2023-12-15 09:37:53 ET
Summary
- UGI is a beaten-down utility company with an attractive valuation trading at a significant discount to peers and its own historical valuation.
- UGI's share price has dropped 60% since 2019 due to headwinds in AmeriGas, rising interest rates, and tax-loss selling. However, the core business segments Utilities and Midstream are performing well.
- UGI management is taking steps to address near-term challenges, including controlling costs, strengthening the balance sheet, and exploring strategic alternatives for AmeriGas.
- Stabilizing AmeriGas, deleveraging the balance sheet, and a potential sale of AmeriGas could all act as catalysts for a stock price rebound.
- I believe UGI trades back into the upper $20's by the Spring.
Mid December is my favorite time of year to look for bargains in the stock market, especially smaller capitalization companies in beaten down sectors, where the stock is in a multiyear downtrend. I often find bargains in companies where long time investors throw in the towel and indiscriminately sell for the tax loss.
One company that I've finally pulled the trigger on is UGI Corporation ( UGI ), a Pennsylvania based mostly-utility company that has been on an ugly ride from a high of $57 in 2019 to the current share price of $23.
With UGI dropping 60% since 2019, you'd think the business was a melting ice cube or earnings had fallen sharply. Despite headwinds in its domestic propane distribution business, it's anything but.
UGI FY22 to FY23 Earnings Bridge (UGI Q4 Investor Presentation)
The move from mid-upper $35+ in early 2023 to $23 now I believe is overdone, as everything but AmeriGas is performing well, including UGI International which had a flattish year despite a warm European winter.
While it's not all roses and sunshine in this story, I believe the move down is far overdone and UGI moves higher in 2024 once the tax loss selling has finished.
UGI Corporation Business Segments: My Views on Them
UGI Corporation has four main business segments: Natural Gas Utilities, Midstream & Marketing (focused in PA), Domestic LPG (AmeriGas), and European LPG (UGI International.)
UGI Adjusted Net Income by business (UGI 2023 10-K)
When analyzing the numbers, note that a big part of the Utilities jump in net income from 2021 to 2022 was inorganic and the result of UGI acquiring Mountaineer gas . Midstream has also made some smaller acquisitions since 2021, like the Pine Run system.
Utilities
Utilities EBIT Comparison (UGI Q4 Investor Presentation)
The business is defined in the latest 10-K as the following
The Utilities segment consists of the regulated natural gas (PA Gas Utility) and electric (Electric Utility) distribution businesses ... and the regulated natural gas distribution business of our indirect, wholly owned subsidiary, Mountaineer.
PA Gas Utility serves customers in eastern and central Pennsylvania and in portions of one Maryland county, and Mountaineer serves customers in West Virginia. Electric Utility serves customers in portions of Luzerne and Wyoming counties in northeastern Pennsylvania.
This regulated utility is the crown jewel of the four, in my opinion. Comparing it to a similar utility across the river in NJ, New Jersey Resources ( NJR ) we see how the overall UGI valuation has widely diverged from a peer.
Qualitatively, I'm bullish on the areas UGI services, especially the areas that border NJ and within the Philadelphia region. The nearest PA counties to Philadelphia (Chester, Montgomery, and lower Bucks) are getting priced out to many buyers and are pushing buyers further West, and I'm seeing new construction in these areas.
UGI PA Service Area (UGI Website)
PA offers great value in the North East with far lower taxes than NY, NJ, CT and other nearby states, and I think the growth in these areas continues.
Midstream & Marketing
Midstream EBIT Comparison (UGI Q4 Investor Presentation)
The 10-K describes this business as
The Midstream & Marketing segment consists of energy-related businesses conducted by our indirect, wholly owned subsidiary, Energy Services. These businesses (i) conduct energy marketing, including RNG, in the Mid-Atlantic region of the United States and California, (ii) own and operate natural gas liquefaction, storage and vaporization facilities and propane-air mixing assets, (iii) manage natural gas pipeline and storage contracts, (iv) develop, own and operate pipelines, gathering infrastructure and gas storage facilities in the Marcellus and Utica Shale regions of Pennsylvania, eastern Ohio, and the panhandle of West Virginia, own electricity generation facilities, and (vi) develop, own and operate RNG production facilities. Energy Services and its subsidiaries’ storage, LNG and portions of its midstream transmission operations are subject to regulation by the FERC.
