ONEOK: Solid Company, But Bakken Weather Likely To Impact Q1 (NYSE:OKE)

With ONEOK (NYSE:OKE) and Magellan now a combined company and set to report its first results with a full quarter of contributions from both companies, let’s catch up on the name. I earlier was against the deal due to the tax consequences for Magellan holders.

Company Profile

Following its merger with Magellan, OKE now operates in four primary businesses. Its largest segment is its Natural Gas Liquids (“NGL”) segment, where it provides gathering, fractionation, transport, and marketing services for NGLs. It operates in a number of basins including the Williston, Powder River Basin, and Mid-continent. The segment accounts for about 44% of its business.

Its Refined Products & Crude segment is its second largest, representing about 28% of its operating income. This is the old Magellan business that consists of the longest refined petroleum products pipeline system in the U.S., as well as 2,200 miles of crude pipelines and storage around Houston and Cushing.

OKE’s Gathering & Processing segment accounts for about 18% of its business. The company is the leading natural gas processor in the Williston and also has G&P assets in the Powder River Basin and Mid-Continent. Its Natural Gas Pipeline segment, meanwhile, makes up about 10% of its business. The segment is comprised of its intrastate natural gas pipeline and storage assets in Oklahoma, Texas, and Kansas.

Merger, Synergies, Buyback, and Upcoming Earnings

Now one of the knocks on Magellan and it being acquired was that Magellan was largely tied to refined products, so its longer-term outlook had some questions surrounding it. Meanwhile, Magellan had been reluctant to pursue any large-scale growth projects, which helped play into this narrative. At the time of the merger, it was only spending a modest $100-150 million a year in growth capex. What it was doing well was managing its balance sheet, and benefiting from increased tariffs that are tied to inflation escalators.

Asked about the impact of the energy transition on the Magellan business it just acquired at a Wells Fargo conference in December, OKE’s CEO Pierce Norton said that the company doesn’t think that refined products such as gasoline, diesel, and jet fuel are going away anytime soon. The CEO noted that in the Midwest there are not many electric vehicles on the road and that car manufacturers aren’t generally even sending many EVs to the lots of car dealers in the Midwest. At the same time, he noted the population shift from the coasts to the Midwest.

Now Norton’s comments are mostly true, as the Midwest in general doesn’t have a lot of EVs registered compared to coastal states. California clearly leads the way both with the number of cars and supporting infrastructure. A combination of lower population, politics, weather, and even the support of ethanol from corn-producing states likely plays a role in the lack of EVs in most Midwestern states. However, interestingly Texas has the third largest number of EVs registered among U.S. states and a solid charging infrastructure base. It’s also home to leading EV maker Tesla (TSLA). On a per capita basis, though, it does still trail coastal states.

I think EV adoption will continue to increase in the U.S. as government policies push people in that direction. However, I also think it will take longer than anticipated given a lack of in-home charging options for consumers living in apartments and urban areas and the current time it takes to charge vehicles at charging stations. There can also be issues with battery lives in cold-weather states, and a percentage of the population will just remain reluctant to EVs.

As such, I think the refined product business that OKE acquired will remain pretty steady, but there likely won’t be much growth outside a few smaller products and tariff increases. As such, much of the benefits of the deal could come down to synergies. At the time of the merger, OKE said it anticipated $200 million in synergies, half of which was just coming from G&A reduction, and $400 million in potential synergies. That is a modest amount for an over $18 billion acquisition.

Now since then, while OKE hasn’t moved from that $200 million synergy number, it has indicated that it could see potential synergies up to $800 million. However, it has risk-adjusted it back to a lower level. This would come from batching (moving NGLs and refined products through the same pipeline), blending (mixing products to get higher values), bundling (bundle service to customers), and improving storage optimization. It now says it sees around 250 different synergy opportunities. A lot of these are smaller ones, with some in the $10-25 million range.

I’m fully expecting synergies from the deal to be at least $400 million, as the $200 million is a very low number. I believe the company has purposely set the bar low to be able to help it top estimates down the road.

Last month, meanwhile, OKE announced a $2 billion stock buyback plan to be executed over the next 4 years. The company also increased its quarterly dividend by 3.7% to 99 cents. That’s good for a yield of around 5.8%.

OKE’s Q4 earnings to be reported later this month, meanwhile, will be the first full quarter of the combined company. I don’t expect too many surprises for Q4, but there could be some negative commentary regarding the current quarter. OKE is still very tied to the Bakken, which saw extreme cold weather take a lot of oil and gas production offline starting in mid-January. Production has been returning more quickly than initially feared, but this will still hurt OKE in Q1.

Valuation

When I last looked at the OKE-Magellan merger, I predicted the company would produce about $6.1 billion in 2024 EBITDA. The company has since guided for over $6.0 billion in 2024 EBITDA and the consensus is $6.06 billion, so that was pretty close. The Q1 issues in the Bakken, though, could have about $100 million impact. This could potentially be offset with more synergies.

OKE trades at 9.8x the 2024 EBITDA consensus. For 2025, it trades at 9.4x EBITDA consensus of $6.33 billion.

OKE trades at a premium to other large-cap midstream companies, with Energy Transfer (ET) trading at 7.1x 2024 EBITDA, Enterprise Products Partners (EPD) at 9.0x, and Kinder Morgan (KMI) at 7.8x.

I see no reason for OKE to trade at a premium to these names, especially with ET and EPD in particular having superior assets and scale. I’m more of the ilk that these companies should trade up closer to where OKE is than OKE trade down to them, as midstream companies have traditionally traded in the 10-12x range or higher before the pandemic.

As such, I’d value OKE around 10x 2025 EBITDA, which would value it around $75.

Conclusion

Overall, I think OKE downplayed initial merger synergies some, but that the Bakken freeze could negate some of that cushion that was likely built into 2024 numbers. Magellan is unlikely to provide a lot of growth on its own, but it will add some incremental opportunities. The energy transition is a risk to the Magellan side of the business over the long term, but I see this taking a long time to play out.

Overall, OKE is a solid midstream operator, I just continue to think there are much better values in the space at the present. As such, I rate the stock a “Hold” with a $75 price target.