Pipeline companies have had trouble keeping their promise to investors over the past few years, with many falling well short of their dividend growth forecasts. Natural gas pipeline giant Kinder Morgan (NYSE:KMI), for example, said in 2014 that after acquiring its master limited partnerships, the combined company could increase its dividend by a 10% compound annual rate through 2020. However, it slashed the payout 75% in late 2015 when it hit a liquidity crunch. Targa Resources (NYSE:TRGP), meanwhile, anticipated increasing its payout 15% in 2016 after buying its MLP, with greater than 10% compound annual dividend growth through 2018. It failed to live up to that pledge, though, since it hasn't increased the dividend once since closing the deal because cash flow didn't grow as expected.
Given that history, there is some skepticism that ONEOK (NYSE:OKE) can achieve its ambitious dividend growth forecast, which would see the pipeline company increase its payout by a 9% to 11% annual rate through 2021. Adding to the leeriness is the fact that ONEOK hadn't secured the expansion projects needed to drive the dividend higher. But after announcing a major growth project this week, along with a bulk of the funding, it's now much more likely that ONEOK will fulfill its promise to investors.
Slowly filling up the pipeline
When ONEOK bought its MLP last year, the company said that the combination of paying out a higher percentage of its cash flow and building high-return expansion projects would fuel its dividend growth forecast. At that time, the company thought that it could secure $1.5 billion to $2.5 billion of high-return, fee-based projects in the coming years, which would provide it with the incremental cash flow needed to achieve its goal. While it had about $480 million of growth projects planned for 2017, it didn't have anything firm beyond those expansions.
However, ONEOK slowly started filling out its backlog last summer. In June, the company announced plans to expand its Mid-Continent natural gas liquids (NGL) gathering system and Sterling III pipeline after EnLink Midstream Partners (NYSE:ENLK) signed long-term contracts supporting the projects. It said it would invest $130 million to help accommodate EnLink Midstream Partners' growth and that it would finish the expansions by the end of 2018.
In October, ONEOK and its 20% joint venture partner, Martin Midstream Partners (NASDAQ:MMLP), announced a $200 million expansion to their West Texas LPG Pipeline, which should start up by the third quarter of this year. Furthermore, ONEOK and Martin Midstream Partners noted that this development could lead to more growth projects for their joint venture in the coming years.
Overall, ONEOK secured about $490 million of expansion projects last year, which would help support its dividend growth through at least 2019 given the timing of these projects. Also, the company increased the estimate for the potential growth projects it could secure up to between $3 billion to $3.5 billion.
A step change in the right direction
ONEOK locked up one of those projects this week when it announced plans to build the Elk Creek Pipeline, which is a 900-mile line that will move NGLs out of the Rockies to its existing facilities in the Mid-Continent region. The company said that it would invest $1.2 billion to build that pipeline, along with another $200 million in related infrastructure, which should all be in service by the end of 2019. It also noted that thanks to the long-term contracts it secured, this investment should generate between $233 million to $350 million in annual EBITDA, which works out to a four to six times multiple. That's a fantastic return, and is higher than the five to seven times multiple it had anticipated for expansion projects and better than the five to seven times multiple Targa Resources will earn on a similar project.
In addition to securing this project, ONEOK also locked up the bulk of the capital needed to build it after selling $1.05 billion in its premium-priced stock. That money, when combined with the cash on its balance sheet, expected excess cash flow, and more debt proceeds should fund its capex budget well into 2019. By securing the necessary financing now, it reduces the risk that the company would need to cut the dividend to finance growth if it couldn't obtain the funding later.
Great news for dividend growth investors
By announcing this large-scale, high-return project, ONEOK has significantly increased the odds that it can achieve its dividend growth forecast. So, by also locking up the bulk of the financing, there is less risk that a market downturn would impact the company's ability to continue growing. That makes it much more likely that this potential income gold mine will produce as promised.