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4 Gas Distribution Stocks to Watch as High Prices Lower Demand

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·9 min read
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Natural gas has become a preferred choice of fuel in the United States due to its clean-burning nature but is facing competition from other clean sources like renewable energy. Wider usage of natural gas in the electric power, industrial, commercial and residential markets increases the demand for a natural gas distribution network. Amid extreme cold weather conditions, U.S. natural gas production dropped 7% sequentially in February 2021 and adversely impacted the pipeline operators.

Despite an expected decline in demand for natural gas in 2021 per the latest report by the U.S. Energy Information Administration (“EIA”), we expect the benefits of natural gas to continue driving its distribution industry. As vaccines are being gradually rolled out in the United States, we expect demand for natural gas to recover in the second half of this year, with an increase in industrial and commercial activities. ONEOK Inc. (OKE), with its widespread infrastructure in key production areas and long-term, fee-based commitments, is poised to benefit when natural gas production volumes increase to touch normal levels. Other utilities worth holding in one’s portfolio include New Jersey Resources Corporation (NJR), UGI Corporation (UGI) and MDU Resources Group Inc. (MDU).

About the Industry

The Zacks Utility Gas Distribution industry comprises companies that offer services to transport natural gas from the region of production to end users. Gas pipelines play a crucial role in delivering natural gas from intrastate and interstate transmission pipelines to consumers through small diameter distribution pipelines.

Notably, the natural gas network in the United States has nearly 3 million miles of pipeline that ensure supply to millions of households. Increasing consumption of natural gas in the United States and internationally is driving demand for distribution pipelines.

Factors Shaping the Future of the Gas Distribution Industry

Reduction in Consumption of Natural Gas by Electric Power Sector: The recent short-term energy outlook released by EIA indicates domestic natural gas consumption of 82.6 billion cubic feet per day (Bcf/d) for 2021, down 0.7% from 2020. The decline in consumption will be primarily due to rising natural gas prices that will adversely impact usage in electric power generation. Per EIA, in 2021, the natural gas share in electricity generation is expected to drop to 35% from 39% in 2020. Per EIA, natural gas prices are expected to rise further in 2021 due to increasing exports of liquefied natural gas (“LNG”). As a consequence, natural gas production is expected to drop 0.3% year over year to 91.1 Bcf/d in 2021. The expected reduction in consumption and production of natural gas would also dampen the demand for natural gas pipelines.

Aging Distribution Infrastructure: The existing U.S. natural gas distribution pipelines are aging. Leakage or breakage in these old cast iron and bare steel pipelines may result in disruption of services. At present, natural gas distribution utilities provide services to over 75 million residential and 5 million commercial customers in the United States. Per a report from Business Roundtable, replacing the old pipelines will cost around $270 billion. To lower the possibility of interruption in services, the Department of Energy announced $38.5 million funding for a program that will promote the development of new technologies to strengthen cast iron and bare steel natural gas distribution pipes by creating a new pipe inside the old pipe. The Rapid Encapsulation of Pipelines Avoiding Intensive Replacement or the REPAIR program will ensure the minimum extension of the service life of distribution pipelines by 50 years and lower the replacement cost of old pipelines by nearly 10 to 20 times per mile. At present, pipe excavation and replacement costs can go up to $10 million per mile. The current near-zero interest rate will assist utilities in sourcing funds for their capital projects at a cheaper rate.

Scope for Fresh Investments: The clean-burning nature and wide availability across the United States are driving the demand for natural gas. Temporary obstacles like the outbreak of COVID-19 or price increases should not dampen the long-term prospect of natural gas. Hence, the distribution network should continue to play a major role in transporting natural gas to customers in all parts of the United States. The EIA expects U.S. LNG exports to increase in 2021 and average 9.2 Bcf/d in both 2021 and 2022, reflecting a 30% increase from 2020. The demand for natural gas will continue to increase with the opening up of industrial and commercial activities post COVID-19 vaccination and natural gas will play a pivotal role in the utilities’ gradual transition toward clean energy. So when the demand for natural gas increases, it will also create new opportunities for the natural gas pipeline operators.

Zacks Industry Rank Indicates Weak Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak near-term prospects.

