NJR - New Jersey Resources: Rate Base Expansion Key To Sustained Dividend

2023-08-16 15:06:40 ET

Summary

• I discuss the valuation and financials of New Jersey Resources, including a general overview and comparable companies' valuation.
• I highlight the importance of cost efficiency and scalability in the company's value proposition.
• The article also mentions the Wall Street consensus and discusses the risks and challenges the company may face.

New Jersey Resources ( NJR ) is a New Jersey-based energy services firm with operations across natural gas, renewables and electricity, and other energy services.

Through these activities, NJR has achieved Q3'23 revenues of $251.43mn - a 54.43% decline - alongside a net income of $1.53mn - an 88.26% decline - and a free cash flow of - 125.98mn - a 3.30% decline.

Introduction

Although NJR has seen reduced revenue and earnings in the past quarter, likely due to rising interest rates and reduced non-utility revenues - a derivative of falling natural gas prices - the company has issued highly positive forward guidance, projecting a net EPS of $2.62-$2.72 for FY23, at an annualized growth target of 7-9%.

To accomplish this, NJR has dedicated itself to four primary operational efforts; the firm seeks to drive capital efficiency and manage its expense base to achieve FY23 guidance, seeks to achieve long-run growth through accretive infrastructure investments, apply a defined and disciplined capital plan, and move towards organic growth opportunities, extracting maximal value from existing assets.

The combined value achieved through the firm's long-run strategy, combined with a general undervaluation and its alignment with government agencies leads me to rate NJR a 'buy'.

However, this rating is contingent upon NJR's ability to bounce back from poor earnings.

Valuation & Financials

General Overview

In the TTM period, NJR's stock - down 7.62% - has experienced middling price action between the SPDR Utilities Index ( XLU ) - down 17.19% - and the broader market, as represented by the S&P 500 ( SPY ) - up 4.49%.

I believe the underperformance of utilities is a product of the inverse convexity the sector has with interest rates since higher-rate bonds offer superior risk-adjusted returns.

On the flipside, NJR's relative outperformance to the rest of the utility industry is a testament to the operational strength of the stock and resilience it maintains, as the premiere utility for New Jersey.

Comparable Companies

The US utility industry remains highly fragmented, with each utility specialized for a certain kind of service - i.e. residential or commercial, natural gas or electric - and regionally consolidated as natural monopolies. As such, rather than compare NJR to direct competitors in the Northeast, I sought to compare the company with similarly sized utilities. This group includes Tulsa, Oklahoma-based natural gas pure play, ONE Gas ( OGS ), Las Vegas, Nevada-based servicer, Southwest Gas ( SWX ), Toronto, Canada-based infrastructure group, Brookfield Infrastructure Partners ( BIP ), and King of Prussia, Pennsylvania-based multi-utility, UGI Corporation ( UGI ).

As demonstrated above, over the previous quarter, NJR has experienced the second-poorest price action among peers, though the firm was already buoyed by the best YoY price movement. Despite this, I believe NJR has room to grow when assessing the firm on a multiples basis, on its ability to grow, and its ability to return capital to shareholders.

For instance, NJR maintains the second-lowest trailing and forward P/E ratios. Alongside outsized growth capabilities, exemplified by the company's best-in-class earnings growth, ROE, and second-best ROA and PEG, the firm is better positioned to serve shareholders.

And NJR is successful in the latter endeavor, recording a sector-averaging 3.56% dividend on the back of a pragmatic payout ratio while sustaining the joint-second-highest 5Y trailing dividend growth rate.

Valuation

According to my discounted cash flow valuation, at its base case, the net present value for NJR is $46.62, meaning, at its current price of $42.71, the stock is undervalued by ~8%.

My model, calculated over 5 years without built-in perpetual growth assumes a discount rate of 10%, incorporating NJR's higher debt levels and industry averaging equity risk premium. To remain conservative, I estimated an average forward revenue growth rate of 6%, lower than the smoothed-out trailing 5Y rate of 7.88%.

Alpha Spread's relative valuation tool more than supports my thesis of undervaluation, estimating a base case relative valuation of $80.27, meaning the stock is undervalued by 46%.

However, Alpha Spread's valuation model fails to accurately represent the equity risk associated with NJR and does not account for higher debt levels.

As such, taking a weighted average - skewed toward my DCF - of my net present value and Alpha Spread's relative valuation, the fair value of NJR is $54.63, with the stock undervalued by ~22%.

Cost Efficiency and Scalability Remain Core to Value Proposition

For sustained growth, NJR continues to focus on a prudent capital deployment strategy which balances organic growth, inorganic growth, capital return to shareholders, and a level of deleveraging. This strategy boils down to increased consumer acquisition at an efficient cost and greater revenue extraction from consumers. Feeding into this is NJR's rate base growth strategy, which seeks to slowly increase utility costs without seeing reductions in utility usage.

With the latter dynamic in play, NJR aims to align itself with the macroeconomic and broader energy landscape of New Jersey. For instance, New Jersey's 'Energy Master Plan' sought the use, management, and development of renewable energy in New Jersey, while EO 317 aims to reduce natural gas-related emissions. Through its SAVEGREEN initiative, among others, NJR has worked towards the simultaneous fulfillment of these targets and margin expansion, maximizing energy efficiency and conservation in the process.

Wall Street Consensus

Analysts seem to generally support my positive opinion on NJR, projecting an average 1Y price target of $51.50, a 19.05% increase.

Even at the minimum estimated price target of $47.00, investors would see 8.65% price growth, netting even more when incorporating a dividend.

This reflects Wall Street opinions that the market has overreacted to temporary headwinds to natural gas prices and interest rate rises.

Risks & Challenges

Rising Interest Rates Continue to Threaten Value Proposition

Even on an operational level, with a relatively high debt/equity, NJR is exposed to a wider and more volatile expense base as interest rates rise. Beyond that, on an equity price level, NJR's price continues to be compressed as interest rates remain sticky since investors can expect superior risk-adjusted returns from fixed-coupon bonds. As such, rising or sticky interest rates are a fundamental risk for investors, especially in terms of the appreciation/depreciation of the stock.

NJR Remains Sensitive to Commodity Prices

As demonstrated in the trailing two quarters, which have seen significant revenue and free cash flow declines, NJR remains highly dependent on natural gas as a source of income. Therefore, investors may be privy to large-scale volatility given the movement of natural gas futures and on the basis of macro or black swan events which affect the said market.

Conclusion

Looking forward, NJR remains discounted, with potential for price reversion supported by the company's disciplined capital deployment and rate base plans.

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