While the stock market is concerned about the short-term implications for lower earnings, the joint venture of San Diego-based Sempra Energy’s successful energy-metals trading business with Royal Bank of Scotland (RBS) offers plenty to like in the long term, according to Michael Heim, an analyst with A.G. Edwards & Sons Inc., who follows Sempra. He still sees Sempra stock as valued in the $67/share to $70/share range.

Heim acknowledges that share prices have been weak the first two weeks after the deal’s July 9 announcement (see Daily GPI, July 11; July 10), dropping 2.4%, but he attributes it almost entirely to the market’s traditional distaste for deals that lower near-term earnings. (Sempra lowered its 2008 earnings guidance by 20 cents/share because of the RBS joint venture in trading.)

But longer term, Sempra can maintain lower cash balances and a more leveraged balance sheet because RBS is assuming all the capital growth and accompanying risk in expanding an energy-metals trading operation that produced $500 million of net profits last year. “A minimal level of trading earnings for Sempra is virtually guaranteed,” Heim said.

Heim’s Thursday research note included the disclosure that A.G. Edwards has an investment banking relationship with Sempra.

“The stock market rarely rewards companies taking actions that reduce risk at the cost of lowering near-term earnings, and that appears to be the case in this situation,” said Heim, adding that Edwards thinks what he called “the benefits of lowering the corporate risk profile” will be more apparent over time. “For example, Sempra may be willing to make investments in riskier projects that will ultimately increase growth.”

Heim continues to rate Sempra as a “buy, aggressive,” and has set a $68/share price objective for its stock, which closed last Thursday under $60 at $59.68/share. It was over $61/share the first day after the announcement on the partnership with RBS but then retreated.

The joint venture called RBS Sempra Commodities LLP was presented by Sempra senior executives as a complex $2.65 billion deal that will give the company the chance to grow its already substantial trading returns while lowering its risk. If all the regulatory approvals come together as expected on both sides of the Atlantic, Sempra should satisfy any past concerns about its trading role among both shareholders and credit rating agencies.

Both companies said they expect to double the trading operation’s profits over the next five years, with the UK-based bank taking over a majority interest and day-to-day trading operations. Sempra will use RBS’s financial heft, and the Edinburgh-based banking giant will use Sempra’s energy industry acumen.

Responding to Sempra’s projection that increased its 2011 earnings estimates by 30 cents/share, A.G. Edwards’ Heim said that after his firm put all of the new data in its models, “we believe such an increase is warranted. We do not publish a 2011 earnings estimates but have increased our long-term earnings-per-share (EPS) growth projection to 8% from 7%.”

“The joint venture will be a significant expansion of the activities of RBS’s Global Banking & Markets Division in this important asset class and provides excellent opportunities for further growth,” RBS said in announcing the deal two weeks ago. RBS currently has no energy trading business in its global commodities unit.

RBS Director Johnny Cameron said the joint venture will give the global bank “immediate global leadership in another important asset class that will complement those leading positions.”

Heim said the new trading entity will be able to “leverage existing RBS relations to generate more business,” and in addition will be able to take advantage of products and trading markets that Sempra has previously identified “but was unwilling to enter because of the capital requirements.

“We expect the unit to grow within the next few years to the point that Sempra will earn as much from trading as it did prior to forming the joint venture.”

On July 9 in a conference call, Sempra CEO Donald Felsinger said the new partnership will provide Sempra with “unlimited opportunities” to provide expanded transactions that have been limited to it in the past because of Sempra’s relatively small balance sheet. “We’ve basically shed all risk here” in the way the partnership is structured.

In addition to trading, Felsinger and other Sempra senior executives indicated that other parts of its business can benefit from its newly created relationship with RBS, one of the world’s largest financial institutions and a leader in financing major energy and natural resource facilities.

The global project financing leverage of RBS could significantly help Sempra’s already substantial holdings in North American liquefied natural gas (LNG) projects.

In response to an analyst’s question, Felsinger said he didn’t anticipate the level of risk in the trading operations changing dramatically with the new venture and RBS’s obvious deep pockets. “Sempra will no longer be subject to the risk associated with trading,”

A.G. Edwards’ Heim said. “Sempra is released from all credit facilities and working capital risks.”

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