Demand for natural gas in 2021 is likely to drop per the latest report by the U.S. Energy Information Administration (“EIA”) but we expect the benefits of natural gas usage to continue to drive stocks in the Zacks
Utility Gas Distribution industry. Despite the uncertainty caused by the Delta variant, we expect demand for natural gas to recover as we gradually move toward 2022, with vaccines being systematically administered in the United States and an increase in industrial and commercial activities. These distribution companies offer services to transport natural gas from the region of production to millions of consumers across the United States. ONEOK Inc. ( OKE Quick Quote OKE - Free Report) with its widespread infrastructure in key production areas and long-term, fee-based commitments is poised to benefit when natural gas production volumes increase to touch normal levels. Steady investments and expanding infrastructure in key production regions will drive the performance of UGI Corporation (), UGI Quick Quote UGI - Free Report) MDU Resources Group Inc. ( MDU Quick Quote MDU - Free Report) , and Southwest Gas Corporation ( SWX Quick Quote SWX - Free Report) . About the Industry
The shale revolution has substantially increased natural gas production. Its clean-burning nature is steadily boosting demand for natural gas in the electric power, industrial, commercial, and residential markets. Natural Gas distribution pipelines play a vital role in delivering natural gas from intrastate and interstate transmission pipelines to consumers through small-diameter pipelines. The natural gas network in the United States has nearly 3 million miles of pipeline that ensures steady supply to millions of customers across the United States. The primary concern for the distribution industry is aging infrastructure and substantial investment is required to upgrade and maintain the vast network of pipelines. In addition, competition from other clean sources of energy can lower demand for natural gas, consequently lowering demand for pipelines.
Factors Shaping the Future of the Gas Distribution Industry
: The recent short-term energy outlook released by the EIA indicates domestic natural gas consumption of 82.5 billion cubic feet per day (Bcf/d) for 2021, down 0.7 Bcf/d from 2020. The decline in consumption will be primarily due to rising natural gas prices that will adversely impact usage in electric power generation. Moreover, more than 90% of natural gas production in the Gulf of Mexico region went offline in late August due to Hurricane Ida, which further increased the price of natural gas. Per EIA, in 2021, the natural gas share in electricity generation is expected to drop to 35% from 39% in 2020. Per EIA, natural gas usage in the electric power sector is expected to further drop to 34% in 2022. The expected reduction in the consumption of natural gas would also dampen the demand for natural gas pipelines in the near term. Reduction in Consumption of Natural Gas by Electric Power Sector : The existing U.S. natural gas distribution pipelines are aging. Leakage or breakage in these old cast iron and bare steel pipelines may result in disruption of services. At present, natural gas distribution utilities provide services to over 75 million residential and 5 million commercial customers in the United States. Per a report from Business Roundtable, replacing the old pipelines will cost around $270 billion. To lower the possibility of interruption in services, the Department of Energy announced $33 million funding for 10 projects involved in natural gas pipeline retrofitting to rehabilitate existing old cast iron and bare steel pipes. The Rapid Encapsulation of Pipelines Avoiding Intensive Replacement or the REPAIR program will ensure the minimum extension of the service life of distribution pipelines by 50 years and lower the replacement cost of old pipelines by nearly 10 to 20 times per mile. At present, pipe excavation and replacement costs can go up to $10 million per mile. The current near-zero interest rate will assist utilities in sourcing funds for their capital projects at a cheaper rate. Aging Distribution Infrastructure : The clean-burning nature and wide availability across the United States are driving the demand for natural gas. Temporary obstacles like the outbreak of COVID-19 or price increases should not dampen the long-term prospects of natural gas. Hence, the distribution network should continue to play a major role in transporting natural gas to customers in all parts of the United States. The EIA expects U.S. natural gas production to increase from 92.7 Bcf/d in 2H21 to 95.4 Bcf/d in 2022. The demand for natural gas will continue to increase with the opening up of industrial and commercial activities and natural gas will play a pivotal role in the utilities’ gradual transition toward clean energy. So when the demand for natural gas increases, it will also create new opportunities for the natural gas pipeline operators. Scope for Fresh Investments Zacks Industry Rank Indicates Weak Prospects
Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak near-term prospects. The Zacks Utility Gas Distribution industry — a 16-stock group within the broader Zacks Utilities sector — currently carries a Zacks Industry Rank #161, which places it in the bottom 36% of the 252 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1. The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of a negative earnings outlook for the constituent companies in aggregate. The industry’s earnings estimate for 2022 has gone down by 11.1% in a year’s time. Before we present a few Gas Distribution stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture. Industry Lags S&P 500 But Beats Sector
The Gas Distribution industry has underperformed the Zacks S&P 500 composite but outperformed its own sector over the past year. The stocks in this industry have collectively returned 20% in the same time frame, while the Utility sector has gained 12.4%. The Zacks S&P 500 composite has gained 34.3% in the said period.
