Examples In MLP Due Diligence - ONEOK Partners

| About: ONEOK Partners, (OKS)

Summary

This is the fourth in a series of "due diligence example" articles on MLPs.

OKS is a large-cap investment grade MLP with average safety attributes.

OKS currently lacks distribution coverage.

This is the sixth in a series where I provide my example of "What is good due diligence for MLP (energy Master Limited Partnership) investors?" For many of you, this will appear to be hyper due diligence. You can opt to weed out some of the hyper diligence to arrive at the level that feels right to you. Prune prudently. For those who have read multiple articles in this series, it is time for you to be asking what - if any - part of my due diligence process would you omit.

MLP Midstream 6-16-16
The consensus Distributable Cash Flow or DCF projections were last updated on 5-30-16. The distribution Compound Annual Growth Rate or CAGR projections were updated 5-30-16. Yields are based on the Q2-16 distribution. Under the 'year to date' header, the change in the distribution is the change since Q2-15 - or the change over the last twelve months. The change in the target, EPS and DCF is the percentage change in the consensus 2016 projection that has happened since the beginning of 2016. The Dist/DCF number is the ratio of the Q2-16 distribution to the 2016 DCF projection. The 2016 DCF projection is an adjusted average of eleven DCF projections from the major brokerages covering MLPs. The CAGR is intended to be the percentage change in my CAGR projection since the beginning of the year - but I lack confidence that I have the timing of this stat right. The target prices and EPS projections are from Yahoo Finance.

Large Cap Midstream

Current Distrib/ Q2 Dist Dist/dcf Dist/dcf Year-to-Date Percent Change
Company name Price Quarter Yield 2016 2017 Price Pr+Dist EPS Target DCF Dist* CAGR
Buckeye Partners, L.P. (NYSE:BPL) 69.85 1.1875 6.80 89.79 86.84 5.90 9.50 0.24 -2.19 0.38 3.26 0.00
Enable Midstream Partners (NYSE:ENBL) 14.08 0.3180 9.03 102.58 100.16 53.04 59.96 -4.88 1.82 -10.79 1.76 -97.50
Enbridge Energy Partners, L.P. (NYSE:EEP) 21.92 0.5830 10.64 105.52 100.95 -4.98 0.07 -40.34 -28.99 -3.07 2.28 -86.84
Enterprise Products Partners L.P. (NYSE:EPD) 27.71 0.3950 5.70 77.83 74.18 8.33 11.42 -6.85 -5.09 -2.87 5.33 -3.64
Energy Transfer Partners, L.P. (NYSE:ETP) 38.29 1.0550 11.02 107.93 91.94 13.52 19.77 -62.76 -19.96 -18.71 3.94 -66.10
Kinder Morgan, Inc (NYSE:KMI) 17.60 0.1250 2.84 23.26 21.83 17.96 19.64 -6.67 -3.75 -5.70 -73.96 0.00
Magellan Midstream Partners LP (NYSE:MMP) 73.57 0.8025 4.36 80.05 72.46 8.29 10.65 -5.69 -0.48 1.01 11.85 -10.11
Oneok Partners, L.P. (NYSE:OKS) 37.87 0.7900 8.34 100.32 96.93 25.69 30.93 13.20 11.34 3.28 0.00 -20.00
Plains All American Pipeline, L.P. (NYSE:PAA) 26.28 0.7000 10.65 137.93 112.45 13.77 19.83 -31.67 -24.60 -24.54 2.19 -96.67
Spectra Energy Partners, LP (NYSE:SEP) 46.31 0.6338 5.47 81.00 74.56 -2.91 -0.26 6.73 1.53 10.99 3.85 7.69
Sunoco Logistics Partners L.P. (NYSE:SXL) 27.01 0.4890 7.24 87.32 72.99 5.10 8.90 -23.26 37.98 -3.03 16.71 -2.11
Williams Partners L.P. (NYSE:WPZ) 33.05 0.8500 10.29 90.67 85.00 18.67 24.78 -48.65 0.00 -2.34 0.00 -33.33
Large Cap Average 7.70 90.35 82.52 13.53 17.93 -17.55 -2.70 -4.62
The Alerian MLP index ETN AMJ is 5.66% and with dividends is 7.51%.
The S&P500 index ETF SPY is 2.21% and with dividends is 2.72%.
The Russell 2000 index ETF IWM is 1.71% and with dividend is 2.00%.
Click to enlarge

OKS has a year to date "Price plus Distribution" of 30.93% - which is well above average for this MLP sub-sector. The current yield is 8.34% - which is slightly above this grouping's average.
OKS has outperformed while having smaller than average declines in its EPS projection, an increase in its DCF projection, an increase in the consensus analyst price target, and a moderate fall in its five year forward distribution CAGR projection.
This is evidence (but not proof) that OKS' price movement is more correlated to price changes in the WTI than average. It would follow that OKS' fundamental performance should be more commodity sensitive than average - if stock performance is in alignment with reality. OKS is one of five MLPs in this grouping that does not have a 2016 DCF projection that is higher than their current distribution. Three of those five have current yields that are higher than 10% - and five out of five have yields higher than the sector average.
The large cap grouping of MLPs has outperformed sector average as a whole. So have the commodity sensitive Gathering and Processing MLPs. The Refinery Logistic group has underperformed.

