Despite a minimal change in interest rates, energy prices or company fundamentals, U.S. natural gas utilities continued their bullish run in the first quarter, and they show no signs of abating, according to a review by A.G. Edwards analysts.
Mike Heim and Daniel Fidell noted that gas utility stocks have outperformed the Standard & Poor's Composite Index (S&P) each of the last three years and in 1Q2007. A.G. Edwards' index of 30 gas utilities provided a total return of 5.3% in the quarter versus a return of 0.6% for the S&P.
A.G. Edwards divides its universe into two categories: "gas distributors and diversified gas utilities. The gas distributor group includes gas utilities that generally receive less than 25% of their earnings from unregulated operations. The diversified group includes companies whose primary business is gas distribution but that also own other energy-related operations that include exploration and production, transmission, storage and marketing.
"Valuation multiples remain high relative to historic ranges," the analysts wrote in their quarterly review. "The median P/E [profit to earnings] as measured by an index of 30 gas utilities on 2008 estimated earnings is 16.8 times versus a historical range of 11.5-17.5 times." The higher valuations have been helped by the recent takeover announcements, Heim and Fidell noted.
"The influx of private investment into the utility space (note, for example, recent takeover bids for Kinder Morgan, TXU Corp. and SEMCO Corp.) have helped move multiples higher. Asset transaction prices in the energy industry also remain high buoyed by a growing number of master limited partnerships chasing a shrinking portfolio of assets for sale. We believe as long as gas utility assets are being bought for 10-12 times EBITDA [earnings before interest, taxes, depreciation and amortization], current gas utility market multiples seen reasonable even if they are high relative to historical levels."
The regulatory environment for gas utilities is positive "as more state regulators grant mechanisms that automatically adjust rates to offset changes in consumption patterns," the analysts wrote. In addition, the United States witnessed its first quarter of colder-than-normal temperatures in at least two years.
"Cold weather will help the earnings of gas utilities that do not have decoupling mechanisms or weather normalization riders in their rates," they wrote. "It may also hep companies seeking to get such mechanisms as consumer advocates realize that rates would have been lower last quarter if mechanisms had been put in place."
Going forward, gas utility stock returns are expected to slow to a rate "more in line" with A.G.Edwards' long-term forecast of 7-9%.
Of the gas utilities it covers, A.G. Edwards' strongest performing stock among the gas distributors was SEMCO (24.9%), which agreed to be acquired in February (see Daily GPI, Feb. 26). Other strong performers included South Jersey Industries (14.7%), AGL Resources (10.9%) and Northwest Natural Gas (8.6). Of the diversified gas utilities, top performers included Equitable Resources (16.3), National Fuel Gas Co. (13%) and MDU Resources (12.7%).
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