JotCast | 11/17/20 Conrad's Utility Investor Live Chat

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11/17/20 Conrad's Utility Investor Live Chat

Roger Conrad

2:02

Hello everyone and welcome to this CUI members only live web chat. Before we begin, the ground rules are there is no audio. Just type in your questions and I'll answer them as soon as I possibly can in a concise and comprehensive way. I intend to keep this thing going so long as there are questions left in the queue, or from emails we received prior. So this will probably go on for a while. If you have to leave at some point, remember there will be a published transcript of the entire Q&A available shortly after I sign off. We will send you a link to it, and it will also be posted on the CUI website.

I'm going to start out by posting my answers to questions we received prior to the chat.

2:03

Q. Hello Roger. Would it be possible to get a quick summary on the issues faced by the natural gas industry, especially utilities. In one hand it seems that some states do not want to rely on natural gas (New York). But on the other, states like California need it to keep up with its climate goals.

In your EEI report you mention that LDCs in most states should remain financially healthy through 2050, even under an aggressive decarbonization case. Does that mean past valuations (P/E. P/FCF, Yield) deserve to stay lower than in the past, due to the reduced long-term visibility on their business model? Also how much of those natural gas assets could be converted to renewal gas from farms and hydrogen? Thanks for your all your work. It’s very helpful. Best regards.

A. Let me start by saying any industry where we can seriously talk about 30 years down the road is by definition exceptionally steady. And natural gas utilities certainly qualify, even under the most pessimistic scenarios I saw from credit raters Fitch and Moody’s, who each presented their ESG—environmental, social, governance—risk models at EEI. Fitch, for example, introduced a scale from 0 no risk to 100 extreme risk under which it rated electric and gas distribution and water utilities at “10” currently. By 2050, that was still in the same neighborhood for electricity and water but was up to 50 for natural gas. Coal power plants by contrast were at 90 by 2030.

The premises were radical policy change—i.e. state rules to squeeze out conventional natural gas usage—and limited ability of gas utilities to respond. Yet even then, the absolute risk in 30 years was still considered little more than half the risk coal fired power faces now.

Credit raters are paid to cover all the angles. And one point made by representatives of both Fitch and Moody’s was that these were not forecasts but an attempt to quantify risks—in fact, gas utilities continue to score very well under credit ratings, which are devised with the next 3 to 5 years in mind. Another point made was that state regulators remain very supportive of rate based spending that reduces distribution system leaks by replacing pipes and mains.

That includes New Jersey, which is one of the states with a goal of being carbon neutral by 2050 and has recently attempted to restrict many new natural gas infrastructure such as the Penn East pipeline. And it demonstrates the degree of regulatory support gas utilities enjoy

Of course, the vast majority of states as I’ve pointed out are trying to encourage more usage of natural gas. And we’re seeing a number of utilities start to implement plans to utilize so-called “renewable” natural gas, which harvests methane and other gasses produced on farms, landfills and other sources—which some consider to be “negative” carbon as using it eliminates emissions elsewhere in the environment. I think hydrogen may be a little further down the line. But the fact that a major utility like Entergy Corp is looking to make all of its new natural gas power plants able to use it means it’s a matter of when not if it will be an available resource.

The bottom line here is natural gas distribution utilities really aren’t at all that much environmental risk now. And I think as that becomes more apparent to investors, they’ll recapture those high valuations we saw earlier this year, if for no other reason that they operate assets with very reliable and regulated cash flows that are attractive in M&A.

2:04

And I believe we’ll see that happen as the distortion of the recent election moves further into the rear view mirror.

In the meantime, there are some real bargains in the natural gas distribution utility space. Those include companies that have been deeply discounted for a while like South Jersey Industries, but also blue chips like Atmos Energy—which if you’re really worried about energy politics operates mainly in Texas.

Q. You made a good call on Alaska Communications as a buyout candidate. What should I do now hold or sell?—Ed D.

A. The offer on the table right now for ALSK is $3 per share in cash. At this point, major shareholders appear to be on board, including TAR Holdings LLC, which owns 8.8 percent. Judging from the action in the share price the past couple weeks, there appears to be a high expectation that this company will wind up with an even better offer—either from another bidder entirely or else the Macquarie consortium that’s behind the current bid. There’s also a number of so-called shareholder advocate law firms “investigating” the Macquarie offer, presumably for not being high enough.

