Image Source: ONEOK investor presentation

Many dividend investors love midstream MLPs because their tollbooth-like business models make for incredibly generous and secure high yields. However, the recent oil crash has proved that some payouts are much safer than others. Take, for example, ONEOK Partners (NYSE:OKS) and its 10.4% yielding distribution.

Obviously, Wall Street has its doubts about the safety of that payout, and since its general partner ONEOK (NYSE:OKE) derives almost all of its income from its MLP, the same holds true to a slightly lesser extent for its 8.5% dividend. Let's look at ONEOK's latest earnings results to see just how badly the oil crash is hurting ONEOK, and, more importantly, how safe these payouts might prove in the year ahead.

ONEOK Partners results show both good and bad news

Metric Q3 2015 Q3 2014 YoY Change
Gross Profit $537.6 million  $536.2 million


Adjusted EBITDA $403.7 million $388.6 million 4%
Distributable Cash Flow (DCF) $302.8 million $293.3 million 3%
Quarterly Distribution $0.79 $0.775 2%
Distribution Coverage Ratio 0.91 1.05 (13%)

Data sources: ONEOK Partners 10-Q, earnings release.

ONEOK Partners is more exposed to falling commodity prices than many of its midstream MLP competitors. Thus this quarter's results were dinged by falling NGL, natural gas, and condensate prices which were offset by increased volumes, and improved margins.

The margin gains came from two sources. First the proportion of ONEOK's margin generated by fee based contracts increased as management works to make the MLP's cash flows more predictable over time. In addition, NGL transportation margin benefited from increased Permian basin volumes due to the 2014 acquisition of the West Texas LPG pipeline system.

However, the most important thing for income investors to focus on is DCF since that is what secures and allows for growth in the distribution. On that front ONEOK Partners didn't do so hot. 

Payout profiles are a mixed bag, but management is optimistic

MLP/CompanyYieldNine-Month Coverage RatioFive-Year Analyst Payout Growth Projections 
ONEOK Partners 10.1% 0.8 2.4%
ONEOK 8.6% 1.24 5.7%

Sources: ONEOK earnings release, Fastgraph.

In order to assure their payouts are sustainable in the long-term both ONEOK Partners and ONEOK should maintain their DCRs above 1. ONEOK's coverage ratio meets that criterion because its combination of general partner interest, incentive distribution rights, and 41.2% ownership of ONEOK Partners means that around 70% of the MLP's marginal adjusted EBITDA flows back to the general partner in the form of distributions and fees. 

On the other hand ONEOK Partners' DCR has fallen substantially over the past year and is now in danger of a possible distribution cut if management can't raise it in the coming quarters. The reason for the DCR's decline (despite a small year over year increase in DCF) was largely due to a 20% increase in unit count that resulted from just over $1 billion in equity sales over the past year. Those proceeds were used to fund growth capital expenditures, pay down debt, and help acquire some pipeline assets from Chevron for $800 million. 

Since ONEOK derives almost all of its income from its MLP, the long-term sustainability of its own dividend is directly dependent on whether ONEOK Partners' DCR can be raised to 1 or more in 2016. Luckily for investors, management believes that it's on track to do just that. 

ONEOK's 2016 plan to secure the payout
ONEOK's plans to preserve its distribution revolves via two strategies. First, over the next year ONEOK Partners will put into service eight growth projects worth about $1.435 billion.$210 million of those projects consist of new natural gas pipelines which is important because they represent ONEOK's most  cash flow source. In fact, the MLP's natural gas pipelines derive 97% of their margin from fixed-fee contracts.

Meanwhile, management expects the percentage of natural gas gathering and processing margin secured by fixed-fee contracts in 2016 to rise from 50% currently to over 70%. That's due to its ongoing strategy of converting commodity-sensitive percentage of proceeds contracts to fixed-fee.  

Bottom line: Growth plans may secure the distribution in 2016, but don't expect much distribution growth
ONEOK Partner's sky-high-yield is indeed justified given the MLP's enormous, though shrinking, exposure to energy prices. Similarly, ONEOK though sporting a much stronger DCR, is tied to the hip of its MLP, because as general partner its cash flows are almost entirely dependent on its MLP's distribution.. 

Next year may prove to be a make-or-break one for ONEOK Partners' distribution. Given that energy prices show no signs of recovering anytime soon, investors will need to keep a close eye on whether management is able to execute on its plans to secure the MLP's DCR via its planned growth and contract renegotiation initiatives.