The current financial stars in the pipeline firmament areColumbia Energy, El Paso Energy and Enron Corp., while distributorsto watch are AGL Resources, MarketSpan, Peoples Energy and UGICorp., according to Curt Launer, vice president of Donaldson,Lufkin & Jenrette.Prospects are good for the companiesnamed, although a biannual report by the New York investment houseshows the overall interstate gas pipeline group “has not been doingvery well” so far in 1998, with stock prices significantlyunderperforming the Standard & Poor’s 500 Index.
Year to date the S&P 500 has seen a 7% increase in shareprices, while stock prices on average for pipelines have plummetedby about 8.5% owing to low commodity prices, concerns aboutinternational activities and some profit-taking. Still, thecompany sees better times ahead for gas pipelines due to a numberof factors, including actions taken by FERC.
“I think what FERC did in July in terms of the notice ofproposed rulemaking on allowed returns on equity, efficiencyfactors in pipelines and balance sheet implications…is enormouslypositive for 60-70% of this industry’s earnings, which are stillregulated,” said Launer. “I think there’s good growth to come forthe 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 formreflected in the share prices as of yet. I think there’s a lack oftrust on the part of investors generally that until the FederalEnergy Regulatory Commission codifies in a formal rule what they’veproposed, it’s something that people would rather wait and seebefore they react.”
Aside from an improved regulatory outlook, Launer cited severalother factors that “could or should” cause gas pipelines to”outperform the overall market on the basis of earnings growth” inthe future, including enhanced earnings from unregulatedbusinesses, “stable to higher” gas prices and greater merger andacquisition activity. The biannual report predicted the compositeearnings growth rate for the pipeline companies would be 9-10%during 1998-2003, assuming gas prices are $2-$2.50 per Mcf and oilprices are $16-$18 per barrel. Of that amount, 5% growth would comefrom the pipeline component, 3% from distribution, and 12-15%unregulated businesses.
Launer said he is betting that a “new wave” of merger and acquisition activity will help spur earnings growth for threereasons. “First, convergence deals make sense. Electric utilitiesare looking to buy into the natural gas industry a la Duke Powerbuying PanEnergy a few years ago, which I regard as a verysuccessful deal. Second, I also think pipeline-buying-pipelinedeals will continue.
“The most successful one of those in history was El PasoEnergy’s purchase of the Tenneco pipelines a couple of years ago.Everybody would love to do that kind of deal because El Paso’sshare price more than doubled since they did that. And third Ithink there’s going to be more deals where you see regulated assetcompanies buying unregulated assets a la El Paso’s recent deal inwhich they acquired the general partnership interest of LeviathanGas Pipeline, which gives them a commanding position as a gasgatherer in the offshore Gulf of Mexico.”
Columbia, El Paso and Enron are “our three favorite stocks inthe 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 upabout 14%. However, the stock price for El Paso, which rose 14%year-to-date in the first half, fell by more than 15% during thethird quarter due to investors’ concerns over its internationalactivities, resulting in about a 2% drop year-to-date.
The investment firm upgraded Columbia Energy’s status to TopPick due to its “visible” earnings growth of 10-12%, greaterinvestments in unregulated areas, low oil and gas price exposureand lack of international earnings exposure. It also maintained itsTop Pick status for El Paso and Enron, estimating anearnings-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. Althoughthere was a 13% uptick in Sonat’s stock during one week in August,that was “largely driven by speculation that the company would beacquired,” according to the Donaldson, Lufkin report. “I’m notsaying that Sonat is for sale. What I was identifying was the factthat Sonat’s share price around the time when I was writing thereport was jumping around pretty wildly,” which led to speculationthat Sonat was talking to Consolidated Natural Gas, Launer noted.Overall, he estimated Sonat’s share price has dropped 30%year-to-date.
But he doesn’t think reports of Sonat being on the auction blockare true. “I think a lot of the stories about Sonat as a takeovertarget may have started [when it] was out trying to sell some ofits exploration and production properties. What could havehappened…is that people linked CNG with Sonat because CNG wentinto the data room to look at some of the packages for propertiesthat Sonat had for sale,” he said.
“I do not feel like there’s anything imminent in terms of anacquisition of Sonat. I feel like Sonat’s management is doing agood job trying to recover from the various problems they have hadover the last year or so, which have halved their stock price.There are many people out there who [think otherwise and] probablywould like Sonat to be taken over…”
As for problem spots, Launer noted that Sonat’s exploration andproduction unit has performed “very poorly” in the past year.Notably, “they made an acquisition about a year ago of ZilkhaEnergy which at the time I thought was a very reasonable deal, butit turns out it was very poorly timed from the perspective ofdeclining oil prices.”
Equitable Resources, whose stock price Launer estimated is downabout 30% year-to-date, “is not one of our favorable stocks,” hesaid, adding that the Pittsburgh, PA-based company has been thetarget of speculative interest. “Again I’m not going to say Ithink this company is going to be taken over, nor do I really thinkit should be taken over,” Launer noted. “You’ve got a newmanagement team [at Equitable] which is developing a new strategicplan…to be unveiled Nov. 5th. They’ve scheduled an analysts’meeting to do that. I’m certainly going to give them the time toget that plan known and see what they say about how they’re goingto invest their capital in the future to try to continue theirfundamental recovery, which I think they can do.”
In the distribution sector, Launer said he’s recommending toindividual 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 investmentposition in each of those four companies to achieve a totaldividend return of in excess of 5%.”
Gatherers, according to the biannual report, have been harderhit than other sectors of the gas industry due to their greatercommodity price exposure and the “failure to sell” properties suchas Aquila Gas. This sector is trading at about 35% below the pricespaid in takeover maneuvers, and 55% below the peak prices that thegathering companies traded for last year, it said. The upside isthat “the failure to sell Aquila has been replaced in the lastcouple of weeks by the success at Equitable Resources in sellingLouisiana Intrastate Gas” to AEP Resources for $320 million, whichwas 20% higher than the $250-275 million range that “we thoughtthose assets would go out at.” Launer noted that he’s “anxiouslyawaiting” to see how Equitable Resources intends to invest thiscapital.
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