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Valuation Corner UGI

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Valuation Corner: UGI Corporation

Bob Ciura Mar 29, 2017


The utility sector is a very good source of reliable dividend stocks. Utilities have one of the most consistent, recession-resistant business models in the entire economy. Consumers always need to keep the lights on and the electricity running, even when the U.S. economy enters recession. This helps utilities continue to generate steady profits each year, which in turn allows them to raise their dividends regularly.


UGI Corporation (UGI ) is a utility stock with several unique characteristics. It has a lower current dividend yield than most utility stocks, but it makes up for this with a long track record of dividend growth.

The company also generates a higher growth rate than the utility sector as a whole. UGI stock is also currently undervalued. This means investors looking for a blend of value and income should consider adding UGI to their equity portfolios.


Fundamental Review


UGI operates in the utility sector. It has a diversified business model. Through various subsidiaries, UGI is an energy distributor and marketer. It has a natural gas and electric utility business in Pennsylvania, it distributes propane in the U.S. and in international markets, it has a midstream energy and electric generation business, and it has an energy marketing business.

UGI is also the sole General Partner and owns 26% of AmeriGas Partners, L.P. (APU), the largest retail propane distributor in the U.S.

UGI Utilities, Inc. operates a regulated natural gas distribution business, with over 620,000 customers in Pennsylvania, through a distribution system of approximately 12,000 miles of gas mains. UGI International distributes more than 820 million gallons of liquefied petroleum gases (LPG) in 16 European countries. Finally, UGI Energy Services sells natural gas and electricity to residential and business customers in 10 U.S. states, through ownership of underground natural gas storage assets and pipelines.

2016 was another year of steady growth for the company. UGI reported adjusted earnings-per-share of $2.05, up 2% from the previous year. The company successfully grew earnings, even though total revenue declined 15% in 2016. UGI was able to increase earnings-per-share because of significant cost cuts. Profitability expanded, particularly in the UGI International business, which grew operating profit by 83% in 2016.


Growth Catalysts


The strong results continued into the first quarter of 2017. Adjusted earnings-per-share soared 42% year over year. One of the biggest catalysts for this growth was favorable weather, as cold conditions spread across most of the U.S. in the first quarter. The company also benefited from strategic investments placed in 2016.

The ability to raise rates has been one of the major growth catalysts for UGI in recent years. Its core utility subsidiary is a regulated business, which means that the company enjoys annual rate increase approvals from regulators.

Another growth catalyst moving forward is customer additions, which the company generates organically and through acquisition. Last year, UGI Utilities added 16,000 heating customers. UGI also acquired France-based Finagaz in 2015, for approximately $456 million. The acquisition nearly doubled UGI’s retail distribution in France, to approximately 500 million gallons each year.

Lastly, lower capital spending will help boost UGI’s earnings. 2016 was one of the most aggressive years of investment in the company’s history. Now that these strategic investments have been placed, the company will not have to spend as much going forward. This has already starting to happen; UGI’s capital expenditures declined 6% in the first quarter of 2017.

For 2017, UGI expects to generate adjusted earnings-per-share of $2.30 to $2.45. At the midpoint of guidance, the company forecasts 16% earnings growth in 2017. This would be plenty of growth to continue increasing the dividend, and could result in a higher valuation as well.


Valuation


UGI’s future returns will be mostly comprised of earnings growth and dividends. That said, UGI stock could also provide positive future returns, from an expanding valuation multiple. Based on its current valuation, UGI stock appears to be undervalued, using the Dividend Discount Model. UGI stock trades for a price-to-earnings ratio of 20. It seems to be undervalued, relative to the broader S&P 500 Index, which has an average price-to-earnings ratio of 26.

Assuming a risk-free rate of 2.44%, which corresponds to the yield on the 10-year U.S. Treasury Bond, 7.5% projected annual dividend growth and a beta of 0.68, the estimated fair value of UGI stock is $55.88 per share. Based on the most recent closing share price of $49.45 per share, the Dividend Discount Model analysis indicates UGI shares are currently undervalued by approximately 13%.

As a result, the stock appears to be undervalued, based on the discounted present value of estimated future dividend payments. This leaves the possibility that UGI stock will experience a further expansion of its price-to-earnings multiple, which would meaningfully boost total returns moving forward.


Dividend Analysis


UGI has an excellent dividend history. The company has paid common dividends for the past 132 consecutive years. This means it has paid dividends to shareholders since 1885. UGI is also a strong dividend growth stock. It has raised its dividend in each of the last 29 years. This makes UGI a member of the Dividend Aristocrats, an exclusive club that includes stocks with at least 25 consecutive years of annual dividend growth.

UGI currently pays a quarterly dividend of $0.2375 per share. On an annualized basis, its dividend payout is $0.95 per share. The stock has a current dividend yield of 2%, which is right on par with the average dividend yield of the S&P 500 Index.

UGI has an average dividend yield, but it is an above-average dividend growth stock. Over the past five years, the company raised its dividend by 6.5% compounded annually, including a 4.4% dividend increase in 2016. The company has kept its dividend steady for the past four quarterly payments, which means another dividend increase is likely over the next few weeks.


The Bottom Line


Utilities are relied upon for predictable earnings, steady growth and reliable dividends. UGI is a good example of a utility that offers these benefits. The current environment for UGI is challenging, as revenue is declining, and interest rates are poised to rise further in 2017 and beyond.

That said, the company should continue to grow earnings, thanks to effective cost controls. Greater investments in modernizing its assets should also help increase efficiencies. These qualities make UGI an attractive stock pick for a mix of growth, value and income.

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