Scalper1 News
Summary Piedmont Natural Gas reported FQ3 earnings last week that missed on both lines, although the EPS miss was not large enough to offset FQ2’s EPS beat. Faced with steady growth to natural gas demand in its service area, the company is raising funds via both debt and equity to finance midstream and downstream capacity expansion. Investors can expect the raising of these funds to reduce the company’s EPS in the near term, although an especially strong El Niño could offset this negative impact. I still expect the company’s valuation to decline in response to a pending interest hike, although conservative income investors should consider the company’s shares if they fall below $35. Natural gas utility Piedmont Natural Gas (NYSE: PNY ) reported FQ3 earnings (its current fiscal year ends in October) last week that missed on both lines. While the revenue miss was not surprising, given that natural gas prices over the summer were much lower than in FQ3 2014, the EPS miss came despite increases to system throughput and gross profit. Investors responded by sending the company’s share price, which was approaching an all-time high just last month following an EPS beat for FQ2 , down still further (see figure). In early June, I discussed the company’s dividend and earnings growth record in the context of an expected interest rate increase, concluding that: Barring a magnitude of earnings growth that I don’t expect to see until the Constitution pipeline is brought online in FY 2017, such a declining premium will lead to a declining share price, at least relative to the S&P 500. Piedmont Natural Gas is an ideal investment for conservative investors but I recommend waiting until after interest rates rise and it begins to underperform versus the broader index before purchasing shares, as I believe that they will be available at a more attractive valuation at that time. This article re-evaluates Piedmont Natural Gas as a potential long investment following its FQ2 and FQ3 earnings reports, the return of low natural gas prices, and new forecasts for this year’s El Niño weather event to achieve near-record strength. PNY data by YCharts FQ2 and FQ3 earnings Back in June, Piedmont Natural Gas reported FQ2 earnings that beat by $0.05 on diluted EPS ($0.84 actual versus $0.79 expected) despite missing on falling revenue ($425 million actual versus $489 million expected). While more substantial than had been expected, the 8% YoY decline to revenue was not surprising given the sharp fall in the price of natural gas that has materialized over the last year (see figure). The company’s FQ3 revenues were also down on a YoY basis by 3.6%, coming in at $158.3 million and missing the consensus by $15 million. In both quarters, the impact of lower prices on revenue was partially offset by continued customer growth of 7% in the first half of FY 2015 and another 2% in FQ3. System throughput increased by 21% YoY in FQ3 alone, although this was from a relatively low base, since seasonal demand is the lowest in FQ3. Henry Hub Natural Gas Spot Price data by YCharts Piedmont Natural Gas reported higher gross income (“margins” in the company’s parlance) on a YoY basis for both FQ2 and FQ3 of 6.7% and 6.7%, respectively. In both cases, this was due to the company’s cost of gas falling by more than the revenue (declines of 21% and 4% in FQ3, respectively). Regulators in Tennessee and North Carolina had previously granted the company rate adjustments that supported revenue in both quarters, resulting in the improvements. While the gross income gain helped push the company to a diluted EPS beat in FQ2, it was not enough to offset the impact of higher corporate expenses on net income in FQ3, which fell from -$7.3 million in the previous year to -$8.3 million in the most recent quarter (see table). This resulted in a FQ3 EPS result of -$0.10 versus -$0.09, missing the consensus estimate by $0.03. The company attributed the bulk of the decline and miss to a 27% increase to its utility interest charges on a YoY basis to $16.7 million, with the increase resulting from a $200 million increase to its long-term debt over the same period. Piedmont Natural Gas Financials (non-adjusted) FQ3 2015 FQ2 2015 FQ1 2015 FQ4 2014 FQ3 2014 Revenue ($MM) 158.3 424.9 607.3 185.8 164.2 Gross income ($MM) 111.6 225.6 270.1 112.3 104.8 Net income ($MM) -8.3 66.4 93.0 -9.0 -7.3 Diluted EPS ($) -0.10 0.84 1.18 -0.11 -0.09 EBITDA ($MM) 46.5 118.4 145.4 24.6 44.7 Source: Morningstar (2015) Outlook Investors were disappointed in the company’s FQ3 earnings report, sending the share price down by almost 3% following the release of the report. Overall, however, the recent earnings reports as well as the FQ3 miss present an image of a utility that is working to meet fairly rapid and, to a certain extent, unexpectedly high demand growth in its service area. Its customer growth rate fell by half between FY 2008 and FY 2011, as annual residential new construction in its area fell from more than 20,000 to roughly 7,000. Both customer growth and residential new construction rates have rebounded since then, however, with each one setting a post-recession high in FY 2014. With three quarters completed, Piedmont Natural Resources is forecasting customer growth in FY 2015 to range from 1.6% to 2%, the upper end of which would represent its largest number since FY 2008 (see figure). Source: PNY June Investor Update (2015) This demand is supported by continued economic growth in its service areas in North Carolina and Tennessee. Both states have experienced rapid economic growth over the last five years (see figure), and are showing few signs of slowing down. North Carolina Real GDP data by YCharts One consequence of this strong growth has been sharp declines in the unemployment rates in both states (see figure), both of which are nearing their pre-recession levels. The housing market has begun to perk up as people’s financial security has increased, and while construction payrolls remain well below their pre-recession highs, they have increased at a more rapid pace since the beginning of FY 2015. All of these factors are contributing to increased demand for natural gas, both in the form of supply to power plants for