How dependent is ONEOK's cash flow on ONEOK Partners?

Very dependent. ONEOK's own risk factors state that its partnership interest in ONEOK Partners is one of its largest cash-generating assets, so a significant decline in ONEOK Partners' earnings or distributions would directly reduce ONEOK's cash flow. In 2011 ONEOK received $333 million in total distributions from ONEOK Partners ($197 million on its limited partner units and $136 million on its general partner interest), and that stream is central to funding ONEOK's dividend and buybacks.

Why did the Energy Services segment's profit collapse in 2011?

Management attributes the 82% drop in segment operating income to structurally narrower natural gas location and seasonal price differentials caused by a surge in shale gas supply, plus lower price volatility that reduced optimization opportunities. Transportation margins fell $65.3 million and storage/marketing margins fell $34.3 million, and inventory lower-of-cost-or-market adjustments of $91.1 million also weighed on results. The company is shedding fixed-cost capacity, but it has warned that impairments or charges could result from contract renegotiations.

What are the main growth projects and how will they be funded?

ONEOK Partners is investing roughly $2.7–$3.3 billion in projects including Bakken Shale gathering and processing plants, the Sterling III NGL pipeline (about $610–$810 million), the MB-2 fractionator at Mont Belvieu, the Bakken NGL pipeline, Bushton fractionator expansion and Cana-Woodford/Granite Wash infrastructure. Capex is funded with operating cash flow, commercial paper, short- and long-term debt, and equity issuance. Projects are expected to add fee-based earnings and cash flow once completed, with many in service in 2012–2013.

How secure is the dividend and what are the leverage risks?

ONEOK raised its dividend substantially, and management expects operating cash flow, existing capital resources and ONEOK Partners distributions to cover operations, planned capex and the remaining buyback. Leverage is manageable: ONEOK's stand-alone debt-to-capital ratio was 44.4% against a 67.5% covenant, and ONEOK Partners' debt-to-adjusted-EBITDA was 2.9x against a 5.0x limit. Risks include a potential downgrade below investment grade, which would raise borrowing costs and require collateral for the Energy Services business, and a possible increase in short-term rates, which management expects in 2012.

What material legal and regulatory exposures should investors watch?

Two long-running matters stand out. The Boles I and II cases in Kansas, alleging underpayment of royalty owners through mismeasurement of gas volumes and heating content, have been narrowed to the claims of two named plaintiffs after class certification was denied. The gas index price reporting litigation (MDL-1566) alleges market manipulation; trial courts granted judgments for ONEOK and affiliates in several cases in July 2011, and plaintiffs have appealed to the Ninth Circuit. Management does not expect these to have a material adverse effect, but outcomes cannot be predicted with certainty. Regulatory risks include pipeline safety legislation enacted in January 2012, greenhouse gas rules and Dodd-Frank derivative reforms.

OKE 10-K Filed Feb 21, 2012

01—Abstract

Summary

Summary of the 10-K filed February 21, 2012. Cited figures are marked; the original filing is the authoritative source.

ONEOK, Inc. (NYSE: OKE) enters 2012 as a holding company whose value is driven largely by its 42.8%^a economic interest (2% general partner plus limited partner units) in ONEOK Partners, L.P.

(NYSE: OKS), which it controls as sole general partner. In 2011, consolidated revenues rose 17% to $14.8 billion^b and operating income rose 23% to $1.16 billion, with net income attributable to ONEOK up 8% to $360.6 million ($3.36 diluted EPS). The growth was driven almost entirely by ONEOK Partners, where operating income jumped 60% to $939.5 million on much wider NGL location differentials between Conway, Kansas and Mont Belvieu, Texas, and higher NGL volumes.

By contrast, the Energy Services segment's operating income fell 82% to $23.8 million^c as narrower location and seasonal price spreads eroded storage and transportation margins, and Natural Gas Distribution operating income fell 12% on higher operating costs. Management is leaning into growth: ONEOK Partners plans roughly $2.7 billion to $3.3 billion of new capital projects in the Bakken, Cana-Woodford, Granite Wash and NGL infrastructure, and 2011 capital expenditures reached $1.34 billion (2012 projected at $2.27 billion). Capital is funded through a mix of operating cash flow, commercial paper and debt; in January 2012 ONEOK issued $700 million of 4.25% senior notes due 2022.

Shareholder returns were also strong: dividends rose about 18.7% to $2.16^d per share for 2011, the January 2012 quarterly dividend was raised to $0.61, and the board authorized a two-for-one stock split subject to shareholder approval. Balance sheet metrics remain investment grade (Baa2/BBB, stable), with ONEOK's stand-alone debt-to-capital ratio at 44.4% against a 67.5% covenant.

