By Mark Bern, CPA CFA
National Fuel Gas (NYSE:NFG) is well-positioned, in my opinion, for future earnings and dividend growth. The company derives the majority of its revenue and profit from three primary segments: gas utilities in western New York and northwestern Pennsylvania; pipeline and storage in New York and Pennsylvania; exploration and production of natural gas and oil in California, Appalachia and the Gulf of Mexico (Seneca Resources). The company also has a small natural gas marketing business that accounts for only about two percent of earnings. Notice that the company's primary operating area is in the one of the snowiest areas of the country. Those people need heat, and NFG provides the natural gas to produce it.
The current price (as of the close on Thursday March 20, 2014) is $71.07, and the dividend is $1.50 per share, or 2.1 percent. The dividend is a little lower than I prefer, but management has a long history of annual increases. The 52-week high is $77.05, or about eight percent above the current level. The shares fell $3.25 (4.37%) on Thursday for no obvious reason that I could find. However, I suspect that since the company has E&P operations in California, the company's stock may have been hit by fallout from a rash of drilling bans in that state. However (if this is the cause), I believe this to be a minor thorn for NFG that will be offset by improving operations in other segments.
First-quarter earnings for fiscal 2014 (ending December 31, 2013) were up strongly by nearly 20 percent over the same period a year ago. With the extreme cold weather starting off 2014, I suspect that revenue and earnings will surprise on the upside for the second quarter of fiscal 2014 (ending March 2014).
One of the things I like best about NFG is that the company has been playing to its strengths by expanding the most profitable segment (as measured by profit margin), the pipeline and storage business. This business has fat margins of about 25 percent. The regulated utility segment has margins of about nine percent in New York and closer to 15 percent in Pennsylvania, while the E&P segment margins are just below 20 percent. The regulated utility segment is the largest of its three primary businesses, but while the pipeline and storage segment may be the smallest, it is growing the fastest, and currently contributes about 27 percent of earnings.
The other factor that makes NFG attractive to me at this particular juncture is that I believe that we are near the long-term bottom in natural gas prices. Sure, natural gas prices will probably dip again this summer, but there are long-term trends that are supporting higher future prices. A big one is the adoption of natural gas as the fuel of choice over coal by more and more electric utilities. Another is the transition of large (Class 8), over-the-road freight truck engines from diesel to natural gas. There is a significant push to build out fueling station infrastructure along the interstate highways in alliance with Pilot Flying J truck stops, among others. It looks like the preference is leaning toward compressed natural gas over liquefied natural gas due to the lower costs involved, both in the fueling infrastructure and in potential conversions of the existing fleet. Cummins (CMI) is a leader in the area of developing engines to run on natural gas. Along the same lines, there is the progress being made in developing locomotives that run on natural gas. I expect that we will see a gradual but steady transition by rail operators due to the significant savings that can be achieved. Finally, the first of three permitted natural gas liquefaction export terminals is scheduled to begin operation in 2015. As the U.S. begins to export its abundance of natural gas to Asia and Europe when the price is triple or more than what we pay, those terminals will be running at capacity, creating additional demand for natural gas supplies. The increases in demand are just beginning, so the impact on the price of natural gas here in the U.S. is not being felt yet. I do not expect the price of natural gas to rise to the levels of Asia or Europe, but I do expect prices to rise by 50 percent or more within two years.
That will result in higher profits for the E&P segment, which is already the second-largest of the three primary components of NFG in terms of revenue (32%) and the largest in terms of profit (44%). I expect sustained growth in both the top and bottom lines for this segment for several years to come.
Now, one might ask: if the price of natural gas goes up, does that not negatively impact the utility segment? The answer is obviously, yes. But as the cost goes up for the utility segment, the profit also rises for the E&P segment. When the price falls, the E&P segment margins may suffer, but the utility segment margins will grow. Then there is the pipeline and storage segment that has a built-in customer in the utility segment, which provides additional stability for that unit. And the utility has ready access to supplies, so there is also a symbiotic relationship between these segments. Also, as demand goes up in the operating region, as it surely will, the pipeline and storage segment makes a profit no matter what the cost of the product running through it.
One last thing that I should mention is the resilience of the stock price. In April 2008, the high for NFG stock was just over $50. The price spiked for three months during May, June and July, reaching as high as $66.50 per share. Then the price dropped back down to about $50, before crashing with the rest of the market all the way down to below $27 in March 2009. But the price popped back up to above $52 before the end of 2009, a 98 percent recovery off the low in just nine months. It took the S&P 500 index until January of 2011 to achieve the same level of recovery. And all during that time, the dividend just kept rising every year.
I like NFG on this pullback close to $70. The company is trading at about 19 times my estimated full-year 2014 earnings of $3.65 a share. If it goes down more on Friday, I just might pull the trigger myself.
As always, any stock can fall during a broad market correction. That is why I have begun to hedge my equity portfolio using the strategy I define, in another series that begins with this article.
As always, I welcome comments and will try to address any concerns or questions, either in the comments section or in a future article, as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NFG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
