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Avinash Gandhi

OKE AT A GLANCE

P/E ► 12.1 AVG EV/EBITDA ► 8.20 AVG ROA ► 4.5% AVG ROE ► 14% AVG Debt to Equity ► 4.47 HIGH Current Ratio ► 0.736 LOW Interest Coverage Ratio ► 3.78 AVG

 

 

 

 

 

 

Oneok operates gas utilities in Kansas, Oklahoma, and Texas that serve over 2 million customers; it also has a 46% stake in a Master Limited Partnership involved in midstream natural gas operations like gathering and pipeline transportation. As General Partner of the MLP, Oneok's income will grow as the partnership's income does, while the company's 46% limited stake gives it a steady periodic cash flow. Furthermore, being part of an MLP allows Oneok to avoid taxes on its midstream income, giving it the ability to spend more on its pipelines business through acquisitions; for example, in October 2007 the MLP purchased a 1,627 mile pipeline from Kinder Morgan that spans from Kansas to Chicago.

Oneok's gas utilities are subject to stringent state regulation, designed to prevent them from taking advantage of the natural monopolies afforded to them by the high cost of gas distribution infrastructure. Furthermore, this guarantees the company a profit, though it also prevents the utilities segment from having much growth opportunity. For this reason, Oneok is relying on its membership in the midstream MLP to provide revenue and income growth in the future. With no real utilities competition, Oneok competes through its MLP with pipeline operators like Kinder Morgan and Atmos Energy.

Business and Financials

Oneok is a gas utilities company that serves over 2 million customers in Oklahoma, Kansas, and Texas. The company is the General Partner and has a 46% limited share in Oneok Partners LP, a Master Limited Partnership engaged in several midstream natural gas operations:

• Gathering: The movement of natural gas from the well to the pipeline.
• Processing: The purification of natural gas for use as a fuel.
• Transportation: The movement of gas from production to distribution hubs.

Oneok Partners has expanded through a series of acquisitions over the past few years, the most recent being an October 2007 acquisition of an interstate pipeline system from Kinder Morgan that spans 1,627 miles from Bushton and Conway, Kansas, to Chicago, Illinois, and has a capacity of 134 MBbl/d.

In 2007, Oneok saw operating revenues of $13.5 billion (excluding energy trading) and a net margin of $1.8 billion. Revenue around $1.5 billion from 2006, and income rose by $90 million.

Oneok Increased its Dividends Four Times in the Last Two Years

In 2006, Oneok increased its dividends two times from $0.28 to $0.32 per share, and in 2007 it again increased its dividends to $0.34 and then $0.36, and for the first quarter of 2008, it increased the dividend to $0.38 per share.^[1] In the past, utilities paid high dividends because stringent government regulation kept them from having much growth potential. This made them very sensitive to short-term interest rates, as higher interest rates made government bonds more attractive as investments; more people investing in government bonds meant less people buying stock (especially stocks with low but steady returns, like utilities), causing shares to fall. Now, however, the combination of deregulation and the diversification of gas utilities into energy trading, generation, and other businesses mean that the companies have greater growth potential and less exposure to interest rate effects. Now, though utilities still pay dividends, these are lower than in the past - because utilities companies now have a chance for strong share growth, so high dividends are no longer necessary to serve shareholder interests.^[2][3] Such fast dividends growth, however, testifies to the company's ability to bring in a healthy profit despite government regulation of utilities rates.

Trends and Forces

Oneok's is General Partner in a Master Limited Partnership Involved in Natural Gas Pipelines

Oneok rearranged its business in 2006 by acquiring a 100% share as General Partner in Northern Border Partners (now Oneok Partners LP)^[4] and then selling its midstream segment to the partnership. Now, Oneok is a gas utilities company that is General Partner AND a 46% Limited Partner in a pipeline and storage partnership, not a holding company with multiple business segments.

Master Limited Partnerships (MLPs) are partnerships in which Limited Partners provide capital and General Partners manage assets and operations. At the end of a given period, Limited Partners earn a set amount of money from the company's cash flow (like dividends) while the General Partner gets paid based on the performance of the MLP (like shares). MLPs have tax benefits, but they are also subject to certain requirements, the primary being that they must receive 90% of their cash from real estate, commodities, or natural resources.^[5] Natural gas transport is considered a commodity.

Since the company is both General and Limited Partner in the MLP, its benefits are twofold. First, it gives the company a steady source of income independent of market conditions or MLP performance, which can be returned to shareholders or recycled back into capital expenditures. Second, it gives Oneok the opportunity to grow as the MLP grows. Because government regulation keeps gas utilities from raising prices (and revenues) at will, while saturated utilities markets and high infrastructure costs prevent utilities from expanding via internal investment, Oneok's MLP offers it a growth opportunity that most gas utilities (especially the ones that are not involved in upstream oil and gas exploration) do not have.

