To say 2020 was a brutal year for the oil market is an understatement. It was one of the worst in history as demand fell off a cliff because of the COVID-19 outbreak, causing crude prices to collapse. That ushered in a wave of bankruptcies across the industry, followed by a merger wave of those surviving to keep their head above water. As a result of the downturn, most oil stocks nosedived last year.
However, 2021 has the potential to be a much better year in the oil patch. Saudi Arabia recently unexpectedly reduced its production, which helped push oil prices back above $50 a barrel, the sweet spot for most producers. That'll give them the cash to drill more wells, which should boost the volumes flowing through midstream systems. One of the many beneficiaries of this rebound is pipeline operator ONEOK ( OKE -1.12% ). Because of that and the shellacking it took last year, it's my top pipeline stock for 2021.
Weathering the storm reasonably well
Shares of ONEOK plummeted 49.3% in 2020, which was a much deeper decline than the average pipeline stock's fall of roughly 30% as measured by the Alerian Energy Infrastructure ETF. While the addition of ONEOK's monster dividend helped boost the total return to a negative 43.4%, it still vastly underperformed its pipeline peers and the broader market.
On the one hand, it's no surprise to see ONEOK's slump since the oil market downturn impacted its financial results and growth prospects. For example, its adjusted EBITDA sank 15.6% year over year during the second quarter while its distributable cash flow plunged 44.4% year over year in that period. Because of that, the company's dividend outlay outstripped its cash flow by $86.8 million. While its result bounce back during the third quarter, it expects to end the year well below its initial forecast.
However, ONEOK estimates it will generate $2.8 billion of Adjusted EBITDA for the full year, which would put it about 8.5% above 2019's level. That might not be the 25% increase it initially anticipated, but it's better than most rivals, which saw their earnings decline in 2020.
Optimistic about 2021
ONEOK hasn't yet put out its official outlook for 2021. However, it provided a glimpse of what it sees ahead on its third-quarter conference call. CEO Terry Spencer stated:
We expect to achieve double-digit earnings growth in 2021 compared with our new and updated 2020 outlook. As it relates to our dividend, distributable cash flow this quarter exceeded the dividend by $125 million. With earning strength expected in the fourth quarter and into 2021, we expect distributable cash flow to cover both the dividend and our 2021 capital expenditures as we continue on our path to deleveraging.
Spencer notes two things. First, he expected earnings to grow by more than 10% from the revised 2020 baseline. That view assumed oil prices stayed around their level at the time. Instead, they've improved significantly since then, rallying about 25% over the past three months. That should boost ONEOK's business. It will enable oil companies to complete new wells quicker -- increasing the volumes flowing through midstream systems -- while also benefiting commodity price-sensitive businesses. In other words, there's some upside to that projection.
Spencer also notes that the company expects to generate enough free cash to cover dividends and capital spending in 2021. That will enable it to reduce its leverage ratio as its earnings grow. On one hand, that doesn't necessarily mean the dividend is safe since Spencer went on to state: "as always has been the case, the dividend remains a potential lever we could pull if our deleveraging expectations are not being met." However, with the oil market improving, it seems less likely that ONEOK will need to cut the dividend to achieve its debt reduction goal.
Plenty of fuel for a big-time rebound
ONEOK's stock lost nearly 50% of its value last year even though it produced reasonably solid results. Meanwhile, it expects its earnings to grow at least 10% this year, which again would be going against the grain since many of its peers expect another down year. It therefore has significant upside potential in 2021 as the oil market recovers. Add in its 9.4%-yielding dividend, -- which looks sustainable -- and ONEOK could produce monster total returns in 2021 if the oil market improves. That potentially massive upside is why it sits atop my pipeline stock list this year.