Off-Radar NiSource Keeps Optionality For Electric Generation

Summary

• NiSource is a $10.8 billion holding company for six utilities, five of which are local distribution companies (LDCs) supplying natural gas and one which supplies both gas and electricity.
• The company offers a 3.2% dividend, a low beta, long-term growth from an established, industrial customer base, and nearby natural gas supply.
• Following energy insecurity events like the European natural gas shortage and Winter Storm Uri, NiSource is appropriately maintaining optionality on coal unit shutdowns to ensure adequate reliability and replacement generation.
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NiSource Inc. (NYSE:NI) comprises five Columbia Midwestern and mid-Atlantic gas local distribution utility companies (LDCs) and one gas and electric utility, NIPSCO. The company offers investors a 3.2% dividend and a stable, low beta of 0.32.

While natural gas prices have been high through the fall and winter, in the US, natural gas production volumes have caught up to pre-Covid levels. NiSource passes gas costs through to direct gas customers, but cheaper (and available nearby) natural gas benefits NiSource’s electrical generation.

Although the company plans to replace its substantial coal-generated electric capacity over the next six years with wind, solar, battery storage and power purchased from the midcontinent electric market over the next six years, such replacement is now explicitly tied to MISO grid requirements, the ability to ensure reliable electric supply, and fully-adequate replacement generation — not just capacity, but operations.

Of note, NiSource has been able to reduce methane emissions by 40% from 2005 via pipeline repair and replacement.

The company projects earnings growth of 7-9% annually in the next three years.

I recommend NiSource. Because it is at the top of its range, potential investors may want to bookmark the company for a dip in the overall market, in the utility sector, or seasonally into the spring. It is not unusual for natural gas companies to see a temporary winter weather boost.

Third Quarter 2021 Results and Guidance

NiSource earned net income of $49.4 million, or $0.12/share, in 3Q21 compared to a net loss of -$186.7 million, or -$0.49/share, in 3Q20.

For the first nine months of 2021, GAAP net income was $377.6 million, or $0.91/share, compared to a net loss of -$143.4 million, or -$0.37/share, for the first nine months of 2020. The 2020 results included a -$312.4 million loss due to the reclassification of Columbia Gas of Massachusetts assets as held for sale. These assets were sold to Eversource (ES) in a transaction closing in October 2020.

Capital investments for 2021-2024 are expected to total about $10 billion. These include $1.9-$2.2 billion/year for growth, safety and reliability, and $2 billion in renewable generation to replace coal-fired generation of the Schahfer Generating Station, due to be retired.

For the first nine months of 2021, non-GAAP net operating earnings were $404.5 million or $0.98/share. Full-year 2021 non-GAAP net operating earnings are expected to be about $1.32-$1.36/share. For full-year 2022, non-GAAP net operating earnings are expected to be $1.42-$1.48/share. The company expects to grow non-GAAP net operating earnings per share at a compound annual growth rate of 7-9% between 2021 and 2024, including growth of 5-7%/year through 2023.

Credit: investors.nisource.com

Segment Earnings

Gas component utilities are:

• Columbia Gas of Ohio
• Columbia Gas of Pennsylvania
• NIPSCO Gas
• Columbia Gas of Virginia
• Columbia Gas of Kentucky
• Columbia Gas of Maryland

The electric utility is NIPSCO Electric.

For the first nine months of 2021, gas distribution non-GAAP operating earnings (the first six utilities) were $458 million, while Electric’s (just NIPSCO Electric) non-GAAP operating earnings were $305 million.

Electric Generation

NIPSCO Electric closed two older coal units at the Schahfer generating station in 2021. Two of its remaining four Schahfer coal units have an expected 2023 retirement date; the last two Schahfer and Michigan City coal units are slated for shutdown in 2026-2028. However, per the company, exact retirement dates, particularly for the last three units are subject to (importantly):

• system reliability impacts;
• policy and regulatory considerations; and
• securing replacement resources (which include input from MISO grid Resource Adequacy rules).

