We have recently been scanning the Spanish market as a way to diversify our portfolio in search for solid dividend growth stocks that can offer all the benefits dividend investors seek, plus the potential for discount prices.
Enagas (OTCPK:ENGGY) appears as a good option for conservative dividend growth investors to diversify within the high yielding IBEX 35 Index. It is a defensive value with attractive operating growth and a solid balance sheet. The company has been able to grow steadily through the Spanish crisis. Having very limited international diversification, it offers full exposure to a potential recovery of the Spanish economy.
Enagas is a regulated entity that manages the natural gas pipelines in Spain. Free-float is high at around 85% with the Kingdom of Spain, Kutxabank and Oman Oil Company holding a 5% stake each. The rest of the shareholders are diversified across the USA & Canada, UK, Spain and the rest of Europe.
The company assets include 10,000 km of pipelines in Spain plus its international connections to North Africa and Europe, four LNG regasification plants and three underground storage facilities, together with a 40% stake in one additional regasification plant in Spain and two other in Mexico and Chile.
Prices charged to utilities for regasification, transportation and storage are regulated separately for each piece of infrastructure to ensure the profitability of the company, a price structure that provides predictable income streams to the company.
Enagas pays dividends twice a year in July and December for a total yield around 6%. Since trading inception in 2002, it has increased its distributions every year by an impressive 19% average, although dividend growth over the last 5 years has slowed down to a 13% yearly average.
The company has been involved for the last few years in an investment cycle aimed at both improving storage capacity, which was lagging behind other European countries, and adding network capacity to improve international connections towards France. This last point is relevant as it will open export flows from Algerian gas fields connecting through the Medgaz pipeline (8 billion cubic meters of annual capacity).
With the exception of regasification plants in the Canary Islands, the need for strategic gas infrastructure in Spain has been reduced after the investments carried out recently. As such, Enagas is not likely going to be spending as heavily in Spain for the next years, especially while demand is still depressed due to the economic woes in the country.
As a consequence, we would expect organic growth to slow down together with Capex requirements, allowing the company to increase its payout up to the expected 75% or beyond. This should sustain dividend increases while allowing the company to focus in reducing leverage. The company could also use its free cash to diversify and buy additional growth through selective purchases.
Enagas sports a solid balance sheet with 1.5 billion in cash in Q3 2013 and net debt to EBITDA under control at 3.6 billion. The company does not have significant debt maturities for 2014 and could benefit if financial conditions improve in Spain.
Trade receivables are a significant item in the balance sheet with 0.6 billion and increasing, partly due to the 255 million pending balance from regulated tariffs.
S&P recently confirmed its BBB rating for the company with a stable perspective and so did Fitch with its A-.
Enagas seems slightly undervalued at current prices if we project the very stable ratio of EBIT to Operating Assets (supported by regulated prices) and make mild assumptions for future growth. Our valuation for the company is in the range 21-23€ while it is currently trading close to 20€.
A P/E ratio comparison with other gas or electricity network operators shows as well the upside potential for the company.
EL PASO PIPELINE (NYSE:EPB)
RED ELECTRICA (OTCPK:RDEIY)
ENERGY TRANSFER (NYSE:ETP)
KINDER MORGAN (NYSE:KMP)
As with any investing decisions, this one carries risks.
In the case of Enagas, it seems necessary to highlight that regulatory changes might impact the company prospects. Tariff deficit has recently been a source of headaches for electricity utilities in Spain and could trigger regulatory reforms for gas utilities. Regulatory uncertainty persists, although the scale of the problem is much smaller in the case of gas and we would expect the impact on the company to be very mild if any.
Currency risks need to be taken into account as well. The dollar has recently gained some strength against the euro and could continue to do so if the Fed tapering goes deeper and the ECB keeps stimulus or increases it.
Finally, Spain seems to be turning a corner out of a protracted slump in its economy, but the situation in the economy is still weak with painfully high unemployment and depressed consumer demand. The market can be reaching its bottom and constitute an excellent opportunity in case that the recovery is confirmed in the coming quarters. On the other hand, any deterioration of the situation in Europe would probably hurt especially the incipient recovery in Spain.
Enagas is a good investment at the current price with limited downside although with a slim margin of safety. Its high yield and growth prospects, together with the good operational performance and a defensive profile make it an attractive option for income investors willing to diversify in Europe.
The company has proven its ability to keep growing along the economic downturn in Spain and should be able to benefit from a potential Spanish recovery. Additional installed capacity for international connections and LNG regasification plants can add to the company prospects as the company diversifies internationally and stays well positioned to profit from new developments in the industry.
Regulatory risks together with currency risk and the overall economic situation in Europe should be considered by any potential investors.
Disclaimer: this article expresses our personal opinions and should not be taken as investment advice. Potential investors are recommended to run their own due diligence before taking any investment decision.
Additional disclosure: I have no positions in any of the stocks mentioned in this article and no plans to initiate any positions within the next 72 hours, with the exception of ENGGY