Updated on October 5th, 2021 by Bob Ciura
In 2021, National Fuel Gas (NFG) raised its dividend for the 51st consecutive year. That puts the company among the elite Dividend Kings, a small group of stocks that have increased their payouts for at least 50 consecutive years. You can see the full list of all 32 Dividend Kings here.
We have created a full list of all 32 Dividend Kings, along with important financial metrics such as price-to-earnings ratios and dividend yields. You can access the spreadsheet by clicking on the link below:
National Fuel Gas has remained a relatively small company, trading at a market capitalization of $5 billion. However, a small market cap is not a negative feature when investing; quite the contrary.
Despite its small size, National Fuel Gas has promising long-term growth prospects and an attractive valuation. In addition, its 3.3% dividend yield is much higher than the broader market yield of 1.4%, and there is room for more dividend raises down the road.
National Fuel Gas is a diversified and vertically integrated company that operates in four segments: Exploration & Production, Pipeline & Storage, Gathering and Utility. The upstream segment (exploration & production) is by far the most important one, as it generates 44% of the EBITDA of the company.
The midstream division (pipeline & storage and gathering) generates 39% of EBITDA while the downstream segment (utility) generates the remaining 17% of EBITDA.
While National Fuel Gas seems to be a pure commodity stock on the surface, with all the disadvantages related to the boom-and-bust cycles of commodity producers, the company has a superior business model when compared to commodity producers. Thanks to its vertically integrated business model, it enjoys significant synergies.
Source: Investor Presentation
Its midstream and downstream businesses provide a strong buffer when the price of natural gas decreases. Moreover, the company enjoys higher returns on its investments, as both its upstream and midstream divisions benefit from its investments in production growth projects.
In early August, National Fuel Gas reported (8/5/21) financial results for the third quarter of fiscal 2021. The company grew its production by an impressive 48% over last year’s quarter, primarily thanks to the acquisition of Appalachian assets. In addition, the average price of natural gas rose 15%, from $1.92 in last year’s quarter to $2.20.
As a result, adjusted earnings–per–share grew 63%, from $0.57 to $0.93, and exceeded analysts’ consensus by $0.11. This confirms National Fuel Gas’ superior business model compared to other commodity producers.
National Fuel Gas pursues growth by growing its natural gas production and expanding its pipeline network. However, it has grown its earnings per share at an average annual rate of only 2.9% since 2010. This is a stern reminder of the sensitivity of the earnings of the company to the prevailing prices of natural gas.
On the other hand, the company has promising growth prospects ahead.
Source: Investor Presentation
A major growth driver will be a more favorable business environment, as the price of natural gas has plenty of potential upside and limited downside in the long run from its current suppressed level.
Thanks to a steep increase in output, company management raised its guidance for a fourth consecutive quarter thanks to favorable commodity prices. It now expects earnings–per–share of $4.05–$4.15 (vs. previous guidance of $3.85–$4.05), for 40% growth at the mid–point.
It also initiated guidance for earnings–per–share of $4.40–$4.80 in fiscal 2022, implying 12% growth at the mid–point, thanks to an improved outlook for natural gas prices and the completion of the FM100 expansion project.
Overall, we expect National Fuel Gas to grow its earnings per share by about 4.0% per year on average over the next five years, primarily thanks to production growth and somewhat more favorable prices of natural gas in the future.
Competitive Advantages & Recession Performance
As mentioned above, the upstream segment generates over 40% of its total EBITDA, with natural gas comprising 90% of the total output. It is evident that the company is highly sensitive to the price of natural gas. This sensitivity was apparent in 2015 and 2016, when the price of natural gas collapsed and the company posted hefty losses.
On the other hand, thanks to its vertically integrated business model, National Fuel Gas is more resilient to downturns than most oil and gas producers, as its midstream and utility businesses provide a strong buffer during downturns.
The superior business model of National Fuel Gas helps explain its admirable dividend growth record. The company has paid uninterrupted dividends for nearly 120 consecutive years and has raised its dividend for 51 consecutive years. This is an impressive achievement for a commodity producer, as commodities are infamous for their high cyclicality, which results in dramatic boom-and-bust cycles.
Given the healthy payout ratio of 44% (based on expected 2021 adjusted EPS) and the decent balance sheet of the company, the dividend can be considered safe for the foreseeable future. We expect National Fuel Gas to continue raising its dividend for many more years.
Valuation & Expected Returns
National Fuel Gas is currently trading at 13.7 times its expected earnings of $4.05 per share this year. This earnings multiple is much lower than the average price-to-earnings ratio of 17.5 over the last decade. Our fair value estimate for NFG stock is a P/E of 15. If the P/E multiple expands from 13.7 to 15 by 2026, it would lift annual returns by 1.8% per year over the next five years.
Given 4% expected earnings-per-share growth, the 3.3% dividend and a 1.8% annualized expansion of the price-to-earnings ratio, we expect National Fuel Gas to offer a 9.1% average annual return over the next five years. This makes the stock a buy in our view.
National Fuel Gas is highly sensitive to the gyrations of the price of natural gas. On the other hand, its midstream and utility segments provide a strong support to its financial results during downturns.
Overall, the midstream and utility segments provide reliable cash flows while the upstream segment offers significant growth potential thanks to strong production growth and a potential improvement in the price of natural gas off its current suppressed level, which has been caused by the pandemic.
In addition, National Fuel Gas stock is undervalued right now. Thanks to its promising growth prospects, its 3.3% dividend, and its low valuation, we believe the stock is likely to offer attractive returns going forward.