UGI Corporation: A Strong Dividend Grower Positioned For The Future

Summary

• UGI operates in four business segments associated with natural gas and liquid petroleum gas (e.g. propane).
• Warmer winters, such as the one we just had, can meaningfully reduce revenue and earnings, but the company is working on expanding its contractual fee-based operating profit.
• The dividend has grown each year for the past 33 years, and the company has been paying steady dividends for 135 years.
• UGI's dividend yield, at 4.5%, is as high as it has been in 17 years.
• Natural gas, unlike coal and oil, can look forward to many more decades of strong demand, assuming the weather mostly cooperates.

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Investment Thesis

UGI Corporation (NYSE:UGI) operates several businesses associated with natural gas and liquid petroleum gas ("LPG") in the United States and internationally. The company boasts an incredibly long history of rewarding shareholders via dividends, having paid them for 135 consecutive years and raised them each of the last 33 years.

In 2019, UGI completed two major acquisitions: AmeriGas in the propane business, and Columbia Midstream in the pipeline & storage business. These acquisitions are important to maintain UGI's long-term growth trajectory, as low commodity prices make it extraordinarily difficult to compete with peers based on price.

Despite a warm winter in 2019, weaker demand during COVID-19, and a relatively large debt load, UGI offers an attractive 4.5% dividend yield and seems poised to benefit from the long-term shift toward cleaner energy sources. After the recent selloff, shares look attractive for dividend growth investors.

The Company

UGI has four business segments. After its needle-moving acquisition of AmeriGas in 2019, Domestic LPG Distribution is the largest segment by profits. This segment sells propane to residential and commercial customers in all 50 states via 1,900 selling locations. It is the largest retail propane marketer in the US, distributing over 1.1 billion gallons of propane in 2019. UGI International distributes and markets LPG in 17 countries across Europe and is generally the market leader in these countries.

Natural Gas & Electric provides regulated gas utilities to a little under 650,000 customers across Pennsylvania (and one Maryland county). Finally, the Midstream & Marketing segment operates a portfolio of gathering, pipeline, and storage assets in the northeastern and Mid-Atlantic regions of the US.

Source: Fiscal Q1 2020 Presentation

Though a significant portion of UGI's operating profit is contractually fee-based, rather than based on customer utilization or spot prices, revenue and earnings are very cyclical. In the winter, when the weather is colder and more natural gas is being burned, revenue and earnings spike. Then they fall to depressed levels in the summer months.

Notice also that revenues and earnings were practically the same during the Great Recession as they were before and after it, which speaks to the resilience and recession-resistance of UGI's business.

The winter of 2019 was warmer than usual, especially in Europe, which led to lower than expected revenue and earnings.

Source: 2019 Annual Report

Hopefully, such significant underperformance based on milder winters will be lessened in the future as the company switches to a more fee-based model rather. By 2023, UGI hopes to derive 81% of its operating profit from contractual fee-based sources, compared to about two-thirds today.

UGI is also investing heavily in natural gas, both now and in the years ahead, in order to further leverage the company's growth to nat-gas.

Source: 2019 Annual Report

I very much like this aspect of the business. While oil and coal are set to decline in usage in the coming decades, demand for natural gas is projected to grow by 40% over the next decade (although that growth may be slower due to COVID-19). The massive growth of renewable energy sources and electric vehicles in the foreseeable future is well understood, but what is less well understood is their reliance on other energy sources — namely, fossil fuels. EVs rely on power grids (i.e. electric utilities), most of which generate only minimal power from renewables. And renewable energy sources (solar, wind, hydro) are not steady and dependable enough to produce the required power during peak usage times, thus requiring fossil fuel-burning "peaker" plants.

Since oil and coal, as the higher carbon-emitting fuels, are going out of fashion, natural gas stands to benefit as the cleaner burning fuel. Utilities will increasingly replace coal plants with gas-fired plants, some for full-time use and others to act as peakers to complement renewable sources. UGI is positioned to benefit as natural gas usage, transportation, processing, and storage increases.

What's more, I can't imagine grilling going out of style anytime soon. Propane could stand to steal more of coal's market share in this area as well.

Valuation

Looking at price to earnings ("P/E"), UGI seems about as cheap as it has been in the post-recession period. However, the stock did get cheaper during the Great Recession.

The same could be said for price to operating cash flow. Right now, UGI definitely looks cheap in this regard, but not as cheap as it was in 2009 and early 2010.

Lastly, I like to look at dividend yield over history as an unofficial valuation metric. Higher yields generally correspond with lower valuations, but sometimes they can be caused by rising payout ratios. In UGI's case, it's a bit of both, but more caused by lower valuation than a higher payout ratio.

As you can see, UGI's dividend yield is higher than it has been at any time in the past 13 years. In fact, its dividend yield hasn't been this high since 2003, when the economy was emerging from the Dot Com Bubble recession.

The Dividend

In 2019, UGI paid out 53.1% of earnings and well over 100% of free cash flow, largely because the company was pushing so much cash out the door for two major acquisitions. UGI's typical payout ratio is around 40-50% of earnings.

The most recent dividend hike, on April 22nd, was a mere 1.5%. This is paltry compared to the 8%+ dividend raises investors have gotten used to over the previous ten years. The raise in 2008 was only 3.94%, though, so there is precedent for lower hikes during bad economies. A low dividend raise this year does not mean that dividend growth is bound to remain slow forever.

Analysts expect earnings growth of 10.7% over the next five years, although it is unclear how many of them have adjusted their estimates in light of the coronavirus pandemic. Being more conservative, we might assume that UGI will raise its dividend by 8% per year on average (closer to its average over the past ten years) over the next ten years. If this plays out, buying in at today's 4.51% starting yield would result in a yield-on-cost ("YoC") after ten years of 9.74%. That is a phenomenal YoC projection!

Being even more conservative and assuming a 6% growth rate, buying in today would still result in a 10-year YoC of 8.08%. The minimum projected 10-year YoC I will accept for relatively safe dividend growth investments is 7%. Average dividend growth would have to drop to 4.5% per year for UGI to hit that number in ten years. I consider that a strong margin of safety for a dividend growth investment.

In my view, UGI is a good buy here.

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Analyst’s Disclosure: I am/we are long UGI. 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.