Names to Watch: Columbia (CG), El Paso (EPG), Enron (ENE)
The current financial stars in the pipeline firmament are
Columbia Energy, El Paso Energy and Enron Corp., while distributors
to watch are AGL Resources, MarketSpan, Peoples Energy and UGI
Corp., according to Curt Launer, vice president of Donaldson,
Lufkin & Jenrette. Prospects are good for the companies named,
although a biannual report by the New York investment house shows
the overall interstate gas pipeline group "has not been doing very
well" so far in 1998, with stock prices significantly
underperforming the Standard & Poor's 500 Index.
Year to date the S&P 500 has seen a 7% increase in share
prices, while stock prices on average for pipelines have plummeted
by about 8.5% owing to low commodity prices, concerns about
international activities and some profit-taking. Still, Launer sees
better times ahead for gas pipelines due to a number of factors,
including actions taken by FERC.
"I think what FERC did in July in terms of the notice of
proposed rulemaking on allowed returns on equity, efficiency
factors in pipelines and balance sheet implications...is enormously
positive for 60-70% of this industry's earnings, which are still
regulated," he said. "I think there's good growth to come for the
industry in terms of relating it to the FERC rulings..." But, he
added, "I do not think that has been in any way, shape or form
reflected in the share prices as of yet. I think there's a lack of
trust on the part of investors generally that until the Federal
Energy Regulatory Commission codifies in a formal rule what they've
proposed, it's something that people would rather wait and see
before they react."
Aside from an improved regulatory outlook, Launer cited several
other factors that "could or should" cause gas pipelines to
"outperform the overall market on the basis of earnings growth" in
the future, including enhanced earnings from unregulated
businesses, "stable to higher" gas prices and greater merger and
acquisition activity. The biannual report predicted the composite
earnings growth rate for pipeline companies would be 9-10% during
1998-2003, assuming gas prices are $2-$2.50 per Mcf and oil prices
are $16-$18 per barrel. Of that amount, 5% growth would come from
the pipeline component, 3% from distribution, and 12-15% from
Launer said he is betting that a "new wave" of merger and
acquisition activity will help spur earnings growth for three
reasons. "First, convergence deals make sense. Electric utilities
are looking to buy into the natural gas industry a la Duke Power
buying PanEnergy a few years ago, which I regard as a very
successful deal. Second, I also think pipeline-buying-pipeline
deals will continue.
The most successful one of those in history was El Paso Energy's
purchase of the Tenneco pipelines a couple of years ago. Everybody
would love to do that kind of deal because El Paso's share price
more than doubled since they did that. And third I think there's
going to be more deals where you see regulated asset companies
buying unregulated assets a la El Paso's recent deal in which they
acquired the general partnership interest of Leviathan Gas
Pipeline, which gives them a commanding position as a gas gatherer
in the offshore Gulf of Mexico."
Columbia, El Paso and Enron are "our three favorite stocks in
the group from the standpoint of their operating fundamentals,
their valuations and everything else we know about them."
Generally, they have outperformed the overall market, he said,
with Enron's share price up about 27.5% and Columbia Energy's up
about 14%. However, the stock price of El Paso, which rose 14%
year-to-date in the first half, fell by more than 15% during the
third quarter due to investors' concerns over its international
activities, resulting in about a 2% drop year-to-date.
The investment firm upgraded Columbia Energy's status to Top
Pick due to its "visible" earnings growth of 10-12%, greater
investments in unregulated areas, low oil and gas price exposure
and lack of international earnings exposure. It also maintained its
Top Pick status for El Paso and Enron, estimating an
earnings-per-share growth rate of 14-15% annually and 15-18%
(1998-2001) for the companies, respectively.
At the same time, it downgraded its rating for Sonat Inc.,
parent of Southern Natural Gas, from Top Pick to buy. Although
there was a 13% uptick in Sonat's stock during one week in August,
that was "largely driven by speculation that the company would be
acquired," according to the Donaldson, Lufkin report. "I'm not
saying that Sonat is for sale. What I was identifying was the fact
that Sonat's share price around the time when I was writing the
report was jumping around pretty wildly," which led to speculation
that Sonat was talking to Consolidated Natural Gas, Launer noted.
Overall, he estimated Sonat's share price has dropped 30%
Sonat, CNG Linked
But he doesn't think reports of Sonat being on the auction block
are especially true. "I think a lot of the stories about Sonat as a
takeover target may have started [when it] was out trying to sell
some of its exploration and production properties. What could have
happened...is that people linked CNG with Sonat because CNG went
into the data room to look at some of the packages for properties
that Sonat had for sale," he said.
"I do not feel like there's anything imminent in terms of an
acquisition of Sonat. I feel like Sonat's management is doing a
good job trying to recover from the various problems they have had
over the last year or so, which have halved their stock price.
There are many people out there who [think otherwise and] probably
would like Sonat to be taken over..."
As for problem spots, Launer noted that Sonat's exploration and
production unit has performed "very poorly" in the past year.
Notably, "they made an acquisition about a year ago of Zilkha
Energy which at the time I thought was a very reasonable deal, but
it turns out it was very poorly timed from the perspective of
declining oil prices."
Equitable Resources, whose stock price Launer estimated is down
about 30% year-to-date, "is not one of our favorable stocks," he
said, adding that the Pittsburgh, PA-based company has been the
target of speculative interest. "Again I'm not going to say I
think this company is going to be taken over, nor do I really think
it should be taken over," Launer noted. "You've got a new
management team [at Equitable] which is developing a new strategic
plan...to be unveiled Nov. 5th. They've scheduled an analysts'
meeting to do that. I'm certainly going to give them the time to
get that plan known and see what they say about how they're going
to invest their capital in the future to try to continue their
fundamental recovery, which I think they can do."
Contrary to beliefs in the industry, "I'd rather think that
there are fundamentals both positive in the industry and positive
for particular companies, which can foster a recovery without the
companies being taken over."
In the distribution sector, Launer said he's recommending to
individual and institutional investors that they invest in a
"package" of higher yielding, fundamentally improving companies,
including AGL Resources, MarketSpan, Peoples Energy and UGI Corp.
"What I'm advocating here is that investors take an investment
position in each of those four companies to achieve a total
dividend return of in excess of 5%."
Gatherers, according to the biannual report, have been harder
hit than other sectors of the gas industry due to their greater
commodity price exposure and the "failure to sell" properties such
as Aquila Gas. This sector is trading at about 35% below the prices
paid in takeover maneuvers, and 55% below the peak prices that
gathering companies traded for last year, it said. The upside is
that "the failure to sell Aquila has been replaced in the last
couple of weeks by the success at Equitable Resources in selling
Louisiana Intrastate Gas" for $320 million, which was 20% higher
than the $250-275 million range that "we thought those assets would
go out at." Launer noted that he's "anxiously awaiting" to see how
Equitable Resources intends to invest this capital.