UGI Midstream Assets (UGI December 2021 Investor Presentation)
Much of the assets support the PA delivery businesses and are focused on the Marcellus and Utica Shales, both prolific gas plays that should produce for a very long time and support the US's growing LNG and LPG export business.
It's difficult to find a pure play comp for this business. NuStar ( NS ) may be a least bad proxy. But considering EBIT grew 8.2% YoY, if this business were trading on its own, I suspect it would be flat at worse, and probably up a bit. It's done well especially considering the warmer weather.
Domestic LPG (AmeriGas)
If there is one business of the four that is responsible for most of the YoY share price decline, it's AmeriGas.
AmeriGas EBIT Comparison (UGI Q4 Investor Presentation)
The business description is straightforward
Our domestic propane distribution business is conducted through AmeriGas Propane. AmeriGas Propane serves nearly 1.2 million customers in all 50 states from approximately 1,380 propane distribution locations. Typically, propane distribution locations are in suburban and rural areas where natural gas is not readily available. Our local offices generally consist of operations facilities and propane storage
AmeriGas is down YoY primarily driven by OPEX increases, including driver shortages. It is also more levered than the rest of the business at between 5.2-5.3x (per the latest earnings call ) including having to issue $500 million of 9.375% Senior Notes due May 2028 this year. (Management believes they can get this below 5x by FY24 end.)
The higher leverage, complexity of the business, and earnings volatility are the reasons that UGI is considering strategic alternatives for the business.
While again not a direct comp, Suburban Propane Partners ( SPH ) is largely in the same business. I think SPH has executed better than AmeriGas and is less levered (4.3x versus 5.3x) but it is worth noting that they also saw EBITDA decline YoY and leverage increase for the same reasons.
SPH FY23 Operational Results (SPH Investor Presentation)
Yet SPH units are UP versus a large overall decline for UGI stock price. SPH units jumped in late September on no real news other than UGI's announcement! You can't make this stuff up sometimes.
AmeriGas EBITDA and FCF (UGI December Investor Presentation)
It's not all gloom and doom with AmeriGas. It's generated $1.5 billion in FCF over the past four years, which has been used to deleverage 15% and provide funding to UGI which has been reinvested in the Natural Gas businesses (and to pay dividends.) Depreciation is running higher than CapEx, so the business produces more cash flow than earnings, and CapEx should see a further step down to $100 million per management in 2024. The debt here is high, but I believe it's manageable.
If AmeriGas traded on its own, it would be down, possibly significantly. But it is still producing positive net income and cash flow. While UGI management is not pointing to an imminent turnaround for AmeriGas, I do see potential positives compared to last year
- The truck driver shortage should be less of an issue this year.
- Vehicle fuel, particularly diesel, is far cheaper now than last year at this time.
- Wholesale propane is even cheaper than last year and down considerably from 2022 levels which should be supportive for margins and could drive some incremental demand.
I think all of the bad news from AmeriGas is priced in at this point, and expectations are reset at a very low point. That leaves one direction to go, and short of an exceptionally warm winter in the US, "AmeriGas stabilizing" could be a big positive for UGI in 2024.
International LPG (UGI International)
UGI International EBIT Comparison (UGI Q4 Investor Presentation)
UGI International has a straightforward business description
UGI International, through its subsidiaries and affiliates, conducts an LPG distribution business in 17 countries throughout Europe (Austria, Belgium, the Czech Republic, Denmark, Finland, France, Hungary, Italy, Luxembourg, the Netherlands, Norway, Poland, Romania, Slovakia, Sweden, Switzerland and the United Kingdom).
Unlike AmeriGas, the shortfall from UGI International last year was from a warmer European winter.
EU Propane Feb24 Spot Price on 12-14-23 (Barchart/Argus)
European Propane prices are down 20% and down 40%+ from two years ago, which should be supportive of this business in FY24.
UGI International is still down from its 2021 performance, but could see a YoY boost in 2024.
Debt
Outside of AmeriGas (covered above) leverage at UGI is reasonable for a utility. They ended 2023 in the low 4's and are focused on getting to a sub-4 multiple in 2024.
UGI Debt Profile (UGI 2023 10-K)
There is a maturity wall in 2025 that they will need to deal with soon. The recent lower interest rates should help. After 2025, the debt is reasonably well termed out (it would be very well termed out without AmeriGas!)
