Growth capex is one of the major trends in the energy MLP space, and ONEOK Partners, L.P. (OKS) is no exception. Already a top player in gas gathering and processing and NGL fractionation in the Mid-Continent and Rockies, ONEOK still has over $2.5 billion of growth projects on the docket as well as up to $4 billion in unannounced projects - much of which will go towards gathering and processing the growing output of the Williston and Powder River basins.
ONEOK Partners offers good distribution coverage and double-digit cash flow growth potential, though actual distribution growth is likely to be more in the mid-to-high single digits as the general partner ONEOK Inc (NYSE:OKE) takes a sizable cut and the partnership issues additional units to fund its growth targets. ONEOK Partners still offers some upside in a somewhat expensive MLP space, but it's no longer notably cheap.
A Quick Review
Along with Enterprise Products Partners, L.P. (NYSE:EPD), Targa Resources Partners, L.P. (NYSE:NGLS), and MarkWest Energy Partners, L.P. (NYSE:MWE), ONEOK Partners is one of the largest natural gas gatherers, processors, and NGL fractionators. ONEOK's focus is on the Mid-Continent and Rockies, over which it operates over 18,000 miles of gathering pipelines, thousands of miles more of transportation pipelines, and over 4,000 miles of NGL gathering pipelines with substantial processing, fractionation, and storage capacity. Assuming capacity additions go as planned, ONEOK Partners will control about 20% of the country's fractionation capacity by the end of 2014.
About 25% of the partnership's EBITDA comes from natural gas gathering and processing, with another 20% or so from its natural gas pipeline operations. The remaining 55% is from the NGL operations, including gathering, processing/fractionating, and transport. About two-thirds of operating profits come from fee-based operations, with about 20% tied to gas processing and 15% tied to the difference in NGL prices between the Gulf (Mont Belvieu) and Mid-Continent (Conway, Kansas).
ONEOK Inc owns upwards of 40% of ONEOK Partners, as well as the general partner interest and incentive distribution rights (or IDRs). Because of the way the IDRs are structured and ONEOK Partners' payout level, ONEOK takes more than 30% of the partnership's distributions, effectively raising the partnership's cost of capital. It is also unfortunate for ONEOK Partners that ONEOK really doesn't have desirable assets well-suited to drop-downs.
Investing And Building For Growth
It's the unusual MLP that isn't spending billions these days to take advantage of expanding U.S. energy production, and ONEOK Partners is no exception in that regard. As of the first quarter of this year, the company has completed about 60% of the over $6 billion in growth projects announced between 2010 and 2016, with $1.2 billion placed into service in the first quarter.
Management is still banking on the Williston Basin (which includes the Bakken formation) as a major source of future cash flow, with over $3 billion in growth projects targeted here. Management is also developing an unannounced backlog projects totaling upwards of $4 billion that includes further gathering and processing assets in the Williston and Rockies (including the Powder River Basin and DJ Basin).
With these projects, management is looking to shift its profit mix even more towards fee-based sources, adding to the stability of the cash flow streams. Assuming these projects are completed and generate the expected volumes and returns, unitholders will see strong distributable free cash flow growth with less variability. The catch is in how the partnership will pay for it - additional equity offers to raise funds are, in my opinion, all but certain. The dilution will likely mean that the double-digit growth in distributable free cash flow translates into high single-digit distribution-per-unit growth, which still isn't bad.
Pluses And Minuses
Considering the negatives on ONEOK Partners, there is the aforementioned hefty cut that goes to ONEOK, Inc and increases the partnership's cost of capital. There is also the ongoing risk of spread volatility between Conway and Mont Belvieu NGL prices - the spread rebounded to $0.12/gallon in the first quarter, but was just $0.01/gallon in the prior year (and $0.05/gallon in the prior quarter) and has actually gone negative for a few brief periods (and has been as wide as $0.50/gallon in the last two and a half years).
On a related note, ethane rejection remains a headwind for the company. Put simply, when NGL prices aren't high enough, producers elect to leave ethane in the gas stream and ONEOK Partners can't profit from the processing/fractionation services. Ethane rejection is likely to remain a challenge through 2016 and the addition of more ethylene capacity in the Gulf and/or export facilities is going to be a key to resolving this oversupply issue.
On the plus side, ONEOK Partners is strongly positioned in the Williston and Mid-Continent and has the opportunity to expand into the Powder River and DJ basins and connect those into existing infrastructure. I also consider it a positive that state regulators are looking to cut flaring in the Williston from about 30% to 5% by 2020, meaning more demand for gas gathering and midstream services.
As far as growth goes, though, investors should also consider the other NGL-exposed names in the MLP space. Enterprise has sizable assets exposed to the Eagle Ford in Texas and Targa is likewise a significant player in Mont Belvieu, while MarkWest is more focused on the Marcellus region. The companies' spread exposures and gathering/processing asset bases are all different of course, so please do careful due diligence on those differences.
Estimating The Growth
As I've mentioned a few times through this piece, I'm expecting ONEOK Partners to deliver double-digit distributable cash flow growth over the next five years and high single-digit to low double-digit growth in the following five years. Depending upon the mix of debt and equity that the partnership uses to fund its growth projects and its intended long-term coverage ratio, distribution growth should be in the high single digits. Discounted back, I arrive at a fair value of $57 per unit today, with a current yield of over 5% that is currently about 90% tax-deferred.
The Bottom Line
It has been about 10 months since I wrote about ONEOK Partners, L.P. as a Top Idea and in that time the units have appreciated about 16%. That's a little better than the energy MLP space over that time, but I expect Top Ideas to substantially outperform their peers and in that regard ONEOK Partners has not been a good enough pick.
I do still believe that ONEOK Partners is well-positioned to benefit from Bakken production growth and eventual exports of NGLs. The valuation is not quite as compelling these days but there is still some upside here and it could also make sense as a holding in combination with a different regional operator like Enterprise or MarkWest.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.