Updated on September 29th, 2022 by Quinn Mohammed
In 2022, National Fuel Gas (NFG) raised its dividend for the 52nd 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 45 Dividend Kings here.
We have created a full list of all 45 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 $5.8 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 3.1% dividend yield is much higher than the broader market yield of 1.7%, 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 52% of the EBITDA of the company.
The midstream division (pipeline & storage and gathering) generates 35% of EBITDA, while the downstream segment (utility) generates the remaining 13% 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 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 natural gas prices decrease. Moreover, the company enjoys higher returns on its investments, as both its upstream and midstream divisions benefit from its investments in production growth projects.
On August 4th, 2022, National Fuel Gas reported financial results for the third quarter of fiscal 2022. The company 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, the realized price of natural gas jumped 30% thanks to strong demand and tight supply.
As a result, adjusted earnings-per-share grew 66%, from $0.93 to $1.54, and exceeded analysts’ consensus by $0.11.
National Fuel Gas pursues growth by increasing its natural gas production and expanding its pipeline network. The company has grown its earnings-per-share at an average annual rate of 5.6% since 2012. This is fairly improved over returns from years earlier due to the current multi-year high price of natural gas and the company’s record production.
And the company has promising growth prospects ahead.
Source: Investor Presentation
Thanks to more clarity around the level of increase in output, company management narrowed its FY 2022 guidance. It now expects earnings-per-share of $5.85 to $5.95 (vs. previous guidance of $5.70 to $6.00), for 38% growth at the mid-point.
It also initiated guidance for earnings-per-share of $7.25 to $7.75 in fiscal 2023, implying 27% growth at the mid-point.
Overall, we expect National Fuel Gas to experience a decline in its earnings per share by about 3.0% per year on average over the next five years, given the high cyclicality of the price of natural gas and its current high comparison base.
Competitive Advantages & Recession Performance
As mentioned above, the upstream segment generates over 50% of its total EBITDA, with natural gas comprising roughly 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, it’s also been made apparent in the trailing twelve months as NFG has outperformed the broader market by a wide margin, primarily due to the increased price of natural gas.
And 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 120 consecutive years and has raised its dividend for 52 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.
Source: Investor Presentation
Given the healthy payout ratio of 31% (based on expected 2022 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 10.1 times its expected earnings of $6.10 per share this year. This earnings multiple is much lower than the average price-to-earnings ratio of 16.2 over the last decade. Our fair value estimate for NFG stock is a P/E of 14. If the P/E multiple expands from 10.1 to 14.0 by 2027, it would lift annual returns by 6.6% per year over the next five years.
Given the -3% estimated annual decline in earnings-per-share, the 3.1% dividend, and a 6.6% annualized expansion of the price-to-earnings ratio, we expect National Fuel Gas to offer a 6.1% average annual return over the next five years. This makes the stock a hold 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 long-term growth potential thanks to strong production growth. However, the price of natural gas is at a cyclical high, and we expect a downturn in earnings over the next five years.
In addition, National Fuel Gas stock is undervalued right now. Given an expected decline in earnings over the intermediate term, its 3.1% dividend, and its low valuation, we view the stock as a hold here.
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