The broader market continues to show strength on the back of speculation that the Federal Reserve will continue Quantitative Easing because the economy has not shown that it is strong enough to continue a recovery by itself. Whether or not QE continues or tapers, and whatever the reason the broader market continues to be modestly overvalued really matter not to me. I don’t focus on major macroeconomic trends or try to predict the future, and my success doesn’t hinge on my ability to do so. My success simply hinges on my ability to find wonderful businesses and buy equity positions in these businesses at attractive prices relative to their intrinsic value. I believe that equity positions in high quality businesses is the best way to build wealth over the long haul.
As such, I decided to put more cash to work into what I believe is a high quality business trading for an attractive price on a long-term basis.
As part of my Recent Buy series, I try to let my readers know of any equities I purchase soon after the transaction is completed. This is just one way I try to document my progress toward early retirement and financial independence.
Oneok is a diversified energy company. They operate in three segments, including: Oneok Partners, Distribution and Energy Services (Energy Services to be discontinued April 1, 2014, however).
This is a really interesting company. While they are one of the largest natural gas distributors in the United States, serving over 2 million customers throughout Oklahoma, Texas and Kansas and while they also have the Energy Services segment that primarily markets natural gas and related services to other natural gas distribution companies, electric-power generators and industrial customers, the primary reason I invested in OKE is for the sole General Partner and 43.4% ownership of Oneok Partners, L.P. (OKS). This is the real growth engine behind the company, and makes this company one of the premier midstream energy companies in America.
Oneok Partners, L.P. (OKS) is a Master Limited Partnership that focuses on the gathering, processing, storage and processing natural gas and natural gas liquids.
OKE’s future growth will be largely dependent on the growth of OKS because they not only own 43.4% of the Limited Partner units, but also 100% of the Incentive Distribution Rights, which effectively grants OKE an increasing share of the cash flow the partnership generates. Combine a growing payout directly to OKE via the IDR (because they are the sole GP), along with growing payouts to the Limited Partners (of which OKE owns 43.4% of) and one can see how this investment can provide superior cash flow returns to an investor. Another factor that continues to tie OKE’s success to OKS is the fact that OKE continues to purchase OKS common units while simultaneously buying back OKE shares. If OKS continues to grow and focus on high ROE projects, OKE will continue to see outsized returns from the partnership. OKS has announced $4.5 billion of growth projects through 2015 and OKE has targeted dividend growth of 65-70% between 2012 and 2015.
I’ve discussed why I’m such a fan of ownership stakes in General Partners of well-run Master Limited Partnerships before. I’m long Kinder Morgan, Inc. (KMI) and discussed some of the thesis behind that ownership stake, as well as a little on how a General Partner and Incentive Distribution Rights (IDR) works here.
OKE has experienced significant growth since purchasing the majority of the General Partner of Northern Border Partners in 2004, then later in 2006 becoming the sole General Partner and renaming it Oneok. Before that they were primarily a utility company (and still operate as one). OKE is a dividend growth stock, and has been growing the dividend for 11 years. The 10-year dividend growth rate stands at 15.1%, and it isn’t slowing down. The dividend increased by 18% in 2012 over 2011’s payout. The most recent dividend increase was earlier this year, in which OKE increased the quarterly payout from $0.33 per share to $0.36 per share. That’s an increase of 9%, and I think there’s a chance it might increase again. The payout ratio stands at 86.2% of earnings, but as stated earlier earnings are not necessarily a great way to analyze the profitability of a GP of an MLP. It’s better to focus on cash flow and Limited Partner/IDR distributions.
Focusing on the value of a company is what I pride myself on, and I’m comfortable buying shares in OKE at current prices. OKE is up 2.53% YTD, while the S&P 500 is up just over 14% YTD. More importantly, it’s down 14.64% since April 22 and on the day of purchase it was down 1.83%. I purchased shares in OKE at the same price they were going for in December of 2011. The P/E ratio of OKE is currently just over 26, but this can’t really be compared to a typical utility because of the obvious MLP/GP structure and the growth behind that. Also, as an asset-heavy MLP there is significant depreciation which negatively affects earnings.
Using a Dividend Discount Model and a very conservative 7% long-term dividend growth rate (well below the historical average) and a 10% discount rate I get a Fair Value on shares at just over $51 per share. I believe OKE shares are currently attractively valued after the significant drop in price over the last month or so. Shares are trading for less than 10% above the 52-week low and I think a comfortable margin of safety exists at the current price.
OKE offers me an entry yield of 3.28% on my purchase price, which is obviously attractive factoring in the historical and targeted dividend growth. This purchase adds $50.40 to my annual dividend tally based on the current quarterly payout.
I currently have 35 positions in my portfolio after this purchase, as this was another new investment (I’m on a roll!).
Some current analyst opinions on my recent purchase:
*S&P rates OKE as a 3/5 star Hold with a Fair Value Calculation of $34.50.
I’ll update my Freedom Fund in early July to reflect my recent addition.
Full Disclosure: Long OKE, KMI
Thanks for reading.
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