Breaking Down the Alerian MLP Index: OneOK Partners

Includes: OKE, OKS
by: Mike Maher

The ninth largest holding in the Alerian MLP Index is ONEOK Partners (NYSE:OKS), making up 3.33% of the index.

OneOK Partners is involved in the gathering, processing and transportation of natural gas and NGLs in the United States. The partnership is divided into two segments, the Natural Gas segment, which focuses on midstream services in six producing basins in the U.S., and the NGL segment which gathers, processes transports and stores NGLs. The partnerships' assets spider-web out from Oklahoma and Kansas, and provide access to NGL hubs in Conway and Mont Belvieu. The partnership was formed by OneOK Inc. (NYSE:OKE), which is the GP and holds a 42.8% stake in OKS.

OKS has been expanding rather aggressively over the last several years. Out of the $2 billion in growth projects completed in the 2006-2009 time period, 66% of it was to expand fee based NGL services. This has allowed NGLs to expand from $152 million in Operating Income, or 28% of the total in 2007, to $340 million and 44% of Operating Income based on 2011 guidance. This large shift toward a more fee based NGL model has greatly helped the partnership grow distributions, and is providing a base to further expand. The partnership is also betting heavily on the Bakken Shale, with $1.5-$1.8 billion in planned construction over the next three years focused on expanding services and takeaway capability to the region. The largest of the projects is the Bakken NGL pipeline, with a cost of $450-$550 million. This pipeline will carry NGLs from the Bakken Shale down to the Overland Pass Pipeline, where the NGLs can then be transported to fractioning facilities, which are also being expanded. The pipeline is expected to come online in the first half of 2013.

After distribution growth stalled during the financial crisis, distributions have been increasing at the rate of a penny per quarter for the last six quarters. That level of growth is set to continue through 2011, amounting to an about 3.5% increase over 2010. This rate is forecast to rise to 5%-10% annual growth in both 2012 and 2013, as the current construction and expansion plans begin to come online over the course of the next few years. Based on the current guidance the partnership will distribute $4.66 in fiscal year 2011, for yield of 5.8% going forward.

The partnership has a coverage ratio of 1.01x the distribution last year, which is below the target coverage rate of 1.05x-1.15x. That coverage is projected to rise to 1.06x in 2011, based on the guidance given by the partnership. While still low, at least this is moving in the right direction. Given the guidance for distribution growth accelerating in the coming years, as well as the growth projects currently under construction, the low distribution coverage ratio does not seem to be cause for concern, should the partnership be able to achieve its targets. However, with such a low coverage ratio it would not take a major interruption or project delay to call into question the distribution growth rate.

ONEOK Partners seems to be strongly positioned for growth over the next few years. The partnership is positioning itself to become a major player in serving the Bakken Shale, which is receiving a lot of attention recently given the estimates of how much oil, NGLs and natural gas could be produced from the area. The demand for NGLs is being held up by a strong U.S. chemical industry, as has been previously discussed, and OKS is poised to benefit from that industry's strength. The foresight of the partnership to diversify out of purely natural gas and into the liquids business should not be ignored, as this decision is a key driver to the distribution growth. OKS has seen its unit price stalled over the last few months, and this may be an opportunity to get into a partnership whose distribution growth rate should begin to accelerate over the next five years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.