Oneok's Positioned to Outperform

We recently increased our fair value estimate for

Our new fair value estimate implies a 2018 EBITDA multiple of 12 times and a 2018 distribution yield of 4.6%. We expect the main driver for Oneok will be natural gas liquids, specifically a recovery in the ethane market as new plant capacity comes on line in the next few years.

Because the low utilization levels across much of Oneok’s NGL portfolio are related to ethane, we expect earnings to benefit from around $200 million in uplift over the next five years. We believe the company is currently undervalued.

The newly combined Oneok family brings several attractive financial elements to the corporation’s story, including no cash taxes through 2021, a lower cost of capital through the elimination of incentive distribution rights, an investment-grade credit rating, and a very attainable 9%-11% dividend growth forecast through 2021. The core Oneok narrative is equally compelling, in our view, built primarily around Oneok’s efforts to benefit from a fully integrated network of NGL assets. About 90% of Oneok’s earnings are fee-based, limiting direct commodity price exposure, but we estimate only about 20% of earnings are derived from long-term firm pipeline contracts, meaning Oneok is more volume-sensitive to NGLs and natural gas supply and demand than peers. The volume risk is mitigated to some extent by Oneok’s supply diversity, and acreage dedications.

In this industry environment, we see the NGL volume exposure (largely ethane) as more of an opportunity than a threat. Oneok has been waiting since 2013 for ethane demand to recover; this seems to be finally taking place in 2017 with demand at 1.4 million barrels a day and all-time highs compared with 1 mmb/d in 2013. Similarly, industrywide ethane rejection levels are around 600 mb/d, roughly twice 2013 levels. Oneok estimates its fractionation plants can handle an additional 175-200 mb/d of ethane, resulting in a $200 million earnings uplift. Industry estimates from new ethylene plants starting up put incremental demand for ethane between 750,000 and 1 million b/d by 2020. Oneok is also adding another 100 mb/d in NGL gathering capabilities in the STACK and SCOOP plays by 2019, positioning it to further take advantage of strong production growth prospects.

The largest contributors to Oneok’s operating margin are its natural gas liquids assets, which we think have a narrow economic moat. These assets primarily deliver NGLs from the Rockies and the midcontinent to the Gulf Coast and include both Federal Energy Regulatory Commission and non-FERC regulated NGL gathering and distribution pipelines (about 11,500 miles), about 840 mb/d of NGL fractionation capacity (the second-largest fractionator in the U.S., by our estimates), storage facilities, and truck and rail loading and unloading facilities. It’s reasonable to expect much of the NGL supplied would come from Oneok’s 1.8 billion cubic feet per day of gas processing capacity in the same regions, however, Oneok is connected to more than 100 third-party gas processing plants in the midcontinent and nearly 40 more plants in the Permian Basin. Altogether, Oneok has connections to more than 90% of gas processing plants in the midcontinent, where its biggest strengths are its exposure to the low-cost Permian Basin, STACK, and SCOOP plays. Oneok’s network is deep enough in Texas and the midcontinent that it has options in terms of marketing NGLs in the midcontinent or moving them down to the Gulf Coast, depending on the widest differentials.

Despite the attractive exposure, with NGL plant utilization levels in the mid-70s compared with larger NGL peer Enterprise Products Partners EPD, where NGL utilization levels are in the 90s, we think Oneok’s NGL assets are not as well positioned. It’s also possible that Oneok’s control over the molecule downstream (either via gathering and processing or marketing efforts) is weak enough to keep returns across the NGL portfolio lower, although given high levels of ethane rejection, Oneok is well positioned to capture upside on this front. Still, we consider fractionators to be higher-quality assets than natural gas and processing assets because of the more concentrated nature of the market. Gas processing plants typically only connect to a single NGL fractionation plant because it is uneconomic to have multiple connections, whereas shippers often have multiple options for gas gathering and processing. We estimate around 5 mmb/d of fractionation capacity is in the United States versus about 77 bcf/d (or 13 billion b/d) of natural gas processing capacity. Because NGL fractionation plants are between natural gas processing plants and refined NGL pipelines in the value chain, we think these investments are more likely to be sanctioned by a company that owns all three parts of the chain versus an independent third party that will not be able to guarantee enough upstream and downstream supply to make the investment profitable.