One Year Price Performance
Gas Distribution Industry's Current Valuation
Since utility companies have a lot of debt on their balance sheets, the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio is commonly used to value them.
The industry is currently trading at a trailing 12-month EV/EBITDA of 11.01X compared with the S&P 500’s 15.92X and the sector’s 18.57X. Over the past five years, the industry has traded as high as 14.99X, a low of 9.96X, and at the median of 12.61X. Utility Gas Industry vs S&P 500 ( Past 5 yrs) Utility Gas Industry vs Sector( Past 5 yrs)
4 Gas Distribution Stocks to Keep a Close Watch On
Below are four stocks that have been witnessing positive earnings estimate revisions and have returned higher than its industry’s growth of 0.1% in the past six months. All natural gas distribution stocks mentioned below presently carry a Zacks Rank #3 (Hold).
ONEOK Inc: This Tulsa, OK-based company is engaged in natural gas and natural gas liquids (“NGL”) businesses. The company will continue to gain from long-term, fee-based earnings contract and location of its assets in the highly productive regions of the United States. Courtesy of completed projects and 40,000 miles of NGL and natural gas pipelines in the most prolific U.S. shale basins, the company is well poised to gain traction once production volumes improve from the present levels. The Zacks Consensus Estimate for the company’s 2021 earnings has moved up 0.3% to $3.29 per share over the past 30 days. The current dividend yield of the company is 7.05%. In the past six months, the stock has gained 10.7%. Its long-term earnings growth (three to five years) rate is pegged at 6%. Price and Consensus: OKE UGI Corporation: This King of Prussia, PA-based company distributes, stores, transports, and markets energy products and related services through its subsidiaries. The company continues to expand its operation and customer base organically and through acquisitions. The consistent performance of the company has enabled it to reward its shareholders through a raise in annual dividend rates and share repurchase. The Zacks Consensus Estimate for the company’s fiscal 2021 earnings has moved 0.7% higher to $3.02 per share over the past 60 days. The current dividend yield of the company is 3.15%. In the past six months, the stock has gained 6.5%. The long-term earnings growth rate is pegged at 8%. Price and Consensus: UGI MDU Resources Group: This Bismarck, ND-based, company provides value-added natural resource products and related services that are essential for energy transportation, regulated energy delivery, and the construction materials and services business. Its two-platform business model, regulated energy delivery platform, and construction materials and services platform provide it an advantage over its peers. Its system is strategically located near four natural-gas-producing basins, making natural gas supplies available to its transportation and storage customers. It has plans to make a $508 million investment in the pipeline business over the next five years and strengthen its core operations. The Zacks Consensus Estimate for the company’s 2021 earnings has moved 1.9% higher to $2.12 per share over the past 60 days. The current dividend yield of the company is 2.76%. In the past six months, the stock has gained 0.3%. The long-term earnings growth rate is pegged at 6.94%. Price and Consensus: MDU Southwest Gas Corporation: This Las Vegas, NV-based company is involved in the sale, distribution, storage, and transportation of natural gas. For the 2021-2023 period, it expects to make investments worth $2.1 billion to strengthen its natural gas infrastructure and provide reliable services to its expanding customer base. The Zacks Consensus Estimate for the company’s 2021 earnings has moved 0.5% higher to $4.09 per share over the past 60 days. The current dividend yield of the company is 3.43%. In the past six months, the stock has gained 4.5%. Its long-term earnings growth rate is pegged at 5.5%. Price and Consensus: SWX