It's been a rough year for the energy industry, which only got worse last quarter, after oil prices slumped more than 20%. That's something investors need to keep in the back of their mind when reviewingONEOK's upcoming third-quarter report. Sure, it's largely immune from commodity price volatility because it has no direct exposure to commodity prices. However, its MLP, ONEOK Partners , does have exposure, because of the way many of its natural gas gathering and processing contracts are currently structured. That direct exposure could play a key role when both companies report results on Tuesday after the markets close.
First, let's reviewWe saw this direct exposure last quarter, after ONEOK Partners reported less-than-ideal results. While the company's distributable cash flow was higher on an absolute basis, it slipped on a per-unit basis because of a higher unit count and a higher distribution. ONEOK Partners' distribution coverage ratio ended up slipping from 1.02 last year to 0.88 in the second-quarter, meaning it paid out more cash than it earned.
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However, we saw an entirely different result at ONEOK, because it benefited from having its MLP grow its cash flow and distribution. Those two factors pushed ONEOK's cash available for dividends higher, thereby improving its dividend coverage ratio from 1.09 to 1.18.
Watch the coverage ratio and contracts at ONEOK PartnersWe can expect another quarter of a sub-1.0 coverage ratio at ONEOK Partners, given that the expectation for the coverage ratio is that it will be between 0.87 and 0.97 for 2015. This is a warning sign, because the company can't keep that rate up indefinitely. However, at the moment, a distribution cut doesn't appear to be in the cards, because the company is working to provide a firmer footing under that distribution by increasing its fee-based earnings. The plan is to obtain a coverage ratio in excess of 1.0 next year by converting more of its commodity price-exposed contracts to fee-based contracts. Because of the importance of this plan, investors will want to look for any signs that the company has been successful in converting customers to new contracts.
Watch volume growth at ONEOK PartnersLast quarter, ONEOK CEO Terry Spencer said in the earnings release: "ONEOK Partners expects significant volume growth in the second half of the year. With the first half of 2015 complete, we have increased confidence the partnership will reach its natural gas gathering and processing volume guidance expectations, and we expect ONEOK to be within its 2015 financial guidance ranges as well."
Given the importance of volume growth, keep an eye on whether the company remains on track to hit its growth targets. Pay particular attention to the Lonesome Creek processing plant in the Williston Basin, which is scheduled to come online next quarter. Given how much drilling has slowed in that basin, it's possible that project might not deliver as expected.
Watch for any changes to the 2015 outlookDespite the volatility in the energy market, both companies reaffirmed 2015 guidance in their second-quarter earnings release. However, that was after having reduced guidance once this year, so it's possible that they could do so yet again. Here are the numbers to keep an eye on:
Source: ONEOK and ONEOK Partners.
Another negative reduction to the company's guidance would suggest that commodity price volatility is having a deeper impact on ONEOK than initially expected.
Investor takeawayInvestors have to realize that the key to ONEOK is its MLP. So while ONEOK might report solid results, its MLP will probably struggle a bit because of its direct exposure to commodity prices. If that exposure is worse than initially feared, which is quite possible given how much commodity prices weakened last quarter, then it could lead to problems at ONEOK down the road.
The article What to Watch When ONEOK, Inc. Reports This Quarter originally appeared on Fool.com.
Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Oneok. The Motley Fool recommends Oneok Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.