These changes are part of NiSource’s Integrated Resource Plan for electric generation. Retirement of all coal units is expected to result in a 90% reduction in greenhouse gas emissions by 2030 compared to 2005.

The company plans to have 14 renewable energy generation projects in service by the end of 2023. However, in its 3Q21 10-Q, it noted shipment of solar panels from Hoshine Silicon Industry for its 200-megawatt Elliott and 280-megawatt Gibson solar project, both due online in 2Q23 had been delayed by US Customs and Border Protection for an indeterminate time due to the June 2021 Withhold Release Order ("WRO") on silica-based products made by the supplier, Chinese company Hoshine Silicon Industry Co.

By contrast, its Dunns Bridge Solar I unit is being constructed by a NextEra Energy (NEE) subsidiary.

NiSource CEO Joe Hamrock emphasizes the importance of natural gas units (which can be "turned on" quickly) plus potential battery storage to support generation from intermittent renewables.

Renewables and Other Strategies

Investors should be aware that both Virginia and Maryland have explicit hydrocarbon emissions reductions targets. While these tend toward regulation of tailpipe emissions and coal and gas-fired electric generation plants, clean energy standards are sometimes extended to reducing the direct use of natural gas for heat and cooking, as has occurred in cities in California, Colorado, and the northeastern US, notably New York City.

Yet, the high costs and health harm of reducing hydrocarbon energy sources without adequate, reliable replacement have been dramatically felt in the UK and Europe. Insufficient summer wind power led to a huge drawdown of natural gas inventories that were not fully replenished in the fall by Russian imports. This led to the highest-ever liquefied natural gas prices in Europe and Asia along with the resumption of using coal and even oil to make electricity. Perhaps as a result, the European Union has just decided to categorize both nuclear and natural gas as green energy.

US Utilities like Black Hills have taken note of this event and the drop in natural gas volumes during winter storm Uri to re-prioritize their coal generation.

Safety and Environmental Metric: Bare Steel Pipe

For each of its six natural gas utilities, NiSource provides metrics of total pipeline miles and pipeline miles that are bare steel and wrought iron or cast-iron pipe. These are shown below.

The company notes pipeline modernization programs like those that replace bare steel pipe have reduced methane emissions from gas mains and service lines by nearly 40% since 2005.

Natural Gas Supply and Prices

While gas costs are treated as pass-throughs for the gas distribution utilities, availability of supply remains an important factor. And gas competes with coal as a generation fuel. This is a boon for NIPSCO Electric because it does still operate five coal-fired units.

The February 2022 Henry Hub natural gas futures price closed January 3, 2022 at $3.83/MMBTU.

While European and Asian LNG prices were up to 10x higher at $35-$38/MMBTU in mid-December 2021, within the US, the Marcellus (Pennsylvania) price is typically lower even than Henry Hub. For example, on December 15, 2021 when the Henry Hub spot price was $3.75/MMBTU, the Tennessee Zone 4 Marcellus price was $2.78/MMBTU.

The graph above shows how unconventional shale gas production has risen from the Marcellus, Utica, and elsewhere in the last decade.

For both retail gas distribution and electrical generation, NiSource is advantaged by its proximity to the giant Marcellus and large Utica natural gas fields in Pennsylvania, Ohio, and West Virginia. Additionally, since many East Coast states are trying to limit use of natural gas for electricity, there’s a “more-for-me” aspect to supply. And, due to the economic incentives of temporarily higher natural gas prices, US production has rebounded more quickly than some expected to pre-Covid levels of 97.5 billion cubic feet/day.

Data by YCharts

Competitors

NiSource is headquartered in Merrillville, Indiana. Its largest component utility is Northern Indiana Public Service (NIPSCO). The company operates in two regulated segments: retail natural gas distribution across several states under the Columbia Gas and NIPSCO brands to 3.2 million natural gas customers and- in northern Indiana - retail electricity supply to about 500,000 electric customers.