The spreadsheet that follows summarizes key metrics in the income statement and balance sheet since Q1-13:

ONEOK Partners, L.P. metrics: 61% NGLs; 17% natural gas pipelines; 22% natural gas G&P; 85% fee based projection

Q1-2016 Q4-2015 Q3-2015 Q2-2015 Q1-2015 Q4-2014 Q3-2014 Q2-2014 Q1-2014 Q4-2013 Q3-2013 Q2-2013 Q1-2013
Revenues 1,773,945 1,930,384 1,898.946 2,128,000 1,804,759 2,844.258 3,120.145 3,066,000 3,162,000 3,449,000 3,135,000 2,768,000 2,517,000
EBITDA 444.586 450.248 403.700 387.277 324.298 415.464 388.562 360.907 393.689 350.384 331.866 315.071 260.455
Total DCF dollars 347.561 339.805 302.800 276.927 217.211 306.044 293.303 271.999 211.230 244.958 259.148 271.999 193.216
GP's DCF dollars 105.608 107.198 105.178 97.875 95.844 95.192 90.135 85.882 76.922 73.089 71.812 67.145 66.045
Net DCF dollars 241.953 232.607 197.722 179.052 121.367 210.852 203.168 186.117 221.230 171.869 187.336 184.713 127.171
Units 285.826 285.826 272.046 257.179 254.075 251.411 249.091 240.503 232.131 231.667 226.991 220.116 219.816
DCF/unit $0.8465 $0.8138 $0.7268 $0.6962 $0.4777 $0.8387 $0.8156 $0.7739 $0.9530 $0.7419 $0.8253 $0.8392 $0.5785
Upcoming Distrib. $0.790 $0.790 $0.790 $0.790 $0.790 $0.790 $0.775 $0.760 $0.745 $0.730 $0.725 $0.720 $0.715
Coverage 1.07x 1.03x 0.92x 0.88x 0.60x 1.06x 1.05x 1.02x 1.28x 1.02x 1.14x 1.17x 0.81x
OKS 2016 guidance: EBITDA of approximately $1.88 billion and DCF of approximately $1.39 billion
Broker1 DCF/unit $0.80
Broker2 DCF/unit $0.84 $0.81 $0.72 $0.70 $0.48 $0.84 $0.82 $0.77 $0.95
Broker3 DCF/unit $0.81 $0.72 $0.70 $0.48 $0.84 $0.82 $0.77 $0.95
LTM EBITDA 1,685,811 1,565.5 1,530.8 1,515.9 1,489.2 1,558.6 1,493.5 1,406.8 1,391.0 1,257.8 1,222.1 1,219.4 1,210.4
Long term debt 6,692,238 6,695,312 6,145.603 6,145,972 6,185,660 6,004,232 6,039.997 6,042 6,043 6,044.867 6,046 4,800 4,802
Debt/EBITDA 3.97x 4.28x 4.01x 4.05x 4.15x 3.85x 4.04x 4.29x 4.34x 4.81x 4.95x 3.94x 3.97x
Short Term Debt 902,217 546,340 944.992 1,528.134 1,483.125 1,062.946 7.650 7.6 132.6 7.650 47.0 429 0
Total Debt 7,594,455 7,241.652 7,090.595 7,674.106 7,668.785 7,067.208 6,047.647 6,049.6 6,175.6 6,052.6 6,093.0 5,229.0 4,802.0
Total Debt/EBITDA 4.50x 4.63x 4.63x 5.06x 5.15x 5.27x 4.05x 4.30x 4.44x 4.81x 4.99x 4.29x 3.97x
Interest Expense 92,555 85,044 106,923 86,492 96,750 70,564 86,052 73,008 94,901 65,596 57,722 57,524 55,872
Interest Coverage 4.80x 5.29x 3.77x 4.48x 5.89x 5.89x 4.51x 4.94x 4.15x 5.34x 5.75x 5.48x 4.66x
On 8-18-15 OKE offered $500 million in 7.50% notes due 2023
On 3-17-15 OKS offered $300 million in 5 year notes at 3.80% and $500 million in 10 year notes at 4.90%
On 1-13-14 OKE offered $300 million in 5 year notes at 2.07% and $300 million in 10 year notes at 3.61% and $600 million in 30 year notes at 4.658%
On 9-09-13 OKS offered $425 million in 5 year notes at 3.20% and $425 million in 10 year notes at 5.00% and $400 million in 30 year notes at 6.20%
Click to enlarge

