SR - Chesapeake Utilities: Great Dividend Growth At A High Price

Summary

• Chesapeake Utilities is a quiet compounder in the utilities space with a low starting yield but good dividend growth rates.
• Long-term growth has been good, and the company has a strong financial position.
• Given the rich valuation, however, this looks like a Hold for me and I will wait for a better entry price.

Given the recent market declines, I remain interested in utilities for security and safety. People will continue to need power and water, no matter what happens to the economy. Given the circumstances of rising inflation and interest rates, I am also looking for stable and strong utilities. Fitting this bill is Chesapeake Utilities ( CPK ). In this article, I will walk you through what I see in this company and provide an assessment of why I think it remains a Hold at this time.

Background on Chesapeake Utilities

Chesapeake traces its roots back to 1859 with the establishment of the Dover Gas Light Company. As a contemporary utility firm, they operate in both regulated and unregulated segments with diverse interests, as well as successes, being recognized for the Best for Corporate Governance award in August 2022 . They have natural gas and electric distribution in Delaware, Maryland, and Florida, which are regulated utility segments, along with the natural gas transmission subsidiary and Aspire Energy Express as an intra-state pipeline subsidiary.

Recent results and operations

Like many other firms, Chesapeake has faced delays and challenges in the present environment. In the Q2 earnings call , they reaffirmed the earnings guidance for 2025, in the range of $6.05 to $6.25, for a five-year CAGR of 9.1-9.5%. The present situation has resulted in shifts in the capital expenditures, as noted on the Q2 earnings call:

as a result of ongoing short-term supply chain constraints and regulatory delays, we've adjusted our capital expenditure expectations in 2022 to $140 million to $175 million [...] a temporary shift from our original guidance range of $175 million to $200 million. To reiterate again, this adjustment does not reflect a negative outlook on the actual projects. Rather, it highlights the challenges that we and many companies are experiencing with securing raw materials, permitting, regulatory approval timing, and the logistics to complete the work , most of which were unforeseen at the beginning of the year.

The current environment, with higher interest charges, has negatively impacted earnings, but the diluted earnings per share were 0.96 per share, with a 10.5% growth on a year-to-date basis, showing the continued effectiveness and steady growth even in this uncertain environment.

There are several reasons to invest in utilities during a market downturn. One reason is that utility companies are typically less affected by economic downturns than other types of companies. This is because people still need to use utilities even when they are cutting back on other expenses. Another reason to invest in utilities during a downturn is that they usually have high dividend yields. This means that you can earn a higher return on your investment, even if the stock price doesn't increase. We will continue to examine these reasons to consider Chesapeake next.

Income and dividend opportunities when investing in Chesapeake

Many investors look to utilities as a good income opportunity. Seeking Alpha gives Chesapeake an "A-" for both dividend safety and growth, but an "F" for yield. Seeking Alpha shows Chesapeake provides a low (for a utility stock!) dividend yield of 1.7% but a strong 10.01% five-year DGR. I've recently covered other utilities and thus far, Chesapeake provides a low yield relative to others, even other gas utilities, but a strong dividend growth rate. This suggests that buying at the right price may lead to a reasonable yield on cost for the long-term investor.

Chesapeake Utilities compared to its peers

For a comparison with peers, I am looking to see how Chesapeake stacks up both in terms of valuation and also investment opportunity and safety. I've selected a range of peers in gas utilities but also included more diversity here:

• New Jersey Resources Corporation ( NJR )
• Northwest Natural Holding Company ( NWN )
• ONE Gas, Inc. ( OGS )
• OPAL Fuels Inc. ( OPAL ); this pick is a little unusual, but I like the comparison with OPAL due to the focus on renewable natural gas.
• RGC Resources, Inc. ( RGCO )
• Suburban Propane Partners, L.P. ( SPH )
• Spire Inc. ( SR )

How does Chesapeake stack up to its peers in terms of valuation? It is richly valued - on Table 1 I have included the highest two options in bold for each of the metrics. While I acknowledge OPAL is a relatively different company, showing up as the highest in each category, Chesapeake remains the second highest in terms of Price/Book and Price/Sales (LTM). For the EV/EBITDA valuation, Chesapeake remains higher than the average value. Also, it is worth noting that Seeking Alpha gives Chesapeake a "D-" valuation grade.

