Small-cap Piedmont Natural Gas (PNY) offers investors a very conservative means of diversifying into the natural gas utility sub-sector. While not particularly exciting, PNY offers a steady return over time through both expanding dividends and earnings.
The true benefit of owning PNY may not become apparent until the next market meltdown. In reviewing performance charts from the last financial crisis, it becomes obvious that PNY withstood the battering that took many stocks to decade-low pricing. PNY helped investors maintain portfolio value because it did not participate in the 50% drop of the S&P 500 in 2008 and early 2009. Preserving capital during a market decline is paramount to all investors, and PNY has a history of excelling in the preservation of capital during such times.
PNY supplies natural gas to almost a million customers in North Carolina, South Carolina, and Tennessee. Below is a map of its service area, from the most recent investor's presentation.
In addition to being a local distribution company, PNY has assets in the natural gas pipeline and storage businesses, but these only contribute about 4% of earnings before taxes. PNY also sells natural gas through a 15% ownership in South Star, a retail-marketing arm, and this asset contributes about 7% of earnings before taxes. South Star is a joint venture with AGL Resources who owns the balance. The regulated distribution business contributes about 89% of earnings before taxes. Shown below are historical earnings contributions from the regulated and non-regulated segments of PNY:
Combined, joint ventures have contributed between $0.20 to $0.23 a share and the major assets are listed below:
- SouthStar Energy Services L.L.C. -- equity participant in one of the nation's largest retail natural gas marketer, serving more than 600,000 customers
- Pine Needle LNG Company, L.L.C. -- equity participant in a liquefied natural gas facility that's among the nation's largest
- Cardinal Pipeline Company, L.L.C. -- equity participant in a 102-mile intrastate pipeline serving portions of North Carolina
- Hardy Storage Company L.L.C. -- equity participant in an underground natural gas storage facility in Hardy County, West Virginia.
- Constitution Pipeline Company L.L.C -- equity participant in proposed natural gas pipeline project to transport natural gas supplies from the Marcellus supply region in Northern Pennsylvania to major northeastern markets beginning in March 2015
Customer growth in its gas distribution business was 1.4% in 2013, the best year of the previous five. New growth was split71% new residential construction (up from 53% in 2012), 11.5% from new industrial additions (similar in 2012), and 17% gas heating conversions (down from 28% in 2012). Management believes this strong customer growth profile will continue in 2014.
The regulatory environment is beneficial for PNY and its shareholders. S&P Credit offers an assessment of the regulatory backdrop by state. North Carolina is rated as "more credit supportive", which is positive; South Carolina is rated "credit supportive", which is neutral; Tennessee is not rated. According to the latest presentation, NC regulators allow a 10.0% Return on Equity ROE on an asset rate base of $1,811 million; SC allows 11.3% ROE on a rate base of388 million; TN allows 10.2% ROE on a $349 million rate base.
Moody's Investor's Services recently upgraded Piedmont Natural Gas outlook to stable. From the press release:
The primary driver of today's rating action was Moody's more favorable view of the relative credit supportiveness of the US regulatory environment…We view the North Carolina (70% of rate base), South Carolina (10% of rate base) and Tennessee (20% of rate base) regulatory environments as credit supportive compared to other state jurisdictions and only less supportive than the FERC regulatory framework. The rating factors Piedmont's constructive relationship with these regulatory bodies.
After spending most of the last decade generating return on invested capital ROIC between 6.5% and 7.3%, ROIC has dropped to around 5% during the past two years. While this drop needs to be monitored over time, it is still above a 5.0% threshold. Below is a graph of historic ROIC as supplied by fastgraph.com
S&P Capital IQ offers an Equity Ranking system that analyzes a 10-yr history of earnings and dividend growth. PNY is ranked A, or high, and is among only eight utilities that garnish this ranking. There are no A+ ranked utilities, so PNY is among the highest ranked utilities, regardless of type.
