Last year was supposed to be a monster one for pipeline giant ONEOK (OKE +1.57%). It was putting the finishing touches on several needle-moving expansion projects, which it thought would fuel 25% earnings growth in 2020 and an additional 20% surge in 2021.
Unfortunately, last year's turbulent conditions in the energy market threw a wrench in those plans, which also put its 8.5%-yielding dividend on shaky ground. However, the oil market has improved significantly in recent months, which was evident in its strong finish to 2020. It now sees more growth ahead in 2021, enhancing the sustainability of its big-time dividend.
Drilling down into ONEOK's fourth-quarter results
|
Metric |
Q4 2020 |
Q4 2019 |
Year-Over-Year Change |
|---|---|---|---|
|
Adjusted EBITDA |
$742.0 million |
$660.5 million |
12.3% |
|
Distributable cash flow |
$517.8 million |
$487.9 million |
6.1% |
|
Dividend coverage ratio |
1.25 |
1.29 |
(3.1%) |
Data source: ONEOK.
ONEOK's earnings and cash flow improved during the fourth quarter. That helped push its full-year adjusted EBITDA total to $2.7 billion, which was up 6% year over year. However, DCF declined by 6.7% in 2020, coming in at $1.88 billion. As a result, ONEOK's dividend coverage ratio tightened from 1.38 in 2019 to 1.17 last year, and it generated only $276.2 million in excess cash after paying its dividend, half of 2019's total and nowhere near enough to cover the roughly $2.2 billion it invested into expansion projects. That caused it to borrow money and sell stock to cover the shortfall.
Fueling the company's strong end to a turbulent year was an across-the-board improvement in each of its three business units:
Data source: ONEOK. Chart by author.
Earnings from the natural gas liquids segment jumped 11.6% during the fourth quarter and rose 10.3% for the full year. The company benefited from higher volumes in the Rocky Mountain region and lower rail and pipeline transportation costs.
Gas gathering and processing earnings leaped 15.9% during the fourth quarter while slumping 7.5% for the full year. The company benefited from higher volumes in the Williston Basin during the fourth quarter, which offset production declines in the Mid-Continent region. Meanwhile, those production declines in the Mid-Continent and lower realized commodity prices affected its full-year results.
Finally, earnings from its natural gas pipelines improved by 8% in the fourth quarter and 7% for the full year. The company benefited from lower operating costs and additional firm transportation contract volumes.
Image source: Getty Images.
A look at what's ahead for ONEOK
ONEOK expects to produce between $2.9 billion and $3.2 billion of adjusted EBITDA this year. That implies a 12% increase at the midpoint. ONEOK also sees its distributable cash flow improving to a range of $1.97 billion to $2.27 billion, up nearly 13% at the midpoint. Fueling that growth will be higher volumes driven by increasing producer activity and additional capacity from recently completed expansion projects.
This year, the pipeline company expects to spend between $525 million and $675 million on capital projects. That's a more than 70% decrease from last year's level at the midpoint. The company expects to finance this spending with excess funds after paying its dividend and cash on hand, which stood at $524.5 million at the end of 2020. ONEOK also finished last year with a 4.6 times debt-to-EBITDA ratio, solid enough that credit rating agencies reaffirmed its investment-grade credit rating. With capital spending coming down and its balance sheet in solid shape, ONEOK's high-yielding dividend appears to be sustainable.
Meanwhile, ONEOK's earnings have significant upside as energy markets recover and producers start increasing their output. It built a considerable amount of capacity in recent years, enabling it to quickly capture volumes as they come online. It could deliver healthy earnings growth for several years with minimal incremental capital investment.
Starting to look like a sustainable income stock
ONEOK bet big that higher volumes would materialize in the 2020 to 2021 timeframe by investing heavily to expand its midstream systems. Unfortunately, the COVID-19 outbreak wreaked havoc on those plans. However, with market conditions improving and its capital spending coming down, ONEOK's earnings should continue growing -- albeit at a slower pace than it initially envisioned -- putting its high-yielding dividend on a more sustainable foundation. It looks like it could be a solid income stock for investors, with intriguing upside potential.
