Another risk potential ONEOK investors should be aware of is that ONEOK Partners does have direct exposure to commodity prices, which it attempts to minimize through hedging. However, as the below table illustrates, starting in 2017 its highly profitable hedges will start expiring and barring a sharp energy price recovery over the next year, it could face cash flow pressure in 2017 that might continue to threaten the long-term sustainability of its current distribution.
Source: ONEOK Partners earnings release
That's especially true given that natural gas, and NGL prices are trading substantially below the price its currently receiving due to these hedging contracts.
Which brings me to the two biggest risk factors facing ONEOK, and the reason I recommend you avoid it.
Risks that limit its ability to grow itself out of trouble
Henry Hub Natural Gas Spot Price data by YCharts
If energy prices remain at current levels, or potentially fall further, ONEOK Partners's cash flows could be at risk given that only 85% of 2016's earnings are expected to be fee-based.
In addition, in 2015 17% of ONEOK's natural gas business was from producer demand, meaning that the MLP's faces a potentially significant risk of declining gas volumes should low gas prices continue reducing rig counts and investment in new drilling.
Bottom line
Don't get me wrong, ONEOK isn't close to being the worst midstream MLP you can buy today. It's recent capital raises likely give it sufficient breathing room to wait for energy prices to recover, which could greatly improve its long-term growth thesis.
That being said, investors need to realize that ONEOK remains a highly speculative, short-term bet that oil and gas will recover before it needs to raise more capital, potentially at higher and unprofitable levels. With so many superior midstream choices available, such as: Enterprise Products Partners, Magellan Midstream, Spectra Energy Partners, and Holly Energy Partners, offering secure, attractive yields and superior growth prospects even in a world of low energy prices, I can't recommend that dividend investors invest new money into ONEOK at this time.
