Natural gas distribution utilities traded at elevated valuations for years as high premium takeovers winnowed their ranks, explains Roger Conrad, editor of the industry-leading advisory service, Conrad's Utility Investor.
That’s no longer the case, in part because of investor worries that some states will phase out natural gas heating, causing utility distribution pipelines to become “stranded.”
I don’t expect that to be a concern for long. For one thing, natural gas heating continues to gain market share with oil conversions, even in states like New Jersey and New York that have been losing population.
And carbon-conscious states like California, renewable natural gas from organic plant and animal waste is gaining credence as an alternative with a process that actually lowers greenhouse gas emissions.
The bottom line is gas distribution infrastructure will be used and useful decades hence. And in the meantime, companies are firing up growth adding to rate base, by investing in network to improve efficiency and safety, as well as adding customers.
The valuation implosion, however, has pushed NiSource Inc. (NI) and South Jersey Industries (SJI) to compelling valuations that seem bound to attract suitors.
South Jersey is exposed to the still-delayed Penn East Pipeline project, and investors are likely to scrutinize its progress as well as other unregulated operations when the company reports Q3 results the first week of November.
But with New Jersey regulators approving an amicable rate increase in late September, the hiring of a CFO and meaningful leverage to government stimulus spending, reassurance and reaffirmation of guidance will likely trigger a recovery in the stock.
And at a market cap of barely $2 billion, it’s not hard to see a high premium all-cash bid from the current price. My highest recommended entry point is still $32.
As for NiSource, the company recently announced a $40 billion infrastructure spending plan over the next 20 years that if regulators approve will boost its regulated electric and gas utility rate base 10 to 12 percent a year through 2024.
That would produce compound annual earnings growth of 7 to 9 percent over that same time frame, which should help close the stock’s valuation gap to other utilities. That’s if a takeover offer doesn’t come first from a utility looking to add reliable regulated cash flows. Buy up to $25.
