Nicor Shares Warrant a Pullback

Nicor, Inc. (GAS) has been downgraded to Sell by Ockham Research because it appreciated so much over the summer that we now view it as overvalued and vulnerable to a correction, particularly if commodity prices continue to slide. Nicor is a holding company for a natural gas distribution business serving 2.2 million customers in Northern Illinois. As a regulated company, Nicor must gain the approval of the Illinois Commerce Commission in order to increase the rates it charges customers. Over the past few months, gas prices have increased dramatically, which has caused the company to seek rate relief so as to pass some of its increased costs on to end users.

Based on Ockham’s valuation methodology, GAS shares are gassed right now and ripe for a pull-back. The weighted average historical Price-to-Sales ratio range over the last ten years has been .52x - .75x, while the stock’s current Price-to-Sales ratio is .59x, which is below its historical weighted average by seven percent. This level merits a neutral stance from Ockham. However, GAS’s Price-to-Cash Flow number is a different story. Its historic range is 5.10x-7.18x and GAS’s current Price-to-Cash Flow metric is 7.43x—well over the upper end of that range. Therefore, the stock is well over glide slope according to our methodology and merits the Sell rating.

While Nicor’s high dividend yield (nearly 4%) and .90 Beta (lower than average volatility) probably appeal to weary investors at the present time, the stock is overbought at present. Ockham placed a Buy on the stock when it hit $32.95 in March. However, in the upper forties, the stock no longer meets our stringent valuation criteria and would be a source of funds for repositioning money into oversold alternatives.

Also, as Nicor’s customers become more conservation conscious given the tough overall economy and rapid rise in the price of gas, earnings could come under pressure for the next few quarters. Also, the pending rate case could end unfavorably for GAS, further impacting earnings. A pullback in price would certainly make us more bullish on these shares. Until such time, we recommend that investors keep their eyes open for better buying opportunities on undervalued stocks.