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Oneok Partners L.P. (NYSE: OKS) is a large midstream natural gas partnership with assets throughout the central United States.

  • Distribution Yield: 5.10%
  • Seven Year Distribution Growth Rate: 7.1%
  • Credit Rating: BBB, Stable Investment Grade

Overall, I view OKS as one of the better income investments on the market currently, with an appealing combination of yield and growth at a reasonable valuation.

Overview

Oneok Partners L.P. is a $12 billion vertically integrated master limited partnership that focuses on natural gas and natural gas liquids. As an MLP, it offers a substantial distribution yield, significant distribution growth, and a tax-advantaged investment. MLPs are flow-through entities, and therefore they avoid the double taxation of the corporate / dividend tax duo.

MLPs like Oneok generally increase their number of outstanding units over time (rather than decrease them as blue chip corporations tend to do), because as a flow-through entity they can generally get a good enough rate of return on their newly issued units in order to grow the distributions on all units, if managed well. This has allowed MLPs to dramatically outperform many standard utility companies (a stronghold of dividend investors) over the last decade, and there isn't a structural reason why this general outperformance should not continue.

The limited partners benefit when distributions increase, and the general partner benefits both when the distributions increase and when the number of units and overall partnership size increases. The disadvantage to this tax-advantaged structure is that individual investors are responsible for an additional tax form during tax season.

Distribution Growth

(click to enlarge)
(Chart Source: DividendMonk.com)

The current distribution yield for Oneok is 5.10%. Over the seven year period ending in 2012, Oneok increased its distribution by an average rate of approximately 7.1% per year. Distribution growth was rather consistent over this period, with an increase each year. In particular, the distribution increased almost every quarter, with an exception in 2009 at the most uncertain point in the recession, when the distribution was held flat for a few quarters.

The distribution for the first quarter of 2013 is 16.4% higher than the distribution for the first quarter of 2012. According to the most recent annual report, management expects to increase the distribution by 8-12% per year through 2015.

Approximate historical distribution yield at beginning of each year:

YearYield
Current5.1%
20124.1%
20115.7%
20106.8%
20098.9%
20086.4%
20076.2%

Particularly for shares/units with a consistent and large dividend/distribution, tracking the yield over time for the units is a relevant valuation method. As can be seen, the price dip in 2009 presented investors with an attractive opportunity to pick up very high yielding healthy units. Apart from that, the yield has fluctuated between 4% and over 6%. The current 5.1% yield offers a better value than this time last year, because the unit price has remained flat while the distribution and partnership assets have continued to grow, and indeed-- actually accelerate in growth.

Balance Sheet

Oneok Partners has a BBB/Baa2 investment grade credit rating, and an interest coverage ratio that is comfortably over 4. The partnership compares fairly to its peers in terms of balance sheet strength.

Investment Thesis

Oneok Partners LP is an option if you want to diversify into more energy assets outside of Texas. Many MLPs like Energy Transfer Partners (NYSE:ETP) and Kinder Morgan Energy Partners (NYSE:KMP) have a substantial asset density on the Texas Gulf Coast, and while Oneok does have Texan assets, the bulk of its assets are further north.

The central hub of Oneok assets is Oklahoma, and the partnership has natural gas and NGL pipelines in the central United States. In particular, the partnership has exposure to the Bakken Shale and Williston Basin in North Dakota, and the Niobrara Shale and Piceance Basin in the central U.S.

The company has $5 billion in growth projects underway or planned for the 2011-2015 period. This is significantly greater than the 2006-2010 period, and the partnership also claims a $2 billion backlog of unannounced natural gas and NGL infrastructure growth prospects with EBITDA multiples of 5-7. Half of the $5 billion is being invested into infrastructure related to the major Bakken Shale and Williston Basin. The other half is going towards infrastructure projects in the central United States and the Gulf Coast.

The partnership has invested heavily into Natural Gas Liquids, which are expected according to partnership guidance to account for 61% of partnership operating income in 2013. The rest comes from Natural Gas gathering, processing, and pipelines.

The holder of the general partner, including the Incentive Distribution Rights (IDRs) of Oneok Partners L.P., is publicly traded as Oneok, Inc. (NYSE: OKE). OKE offers a substantially lower dividend yield, but faster dividend growth, and the investor can avoid the special tax aspects of MLPs by investing in OKE instead. OKE does have a premium valuation, however, because expected growth is substantial due to their general partner holding of OKS. This is similar to how Kinder Morgan Inc. (NYSE:KMI) is the publicly traded general partner of Kinder Morgan Energy Partners (KMP). OKE, however, offers a moderately lower current dividend yield than KMI by about 1 yield percentage point.

Risks

The bulk of Oneok's revenues are generated with stable fees, but there are areas of risk. There is commodity price risk in the natural gas gathering and processing operations, which the partnership hedges against. There is also volume risk in the NGL operations, including from ethane rejection. As an asset-heavy business that necessarily uses substantial debt, Oneok is vulnerable to substantial increases in interest rates.

Since Oneok is at a high level of distributions per unit, a considerably high percentage of its cash flow goes to the general partner (over 24% for 2012), which can eventually limit distribution growth to limited partners. Some partnerships can maintain distribution growth for very long stretches of time (Kinder Morgan, as an example), while others run into issues and have to halt distribution growth due to hefty IDR payments (Energy Transfer Partners (ETP), for example, had to have several IDR rights temporarily waived by the general partner for acquisitions to work).

Conclusion and Valuation

In conclusion, Oneok is a $12 billion diverse collection of natural gas and NGL assets throughout the central United States that offers investors a good combination of distribution yield and growth.

Using a 10% discount rate as the target rate of return for a two stage Dividend Discount Model estimation, the units have an estimated fair price of $66 if the partnership can grow the distribution at an average rate of just 7% over the next decade (which is conservative) and only 5% thereafter. Considering that management expects 8-12% distribution growth over the next three years, there is a potentially higher upside than that. Compared to the current price of approximately $56, I consider there to be an attractive margin of safety, and I view OKS to be one of the rarer attractively valued income investments in a market that otherwise seems to offer a limited number of attractively priced stocks for dividend growth investors.

Disclosure: As of this writing, I have no position in OKS, though it is on my watch list. I am long ETE and KMI.
You can see my dividend portfolio here.

Source: Oneok Partners L.P. MLP Analysis