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Utilities Monthly Summary: Natural Gas and Water - November 2013

Core Content Overview

This report provides an analysis of the performance and outlook for natural gas and water utilities in November 2013, highlighting key financial metrics, recent events, and investment recommendations. It includes price performance relative to the S&P 500, commentary on earnings and market conditions, and industry comparisons.

Natural Gas Utilities

Price Performance

• October 2013: Covered gas utilities underperformed the S&P 500 by 0.58% (3.88% vs. 4.46%).
• YTD 2013 (10 months): Covered gas utilities gained an average of 15.56%, while the S&P 500 rose 23.16%.
• 12-Month Performance: The equal-weighted basket of covered gas utilities rose 14%, compared to 24% for the S&P 500.
• Top Performer: Atmos Energy (ATO) led with a 5.39% rally in October.
• Underperformer: South Jersey Industries (SJI) was the weakest performer, rising only 1.66%.

Key Earnings and Outlook

• Earnings Season: Five of eight covered companies reported Q3 results, with CPK, NWN, SJI, and WGL missing consensus EPS expectations.
• ATO Outperformed: Only ATO surpassed the Street view, with adjusted EPS guidance of $2.66–$2.76 for fiscal 2014.
• WGL Guidance: WGL's fiscal 2014 guidance was ~16% below prior consensus, suggesting a second consecutive year of EPS decline.
• Performance Range: From +26% (ATO) to -3% (NWN) over the 12-month period.
• Valuation Insight: The industry is trading at ~17.8x 2014 EPS estimates, below the 5-year average of 17.0x.
• Investment Strategy: The report recommends focusing on regulated segments and utilities with growth strategies due to low gas prices supporting regulated profit growth.

Recent Events

• WGL Holdings (WGL): Acquired ~20,000 residential and light commercial contracts from Castlebridge Energy Group.
• Atmos Energy (ATO): Raised dividend by 5.7%, deviating from the usual 1-2% increases.
• Piedmont Natural Gas (PNY): Issued fiscal 2014 guidance of $1.73–$1.83 EPS.
• New Jersey Resources (NJR): Tightened guidance range just weeks before quarter-end.
• Laclede Group (LG): Weak comments on gas marketing segment performance noted earlier.
• PNY’s Fiscal Year-End: Will report in mid-to-late December due to October fiscal year-end.

Temperature Data

• October 2013: Similar to last year in the areas of interest for the gas utility coverage group.
• Mid-Atlantic: Above average temperatures, which could impact usage.
• Winter Heating Season: Expected to be relatively fair for the industry, with a potential warmer November-January and cooler February-April period.

Natural Gas Prices

• Spot Price: Rose ~4% in October, the first month of six with a positive move.
• YTD Increase: Over 10% from $3.34 per million BTUs as of the end of October.
• Regulated vs. Unregulated: Regulated segments (transmission and distribution) benefit from low gas prices, while unregulated segments (retail marketing, wholesale) have faced depressed results.
• Shale Gas Impact: Continued low prices due to shale reserves support core fuel status and distribution/ transmission expansion.

Coverage Comparables

• ATO: Long-term Buy, $54 target price, ~14.4x P/E ratio, 3.2% dividend yield.
• CPK: Neutral, $3.42 EPS estimate, ~16.7x P/E ratio, 2.7% dividend yield.
• LG: Underperform, $2.98 EPS estimate, ~15.7x P/E ratio, 3.6% dividend yield.
• NJR: Neutral, $2.87 EPS estimate, ~13.8x P/E ratio, 3.7% dividend yield.
• NWN: Neutral, $2.38 EPS estimate, ~17.5x P/E ratio, 4.4% dividend yield.
• PNY: Long-term Buy, $37 target price, ~18.0x P/E ratio, 5.7% dividend yield.
• SJI: Underperform, $3.26 EPS estimate, ~17.3x P/E ratio, 3.8% dividend yield.
• WGL: Neutral, $2.29 EPS estimate, ~15.1x P/E ratio, 4.1% dividend yield.

Water Utilities

Price Performance

• October 2013: Covered water utilities advanced 3.12%, underperforming the S&P 500 by 134bps.
• YTD 2013 (10 months): Covered water utilities gained 14.28%, while the S&P 500 rose 23.16%.
• 12-Month Performance: The group rose ~14%, versus ~24% for the S&P 500.
• Top Performer: California Water Service Group (CWT) with a 7.28% gain.
• Worst Performer: Connecticut Water Service (CTWS) fell 0.34% in October.

Key Earnings and Outlook

• Earnings Season: All six companies released results in early-November.
• Performance: WTR and CTWS exceeded consensus EPS, while AWK, ARTNA, and YORW underperformed by ~0.01–0.05.
• Industry Outlook: The water utility industry is viewed as positive due to regulated infrastructure investment and tuck-in acquisition opportunities.
• Valuation: The industry is trading at ~19.7x consensus 2014 EPS, below the 5-year average of 21.2x, suggesting upside potential.
• Investment Strategy: The report recommends increased allocation to the water utility sector due to growth characteristics and diversification benefits.

Recent Events

• AWK and CTWS Earnings: Both companies released results in early-November.
• CTWS: Notable for higher dividend yield and regional diversification.
• WTR: Exceeded consensus EPS expectations.
• ARTNA and YORW: Underperformed EPS expectations.

Key Recommendations

• Gas Utilities:
  • PNY is the current top pick, with a $37 target price.
  • ATO outperformed the industry in November, suggesting a potential pullback as an entry point.
• Water Utilities:
  • AWK and CTWS are the only recommended buys.
  • The report upgrades the industry allocation from marketweight to overweight.

Industry Comparables

• AGL Resources (GAS): ~19.1x P/E, ~13.6x 5-year average.
• Delta Natural Gas (DGAS): ~25.1x P/E, ~13.2x 5-year average.
• Gas Natural (EGAS): ~16.6x P/E, ~13.4x 5-year average.
• National Fuel Gas (NFG): ~26.6x P/E, ~18.5x 5-year average.
• Southwest Gas (SWX): ~18.3x P/E, ~15.9x 5-year average.
• UGI Corp. (UGI): ~22.3x P/E, ~13.6x 5-year average.
• Water Industry Averages:
  • P/E ratio: ~19.7x.
  • EPS growth: ~3.5%.
  • EV/EBITDA: ~10.6x.
  • Dividend yield: ~2.8%.

Summary of Key Points

• Both gas and water utilities underperformed the S&P 500 in October.
• Gas Utilities:
  • ATO and PNY are the top picks.
  • Earnings weakness in unregulated segments continues to weigh on performance.
• Water Utilities:
  • AWK and CTWS are recommended for purchase.
  • Industry fundamentals remain positive, with potential for growth and diversification.
• The report recommends increased allocation to the water utility sector due to low valuations and growth potential.
• Valuation Insights:
  • Gas utilities trade at ~17.8x 2014 EPS, below 5-year average.
  • Water utilities trade at ~19.7x 2014 EPS, also below 5-year average.
• Weather Impact:
  • Temperature trends have influenced performance, particularly in the mid-Atlantic.
  • Colder weather generally benefits the gas utility industry.
• Dividend Yields:
  • ATO: 3.2%
  • PNY: 5.7%
  • CTWS: 3.8%
  • CWT: 2.7%

Conclusion

The report concludes that the gas and water utility sectors remain underperforming relative to the broader market, but positive fundamentals and growth potential suggest opportunities for long-term investors. The report recommends increased allocation to the water utility industry and selective buying in gas utilities with strong regulated exposure.