Market orchid
Utilities are the worst-performing sector in 2023. In total, they fell nearly 8%, but many individual stocks fell further.
Utility stock prices typically fall when interest rates rise as investors prefer the safety of short-term U.S. Treasury bills and bonds. Still, valuations for many utility companies are at their lowest levels in a decade and dividend yields are at their highest levels. In addition, UGI Corporation (NYSE:UGI) faced challenges unique to its business model, causing the stock price to fall even more. However, the utility is gradually exiting underperforming businesses in Europe, raising base rates for regulated utilities and reducing costs. These efforts should improve results in 2024. At the same time, the stock is undervalued, has long-term dividend growth, and has an above-average dividend yield. I think UGI Corporation is a stock worth buying for the long term.
UGI Company Profile
UGI Corporation is a diversified energy company Regulated and non-regulated businesses. The company has four operating segments: AmeriGas Propane, UGI International, Midstream & Marketing and UGI Utilities. Total revenue in 2022 is $10.106 billion, and total revenue in the past 12 months was $9.458 billion.
AmeriGas Propane may be the crown jewel of these four companies.It is the largest LPG retailer by annual total volume [LPG] In the U.S. The company serves all 50 states through 1,400 distribution points, reaching 1.3 million customers. The company also distributes LPG in 17 European countries through UGI International. It is the market leader in France, Austria, Belgium, Denmark, Hungary and Luxembourg and one of the largest distributors in Poland, Slovakia, Norway, the Czech Republic, the Netherlands and Sweden.
The regulated utilities are UGI Utilities and Mountaineer Gas Company, which have attractive monopoly positions in the areas they serve. First company to provide natural gas and electric service in Pennsylvania. It is the second largest regulated natural gas utility in Pennsylvania, serving more than 675,000 customers in the eastern and central regions of the state and hundreds of customers in one Maryland county. UGI Utilities also provides power to more than 62,500 customers in northeastern Pennsylvania. Mountaineer Gas is West Virginia’s largest regulated natural gas utility, serving 214,000 customers.
UGI Energy Services is an unregulated midstream and marketing business. It provides natural gas to 12,400 residential, commercial and industrial customers at more than 42,000 locations in Pennsylvania and 21 other states.
UGI Investor Relations
near term challenges
The utility faces challenges in 2022 and early 2023 due to the Russia-Ukraine war, warmer weather and inflation. However, the company has taken steps to address some of the issues. Therefore, the second half of 2023 and 2024 should see better results.
In Europe, Ukraine’s incursion has disrupted LPG markets, tightening supply relative to demand. The response is to promote conservation efforts. As a result, demand fell more than expected. According to EU data, consumption has dropped by about 12% on average compared with previous years. In 2023, demand remains below the long-term trend. But UGI is exiting the non-core energy marketing business. According to its latest quarterly report, the company “entered into definitive agreements to divest certain gas and electricity marketing portfolios in France and wind and solar portfolios in the Netherlands.”
Second, warmer weather and heat waves in the western U.S. in the first half of 2023 led to lower volumes for AmeriGas propane and regulated utilities, impacting margins. Pennsylvania utilities implemented weather normalization riders and higher base rates, which should boost revenue and profits. However, warm weather this winter could still impact AmeriGas Propane.
Finally, inflation has put pressure on profits due to higher labor and vehicle costs. Inflationary pressures are declining, but rising input costs may be permanent. UGI Utilities may increase its base rates in the future to account for higher charges. However, the company is also focused on operational efficiency and cost control.
Dividend analysis
Like many utility companies, UGI Corporation’s dividend yield rose to nearly its highest level in the past decade. The annualized forward dividend rate is $1.44, and the forward dividend yield is approximately 6.34%, which is higher than the 5-year average of 3.40%. Even with the current high short-term Treasury rates, the yield remains attractive, suggesting the stock is significantly undervalued.
Portfolio Insights
In addition to its attractive yield, UGI Corporation is also a dividend growth stock. It has risen for 36 consecutive years, making the list of Dividend Champions. The utility is also one of the few that has paid dividends for at least 100 years. Dividend growth has been relatively stable, at about 7.6% over the past five years and 7.2% over the past decade. The dividend increased last quarter to $0.375 per share from $0.360 per share in May 2023, and investors should expect another dividend increase in May 2024.
Portfolio Insights
UGI Corporation has excellent dividend safety based on earnings per share, operating cash flow (OCF), and its balance sheet.
Earnings for fiscal 2023 are expected to be $2.75 per share, with a dividend yield of $1.44 per share. These values result in a payout ratio of approximately 52%. This percentage is very good for a utility, but below the 65% standard we would expect. Furthermore, even if earnings are lower than in fiscal 2022, dividend safety remains solid.
The utility generated $725 million in OCF over the past 12 months, an amount that satisfied $306 million in dividend requirements. The dividend-to-OCF ratio is conservatively around 42%. This value is below our target of 70%, indicating excellent dividend safety.
Because utilities are capital-intensive businesses, they often carry large amounts of debt. As of the end of the third quarter of 2023, short-term debt was $481 million, current long-term debt was $56 million, and long-term debt was $6.579 billion. In addition, UGI Utilities has a BBB+/A3 low to high investment grade credit rating. However, the parent company is rated lower because UGI International has a non-investment grade rating. However, UGI Corporation still has an investment-grade rating; the total debt is not excessive, and the company’s balance sheet is solid.
Valuation
The company’s stock price has fallen more than 36% year-to-date and last year. Meanwhile, the P/E ratio has fallen to 8.6 times, well below the five- and 10-year range. The lower valuation is mainly due to investors’ preference for shorter-dated bonds and the company’s challenges related to the conflict in Ukraine, higher-than-expected weather and energy-saving efforts in Europe.
Analysts expect fiscal 2023 earnings per share of $2.75. We will use 14x as a fair value multiple close to the midpoint of the 5-year range, taking into account near-term challenges, market leadership in the LPG business, and regulatory conditions. Public utility monopoly. Therefore, our fair value estimate is $38.50. The current share price is approximately $24.09, which means UGI Corporation is undervalued.
Using a P/E ratio between 13x and 15x for sensitivity calculations, we get a fair value range of $35.75 to $41.25. As a result, shares are trading at approximately 58% to 67% of fair value estimates.
Current valuation based on P/E ratio
|
P/E ratio |
|||
|
13 |
14 |
15 |
|
|
estimated value |
$35.75 |
$38.50 |
$41.25 |
|
Percentage of estimated value based on current share price |
67% |
63% |
58% |
Source: Dividend Power Calculations
How does this calculation compare to other valuation models? Portfolio Insight’s hybrid fair value model combines the price-to-earnings ratio and dividend yield to give a fair value estimate of $41.58 per share.Gordon Growth Model [GGM] Assuming a 10% discount rate and a conservative annual dividend growth rate of 6%, its fair value is $36.00.
The average price across the three models is approximately $38.69, indicating that UGI Corporation is significantly undervalued at current prices.
final thoughts
Utilities stocks are currently out of favor due to high interest rates, while technology stocks are rising. In addition, UGI Corporation faces challenges unique to European non-regulated businesses, weather and inflation. However, the company is exiting its non-core assets in Europe and making other moves to improve performance. Meanwhile, regulated utilities are doing well. Additionally, the stock is a Dividend Champion, has a safe dividend, and is undervalued. We view UGI Corporation as a long-term buy.