electricity as well as direct deliveries to residential buildings. North Carolina Payrolls: Construction data by YCharts Faced with such expected demand growth, Piedmont Natural Gas is taking steps to increase its capacity to meeting demand at both the midstream and downstream stages of the natural gas delivery chain. Of the $1,870 million that it has allocated to capex and joint venture contributions through FY 2017, more than one-third will contribute to customer growth projects, while another $250 million will go toward JV contributions (most of the balance is intended for system integrity projects). The JV contributions, on the other hand, are intended to increase the midstream supply of natural gas by connecting unconventional shale production regions, such as the Marcellus, to existing downstream natural gas networks. Construction of the first of these – the Constitution Pipeline project, in which Piedmont Natural Gas owns a 24% stake – is expected to commence by year’s end. Piedmont Natural Gas has nowhere near enough cash on hand to finance its planned capex and JV contributions, while its operating cash flow only covers some of the balance after dividend payouts are accounted for. As such, the company is raising additional funds via increases to long-term debt and equity offerings to finance its bold investment plans. The company previously announced plans to issue up to $170 million in additional equity, and due to this effort, its total number of shares outstanding increased by more than 800,000 between FQ3 2014 and the most recent quarter. Additional long-term debt will also be taken on to offset the new equity and maintain the company’s existing 55:45 debt-to-equity ratio. This new debt will reduce the company’s diluted EPS numbers moving forward by increasing its interest payments, much as occurred in FQ3. The company’s management is still guiding its FY 2015 diluted EPS number to $1.82-1.92, although the lower end of this range is most likely to occur, barring an unexpectedly strong showing in the normally slow FQ4 report. Recent weather developments raise the prospects that its FQ4 will be weaker than normal, followed by an especially robust FQ1 2016 earnings report. Following a no-show last year, the El Niño weather event has already begun to make its presence felt in the Pacific Ocean. This event has historically been characterized in North Carolina and Tennessee by the presence of warmer-than-average temperatures between April and November and colder-than-average temperatures between December and March. Piedmont Natural Gas reports strong seasonal revenues in the fiscal quarters ending in January and April. Forecasters now expect this year’s event to be one of the strongest since 1950, suggesting that demand for natural gas in the company’s service area will be slow in FQ4, but more than offset by a larger number of heating-degree days than average during the subsequent quarter. Finally, it should be noted that recent volatility in the global equities markets has called the Federal Reserve’s planned interest rate increase, which originally was expected to occur as soon as this month, into question . Hawks point to the low U.S. unemployment rate, while doves question the wisdom of such a move at a time when the broad equity indices are hovering at or near correction territory. Given the record of dividend increases at Piedmont Natural Gas, it comes as no surprise that the company’s share price has outperformed the S&P 500 by a substantial margin in recent weeks (see figure). That said, the valuations of dividend stocks in general and utilities in particular are expected to fall in response to the inevitable rate hike when it does occur, presenting potential Piedmont Natural Gas investors with the prospect of more downside than normal. PNY data by YCharts Valuation The consensus analyst earnings estimates for Piedmont Natural Gas have increased slightly for FY 2015 and FY 2016 over the last 90 days, as the likelihood of warmer-than-average conditions across the company’s service area in FQ1 has increased. The FY 2015 consensus estimate has been revised higher from $1.86 to $1.88, while the FY 2016 estimate has been increased from $2.00 to $2.01. Based on a share price of $36.35 at the time of writing, the company is trading at a trailing P/E ratio of 20.2x, a forward FY 2015 ratio of 19.3x, and a forward FY 2016 ratio of 18.1x. These are all near the bottom of their respective ranges in FY 2015, although they are still above the lows seen in early FY 2014. The company’s shares are not as highly valued as they were three months ago, although I would not characterize them as undervalued at present either. PNY PE Ratio (TTM) data by YCharts Conclusion Piedmont Natural Gas reported underwhelming earnings in FQ3, after beating on EPS in FQ2. The latest miss was attributable to the company’s higher interest costs, however, following an increase to long-term debt over the TTM period. This result is not entirely negative, as the company is in the process of raising capital from the debt and equity markets, which is needed to finance its large planned growth investments in new midstream and downstream capacity. Its long-term route to continued earnings and dividend growth is in place, although investors should expect planned increases to its long-term debt to reduce earnings via larger interest payments. Such impacts will likely be muted in coming quarters due to forecasts of a stronger-than-usual El Niño in late 2015 and early 2016, with previous events being characterized by colder temperatures and increased natural gas demand in the company’s service area. Recent volatility in the equity markets has caused Piedmont’s shares to outperform the S&P 500 by reducing the likelihood of a Federal Reserve rate increase this month. I would not hesitate to purchase the company’s shares following the rate increase, should it occur this month and push their price back below 17.5x forward earnings, or $35 at the time of writing, however, as I expect the company’s earnings in early 2016 to exceed current expectations. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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. Scalper1 News
Scalper1 News