As stock markets grapple with the effects of coronavirus, investors are understandably concerned. The timing of the coronavirus outbreak couldn't have been worse for energy investors, who have long been hoping for a recovery.
An expected fall in demand seems set to push oil prices lower, affecting the sector's fragile recovery. Amidst stock price volatility, the importance of stable dividend income increases manifold. One stock offering an attractive 5%+ yield along with attractive growth potential is ONEOK (NYSE:OKE).
Impressive earnings growth
For the year 2019, ONEOK's net income rose 11%. The midstream service provider has been able to consistently grow its earnings over the years. What's more, the company expects a 16% increase in its net income in 2020, primarily driven by contributions from growth projects placed into service recently. The company primarily provides natural gas and NGL gathering, processing, and transportation services.
One thing that separates ONEOK from other midstream providers is the strategic location of its assets. ONEOK's assets are primarily located in the high growth areas including the Williston, Powder River, and DJ Basins in the Rocky Mountains region; the STACK and SCOOP areas in the Mid-Continent region; and the Permian Basin.
Moreover, the company's earnings are primarily fee-based. For example, around 90% of ONEOK's 2019 earnings were fee-based. This provides it a cushion against short-term volatility in commodity prices. Still, ONEOK is exposed to counterparty credit risk if commodity prices remain suppressed for long. However, the company has a diverse customer base that reduces this risk. No single customer contributed more than 10% of ONEOK's 2019 consolidated revenues.
ONEOK has other measures in place to reduce counterparty credit risk. As an example, in 2019, around 90% of the downstream commodity sales in its natural gas gathering and processing segment were made to investment-grade customers or were secured by letters of credit or other collateral. As ONEOK operates under percent-of-proceeds with fee contracts, it isn't exposed to much credit risk from its producer customers in this segment.
Similarly, 85% of ONEOK's revenues from its natural gas pipelines segment were from investment-grade customers. Moreover, its gas and NGL pipeline tariffs require security from shippers. Overall, these measures help reduce the company's counterparty credit risk.
ONEOK's growth projects
Another key factor contributing to ONEOK's sustained growth is its investments in growth projects. The company spent $3.8 billion on growth projects in 2019. ONEOK has placed into service several key projects during 2019 and in 2020, including the Demicks Lake I and II natural gas processing plants, the MB-4 fractionator in Mont Belvieu, and the Elk Creek pipeline. Each of these projects are expected to contribute positively to ONEOK's earnings. For example, more than 550 million cubic feet per day of natural gas gets flared in North Dakota currently. ONEOK's Demicks Lake gas processing plants, which are supported by acreage dedications and fee-based contracts, should help producers reduce flaring and improve value from wells drilled.
Similarly, its Elk Creek pipeline is supported by long-term contracts, which include minimum volume commitments. ONEOK's MB-4 fractionator's capacity is fully backed by long-term fee-based contracts.
What's more, ONEOK has a nice pipeline of expansion projects. It plans to spend around $2.5 billion on growth projects in 2020. Its key upcoming projects include expansions of the Elk Creek and the West Texas LPG pipelines, and an expansion of its Demicks Lake gas processing facility.
ONEOK's net debt-to-EBITDA ratio of 4.8 times at the end of 2019 was on the higher side than the generally accepted norm of 4 to 4.5 times for midstream companies. The company's high capital expenditures -- which peaked in 2019 -- are behind the increase in the ratio.
The good thing is that ONEOK plans to spend 32% less on capital projects in 2020 compared to 2019. However, that does not affect its earnings growth immediately, which is expected to be driven by recently completed projects.
For example, both the Demicks Lake processing plants, the MB-4 fractionator, and the Elk Creek pipeline were completed in late 2019 or early 2020. These projects will significantly contribute to ONEOK's 2020 earnings. The higher earnings should help improve the debt-to-EBITDA to the company's target of around four times.
However, lower growth investments may slow down the company's pace of growth beyond 2021. Still, the company looks set for low single-digit growth beyond that, even with the lowered investments and irrespective of energy commodity prices. With leverage at reasonable levels, that sets the company for steady dividend growth as well in the long term.
ONEOK's per share dividends grew by an impressive 8.8% in 2019 over 2018. The company generated an excess distributable cash flow of $558 million over the $1.5 billion it paid in dividends in 2019.
ONEOK expects its distributable cash flow to rise 18% in 2020, partly contributed by the recently completed projects. This should allow it to raise its dividends in the high single digits in 2020 and at a low but steady rate beyond that.
While coronavirus has made stock and energy markets more volatile, the longer-term outlook for oil and gas is positive. How much ONEOK stock may fall from its current levels is difficult to say, but the positive longer-term outlook makes its safe yield attractive in the current turmoil.