New Jersey Resources: Next Year Is Key For Its Future
Summary The company is in a prime location, located near ample natural gas reserves. The company has not had a rate case filing in several years, leaving net income stagnant. Bottom line growth has instead come from the Energy Services business, which is non-regulated and prone to swings in profitability. New Jersey Resources (NYSE: NJR ) is a relatively under-followed energy holding company. The company’s primary business is regulated natural gas distribution to roughly 500,000 customers in New Jersey, but the company also has started to grow its pipeline and storage businesses and has built a small clean energy generation portfolio. Shares have rallied firmly the past year as the company has garnered some more exposure, but the company is still woefully under covered by analysts and retail investor ownership remains low. Is there an opportunity present to snap up shares before visibility inevitably improves? Location, Location, Location Low natural gas prices highly benefit New Jersey Resources. New Jersey is positioned right next door to the Marcellus/Utica shale, which has dramatically increased the natural gas reserve base available to all gas utilities in the Northeast, including New Jersey Resources. By extension, this means cheap natural gas prices for New Jersey Resources customers. Happy customers make for happy utilities as cheap prices for consumers reinforces support for the public utility commission to back any infrastructure investments the company wants to make. At the same time, the company’s other businesses (midstream/storage) are set to benefit as healthy demand growth increases demand for additional pipeline build out and storage availability. From a customer growth perspective, several locations in New Jersey are commutable to and from New York City or Philadelphia. As much as state residents seem to despise the state, proximity to some of the country’s top metropolitan areas will keep residents around, if begrudgingly. The state has maintained steady population growth over the past five years, in line with national averages. New Jersey Resources has done better than that, as the company operates in only three counties in New Jersey: Monmouth, Ocean, and Morris. (click to enlarge) * NJR Investor Presentation, Service Territory Breakdown New Jersey Resources appears to have its regulated downstream utility operations in ideal New Jersey locations. Ocean County has continued to be the population growth leader in New Jersey, posting healthy increases yearly. The company also has the opportunity to likely easily add roughly 50,000 existing New Jersey residents over the next few years, converting those that are still using propane/electricity for heating while being within or very near New Jersey Resources lines. Operating Results Revenue has largely been flat over the past five years due to falling natural gas prices. Like most natural gas utilities, the cost of natural gas is passed on to consumers through agreements with the public utility commission. High natural gas prices mean higher revenues but lower margins as the utility’s profit share per cubic foot sold is fixed. Compounding problems, New Jersey Resources has not had a base rate case filing in years. Base rate cases adjust the base rate charged to customers and are necessary when the utility has faced rising costs. Thankfully, this will change within the next few months, with the pre-hearing beginning in November. By early second half of next year, we should have a decision that should yield revenue increases for the company. Operational costs for New Jersey Resources have expanded since 2007 (the time of the last case) so the company should have an extremely straightforward filing. Operational cash flow has improved considerably in the past two years as New Jersey Resources recovered from some one-time charges that took place in 2012/2013. Operational cash flow expansion has primarily come from solid results from the Energy Services operating segment, which saw net income more than double. Energy Services takes advantage of pricing differences between regions or time periods, selling excess natural gas inventory when prices are high and building additional stock when prices are low, either through direct sales or through entering derivative contracts. In general, the more volatile natural gas prices are, the more profitable this division becomes. Poor performance in this division could cause future earnings volatility. I would prefer to see net income growth from regulated utility operations, which has only grown 1.3% since 2012. Unfortunately, we won’t see this until we see the results of the rate base case expansion. Debt has remained very low, with net debt of only $814M at the end of Q2 2015. Investors must keep in mind that New Jersey Resources does not generate much in the way of EBITDA currently ($200M in 2014) so leverage still exists even given the relatively low size of debt for a utility. Conclusion The upcoming rate case will be key to the company’s long-term success. Long term, the company will need the cash flow support from that base case. Shares trade expensively for a utility (12.79x EV/EBITDA, 18.5x 2016 EPS estimates) and a bulk of the earnings growth of the past few years has relied on a non-regulated Energy Services business that could prove volatile. Investors should be cautious and watch the rate case proceedings carefully.