Since the beginning of 2013, LTM (last twelve month) EBITDA numbers are up (444.586/260.455) 70% while the unit (MLPs call their "shares" units) count has grown 30%; the General Partner's take in DCF has grown from $66 million to $105 million; and interest payments on a growing amount of debt has grown 66%. DCF/unit growth depends on your start date. DCF is up 46% when compared to Q1-13 - when the distribution began in an uncovered condition. DCF is basically flat when compared to Q2-13. The distribution is up 10.5% over the last three years - or just over a 3% annual pace. There has not been distribution growth since Q4-14.

Pause for a second to ponder those numbers. This is a stock that Harry Truman would hate - because every metric needs a "two handed" assessment. For those of you who still have the idea that due diligence is borrowing the opinion of others - imagine the range of headlines the above stats could generate. (1) "Investment grade MLP with amazing EBITDA growth sells at over an 8% yield". (2) "Rising Costs of Debt and IDRs Kills Distribution Growth for OKS". I would like for the numbers to guide me towards my own opinion.

What can we learn from these numbers?
1. I have verified the DCF/unit (or Distributable Cash Flow per unit) calculations with the DCF numbers from three different brokerage analysts. The DCF calculation is simple - there is one adjustment to subtract DCF dollars - the IDR's or Incentive Distribution Rights - owed to the General Partner. Adjustments for 'normalization' have not been needed. I can consistently arrive at good numbers without going to that degree of complexity.
2. I can have a high level of confidence in my DCF calculation because my numbers frequently match those done by the professional analysts.
3. DCF/unit change since 2013 has been positive. Most MLPs have faced headwinds due to commodity price falls.
Let's move on to some attributes I know due to producing similar spreadsheets for many other MLPs. As you absorb the data from future articles in this series, you will have the data in which to arrive at similar assessments.
4. DCF/unit numbers by quarter are moderately volatile.
5. The 'annual' distribution coverage has been weak - but that is improving. Coverage is both a safety and growth attribute. OKS has become a lower risk investment with some potential for distribution growth.
6. Historically, the debt metrics for OKS are minutely better than average. That produced a relatively low cost of debt capital - but notice the large jump in the cost of debt since the beginning of 2014. There is definitely a mixed message here.
7. In a low inertia environment, a good forward DCF projection will be close to the LTM (last twelve month) DCF number. For OKS, LTM DCF is (.85 + .81 + .73 + .70) $3.09/unit. 2016 EBITDA guidance of $1.88 billion averages to $470 million per quarter - which implies earnings will slightly improve over the Q1 number. The 2016 DCF guidance of $1.39 billion averages to $3.475 billion - which replicates the Q1 number. The annualized Q1 number produces a projection of $3.39 before some needed downward adjustments.
8. You should note that distribution growth stopped with the coverage numbers turned bad. That suggests the distribution growth should begin again when coverage returns.

I have 11 2016 DCF projections from the 12 brokerages I use to create a consensus number. The projections range from $2.90 to $3.29. The average for the projections is $3.15 - and 8 projections are within ten cents of the average. The midpoint in my two projections (309 and 339) is $3.24 - is close to analyst consensus. The small spread in the analyst projections comforts me. I have a much more than average confidence in the $3.19 projection.

Now that I have a good DCF - let's move on the CAGRs - or a five year forward "Compound Annual Growth Rate" projection of the distribution.

Long term metric trends
The average calculation for growth is for ten years - for 2006 through 2015
The first average is the sum of changes for each individual year over ten year period - with that result divided by 10
The 2nd average is the difference between the current and beginning number, divided by the beginning number - with that result divided by 10
The distributions shown are annualized first quarter distributions

Company 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 average average CAGRs PI-CAGRs
OKS DCF 2.15 2.24 2.98 2.31 2.33 3.30 3.30 2.95 3.26 2.71 3.15 3.26 My 1.50% RRR-yield 3.16%
growth 4.2% 33.0% -22.5% 0.9% 41.6% 0.0% -10.6% 10.5% -16.9% 16.2% 3.5% 6.00% 4.65% Last5 0.55% P/DCF Ratio 0.97%
Dist. 1.60 1.96 2.05 2.16 2.20 2.28 2.44 2.84 2.92 3.16 3.16 Broker1 0.80% Broker2 1.10%
growth 22.5% 4.7% 5.3% 1.9% 3.6% 7.0% 16.4% 2.8% 8.2% 0.0% 7.24% 9.75% Broker3 0.10% Broker4 2.00%
Dist/DCF 74% 87% 69% 94% 94% 69% 74% 96% 90% 117% 100% 89.01%
Click to enlarge

My average 2018 DCF projection for OKS is $3.46 and the median 2019 projection is $3.70. With those numbers, there should be moderate distribution growth returning to OKS in 2017. I show brokerages with tiny CAGRs. The right CAGR projection is a conservative projection - so my projection is tiny, too.