Table 1. Chesapeake vs peers showing relative valuations

Source: Author, with data from Finbox.io

While Chesapeake looks richly valued, it does not seem unwarranted. Table 2 provides some insight into dividends and a few financial stability measures. Considering the income opportunities, Chesapeake provides the lowest dividend yield but the second-highest dividend CAGR. However, when we look at the ROIC, it comes in above average and a reasonable value. Further, they have a good interest coverage ratio, higher than these peers, and the lowest Debt/Common Equity ratio, and a respectable Piotroski Score of 6. These values suggest that, while richly valued, Chesapeake can provide some stability and security.

Table 2. Chesapeake vs peers in terms of dividends and financial stability

Source: Author, with data from Finbox.io

Valuation for Chesapeake Utilities and the investment opportunity

When I look to assess investment opportunities and the impact of the present valuations, I often turn to FAST Graphs. The software uses the analysts' estimates of earnings coupled with a target P/E multiple to assess likely returns if prices achieve the particular multiple at a point in time. The calculation function then provides an estimated price and, based on this, the rate of return. To be useful, we need both a reasonable estimate of what the P/E multiple should be and accurate analysts' estimates.

The FAST Graphs' analyst scorecard shows that the analysts' two-year forward estimate (with a 20% margin for error) is a hit 92% of the time, a beat 8% of the time, with no misses. The one-year forward estimate is a beat 23% of the time, a hit 77% of the time, with no misses. The analysts' accuracy is a testament to the effectiveness and stability provided by this investment opportunity. We can also examine the lower panel in Figure 1 to get an insight into how the analysts' consensus estimate has changed over the last six months; we see that there is stability in the estimates, again providing an indication of the reliability of the earnings estimates.

To evaluate the potential returns, we can use the FAST Graphs forecasting calculator (Figure 1). If we take the end of 2024 as the target, and consider the valuation assessments provided earlier (which are rich), we can select a more reasonable P/E multiple we might expect in 2024. Given that Chesapeake is, in my mind, a well-run utility, I've opted to use what I think is a generous 19.5x P/E as a target for 2024. The 'normalized' P/E provided by FAST Graphs of 24.86x, as achieved over the last five years, appears too high. A 15x would undervalue this solid utility.

I could make an argument for an 18x P/E in 2024, and this would give a total rate of return of -11.9% or an annualized RoR of -5.4% (Source: FAST Graphs forecasting calculators).

As a check, Finbox.io reports seven analysts following Chesapeake with an average target of $141.86 and a range from $126 (also the present price) through to $162. Given the consistently optimistic nature of the analysts' targets and taking the lower end of the range as a reasonable target, it suggests that the present price is 'about right.'

New investors may want to focus on waiting for a better entry at a lower price, where they will receive a higher dividend yield and have more upside over time. Entering at a lower price will enable the investor to more fully grow their investment as the company grows its earnings.

A summary of my thoughts on Chesapeake Utilities

I have included a summary section that might be useful when my thoughts were for a Hold or tentatively edging into a Buy or Sell.

Business: Very solid, good financial position, operating in regulated markets. Should compound and grow steadily over time.

Valuation: no margin of safety; richly valued. No real opportunity here for upside. If P/E multiples return to more reasonable levels, this will deliver capital losses. Presently at the lower end of analysts' price targets, representing a fair value.

Financial safety: Secure financial position and operations in regulated sectors.

Dividend: A low 1.7% yield is about the market average; they have guided dividend raises as continuing to be strong. Good dividend coverage and security.

Catalysts: none apparent.

My investment thesis for Chesapeake Utilities

I started the analysis and article with the perspective that this would be a solid Hold. However, while my analysis has confirmed my belief about the quality of the investment opportunity in Chesapeake, I find the present valuation too high.

For these reasons, I suggest investors already in Chesapeake Utilities continue to Hold their investment.

For those investors looking to start a position, consider adding Chesapeake to the watch list and look to enter at lower values.

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