I see the current market as being rather expensive, with elements of a bubble forming in certain sectors. This was also noted by Lloyd Blankfein, the former CEO of Goldman Sachs (GS), who did an interview with CNBC on Oct 8th. During the interview, he noted that low interest rates were essentially creating free money for big institutional players. He also cautioned on SPACs (special purpose acquisition companies) being in bubble territory, and on how much money is “available on the basis of someone’s reputation,” as opposed to a business plan.
In this article, I’m focused on UGI Corporation (UGI), which is a regulated utility and distributor of natural gas that has been left behind by the market rally, with a 24% decline in its share price since the start of the year. I evaluate what makes this an attractive long-term investment, so let’s get started.
(Source: Company website)
A Look Into UGI
UGI Corporation is a regulated utility and a domestic and international distributor (western and central Europe) of natural gas and LPG (liquefied petroleum gas). Those who enjoy outdoor BBQ may be familiar with its AmeriGas propane tanks at retail destinations. UGI has been in business for 138 years, and has paid common dividends for more than 134 consecutive years. Last year, it generated over $7B in total revenue.
COVID has presented some near-term challenges, as UGI has seen a drop-off in demand from commercial customers in all four of its business segments. In addition, warmer climates present a long-term risk, as that could lead to a drop in demand for home heating. Management is adjusting to this change by shifting to a financial model that uses a 10-year trailing average of daily temperatures versus a 15-year average, and as a result, expects a $0.04 decrease to 2021 EPS.
Despite these risks, I see UGI benefiting from increased domestic and international demand for natural gas in the coming years. This is supported by analysis from the IEA (International Energy Agency), as noted in its research report regarding natural gas demand for 2021- 2025:
“Mature markets in Europe, Eurasia and North America, which were the hardest hit in 2020, are expected to recover most of their consumption losses in 2021 as demand from the industrial and power generation sectors gradually returns. Some marginal gains are also expected from coal-to-gas switching, helped by low gas prices and ample supply, while residential heating demand is assumed to return to normal after an exceptionally mild winter in 2019/20.”
Meanwhile, the company appears to be executing well. As seen below, UGI has posted a strong 18% YoY growth on a fiscal YTD basis (Q1-Q3). This speaks to the strength of UGI’s diversified model, as strength in the midstream and AmeriGas segments more than offset weakness (due to COVID) from the International and Utilities segments. AmeriGas, in particular, benefitted from increased cylinder business, as consumers spent more time cooking at home during the pandemic.
(Source: Company Earnings Presentation)
Looking forward, I expect to see strong growth in UGI’s midstream business, as natural gas volumes from the Appalachian region continue to grow. This could provide decades of growth, as the US Geological Survey estimates that there are 214 trillion cubic feet of natural gas reserves in the Appalachian Basin. This is further supported by UGI’s joint partnership (as one of 5 member companies) in the PennEast Pipeline project, and its other key assets in the region, as noted by management during the last conference call:
“We are encouraged by the firming of natural gas commodity values and believe that our existing network of midstream assets is ideally positioned to benefit from the improving commodity market. We are nearing completion of the Bethlehem LNG storage and vaporization system. This is an important expansion of our LNG network as we see LNG peaking demand increasing as pipeline expansion and Greenfield projects are cancelled or delayed. We also continue to transport LNG to other regions in the Mid-Atlantic and the Northeast as peak customer demand exceeds existing pipeline supply capacity.”
I’m encouraged to see that management increased its FY 2020 guidance from $2.25 to $2.50 at the midpoint. This would equate to a 9.6% YoY EPS growth.
Based on the YoY EPS growth estimates above, I wanted to calculate what the PEG ratio is, based on the following inputs.
- Price: $35.18
- EPS: $2.50 (midpoint of FY 2020 Guidance)
- EPS Growth Rate: 11 (based on the average of FY 2021 and 2022 growth rates above)
With the inputs above, I arrive at a PEG ratio of 1.28. Using a PEG ratio of 1 as a standard for fair value, the shares appear too overvalued. However, I don’t believe this standard is one-size-fits-all.
For stable and well-run utilities, I generally use a PEG ratio of 1.5 to 1.75 as my own standard for fair value. This equates to a potential 17% (1.5/1.28 -1) to 37% (1.75/1.28 -1) upside from the current share price.
Analysts seem to agree that the shares are undervalued, with an average price target of $45.25, which sits 29% above the current share price.
In the meantime, I find the current 3.8% dividend to be safe and attractive, with a dividend to earnings payout ratio of 54%, and a 5-year dividend CAGR of 8%.
UGI Corporation is a well-established utility and natural gas/LPG distributor with 138 years of service. While it has some near-term headwinds from COVID, the strengths from the diversified business model more than offset the weaknesses. Long term, I expect to see continued growth for the midstream business, and a continued expansion of its AmeriGas distribution services, which has seen strong growth. Based on these factors, and the valuation exercise, I see the shares as undervalued with strong upside potential.
(Source: F.A.S.T. Graphs)
Thanks for reading! If you enjoyed this piece, then please click “Follow” next to my name at the top to receive my future articles. All the best.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in UGI over the next 72 hours. 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.
Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.