I rated the stock a hold in the Utility Report Card of the November issue, which followed the takeover news. That remains my advice now for two reasons.

First, I think Alaska Communications could fetch a higher offer, much as Cincinnati Bell did earlier this year. Like CBB, ALSK’s primary value is in a rapidly growing fiber broadband network. And in fact, this company carries less baggage than CBB, demonstrated by solid gains in both revenue and EBITDA in Q3. Mainly, it’s already growing its broadband business faster than its legacy wireline business is shrinking, while the opposite is true for CBB. An elevated bid for Alaska Communications could be as much as $4, though $3.50 or so is more likely.

My second reason for staying with it now is this company is perfectly capable of making it on its own. In the unlikely event that this deal collapses, it’s likely the stock would head back toward the $2 to $2.50 area. But given how the business plan is working, it would be only a matter of time before we got back to this level again, especially given the appeal of buying fiber networks and the current low cost of capital would be buyers enjoy.

Finally, I’m not so convinced we’ll see a higher offer that I want to recommend anyone buy Alaska Communications, especially with this kind of gain. But if the final bid does stay at $3, that’s still an excellent gain. And the possible erosion in price from here of roughly 12 cents a share is worth risking in my view for a bigger gain.

2:05

Q. Roger--I have been a happy subscriber for close to 30 years to your services. Over the years, I have added Canadian essential service companies (telco, electric utilities, a pipeline, a water company) that you recommended and, as I have aged, I love the lush dividends that they provide. My question is how much of my essential services portfolio should I place in Canada specifically or other foreign countries? Thanks for all of your great work.—Don C.

A. Thanks Don. The Conservative Portfolio of CUI has 22 stocks. Of those, 14 have operations in the US only, but only one company does business only outside the US. Of the other seven, four of them do business primarily in the US. Of the 17 current Aggressive Holdings, only seven do all of their business in the US. Seven do substantially all of it in other countries, with the other three broadly diversified across borders.

The Conservative Portfolio “foreign” utilities are primarily Canadian, while the Aggressive Portfolio features a wider mix. That reflects my view that Canadian utilities present fundamentally less risk as non-US companies to US investors. That’s not a universally shared view by any means—and the past few years it’s true the Canadian dollar’s volatility against the US has more often been a headwind than a tailwind for returns. But except for BCE, all of my recommendations from that country also have extensive operations in the US.

The primary conclusion I think you can draw here is I think Canadian essential services companies are attractive enough in terms of yield, growth and reliability to merit a significant piece of a balanced portfolio—but that US-based companies should still be lion’s share, including some that have operations outside the US. And I would use roughly the same proportions I do in the model portfolios.

Q. In your opinion, what are the prospects for MPLX over the next year or so?—P.J.

A. I think they’re quite solid. As an MLP, MPLX’ long-term outlook is very closely tied to its general partner and 62.24 percent owner Marathon Petroleum. That refiner is in the midst of a strategic shakeup, currently trying to execute the sale of its Speedway fuels distribution business to 7-Eleven Inc for $21 billion in cash. And there’s still talk it will look for a way to either sell or spin off MPLX, and/or look for a way to convert it to a C-Corp from an MLP without incurring a big tax bill.

I think any of those actions is likely to push MPLX shares quite a bit higher from here. But what’s become very clear the last several months is this MLP’s resilience in what’s probably the worst operating environment in its history. Key numbers are flat Q3 EBITDA versus a year ago, a 3.9 percent lift in distributable cash flow and strong distribution coverage of 1.44 times, with EBITDA to debt leverage a low 4 times. Management also affirmed guidance that it will generate positive free cash flow after all CAPEX and dividends in 2021, which in turn will fund debt reduction and projected share repurchases of up to $1 billion.

There’s pressure on core businesses from lower commodity prices and reduced demand for refined products. But the company continues to offset the potentially negative impact on the bottom line and balance sheet with effective cost cutting. And key regions like the Marcellus shale assets are performing well also. It may still be some months before MPLX again trades in the 30s. But that’s where I see it next year. We rate the shares a buy up to 25 in our Energy and Income Advisor, along with a large number of other energy companies that also have potential for dramatic upside in the next 12 to 18 months.