Trade Recommendation: Buy Oneok Partners LP (NYSE:OKS)

Investment Synopsis:

Oneok Partners is a large, financially stable MLP focused on the full spectrum of natural gas midstream services. Since Oneok has about one-third of its operating margin dependent on energy prices and price differentials, the company’s cash flow growth will not be linear. Currently distribution growth has been suspended, but the near 10% distribution yield makes OKS attractive as an income source that will resume growth when capital projects come online and energy prices start to recover.
• IPO Date: September 24, 1993
• Market Cap: $8.19 billion
• Annual adjusted EBITDA: $1.42 billion (H1 2015 annualized)
• GP/Sponsor: Oneok Inc. (NYSE:OKE)

Distribution Facts
• Current yield: 9.9%
• TTM distribution growth: 3.95%
• Forecast annual distribution growth rate: 2%-4%

Business Operations

Oneok Partners operates primarily as a natural gas and natural gas liquids –NGL– midstream services company. OKS is the ninth largest MLP by market cap. The company’s operations are divided into three business segments:
• Oneok’s natural gas gathering and processing operations are located in a dozen different shale plays in Texas, Oklahoma, the Rockies and North Dakota. The focus is on natural gas and NGL services for upstream companies operating primarily to produce crude oil. Oneok’s services allow these production companies to generate additional revenues from the gas and NGLs that are by-products of crude oil wells. The current focus area for growth is the Bakken play in North Dakota, which has little gas processing and new laws that force drillers to eliminate gas flaring at the wells. The revenues of this segment are dependent on gathering volumes and NGL and natural gas prices. Processing at this level is the separations of natural gas to be used as fuel from the NGLs, which remains combined. The segment produces 14% of Oneok Partners’ operating income.
• The natural gas liquids segment processes the gathered NGLs from the wells into commercially marketable gases such as butane, ethane, propane and natural gasoline. Oneok stores and delivers via pipeline the fractionated NGL products. This segment accounts for 68% of the company’s operating income. Operating margins are dependent on product prices and price differentials.
• Oneok’s natural gas pipelines provide interstate and intrastate transport of up to 3.2 billion cubic feet per day of natural gas. The company also owns 10 underground gas storage facilities with 54 Bcf of capacity. Gas pipelines and storage account for 18% of operating income. This is almost exclusively long term contract fee based business.

Oneok Inc. (NYSE:OKE) is the pure-play general partner of Oneok Partners. OKE’s only revenue sources are the general partner, incentive distribution rights –IDR, and limited partner distribution (OKE holds about 38% of OKS) payments. Oneok Inc. does provide a financial backstop for OKS and can provide additional borrowing power and cash flow help by adjusting IDR payments. Oneok Inc. and Oneok Partners are both investment grade companies with BBB credit ratings.

Growth and Investment Prospects

Compared to many of its large midstream peers, Oneok Partners has a higher portion of revenue and cash flow dependent on energy commodity prices. About one-third of Oneok’s overall gross margin is based on commodity prices or price differential contracts. The remaining two-thirds is from more stable fee based contracts. With the drop in energy prices, the cash flow growth Oneok had forecast in 2014 has not materialized so far in 2015. As a result, after 22 consecutive quarters of distribution increases, the 2015 first and second quarter distributions have remained level with the 2014 Q4 payout rate. In 2009, the last time energy prices took a dive, Oneok leveled off the distribution rate for four quarters.

There was some good news in Oneok’s 2015 Q2 earnings information. Gathered and processed volumes continue to grow, with some areas showing moderate declines which are being offset by the plays where Oneok is focusing its growth efforts. In North Dakota’s Williston Basin the company connected 260 new wells in Q2 and expects to hit the full year goal of 700 connections. The growing connection numbers will result in continued volume growth for Oneok. Energy production companies have continued to drill wells, even in the face of lower energy prices. This is very positive for Oneok in the longer run.

Oneok’s cash flow results will cycle with changing energy commodity prices. This means that while distributions may stay flat as we work through the bottom of the cycle, OKS can produce near 10% distribution growth rates when prices turn higher. As a large, financial stable MLP with more than 20 years of operating through energy price cycles. The MLP is the prime natural gas midstream player and the company’s growth capital spending will enhance its network that allows it to generate fees or earnings along the entire natural gas/NGL journey from wellhead to end user. Currently, announced capital growth projects total almost $3 billion. At a six times EBITDA multiple, this amount in spending will increase total annual EBITDA by 35% over the next several years.

The current MLP sector bear market has driven down the OKS unit price and the yield up to almost 10%. I view that level of income a nice wage to collect while waiting for the growth project completions and energy price increases that will allow Oneok Partners to resume a high single digit level of annual distribution growth. A return to distribution growth should result in a market price driven lower yield, producing an attractive total return.

Recommendation: Buy and Accumulate as a part of the MLP Income Portfolio.