Is ONEOK a Buy?

ONEOK (NYSE: OKE) has enjoyed a strong year in 2018. Overall, the high-yielding midstream giant has delivered a total return of more than 20%. While it has come off its high a bit in recent weeks, due to volatility in both the stock and oil markets, the company has significantly outperformed most peers; the average holding in the Alerian Energy Infrastructure ETF, for example, has produced a total return of worse than negative 10% this year.

That significant outperformance likely leaves investors wondering if ONEOK has anything left in the tank. Here's a look at whether the pipeline company is still a good stock to buy.

A look at ONEOK's growth engine

ONEOK's earnings and cash flow have grown at a fast pace in 2018. Thanks to some recently completed expansion projects, a small acquisition, and ramping up volume across its system due to improved oil prices, the company is on pace to grow EBITDA nearly 24% compared to 2017; cash flow is on track to expand at an even faster 34%. That significant uptick in earnings has helped fuel ONEOK's outperformance this year.

ONEOK should be able to continue growing earnings and cash flow rapidly. The company has secured $6 billion of expansion projects over the past year; these projects are all under construction and should enter service through 2021. ONEOK currently has two major natural gas liquid (NGL) pipelines under construction, one of which should start service by the end of next year and the other in early 2020. In addition, it's building two large NGL fractionators, which separate raw NGLs into higher valued products like ethane and propane; one should start up in early 2020 and the other in 2021. Finally, the company has two large natural gas processing plants under construction that should begin service in late 2019 and early 2020.

These projects position ONEOK to deliver 12.7% compound annual EBITDA growth through 2020. For comparison's sake, the average stock in the S&P 500 is only expected to increase EBITDA by a 7.2% compound annual rate over that same time frame. That faster-paced growth should enable ONEOK to increase its dividend (currently yielding 5.6%) at a 10.6% annual rate over that period, which is well above the 6.2% expected dividend growth rate of stocks in the S&P 500. That faster growth for such a high-yielding stock puts ONEOK in a class of its own.

All this growth comes at a price

In addition to considering a company's growth potential, investors need to look at a stock's valuation. Currently, ONEOK expects to generate $1.86 billion in cash flow for 2018 at the midpoint of its guidance range. The company's current market value of around $25 billion implies that ONEOK sells for roughly 13.5 times cash flow. For comparison's sake, the average pipeline stock fetches about 11 times cash flow. Meanwhile, fellow pipeline giant Kinder Morgan (NYSE: KMI) trades at about eight times cash flow.

On the one hand, ONEOK deserves to sell for a premium valuation since it's growing at a much faster rate than Kinder Morgan, which sees its adjusted EBITDA expanding at around a 4% annual rate, though its cash flow should grow at a 10% pace in 2019. However, one thing worth noting is that Kinder Morgan is fully funding growth with internally generated cash flow. ONEOK, on the other hand, will need to raise capital in 2019 to finance its large backlog of capital projects. While its current premium valuation affords it the luxury of issuing stock to finance growth without significantly diluting existing investors, there is a risk that the company might wait too long to sell shares and end up paying a higher price for the capital it needs. (It does have other funding options at its disposal, such as bringing on a cash-rich joint-venture partner.)

Verdict: It's a buy

ONEOK currently expects to grow its earnings and dividend at a double-digit annual pace through at least 2020. Add that to the company's yield of more than 5%, and ONEOK has the potential to generate total annual returns in the mid-teens from here, assuming it maintains its current premium valuation. While it's not quite the bargain that Kinder Morgan is these days, it still looks like a solid dividend growth stock to buy for the long term: Its combination of high yield and a high growth rate could fuel market-beating total returns.

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Matthew DiLallo owns shares of Kinder Morgan. The Motley Fool owns shares of and recommends Kinder Morgan. The Motley Fool recommends ONEOK. The Motley Fool has a disclosure policy.