National Fuel Gas Is Cheap
$409 million reserve write-down for the company’s E&P segment overshadows its regulated utility and pipeline operations. National Fuel Gas offers the highest number of Marcellus acres per million dollars of enterprise valuation. On a yield basis, National Fuel Gas has not been this cheap since 2006 and 2008. National Fuel Gas (NYSE: NFG ) is three companies in one: a regulated gas utility with midstream assets and an exploration and production company with assets in California and the Marcellus. With the collapse of the oil and gas markets, share prices have followed suit, falling from a high of $72+ registered in 2013, 2014, and again this year. However, NFG’s base of regulated assets provides a cushion for the obvious volatility of its E&P business. A good business overview is offered on 4-traders.com : “NFG is a diversified energy company, which operates through the following business segments: Utility, Pipeline and Storage, Exploration and Production, Energy Marketing & Gathering. The Utility segment through National Fuel Gas Distribution Corp. is engaged in selling and providing natural gas and transportation services to customers through a local distribution system located in western New York and northwestern Pennsylvania. The utility segments services 775,000 customers. The Pipeline and Storage segment through National Fuel Gas Supply Corp. and Empire Pipeline, Inc. is engaged in providing interstate natural gas transportation and storage services for affiliated and non-affiliated companies. The Exploration and Production segment through Seneca Resources Corp. and Seneca Western Minerals Corp. is engaged in the exploration, development and purchase of natural gas and oil reserves in California and in the Appalachian region of the U.S. The Energy Marketing segment through National Fuel Resources, Inc. is engaged in marketing of natural gas to industrial, wholesale, commercial, public authority and residential customers in western and central New York and northwestern Pennsylvania. The Gathering segment through its subsidiary National Fuel Gas Midstream Corp. which builds owns and operates natural gas processing and pipeline gathering facilities in the Appalachian region. National Fuel Gas was founded on December 8, 1902 and is headquartered in Williamsville, NY.” It seems not many analysts like NFG as demonstrated by both a lack of research coverage and a low consensus timeliness rating. There were 12 analysts covering NFG in May 2014, but that number has shrunk to 7, of which four rate NFG as a Hold, two as a Buy, and one as a Strong Buy. Keep in mind, in the world of analyst-speak, a Hold usually and loosely translates to Avoid. At the heart of this dislike is the large write-off NFG took in its recent quarterly reporting . GAAP procedures call for a redetermination of oil and gas reserves every quarter, and in keeping with this process, NFG has taken $409 million write-down over the past 9 months. This creates a GAAP loss of -$2.24 a share. However, the operating results were not nearly as bad with 9-month operating results declining from $2.82 last year to $2.58. Below is a table comparing operating results per share for the first 9 months of FY2015 vs. same time last year. Source: National Fuel Gas press release, Guiding Mast Investments As shown, operating earnings are down “only” -$0.24 a share, or about 9%. However, share prices have declined by 25% this year. NFG has not been this cheap on a yield basis since 2006 and 2008, and 2006 and 2011 on a PE basis. Below is a 20-year FAST Graph chart indicating a more reasonable PE and dividend yield in line with its history. Prior to 2006, NFG did not have as extensive an E&P footprint, and traded primarily with a regulated gas utility matrix. (click to enlarge) Management announced its earnings per share guidance for FY2015 of $2.90 to $3.00, up from previous guidance of $2.75 to $2.90. Guidance was also given for FY2016 of $3.00 to $3.30. Over the years, NFG has generated acceptable and reliable returns on invested capital, with a current 3-year average of 8.75%. Below is a chart, also from fastgraph.com, of 20-year history of ROIC. (click to enlarge) National Fuel Gas is the second largest landholder in the Marcellus shale, controlling over 800,000 acres, with 75% fee-owned. For example, below is a slide from the most recent investor presentation showing the location of the fee-owned 720,000 acres out of 790,000 acres controlled in Pennsylvania. Morningstar believes NFG has a 10-year footprint of over 1500 drilling locations, based on its current drilling schedule. (click to enlarge) NFG offers one of the lowest valuation of its Marcellus acreage compared to its peers. Below is a table of various net acres ownership, current enterprise value, and the number of acres owned for each million dollars of EV. Source: Guiding Mast Investments Although natural gas production has expanded from 30 MMcf in 2010 to 142 MMcf in 2014, NFG continues to expand its reserves by a factor of 3 to 5 times production levels. There is no reason to believe this trend won’t continue. Morningstar forecasts natural gas production will increase 74% between 2014 and 2019. Oil production in California has not been fully replaced, and reserves have declined 15% over the previous 5 years. In the current era of low prices, company-wide production growth has slowed to just 5% for the first 9 months of 2015 over 2014. National Fuel Gas is expanding its midstream assets of pipelines, storage facilities, and gathering. Over the next few years, transportation capacity will increase from a current 1 bcf/d to over 1.6 bcf/d. This expansion should continue to translate into higher earnings per share. Fund manager Mario Gabelli controls 10% of NFG shares. Last fall and spring, Gabelli pushed for a financial re-engineering of the company by spinning off the utility segment. Management resisted, and Gabelli called for a proxy vote on the issue, but he lost. It is interesting that according to Gabelli’s latest fund notes, NFG is still looking at some type of restructuring, but management is mum on the issue. As NFG continues to gain critical mass by expanding its midstream assets of pipelines and gathering systems, some type of financial restructuring seems inevitable. Morningstar’s even-handed analysis summary is: “Bulls say: National Fuel offers years of development potential with a reasonable margin of safety. We estimate the firm wide break-even index price to be approximately $2.45 per thousand cubic feet. This company has an impressive record of 112 consecutive years of dividend payments, and its 44 consecutive years of dividend increases should appeal to income investors. Midstream infrastructure has lagged production growth in the Appalachian region for several years, leaving NFG’s midstream businesses well positioned to capture incremental transport volumes from Marcellus producers. Bears Say: North American natural gas fundamentals could remain weak for an extended period of time. NFG will remain leveraged to this market for several years while developing its Marcellus acreage. We anticipate that National Fuel Gas will outspend cash flow in each year of our forecast, which could be detrimental to its development aspirations in the event of declining commodity prices. As its higher-risk E&P business continues to grow at a feverish pace, NFG will become less appealing to traditional income investors on the whole, as predictability of future cash flows becomes less certain.” A year ago, I penned a bullish article on NFG when it was trading at $74, and I apologize to those who took my advice at that time. I still believe in the value National Fuel Gas offers in its combined assets of a gas utility with an expanding footprint of natural gas infrastructure and an oil/gas E&P. Management announced the probability of additional reserve valuation adjustments over the next two quarters and this has weighted on share prices. Longer-term thinkers should have this value play on their radar screen. Author’s Note: Please review disclosure in Author’s profile. Disclosure: I am/we are long NFG. (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.