Government Regulation of Gas Distribution Gives the Company Little Control over its Margins

Utilities tend to be highly regulated in the U.S., with the national government setting transmissions rates and state governments setting electric and gas distribution rates. These rules are designed to ensure both profitability for the company and accessibility for the consumer, but often hold back utilities companies, like Oneok, from achieving potential revenues and profitability by preventing them from charging delivery rates that the level of demand would really allow. Regulation can also cause the company's margins to be very volatile, as lobbying the government is the only way the company can control its prices. Unfortunately, natural gas costs fluctuate very rapidly, but it takes a long time for Oneok's lobbyists to convince state and regional regulators to raise the price ceiling. For the most part, regulators will only raise rates if the company can show that something, whether rising costs or inflationary pressure, is causing their margins to shrink to unfair levels.

Gas Utilities' Revenues Follow Seasonal Patterns

Natural gas is used most commonly in home heating systems, making its demand partially dependent on the temperature outside. First- and fourth-quarter revenues for Oneok tend to be higher than second- and third-quarter revenues because late fall through early spring are much colder than late spring through early fall. The company saw 2007 operating revenues of $3.8 billion (1Q)^[6], $2.9 billion (2Q)^[7], $2.8 billion (3Q)^[8], and $4 billion (4Q)^[9], effectively illustrating how colder temperatures lead to higher gas revenues. This temperature dependence also means that unusual seasonality has a real effect on the company's operations; warmer winters, a predicted outcome of global climate change, will damage the company's revenues by decreasing demand at a key part of the year.

Incidentally, the gas utilities demand cycle is exactly opposite that of electric utilities, who see higher demand in warmer months because air conditioning units are electrically powered.

Fluctuating Natural Gas Prices Make Oneok's Margins Much Less Predictable

Oneok is not a natural gas exploration and production company, so it must purchase the natural gas it sells from other companies. Natural gas prices are extremely volatile, fluctuating between $5/cf and $10/cf several times in the past three years; Oneok tries to hedge against these fluctuations by purchasing long-term supply contracts, but most E&P companies are loath to sell at fixed prices natural gas prices are trending upwards, though the company offers supply contracts through a competitive bidding process, keeping costs down. Furthermore, utilities regulations mean that Oneok cannot pass rising costs onto consumers, giving the company less control of its margins.

Competition

ONEOK is a transport and distribution company that acts as a utility in Oklahoma, Kansas, and Texas. In the markets it serves, the company has little real competition thanks to the high cost of infrastructure installation; government regulation, however, keeps the company from charging the rates and turning the profits that would otherwise be expected of a monopolist that sells products with inelastic demand. On a larger scale, Oneok competes pipelines operators like Kinder Morgan and Atmos Energy. Other major gas utilities include:

• Atmos Energy - Atmos operates in Texas, Kentucky, Louisiana, Mississippi, Colorado, Kansas, Tennessee, Georgia, Illinois, Iowa, Missouri, and Virginia. It is not only a gas utility but also a natural gas marketing, pipeline, and storage company.
• Energen - Energen is an energy holding company that operates in a variety of businesses, from oil exploration and production to natural gas marketing and distribution. Its utilities business is the largest gas distributor in Alabama.
• Equitable Resources - Equitable Resources is a vertically integrated natural gas company that operates from the upstream to natural gas distribution. Its gas utilities operate in Pennsylvania, West Virginia, and Kentucky.
• National Fuel Gas Company - NFG is a diversified natural gas company that does exploration, production, transportation, marketing, and distribution of gas; its utilities segment operates in New York and Pennsylvania.
• Sempra Energy - Sempra is a gas and electric utilities company in California.
• Southern Union Company - Southern Union is engaged in the storage, transport, production, and refining of natural gas; its utilities business operates in Missouri and Massachusetts.
• National Grid Transco - National Grid is a gas and utilities company that operates in the United Kingdom and the United State; in the U.S., it operates in Rhode Island and New York.

References

1. ↑ OKE 2007 10-K, page 26
2. ↑ Business Week: "Utility Stocks With Plenty of Spark"
3. ↑ USA Today: "Utilities funds turn into power players"
4. ↑ http://www.northernborderpartners.com/redirect1.html
5. ↑ Investopedia: "Master Limited Partnership"
6. ↑ OKE 1Q07 10-Q
7. ↑ OKE 2Q07 10-Q
8. ↑ OKE 3Q07 Earnings Release
9. ↑ OKE 4Q07 Earnings Release
10. ↑ ATG 2007 10-K
11. ↑ ATO 2007 10-K
12. ↑ EGN 2007 1-K
13. ↑ EQT 2007 10-K
14. ↑ NFG 2007 10-K
15. ↑ OKE 2007 10-K
16. ↑ SUG 2007 10-K
17. ↑ SRE 2007 10-K
18. ↑ Equitable Resources: Equitable Utilities: Equitable Gas
19. ↑ Reuters Full Description: National Fuel Gas Co
20. ↑ Reuters: Full Description: National Grid Transco