Now that I have arrived at a growth projection with which I can have a fair amount of confidence - it is time to make a numeric risk assessment.

When it comes to distribution coverage - it is on the cusp of coverage. Because of these attributes, I assess OKE with a 11.5% Required Rate of Return ("RRR" or risk assessment). Low RRRs are in the 10s and mainly go to BBB+ rated companies. Average RRRs for covered distributions are in the 11s and mainly go to BBB rated companies. Uncovered distributions result in RRRs in the 12s and mainly go to BBB- rated companies.

And with that - you should be sufficiently prepped for the ending spreadsheet that compares valuations:

Yield + CAGR Total Return Expectations

Company Q2-16 Consensus Total Bonds DCF My Total Rtn Consensus Price Implied CAGR Distrib Price
Yield CAGR Return Ratings Accr RRRs - RRR Ratings RRR-Yld P/DCF / DCF / DCF
Large Cap Midstream
Buckeye Partners, L.P. BPL 6.80% 4.40% 11.20% BBB- 2.50 11.00 0.20 2.1 4.20 4.08% 89.79 13.20
Enable Midstream Partners ENBL 9.03% 0.10% 9.13% BB+ 3.00 12.50 -3.37 2.6 3.47 1.58% 102.58 11.35
Enbridge Energy Partners, L.P. EEP 10.64% 0.50% 11.14% BBB 2.00 12.00 -0.86 2.9 1.36 -0.15% 105.52 9.92
Enterprise Products Partners L.P. EPD 5.70% 5.30% 11.00% BBB+ 1.30 10.00 1.00 1.7 4.30 3.05% 77.83 13.65
Energy Transfer Partners, L.P. ETP 11.02% 2.00% 13.02% BBB- 3.00 12.50 0.52 2.2 1.48 0.54% 107.93 9.79
Kinder Morgan, Inc KMI 2.84% 6.00% 8.84% BBB- 1.30 11.00 -2.16 2.4 8.16 -5.21% 23.26 8.19
Magellan Midstream Partners LP MMP 4.36% 8.00% 12.36% BBB+ 1.00 10.30 2.06 2.1 5.94 12.30% 80.05 18.35
Oneok Partners, L.P. OKS 8.34% 1.50% 9.14% BBB 3.00 11.50 -1.66 2.9 3.16 0.97% 100.32 12.02
Plains All American Pipeline, L.P. PAA 10.65% 0.10% 10.75% BBB 3.00 12.50 -1.75 2.7 1.85 6.37% 137.93 12.95
Spectra Energy Partners, LP SEP 5.47% 7.00% 12.47% BBB 1.00 10.30 2.17 2.2 4.83 5.73% 81.00 14.80
Sunoco Logistics Partners L.P. SXL 7.24% 9.30% 16.54% BBB 1.10 12.00 4.54 2.1 4.76 3.81% 87.32 12.06
Average 7.47% 3.95% 11.42% 2.35 3.95% 3.01% 12.39
Click to enlarge

"Total Return minus RRR" is my the buy, hold or sell number. Positive is buy - the stock is selling below what the valuation assessments suggest. Negative is sell - the stock is selling above what the valuation assessment suggest. Close to zero means the stock is correctly priced. In most sectors there is superior metric transparency compared to MLPs - and I produce TR - RRR numbers that are close to zero. Projected Total Return or "TR" = Yield + CAGR.

What does all of this math mean?

With a "Yield + CAGR" that is 228 bps below sector average combined with a RRR assessment that is average, OKS is between a hold and a sell based on current valuations. Given the major price appreciation already experienced in 2016, that conclusion should not come as a surprise. OKS has been swept up in positive momentum to a valuation that is too high by a nebulous degree. On one hand, the metrics I have provided give evidence that the lion's share of the 2016 price appreciation was merited. On the other hand, the "Yield + CAGR - RRR" is negative. And negative metrics are sell ratings. But there still is one metric - the PI-CAGR based on the Price/DCF ratio - that suggests OKS is still slightly undervalued.

Disclosure: I am/we are long EPD, MMP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.