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Stock Research: Oneok Limited
About the company
Founded in the year 1906, ONEOK Inc. is a diversifed entity that is engaged in gathering, processing, storage and transportation of Natural Gas in the mid-continent areas of the United States. The company operates through natural gas gathering and processing, natural gas liquids and natural gas pipeline segment. The company is a mid-stream energy pure play company that owns 32% in Oneok Partners and thus, the effective control over the partner company and its cash The company is also one of the largest limited partnership involved with natural gas industry.
Oneok Limited is headquartered in Oklahoma and is listed on NYSE under the ticker symbol of ‘OKE’.
Alarming Financials
Our five-year projection for the company’s financial standing reveals a gloomy side where even though the cash and other current assets are expected to increase ever year, however, with the percentage increase in current liability likely to be higher than the percentage increase in the current assets, we expect the company will face liquidity crunch over the time as we forecast a stable trend in the liquidity ratios.
Another negative outlook is related to forecasts for leverage position as while we forecasts that over the period of five years, around 80% of the company’s assets will be financed with debt funding, the overall leverage position will turn to unsustainable levels with debt-equity ratio expected to surge to 5.1 times than the equity level. This, aligned with the constant profitability outlook for the company, signals towards a possible financial risk in the company.
Lastly, the efficiency ratios also reveals weaknesses in the asset management policy of the company. Beginning with the inventory turnover ratio, we have forecasted the multiple to decrease consistently year-after-year. In other words, over the year, it will take more time for the company to sell its inventory and the capita will remain tied up in the inventory for a longer period of time. Additionally, the asset turnover ratio is also forecasted to plummet year-after-year, indicating that a lower amount of revenue will be generated per unit of the asset base available.
No recovery in oil markets
Oneok, being a natural gas extractor and distributor, depends largely on the price of crude oil in the global market, which since past two years have declined by 75% plummeting from the peak of $120/barrel to $40/barrel in January, 2016. US oil industry depends on shale-style oil drilling and since this oil drilling method is expensive compared to one in the Middle East, the oil related industry is not expected to witness the bullish period soon. However, Oneok Partners is positioning itself to weather down the downturn and counter the commodity swings as the firm is now increasing its fee-based gas gathering and processing contracts to reduce its exposure to commodity prices. Most recently, the company has announced that it will generate 85% of its EBTDA margin from fee-based contracts compared to 66% in 2014. On the other hand, while many US onshore producers are shutting down their business, Oneok nonetheless remains positioned in many of the world’s lowest-cost shale plays. However, large remaining inventory available with oil-rich nations will not provide any cushion to the company’s profitability anytime soon.
Valuation
I used the traditional Free Cash Flow Model to calculate the intrinsic price of the stock. My finding suggests that the stock is currently overvalued and has a downside probability of 28% with intrinsic value estimated at $25.14/share.
Revenue
We have relied on Ernst and Young annual survey report for the natural gas industry to estimate the growth rate in the revenue figures. The report reveals that during the past years, the natural gas industry has increased by 7.9%, however, considering the present scenario with the industry wrestling with unfavorable swings in the commodity prices, we assumed a 4% growth in the revenue figures.
Cost of Goods Sold
Oneo’s costs of goods sold is forecasted to stay at 81.32% over the next five years. That forecast came from taking the average of the previous five years.
Operating Expenses
Operating expenses are forecasted to stay constant at 5.73% of the revenue figures. The multiple has been calculated on a five-year historical average basis.
Capex
We have assumed that the company will increase the capital expenditure amount by 5% every year. The Capex growth percentage has been calculated in proportion to the revenue figures.
WACC
WACC was the most important multiple as the accuracy of the entire FCFF model was based on it. As for cost of equity, the multiple was calculated using the CAPM model. While I used long-term 10-year bond yield of 2.55% as a proxy for risk free rate, beta multiple of 1.38 was sourced from Yahoo Finance. Using the market return of 8%, we calculated the cost of equity to be 10.1%. On the other hand, the value and costs of long-term debt and short-term debt was sourced from the recent annual report of the company.
Assimilating all the required inputs, the WACC rate was calculated at 5.15%
Investment Risk
While the preceding sections has already discussed the risk related to Oneok’s stock price, below we have discussed few more:
Midstream business structure
Even though the company has aggressively turned to fee-based business model, however, since it is a mid-stream company, it will always be prone to commodity price swings.
Correlation to Major Limited Partnership(MLP) Model
Even though Oneok is a standard corporation and not an MLP, however, since it has high interest in partnership firm, Oneok Partners, any adverse situation that threatens the MLP structure could have adverse effects on Oneok.
Recommendation: Sell
On the basis of the outcome of the valuation model, which indicates 28% downfall in the stock price and pessimistic outlook for the industry, I have issued Sell recommendation for the company’s stock as amid growing concerns over crude prices and turbulence in the American energy markets, I do not expect any recovery in stock price.
References
Profile: Oneok . n.d. 20 April 2016 <http://finance.yahoo.com/q/pr?s=OKE+Profile>.
Simko, Stephen. "Lower Commodity Prices are a big headwind for Oneok in 2016." Equity Research. 2016.
FCFF Model
