Southern Union: Southern Comfort for Investors

Jun.17.09 | About: Southern Union (SUG)
Southern Union (NYSE:SUG) Jun. 16, 2009: $17.85

52-week range: $10.60 (Nov. 21, 2008) - $27.24 (Jul. 1, 2008)
Dividend = $0.15 quarterly = 3.36% current yield

Southern Union* operates an array of regulated and unregulated natural gas assets divided into the transportation and storage, gathering and processing, and distribution segments. The transportation and storage assets, comprising one of the nation's largest LNG terminals and a pipeline network stretching from Texas up through the Midwest and across to south Florida, generate the lion's share of cash flows.

* Company profile from Morningstar

2009 may turn out to be the second down year-over-year earnings comparison for Southern Union since 2001. Value Line sees a slight gain while Zacks projects a small dip in EPS versus 2008. Regardless of which view turns out correctly SUG shares are looking like a bargain.

Here are the per share numbers from continuing operations as reported by Value Line:

Year …... Sales …... C/F ….. EPS …... Div ….. B/V ….. Avg. P/E
2001 ….. 29.77 …. 1.54 …. 0.19 …... nil ….. 11.12 ….. NMF
2002 ….. 20.30 …. 1.79 …. 0.56 …... nil ….. 10.78 ….. 29.5x
2003 ….. 14.75 …. 1.29 …. 0.67 …... nil ….. 11.42 ….. 17.9x
2004 ….. 22.22 …. 2.77 …. 1.24 …... nil ….. 12.74 ….. 13.4x
2005 ….. 17.95 …. 2.71 …. 1.58 …... nil ….. 14.43 ….. 15.0x
2006 ….. 19.54 …. 2.96 …. 1.33 …...0.40…. 15.20 ….. 15.3x
2007 ….. 21.14 …. 3.15 …. 1.75 …...0.45 … 15.96 ….. 17.5x
2008 ….. 24.76 …. 3.27 …. 1.81 …...0.60 … 18.17 ….. 12.6x

Using Zacks 2009 estimate of $1.71 puts Southern’s P/E at < 10.5x this year’s expectation, well under any of its prior multiples. The 3.36% current yield is a well covered 35% payout ratio and the highest ever for SUG holders.

Value Line rates SUG with a ‘B+’ for financial strength and assigns them 85th and 90th percentile rankings for ‘stock price stability’ and ‘price growth persistence’ respectively. Morningstar sees ‘fair value’ at $20.

A rebound to even twelve times earnings leads to a year-end 2009 target price of $20.52 /share.

Is that a reasonable goal? Sure. Southern Union posted absolute lows of $20.80, $22.80 and $26.80 in 2005-2006-2007 respectively on EPS of $1.58, $1.33 and $1.75. Its highs in those same years were $26.30, $29.80 and $35.50.

Here’s a solid six-month combination play with SUG that makes sense to me:

.............................................Cash Outlay...Cash Inflow
Buy 1000 SUG @$17.85 .......$17,850
Sell 10 Dec. $17.50 calls @$2.00 .................$2,000
Sell 10 Dec. $20 puts @$3.20 ......................$3,200
Net Cash Out-of-Pocket ........$12,650


If Southern Union shares rise by 12.1% to $20 or higher by Dec. 18, 2009:

The $17.50 calls will be exercised.
You will sell your shares for $17,500.
The $20 puts will expire worthless.
You will have collected $120 in dividends.
You will have no further option obligations.

You will hold no shares and $17,620 cash for your original outlay of just $12,650.

That’s a best-case scenario total return of $4,970 / $12,650 = 39.28%
achieved in just six months on shares that only needed to rise by 12.1%.

What’s the static return?

If Southern Union is still $17.85 on the Dec. 18, 2009 expiration date:

The $17.50 calls will be exercised.
You will sell your original shares for $17,500.
The $20 puts will be exercised.
You will be forced to buy another 1000 shares and to lay
out an additional $20,000 cash.
You will have collected $120 in dividends.
You will have no further option obligations.

You will end up with 1000 SUG shares [worth $17,850] plus $120 cash.
Thus you’d have a liquidating value of $17,970 for your cumulative
total cash outlay of $15,150.

Here’s the detailed accounting break down:

Buy 1000 SUG @$17.85 ..............$17,850
Sell 10 Dec. $17.50 calls @$2.00 ...............$2,000
Sell 10 Dec. $20 puts @$3.20 ....................$3,200
Net Cash Out-of-Pocket ...............$12,650

Sold 1000 shares @$17.50 via calls .................$17,500
Bought 1000 shares@$20.00 via puts..$20,000
Net Cumulative Cash Out-of-Pocket .....$15,150

You would have a net profit of $2,820 / $15,150 = 18.6% in just six months, on shares that did not go up.

What’s the break-even on the whole trade?

On the first 1000 shares it’s their $17.85 purchase price less the $2.00 /share
call premium = $15.85 /share.

On the ‘put’ shares it’s the $20 strike price less the $3.20 /share
put premium = $16.80 /share.

Your net break-even is $15.85 + $16.80 / 2 = $16.33 /share
[excluding dividends].

Southern Union shares could fall by up to (-8.5%) without causing
a loss on this trade.

Disclosure: Author is long SUG shares and short SUG options.