We have downgraded leading North American energy firm Williams Companies Inc. (WMB) to Neutral from Outperform.
Tulsa, Oklahoma-based Williams is a premier energy infrastructure provider in North America. The company’s core operations include finding, producing, gathering, processing, and transportation of natural gas.
Boasting a widespread pipeline system, Williams is one of the largest domestic transporters of natural gas by volume. Its facilities – gas wells, pipelines, and midstream services – are concentrated in the Northwest, Rocky Mountains, Gulf Coast, and Eastern Seaboard.
The company divides its business into three segments: Williams Partners – that includes the company’s 72%-owned master limited partnership Williams Partners L.P. (WPZ) – Midstream Canada & Olefins, and Other.
In December 2011, Williams completed the spin-off of its exploration and production (E&P) business into a separate, independent and publicly traded company WPX Energy Inc. (WPX).
Williams, after the WPX Energy spin-off, has transformed itself into a pure play midstream conglomerate with operations spanning from the Canadian oil sands to deepwater fields in the Gulf of Mexico.
We believe this North American pure play energy infrastructure company will be able to generate highly visible cash flow and dividend growth over the next several years through strong operational performances by its business units.
In particular, the growth prospects for energy infrastructure all across North America remain exciting with the requirement to support producers in the growth of shale plays, especially in regions where there is a severe lack of facilities. This creates exciting opportunities for pipeline firm like Williams, as it looks to capture the economic benefit of this trend.
Additionally, with Williams now free from the capital constraints of a typical E&P firm, the company’s exposure to a bullish natural gas liquids (NGL) processing market and a deep inventory of growth projects is set to unlock significant shareholder value.
However, we remain worried about low natural gas prices, which are likely to restrict near-term growth prospects at Williams. The glut in domestic gas supplies continues with storage levels remaining well above their five-year average. This translates into a bearish near- to medium-term outlook for natural gas-weighted firms like Williams Companies.
Additionally, we believe that transfer of the upstream assets (post-split) has left Williams with a less diversified business. As a result, the business risk profile of the reorganized Williams is weaker than that of the pre-spin-off company.
Lastly, we remain concerned about Williams Companies’ high debt levels, which leave it vulnerable to an extended drop in commodity prices. As of December 31, 2011, Williams had debt of $8.7 billion, representing a debt-to-capitalization ratio of 82.9%.
Considering these factors, we think that the current valuation is fair and adequately reflects Williams’ future growth prospects. As such, we prefer to remain on the sidelines at this point. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).
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