The Zacks Utility Gas Distribution industry — a 17-stock group within the broader Zacks Utilities sector — currently carries a Zacks Industry Rank #178, which places it in the bottom 29% of the 254 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate.

Before we present a few Gas Distribution stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags S&P 500 & Sector

The Gas Distribution industry has underperformed the Zacks S&P 500 composite and its own sector over the past year. The stocks in this industry have collectively returned 25.8% in the same time frame, while the Utility sector has gained 47.1%. The Zacks S&P 500 composite has gained 52.2% in the said period.

One-Year Price Performance

Gas Distribution Industry’s Current Valuation

Since utility companies have a lot of debt on their balance sheets, the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio is commonly used to value them.

The industry is currently trading at a trailing 12-month EV/EBITDA of 9.83X compared with the S&P 500’s 17.2X and the sector’s 9.4X. Over the past five years, the industry has traded as high as 12.59X, low of 8.48X and at the median of 10.93X.

Industry Versus S&P 500 (five years)

Industry Verus Sector (five years)

4 Gas Distribution Stocks to Keep a Close Watch On

Below are four stocks that have been witnessing positive earnings estimate revisions and returned higher than its industry’s growth of 13.4% in the past three months. Out of these, two have a Zacks Rank #2 (Buy) and the remaining two carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

ONEOK Inc: This Zacks Rank #3, Tulsa, OK-based company is engaged in natural gas and natural gas liquids (“NGL”) businesses. The company will continue to gain from long-term, fee-based earnings contract and location of its assets in the highly productive regions of the United States. Courtesy of completed projects and 40,000 miles of NGL and natural gas pipelines in the most prolific U.S. shale basins, the company is well poised to gain traction once production volumes improve from the present levels.

The Zacks Consensus Estimate for the company’s 2021 earnings has moved up 7.3% to $3.23 per share over the past 60 days. The current dividend yield of the company is 6.9%. In the past three months, the stock has gained 18.1%. Long-term earnings growth (three to five years) is pegged at 6%.

Price and Consensus: OKE

New Jersey Resources Corporation: This Zacks Rank #2, Wall, NJ-based energy company provides regulated gas distribution, and retail and wholesale energy services. The company plans to invest $461-$492 million in fiscal 2021 to further strengthen its natural gas operations.

The Zacks Consensus Estimate for the company’s fiscal 2021 earnings has moved 21.9% higher to $1.95 per share over the past 60 days. The current dividend yield of the company is 3.06%. In the past three months, the stock has gained 18.4%. Long-term earnings growth is pegged at 7.1%.

Price and Consensus: NJR

UGI Corporation: This Zacks Rank #2, King of Prussia, PA-based company distributes, stores, transports and markets energy products and related services through its subsidiaries. The company continues to expand its operation and customer base organically and through acquisitions. The consistent performance of the company has enabled it to reward its shareholders through a raise in annual dividend rates and share repurchase.

The Zacks Consensus Estimate for the company’s fiscal 2021 earnings has moved 3.4% higher to $3.00 per share over the past 60 days. The current dividend yield of the company is 2.9%. In the past three months, the stock has gained 17.8%. Long-term earnings growth is pegged at 8%.

Price and Consensus: UGI

MDU Resources Group: This Zacks Rank #3, Bismarck, ND-based, company provides value-added natural resource products and related services that are essential for energy transportation, regulated energy delivery, and the construction materials and services business. Its two-platform business model, regulated energy delivery platform, and construction materials and services platform provide it an advantage over its peers. Its system is strategically located near four natural-gas-producing basins, making natural gas supplies available to its transportation and storage customers. It has plans to make a $508 million investment in the pipeline business over the next five years and strengthen its core operations.

The Zacks Consensus Estimate for the company’s 2021 earnings has moved 1.5% higher to $2.08 per share over the past 60 days. The current dividend yield of the company is 2.5%. In the past three months, the stock has gained 23%. Long-term earnings growth is pegged at 6.63%.

Price and Consensus: MDU

Zacks Top 10 Stocks for 2021

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UGI Corporation (UGI) : Free Stock Analysis Report

ONEOK, Inc. (OKE) : Free Stock Analysis Report

NewJersey Resources Corporation (NJR) : Free Stock Analysis Report

MDU Resources Group, Inc. (MDU) : Free Stock Analysis Report

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