Pipeline companies Magellan Midstream Partners (MMP 0.27%) and ONEOK (OKE 2.36%) appear evenly matched on the surface. Both generate rather stable cash flow, since more than 85% of their earnings come from fee-based assets. Furthermore, both pay nearly identical current yields of around 4.5%. That said, there are three subtle differences that, in my opinion, make Magellan the better dividend stock over ONEOK.
1. Stronger credit
Currently, ONEOK has junk-rated credit. However, it's about to receive a significant upgrade when it gobbles up the rest of its MLP ONEOK Partners (OKS). Rating agencies have already told it that the deal should result in its credit rating rising from BB+/Ba1 up to BBB/Baa3. That said, even at that level, the company's credit rating will remain below Magellan's BBB+/Baa1 rating, which is one of the highest in the MLP space.
One reason Magellan Midstream Partners has such a high credit rating is due to its low leverage ratio. The company has historically maintained a leverage ratio of less than 4.0 and has recently had it below 3.5. Contrast this with ONEOK, which ended last year with a consolidated leverage ratio of 5.2. While ONEOK expects that to improve to 4.7 this year, it's still a long way from its target of a sub-4.0 leverage ratio. However, even at its target leverage, ONEOK's credit metrics would still trail Magellan.
2. A history of stronger coverage
One of the reasons ONEOK has a weaker balance sheet is that ONEOK Partners has historically paid out a larger portion of its cash flow than Magellan in distributions. Last year, for example, ONEOK Partners' distribution coverage ratio was 1.09 while in 2015 it was 0.86, meaning it paid out all its cash flow and then some that year. Contrast this with Magellan, which maintained 1.25 times distribution coverage last year. Because of that healthy coverage, Magellan was able to retain $190 million of cash to help finance a portion of its $736 million in capital spending.
Going forward, the consolidated ONEOK will attempt to take a similar approach by increasing its consolidated coverage ratio to 1.2 and using excess cash to finance growth projects and reduce debt. That said, at best, that only puts it in line with what Magellan has done for years.
3. More clarity on what'll fuel future growth
Speaking of growth projects to finance, Magellan currently has $900 million of projects underway, which should enter service over the next two years. Meanwhile, it has more than $500 million of potential growth projects further down the pipeline. For a $21 billion company, that's a fairly decent backlog that it expects will fuel 8% annual distribution growth over the next two years.
ONEOK, meanwhile, has $1.5 billion to $2.5 billion of projects under development, which it expects to complete over the next five years. While that's a larger growth pipeline, that's what we should expect from a $30 billion company like ONEOK. Further, ONEOK anticipates that this backlog will fuel 9% to 11% annual growth through 2021.
That said, the concern with ONEOK's pipeline is that it's less of a sure thing due to the nature of the projects it has under development, many of which rely on production growth from oil and gas producers. For example, the company expects to invest between $380 million and $480 million on growth projects this year, which is less than the $500 million of growth projects Magellan already has under construction. Because of this variability, ONEOK might not grow as fast as its forecast -- another big decline in commodity prices could cause its customers to pull back spending, reducing the need for new infrastructure by ONEOK. Until the company announces new projects and firms up its backlog, there's a real risk that its growth could miss the mark.
ONEOK is a solid dividend stock with improving financial metrics and compelling growth potential, and getting closer to Magellan's level, but it's not in that class just yet. That's why I'd pick Magellan's dividend over ONEOK's.