Despite this week's consumer price index report, inflation is still at high levels, giving investors anxiety. Inflation has been imparting a double-hit on many stocks; it has compressed the operating margins of most companies due to high costs and it has pressured their valuation, as the present value of future cash flows has decreased.
In this article, we will discuss the prospects of three energy stocks, which are resilient to inflation and in fact somewhat benefit from the highly inflationary environment prevailing right now.
Fuel Up on National Fuel Gas
National Fuel Gas (NFG) is a vertically integrated natural gas company. It generates 49% of its earnings before interest, taxes, depreciation, and amortization
from its upstream segment (exploration & production) while its midstream segment (gathering and storage) and its utility segment generate 36% and 15% of the earnings before interest, taxes, depreciation, and amortization of the company, respectively.
National Fuel Gas proved much more resilient than most energy companies during the coronavirus crisis. While global oil consumption slumped in 2020, the natural gas market proved much more resilient, as consumers continued consuming natural gas during that downturn.
National Fuel Gas also benefits from the conflict created by Russia. Due to the sanctions imposed by Western countries on Russia, the natural gas market has become extremely tight. Russia was providing approximately one-third of the natural gas consumed in Europe before the initiation of sanctions. Due to the sanctions, a record number of LNG cargos is exported from the U.S. to Europe to make up for the lost amounts from Russia and hence the U.S. natural gas market has become exceptionally tight. As a result, the price of natural gas rallied to a 14-year high earlier this year and remains at elevated prices. This is a strong tailwind for the business of National Fuel Gas.
The positive effect of the tight domestic natural gas market on National Fuel Gas was evident in the latest earnings report of the company. In the third quarter, National Fuel Gas grew its Seneca production by 11% over the prior year's quarter, primarily thanks to the development of core acreage positions in Appalachia. In addition, its average realized price of natural gas jumped 30% thanks to strong demand and tight supply. As a result, its adjusted earnings per share jumped 66%, from $0.93 to $1.54, and exceeded the analysts' consensus by $0.11.
National Fuel Gas has exceeded the analysts' earnings-per-share estimates for 13 consecutive quarters. This is a testament to the sustained business momentum of the company and its solid execution.
Thanks to the exceptionally favorable business environment prevailing right now, National Fuel Gas expects to achieve all-time high earnings per share of $7.25-$7.75 in fiscal 2023. At the mid-point, this guidance implies 27% growth vs. the guidance for all-time high earnings per share of $5.85-$5.95 this year. It is also important to note that management has proved conservative most of the time and thus the company is likely to exceed its guidance this year.
Moreover, National Fuel Gas has an exceptional dividend growth record. It has paid uninterrupted dividends for 119 consecutive years and has raised its dividend for 52 consecutive years. It is thus the only Dividend King in the energy sector. Given the dramatic cyclicality of the energy sector, the accomplishment of National Fuel Gas is admirable and confirms the focus of its management on sustainable long-term growth.
National Fuel Gas is currently offering a 3.0% dividend yield. It also has a healthy payout ratio of 31% and a strong balance sheet, with interest expense consuming just 16% of operating income. As a result, National Fuel Gas can easily continue raising its dividend for many more years.
Warm Up to UGI Corporation
UGI Corporation (UGI) operates natural gas and electric utilities in Pennsylvania, natural gas utilities in West Virginia and distributes LPG in the U.S. (through AmeriGas) and in international markets. It has a key difference from fully-regulated utilities, as it has somewhat less predictable performance due to the effect of the gyrations of weather on the business of distribution of propane and LPG.
Despite its sensitivity to weather, UGI has exhibited a markedly consistent growth record. The utility has grown its earnings per share in eight of the last nine years, at an average annual compounded rate of 10.9%. During the last five years, the company has somewhat decelerated, having grown its earnings per share by 7.6% per year on average. Nevertheless, this is undoubtedly an attractive growth rate for a utility.
Moreover, UGI has a huge investment program, which aims to expand and improve the infrastructure of the company. In addition, the utility has added more than 11,000 new residential heating commercial customers so far this year and has repeatedly affirmed its guidance for 6%-10% growth of its earnings per share and 4% growth of its dividend. Thanks to the investment plan of UGI and its acquisitions of new customers, the company is likely to continue growing its earnings per share at a rate close to its historical rate.
Furthermore, thanks to its regulated business, UGI is resilient to high inflation. While the surge of inflation to a 40-year high has greatly increased the costs of most companies, UGI can easily pass its increased costs to its customers. The 2% decrease in the earnings per share of the company this year is a testament to its defensive business model.
It is also important to note that UGI is a Dividend Champion, with 138 consecutive years of uninterrupted dividends and 35 consecutive years of dividend growth. This is certainly an outstanding dividend record.
Moreover, the stock is currently trading at a nearly 10-year low price-to-earnings ratio of 12.2 and is offering a nearly 10-year high dividend yield of 4.1%. Given its healthy payout ratio of 50% and its strong balance sheet, the company is likely to keep raising its dividend for many more years. This means that investors can lock in a nearly 10-year high dividend yield and rest assured that the dividend will remain on the rise for the next several years.
Head to Northwest Natural
Northwest Natural Holding Company (NWN) was founded in 1859 and has grown from a company with just a few customers to a company serving more than 760,000 customers today. Its mission is to deliver natural gas to its customers in the Pacific Northwest.
Northwest Natural enjoys a wide moat in its business, as it has a monopoly in its service areas. In addition, thanks to the essential nature of natural gas and water, consumers do not reduce their consumption of these goods even under the most adverse economic conditions. As a result, Northwest Natural has proved essentially immune to recessions.
On the other hand, Northwest Natural has exhibited a much poorer performance record than most utilities. To be sure, during the last decade, the company has grown its earnings per share by only 0.8% per year on average. Such a low growth rate is insufficient even to offset a normal inflation rate.
On the bright side, Northwest Natural is a Dividend King, with 66 consecutive years of dividend growth. It is also currently offering a nearly 10-year high dividend yield of 4.3%, which is more than double the 1.6% yield of the S&P 500. Given its reasonable payout ratio of 77% and its decent balance sheet, the company is likely to continue raising its dividend for many more years. On the other hand, income-oriented investors should note that Northwest Natural has grown its dividend by only 0.8% per year on average over the last decade. Such a low dividend growth rate is unappealing to most income investors.
However, the stock is somewhat attractively valued right now. It is trading at a 10-year low price-to-earnings ratio of 17.2, which is much lower than its historical 10-year average of 24.1. As soon as inflation begins to subside, the stock will probably begin to revert toward its historical valuation levels. Therefore, it will reward its shareholders with a generous dividend yield and an expansion of its valuation level. Nevertheless, due to the lackluster growth prospects of Northwest Natural, we advise investors to wait for an even more attractive entry point.