Please ensure Javascript is enabled for purposes of website accessibility

The Oil Market Crash Is Starting to Bite This High-Yielding Pipeline Stock

By Matthew DiLallo - Apr 30, 2020 at 8:07AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

ONEOK's growth engine is stalling out.

ONEOK (OKE -0.54%) expected 2020 to be a banner year. It initially thought that its earnings would soar 25%, fueled by several recently completed expansion projects.

While the company did get off to a solid start in the first quarter, plunging oil prices forced many of its customers to reduce their production and drilling activities, and far fewer volumes will flow through the pipeline company's systems this year. That will take a big bite out of its growth expectations.

A quick review of ONEOK's first-quarter earnings

Metric

Q1 2020

Q1 2019

Year-Over-Year Change

Adjusted EBITDA

$700.8 million

$637.5 million

9.9%

Distributable cash flow

$522.3 million

$506.8 million

9%

Dividend coverage ratio

1.35 

1.43 

(5.6%)

Data source: ONEOK. 

ONEOK burst out of the gates in 2020. Earnings and cash flow surged 10% and 9%, respectively, which enabled it to generate enough cash to cover its 11.7%-yielding dividend with room to spare. The pipeline company benefited from across-the-board growth in all three business segments:

ONEOK's earnings by segment in the first quarter of 2020 and 2019.

Data source: ONEOK. Chart by the author.

Earnings in the natural gas liquids (NGL) segment grew 9% year over year, fueled by higher volumes in the Rocky Mountain region and Permian Basin. Driving that growth was the recent completion of several NGL-related projects, including a section of the Arbuckle II pipeline, a fractionation plant in Texas, and expanded capacity of the West Texas liquefied petroleum gas (LPG) pipeline system.

Natural gas G&P earnings, meanwhile, rose 5%, driven by higher volumes in North Dakota's Williston Basin. One factor fueling that growth was the recently completed the Demicks Lake II gas processing plant in that region.

Finally, earnings in the natural gas pipeline segment increased by 6%. The main driver was higher volumes as a result of expansion projects completed last year as well as increased rates.

Red pipelines at an oil storage terminal.

Image source: Getty Images.

A look at ONEOK's murky outlook for 2020

While ONEOK got off to a good start this year, market conditions have deteriorated significantly over the past several weeks because of crashing crude oil prices. Many of its producing customers have slashed their drilling budgets, which will affect volumes this year. Accordingly, the company has reduced its outlook. 

While ONEOK said it's "impractical" to provide guidance, it did perform a scenario analysis based on currently available information. Those calculations led it to estimate that adjusted EBITDA is likely to range between $2.6 billion and $3 billion. That's significantly below its previous guidance range of $3.1 billion to $3.35 billion. At the midpoint, this forecast implies about 9% earnings growth.

ONEOK also further reduced its capital spending plan for the year. It now expects to invest between $1.4 billion and $1.8 billion, down roughly $1 billion from its initial view and $500 million less than its prior revision. Driving the spending decline was the decision to pause construction on several projects, including the Bear Creek natural gas processing plant in North Dakota, a fifth NGL fractionator in Texas, and an additional expansion to West Texas LPG. By further reducing spending, ONEOK will keep the pressure off its balance sheet, which saw leverage rise to 4.86 times net debt-to-EBITDA at the end of the quarter, well above its sub-4.0 target.

The company spent more than $900 million on capital projects during the first quarter, leaving it with a significantly reduced investment level for the balance of the year. It had $530 million of cash, $2.5 billion of available credit, and a business that's generating more than $100 million of free cash flow each quarter after paying the dividend to finance this remaining capital commitment.

Adjusting quickly to weakening market conditions

ONEOK's customers have taken it on the chin this year as crashing crude prices are forcing them to reduce spending. That will have some impact on volumes, which will affect the company's earnings. It's also allowing the company to pause on some expansion projects since customers won't need that capacity as fast as expected. The reduced investment level will take some pressure off ONEOK's financial profile, which will help it maintain its high-yielding dividend.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends ONEOK. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

ONEOK, Inc. Stock Quote
ONEOK, Inc.
OKE
$63.95 (-0.54%) $0.35

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
397%
 
S&P 500 Returns
128%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/19/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.