Management expects PNY to earn between $1.73 and $1.83 in 2014, with a mid-point of $1.78. This would about equal 2013 earnings. Going forward, PNY could increase earnings in the 4% to 5% range. The current PE ratio of 17.8 is favorable compared to the average natural gas utility of 22.8 PE. The price to book value of 2.08 is also slightly below average peers at 2.28.
PNY currently offers a yield of 3.8% and is in line with its natural gas peers. Based on a forward dividend of $1.24 and EPS of $1.78, the payout ratio is 69%. Dividend growth over the past 12 years has averaged 4.3%, but has slowed to a 3% to 4% since 2007. Below is a graph of both EPS and declared dividend over the previous 20 years:
PNY plans to invest about $690 million between now and 2016 to upgrade its distribution network in NC and TN. These expenditures will increase its approved asset rate base, driving future earnings higher. Total capital expenditures over the next three years will equal about $1.5 billion. The majority of the investment can be funded by operating cash flow of about $1 billion over the same three-year timeframe. Below is a graphic breakdown of the major categories of investments over the next few years:
Management has been very prudent in taking on new debt and diluting shareholders through stock issuances. Total long-term debt has increased from $664 million in 2004 to $1,124 in 2013. Interest expense has increased only slightly from $49 million in 2004 to $59 million in 2013. Shares outstanding have remained the same at 75 million. The growth in debt has helped expand capital investment of $2.225 billion over the past 10-years. This expansion of investment has increased PNY rate-based assets, expanding earnings over the same timeframe. Similar to many utilities, PNY is currently in an expansion phase where cap ex is not fully supported by operating cash flow and management will generate negative free cash over the next few years. However, as the majority of spending will become cash flow accretive, investors should see a return to free cash flow positives after the next round of expansion is compete.
The increase in rate-base assets over the next few years will fuel cash flow growth. While debt has increased over the past ten years, and will continue to grow over the next three, the majority of expenditures are in areas where ROE is allowed in the 10% to 11% range. Investments in System Integrity are incorporated in rate-based assets within a year, and becomes part of additional revenues and cash flow to PNY.
The graph below indicates that Fastgraph.com has PNY about fully valued. It would be difficult to argue that PNY is not fully valued at its current price. Most Street analysts have a "hold" rating on the stock, with the occasional 'sell".
If Piedmont Natural Gas is rated as a "hold" and seems fully valued, what is the investment thesis supporting adding it to your portfolio?
The answer could lie in its conservative numbers of a 3.8% current yield and dividend growth in the 3.5% to 4.0% range. While not barnburners by any stretch of the imagination, these factors help PNY investors sleep well at night. In addition, PNY performed quite well during the market meltdown of 2008-2009. Below is a performance chart from Morningstar.com. What should become obvious is the outperformance of PNY compared to SPY. From Jan 2008 to Jan 2010, PNY generated a total return of about 12% while the S&P was a negative -20%.
Below are charts of price only returns for both PNY and the SPY, from Jan 2008 to current and from Jan 2008 to Jan 2010. As shown, PNY outperformed the SPY until recently, and most definitely outperformed during the critical period of 2008 to 2010.
Digging a little deeper in history, PNY also outperformed the S&P 500 during the market decline of 2000 to 2003. Below is a graph from Ycharts.com comparing the two from March 31, 2000 to Jan 1, 2003. As shown, PNY increased in price from $13.28 a share to $17.78 a share over this period while the SPY declined from $152 to $91. On a percentage basis, PNY increased by 33.8% while the S&P sank by 40.1%
If there is another stock market meltdown, there are no guarantees that PNY will perform as admiralty as it did during the previous overall market declines. However, for conservative investors looking for income along with some growth, Piedmont Natural Gas should be high on their research lists. If PNY performs as well in the next market crisis as it did in 2000 to 2003 and again in 2008 to 2010, investors will be glad to have PNY in their portfolios.
Author's Note: Please review important disclaimer in author's profile.