NiSource: Unexciting Prospects, Unless…
NiSource is the third largest natural gas distribution company in the US. Unlike some peers, the spin-off of its MLP assets was structured with no residual income or ownership. Share prices seem fully valued unless a potential acquisitioner were to pony up a nice premium. NiSource (NYSE: NI ) is a 100% regulated natural gas and electric utility. After spinning off its natural gas midstream pipelines, the assets remaining are mainly regulated by state-PUC in seven states in the Mid-Atlantic, Northeast and Midwest. Servicing 4 million customers total categorizes NI as a medium tier utilities by customer count and ranks third largest in natural gas distribution. Of this number 3.5 million are natural gas customers and 500,000 electric customers in Indiana. The company’s rate base assets are $5.0 billion in natural gas and $3.0 billion in electricity. While its natural gas interstate pipelines and the vast majority of its storage business was divested last July, NI retained 58,000 miles of distribution pipelines and about 5% of its previous storage facilities. These are reported as part of the natural gas distribution segment. NI also operates a network of four coal-fired plants with 2,540 MW capacity, along with natural and hydro plants generating an additional 745 MW. Management has previously indicated it would consider the possible sale of this business. The service territory is pictured below, from their most recent presentation . (click to enlarge) Management believes its current configuration and its capital expenditure forecast will drive earnings higher by 4% to 6% annually. Over the next 5 years, management forecasts capital investments of $6.9 billion, about evenly spread out at $1.3 billion a year, substantially increasing its rate base. The company recently received approvals for natural gas rate increases in MA and PA totally $60 million, and annual automatic “trackers”, or inclusions in rate base assets, cover about $1 billion a year of current multi-year investment projects. For example, similar to its peers, NI has an ongoing natural gas distribution infrastructure project to upgrade 7,200 miles of bare steel or cast iron pipes with plastic. Management expects to increase its rate base by 6% to 8% a year. Where is the capital for the cap ex budget going to come from? With the divestiture, cap ex needs are reduced from over $2 billion last year, but the reduced cap ex budget is accompanied by lower operating cash flow. Investors should pour over the next 3 quarters operating cash flow reports to evaluate the balance between cash flow and cap ex, with the understanding any shortfall will be made up by either more debt or dilutive equity raises. In early 2011, the company settled with the EPA concerning compliance of its coal plants. NI agreed to spend $850 million between 2011 and 2018 to bring its plants into compliance, and these improvements are part of its rate base calculations. While there is a risk the fight against coal power plants will continue to result in higher emission standards, translating into higher cap ex requirements for its aging fleet, the company should be in compliance with current standards. As with many of its peers, NI mainly uses pass-through natural gas pricing so the utility has very little commodity risk and offers a bit more stability in earnings. In addition, 45% of revenue is volume based while the balance of revenue is not, reflecting a more constant income model. According to the company, operating earnings are split 65% natural gas and 35% electric. Distractors of the company point to its high use of coal to generate electricity, the exit of top management to its MLP spin-off, and the substantial percentage of commercial and industrial customers. The CEO and CFO went with the MLP and while both replacements have extensive experience in the utility industry, they are fresh to their respective responsibilities. Residential gas deliveries accounted for 28% of volume and 55% of revenue, while industrial and commercial customers completed the balance. Some investors believe the company’s higher exposure to industrial volumes makes NI more susceptible to swings in economic growth. Of interest in the spinoff of its MLP is the lack of continuing ownership by NiSource. Many of the recent separations offer the sponsor a potentially lucrative General Partner contract and the sponsor retains a large percentage ownership of the MLP though its publicly traded unit holdings. The sponsor maintains a positive cash flow interest through MLP distributions, GP incentive distribution rights, and management fees. In the case of NI, however, shareholders received 100% ownership of both in a 1 for 1 stock distribution. The business split instills a bit more risk as the utility finds its own footing. With the recent separation and associated one-time fees, financial comparisons are difficult. Ongoing 2015 EPS are expected at slightly less than $1.00, not including the storage and transportation contribution for the first half. For 2016, the company is expected to earn $1.06, and investors may want to use this consensus number for their own due diligence research. There are few ETFs that offer sector comparisons, and the closest is the Hennessy Natural Gas mutual fund (MUTF: GASFX ) as a sector comparison. Using GASFX as a comparison, NI trades at a PE of 19.0 vs 20.6 for the fund; dividend yield of 3.2% for NI vs sector average of 3.82% and a fund yield of 2.46%. It seems at its current price, NI is fairly valued. It should be noted NI is one of only a few new additions GASFX made last quarter, buying an initial position of 1.5 million shares and NI now represents 1.77% of the funds portfolio. Within the longer term consolidation of the utility business and the current appetite for natural gas utilities, NiSource could become an acquisition target. Mario Gabelli offers an insightful quarterly review of sector events in its utility fund Shareholder Commentary report pdf. Using this report as a benchmark, a recent asset purchase by a merchant power producer pegs a ballpark price for 3,200 MW of coal and gas capacity at between $1.4 and 1.6 billion, plus the value of NI’s electric distribution assets. There have been several acquisitions in the natural gas distribution business which could be used for back-of-the-napkin comparisons. Based on customer count acquisition cost for recently acquired New Mexico Gas, Alabama Gas, and municipal utility Philadelphia Gas Works, NI’s 3.5 million natural gas customers could bring in $8 to $10 billion. With a current market capitalization of $6 billion and long-term debt of $6 billion, it would seem share prices are trading at about its value in an acquisition. While there has been a change in management in the corner office, and the other guys were open to merger discussions a year ago, with the then-CEO not directly rebutting conference call questions concerning a potential acquisition by one of the top-tiered utilities, investors should not bank on a repeat performance anytime soon. NiSource offers a steady income potential at slightly higher yields to its natural gas distribution peers, with earnings and dividend growth at industry averages, and a possible acquisition candidate. However, all these attributes are fully discounted in its current share price…Unless an acquirer decides a premium price is warranted. Author’s Note: Please review disclosure in Author’s profile.