Key investor considerations include concentration risk, since ONEOK's cash flow depends heavily on distributions from ONEOK Partners; the Energy Services segment's exposure to narrowing spreads and a potential impairment of its leased storage and transportation capacity; and the regulatory, environmental and litigation overhang, including the long-running Kansas gas-measurement (Boles) cases and gas index pricing suits. Fixed-cost commitments to firm transportation and storage contracts remain material at roughly $370 million for ONEOK alone.

02—Key points

Key Highlights

Consolidated revenues rose 16.8% to $14.81 billion and operating income rose 23% to $1.16 billion in 2011, while net income attributable to ONEOK rose 7.8% to $360.6 million ($3.36 diluted EPS).
ONEOK Partners (42.8% owned) drove results: segment operating income rose 60% to $939.5 million on wider Conway-to-Mont Belvieu NGL price differentials, which added $335 million to optimization margins.
Energy Services operating income fell 82% to $23.8 million as narrower location and seasonal price spreads cut transportation margins by $65 million and storage/marketing margins by $34 million; management expects pressure to persist through 2012 and possibly into 2013.
ONEOK Partners plans $2.7–$3.3 billion of growth capex; ONEOK's 2011 capital spending was $1.34 billion and projected 2012 capex is $2.27 billion.
Dividend per share rose 18.7% to $2.16 in 2011; the January 2012 quarterly dividend was raised 17.3% to $0.61 ($2.44 annualized), and a two-for-one stock split was authorized pending shareholder approval in May 2012.
Liquidity remains solid: $700 million 4.25% senior notes due 2022 issued in January 2012 (net proceeds about $693.9 million), ONEOK stand-alone debt-to-capital of 44.4% versus a 67.5% covenant, and investment-grade ratings (Baa2/BBB, stable).
Share repurchases continue under a three-year $750 million program, with about $300 million executed in 2011 via an accelerated repurchase agreement and roughly $450 million remaining authorization.

03—Questions

Frequently Asked Questions

How dependent is ONEOK's cash flow on ONEOK Partners?
Very dependent. ONEOK's own risk factors state that its partnership interest in ONEOK Partners is one of its largest cash-generating assets, so a significant decline in ONEOK Partners' earnings or distributions would directly reduce ONEOK's cash flow. In 2011 ONEOK received $333 million in total distributions from ONEOK Partners ($197 million on its limited partner units and $136 million on its general partner interest), and that stream is central to funding ONEOK's dividend and buybacks.
Why did the Energy Services segment's profit collapse in 2011?
Management attributes the 82% drop in segment operating income to structurally narrower natural gas location and seasonal price differentials caused by a surge in shale gas supply, plus lower price volatility that reduced optimization opportunities. Transportation margins fell $65.3 million and storage/marketing margins fell $34.3 million, and inventory lower-of-cost-or-market adjustments of $91.1 million also weighed on results. The company is shedding fixed-cost capacity, but it has warned that impairments or charges could result from contract renegotiations.
What are the main growth projects and how will they be funded?
ONEOK Partners is investing roughly $2.7–$3.3 billion in projects including Bakken Shale gathering and processing plants, the Sterling III NGL pipeline (about $610–$810 million), the MB-2 fractionator at Mont Belvieu, the Bakken NGL pipeline, Bushton fractionator expansion and Cana-Woodford/Granite Wash infrastructure. Capex is funded with operating cash flow, commercial paper, short- and long-term debt, and equity issuance. Projects are expected to add fee-based earnings and cash flow once completed, with many in service in 2012–2013.
How secure is the dividend and what are the leverage risks?
ONEOK raised its dividend substantially, and management expects operating cash flow, existing capital resources and ONEOK Partners distributions to cover operations, planned capex and the remaining buyback. Leverage is manageable: ONEOK's stand-alone debt-to-capital ratio was 44.4% against a 67.5% covenant, and ONEOK Partners' debt-to-adjusted-EBITDA was 2.9x against a 5.0x limit. Risks include a potential downgrade below investment grade, which would raise borrowing costs and require collateral for the Energy Services business, and a possible increase in short-term rates, which management expects in 2012.
What material legal and regulatory exposures should investors watch?
Two long-running matters stand out. The Boles I and II cases in Kansas, alleging underpayment of royalty owners through mismeasurement of gas volumes and heating content, have been narrowed to the claims of two named plaintiffs after class certification was denied. The gas index price reporting litigation (MDL-1566) alleges market manipulation; trial courts granted judgments for ONEOK and affiliates in several cases in July 2011, and plaintiffs have appealed to the Ninth Circuit. Management does not expect these to have a material adverse effect, but outcomes cannot be predicted with certainty. Regulatory risks include pipeline safety legislation enacted in January 2012, greenhouse gas rules and Dodd-Frank derivative reforms.

04—Continue

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