Although regulated utilities have their own geographic territories and business lines (electricity, gas, water, steam, or a combination) and so don’t compete directly, they do compete for investment.

Other fuels such as propane and heating oil compete with natural gas in the residential and commercial heating market.

Governance and Regulation

At September 26, 2021, Institutional Shareholder Services ranked NiSource's overall governance a 3, with sub-scores of audit (10), board (2), shareholder rights (4), and compensation (2). In this ranking a 1 indicates lower governance risk and a 10 indicates higher governance risk.

As of September 2021, NiSource’s ESG total risk score of 30 (61st percentile) was categorized as “high.” Component parts are environmental risk 15.4, social 9.7, and governance 5.3. Controversy level is 3 on a scale of 0-5, with 5 as the worst.

On December 15, 2021, shorted shares were 5.7% of floated shares. Insiders own a negligible 0.39% of the outstanding stock.

The company’s beta is a low 0.32: the stock moves with the overall market but much less sharply, as is typical for utilities.

NiSource has oversight from and reporting responsibilities to public utility commissions in each state in which it operates. In rate cases NiSource answers to a wide variety of input from customer-stakeholders.

Financial Highlights

The company’s closing price on January 3, 2022, was $27.52/share, 99% of its 52-week high of $27.85 and 97% of the one-year target price of $28.45/share.

This price gives NiSource a market capitalization of $10.8 billion; its enterprise value is $21.5 billion.

Using the company’s estimates for 2021 and 2022 EPS of $1.36/share and $1.45/share, respectively, yields a current price-earnings ratio of 20.2 and a forward price-to-earnings ratio of 19.0.

Trailing twelve-month return on assets is 2.8% and return on equity is 8.4%.

Trailing twelve-months’ operating cash flow was $1.18 billion while levered free cash flow was $586 million.

The dividend of $0.88/share yields 3.2%, higher than the current 10-year Treasury rate of 1.52%.

Data by YCharts

As of September 30, 2021, the company had liabilities of $16.2 billion including $9.2 billion of long-term debt and assets of $22.8 billion giving it a liability-to-asset ratio of 71%.

Data by YCharts

NiSource has an average analyst rating from fourteen analysts of 2.3, or “buy” leaning somewhat to “hold.”

Notes On Valuation And Risk

The company’s market value per share is more than twice its book value of $12.16/share, indicating positive market sentiment.

The ratio of enterprise value to EBITDA is 12.5, suggesting the stock is not bargain-priced.

The current rise in inflation will increase NiSource’s costs, recovery of which may be limited.

The Fed’s plan to raise interest rates to combat that inflation will likely impact NiSource and all utilities whose investors are otherwise drawn by dividend payouts and whose debt costs could rise.

Indiana growth could slow. More state or local governments in NiSource’s gas service areas could continue limiting natural gas pipelines or target reducing direct use of natural gas for heating and cooking.

Recommendations

NiSource has a high liability-to-asset ratio of 71%, typical for utilities but a risk assuming interest rates rise.

I recommend NiSource. Because it's at the top of the 52-week range, investors may wait to invest if the price dips due to, for example:

• Federal Reserve rate increase
• mild weather reducing gas demand
• even more inflation

NiSource’s traditional coal generation is newly valuable from a cost and reliability standpoint. The company has retained good optionality in the timing and type of planned coal unit replacements. NiSource's NIPSCO Electric serves industrially vibrant northern Indiana.

Its component gas utilities have plentiful nearby reserves in the Pennsylvania Marcellus and Ohio Utica formations.

Those looking for stable, long-term investments may be interested in low-beta NiSource with its 3.2% dividend (compared to a 10-year Treasury rate of 1.52%). The good governance rating is a plus. It is attentive to meeting ESG goals while keeping critical fuel source flexibility for electric generation.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of NEE either through stock ownership, options, or other derivatives. 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.