UGI Debt Profile (UGI December 23 Investor Presentation)
Why I believe shares are down
Should shares of UGI by down this year? Probably.
Should they be down almost 50% from the start of the year? No. I think a 15% decrease would be more appropriate.
So why are shares down? I see a few reasons.
1. Multiple compression from higher interest rates
Higher interest rates negatively impacted most utility stocks this year.
Stable, slow growing utility companies that trade at 20x, have a low cost of capital, and pay out a 3% qualified dividend are a compelling investment in a 0% interest rate environment.
When 5 -year treasury rates yield 3.9%, they're less compelling, especially in tax advantaged accounts. Utility stocks are low risk, but not no risk, as we've seen with Hawaiian Electric ( HE ).
Higher interest rates are a double-negative for utilities as it both raises their cost of capital and lowers their attractiveness as investments. But, recent action shows this may be turning around, perhaps quickly.
2. Uncertainty and problems with AmeriGas
As described above.
3. Tax loss selling
UGI is down so much over the past five years that many people invested in the shares are sitting on a tax loss, in some cases, a sizable one.
With the market up 20% this year, I believe many investors are simply harvesting these tax losses and throwing in the towel.
Investors buy shares of conservative utilities to not lose money, so many will simply sell the "dog", take the loss and move on.
4. Confusion around adjusted earnings
UGI didn't "lose" $1.5 billion this year, in the same way that they didn't "make" $1.5 billion in 2021.
Most of this net loss was a non-cash fair valuation of derivatives it uses to lock in supply pricing. Effectively, this was reversing reported non-cash gains in prior years. Along with this, there was a non-cash goodwill impairment for AmeriGas.
UGI select Financial Results (UGI December 23 Investor Presentation)
Headline losses, even when they're non-cash and fully explained by the company, do not inspire confidence in many individual investors. They also can exclude companies from various earnings screens and other tools.
Valuation
As much as I'm wary of sum-of-the-parts (SOTP) valuation analysis, I believe it's an appropriate exercise here. Using 2023's earnings, which I believe are mid-cycle at worst, and assign the following after-tax earnings multiples, which I consider to be conservative
- 14x multiple to the Utility business ($3.1 billion)
- 10x multiple to the Midstream business ($1.9 billion)
- 8x multiple to UGI International ($1.4 billion)
- 5x multiple to AmeriGas, at likely an earnings bottom ($350 million)
Then haircut this another 10% to be even more conservative and account for a conglomerate discount, I get a valuation of $6.1 billion, or $28/share.
I believe this is a reasonable margin of safety.
Conclusion
UGI offers a compelling value proposition of a stable, dividend-paying utility stock with significant upside potential.
This is a good business with a long track record of growing earnings that has been hit with near term cost pressures and warm weather and is now trading at levels last seen in 2012 (UGI's COVID dead bottom tick was $24.18.). UGI earned $2.84 in 2023 and is guiding for roughly the same this year. It's rare that you see a utility trade under 8x earnings with a nearly 7% dividend, even if their earnings growth has stalled a bit.
UGI Earnings and Dividend History (UGI December 22 Investor Presentation)
I think Management is focused on the corrective actions and doing exactly what they should be doing:
- Investing in the Natural Gas business.
- Taking a hard look at controlling costs.
- Strengthening the balance sheet.
- Exploring a sale of AmeriGas.
From the last conference call:
We're also taking a hard look at our processes to identify inefficiencies and opportunities to reduce expenses. These efforts are currently underway with some actions already taken to help us with achieving 25% to 30% of the targeted cost savings in fiscal 2024. In totality, we are targeting permanent savings of approximately $70 million $100 million by the end of fiscal 2025.
Secondly, we are focused on strengthening the balance sheet to reduce leverage and provide more flexibility and capacity to make attractive growth investments. As a result, we have realigned our capital allocation plan to align with our strategic priorities.
Whatever issues there were with the weather and at AmeriGas were known back in May when shares were far higher. I see this as a good company that got hit with a double-whammy of a sector wide, interest rate driven selloff and tax loss selling.
The sector wide interest rate driven sell off is over and reversing, while the tax loss selling should be ending soon. While near-term headwinds remain, the company's strong fundamentals and management's actions position it for a rebound in 2024.
I think UGI trades back into the upper $20's by the Spring.
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