Pipeline giant ONEOK (OKE 0.47%) had high hopes entering this year. The company was in the midst of a major expansion program, which had it on track to finish five projects by the end of the first quarter. Because of that, the energy company expected its earnings to grow by more than 20% this year, which would have put its high-yielding dividend on an even more sustainable foundation.

Unfortunately, crude oil prices collapsed earlier in the year as COVID-19 sapped demand. That forced many of ONEOK's producing customers to shut in some of their wells, which impacted the volumes and cash flowing to ONEOK. As a result, its stock cratered more than 65%, pushing its dividend yield up close to 15% Here's a look at whether that sell-off now makes this big-time payout worth buying.

Pipelines over water at sunset.

Image source: Getty Images.

Drilling down into ONEOK's dividend

One of the main issues weighing on ONEOK's stock this year is the sustainability of its dividend. As a result of crashing crude prices during the second quarter, ONEOK generated less cash than it paid out in dividends. Because of that, it had to borrow money to cover the difference and its capital program. That pushed its leverage ratio to 4.5 times debt-to-EBITDA, which is above its 4 times target and its sub-3.5 times aspirational goal. 

With leverage rising, it's getting more expensive for the company to borrow money even though it has a solid investment-grade balance sheet. That led ONEOK to sell more than $900 million of its stock in June to help bolster its finances. While that equity issuance reduced the need to cut its dividend, it significantly diluted existing investors. The company isn't out of the woods just yet; market conditions remain weak, and it still has several hundred million dollars of remaining capital projects to finance. 

What's ahead for ONEOK and its dividend?

ONEOK issued debt and equity earlier this year, pulling as many levers as possible to maintain its monster dividend. Because of that, and the improvements in volumes in recent months, "we don't see the need to take action on the dividends," according to comments by CEO Terry Spencer on the second-quarter conference call. However, the CEO did warn that we "recognize that [a dividend reduction] is a lever we could [pull] if our deleveraging expectations are not being met." There thus remains a risk that ONEOK could cut its payout if it's unable to reduce debt through other means.

Aside from the equity issuance, the company's main debt reduction tool is earnings growth, as its expansion projects come online and boost its volumes and cash flow. If oil demand improves, oil companies will complete more wells and start filling up ONEOK's pipelines. 

Unfortunately, next year's oil market outlook looks bleak, which doesn't bode well for the company's deleveraging strategy. Because of that, there's lots of uncertainty about what's ahead for ONEOK. If market conditions don't bounce back, the company's recent growth projects might never pay off. That would likely force the pipeline company to consider reducing its dividend and using that cash to repay debt and then maybe repurchase some of its beaten-down shares.

Too much uncertainty these days

The market fully expects ONEOK to slash its dividend at some point, which is why the yield has risen to such heights. While the company is trying to prevent that outcome, it might have no choice if market conditions don't bounce back since it needs to reduce its leverage. Because of that, it's too risky for dividend investors these days.