The Best of Both Worlds

02/05/2009 11:43 am EST

Focus: STOCKS

Charles Carlson

Editor, DRIP Investor

Charles Carlson, editor of the DRIP Investor, finds a dividend-paying utility with stable regulated businesses and growth from its nonregulated business.

Any stock related to the energy sector saw its shares plummet in the second half of 2008. Questar (NYSE: STR) was no exception.

The company, which provides natural-gas utility services as well as natural-gas exploration and production, saw its stock price fall from nearly $75 per share to below $21 before rebounding in the last two months.

Questar provides regulated natural-gas utility services to more than 800,000 customers in Utah, Wyoming, and Idaho. More than 40% of the natural gas sold to retail customers comes from utility-owned supplies. The company’s nonregulated Questar Market Resources provides oil and gas exploration and development; field services, such as natural gas gathering and processing, and gas-storage services.

Nonregulated operations have been Questar’s growth engine in recent years. Per-share profits jumped from 87 cents in 2002 to around $3.80 when final 2008 results are reported, largely as a result of the growth of the nonregulated business.

However, earnings growth is likely to stall in 2009. The consensus earnings estimate for 2009 is $3.17 per share. To be sure, earnings estimates for energy companies can prove to be wide of the mark. Still, it is hard to see natural-gas prices jumping sharply in the near term. In mid-January, underground inventories exceeded both last year’s levels and the five-year average.

Despite near-term pressures on the stock, the long term looks positive for Questar and its gas exploration and production services. The Energy Information Administration forecasts that more than half of American’s new energy capacity will come in the form of natural gas. That’s good news for Questar, which owns some of the richest gas fields in the country.

The stock has been hurt by a sharp decline in natural gas prices, and that decline will likely lead to lower profits in 2009 following a record year in 2008. Still, Questar’s utility business provides a relatively stable earnings base, and a recovery in energy prices would jump-start interest in these shares.

The stock may lag until the economy shows more evidence that energy demand is improving. However, at these prices (around $35—Editor), the stock seems too cheap. I would feel comfortable nibbling on the stock in the $30s and buying more aggressively on dips into the $20s.

Questar trades at 11x the 2009 consensus earnings estimate. That’s a discount to the stock’s three-year average forward P/E ratio of 14x. If there is one factor missing from Questar’s bullish story, it is a near-term catalyst.

However, investors should not discount the company’s combination of a stable utility operation with a volatile but lucrative exploration business. This mix of businesses sets the company apart from other energy stocks and should be a draw that lures investors back as energy markets recover.

Enhancing total-return appeal is the yield of 1.5%. Questar offers a direct-purchase plan whereby any investor may buy shares directly, the first share and every share.

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