Vertically integrated across the natural gas sector, National Fuel Gas Company (NFG) doesn’t fit into just one sub-sector. Its four reporting segments span upstream to downstream:
*exploration and production (Seneca Resources);
*pipeline and storage (National Fuel Gas Supply and Empire Pipeline);
*gathering (National Fuel Gas Midstream);
*utility (National Fuel Gas Distribution).
NFG has an off-cycle financial reporting schedule, albeit one that makes sense for natural gas demand, which peaks in the winter and summer. The company’s fourth quarter ends in September; its March 2020 financials thus marked six-month or half-year results.
The company’s dividend yield is 4.1%, good especially when compared to competitors. Its vertical integration, including midstream and utility operations, gives it a buffer against changeable natural gas prices. The company has strong governance ratings, also different from some of its competitors.
NFG will close an additional 3.8 million share offering on Tuesday, June 2, 2020 priced at $39.50/share. Its price on June 1, 2020, was $42.52/share.
Acquisition and Guidance
*710 billion cubic feet (BCF) of developed producing reserves with net production of 215-230 million cubic feet per day (MMCF/D);
*142 miles of gathering pipelines, compression, and related facilities;
*over 400,000 net acres across Pennsylvania, 200,000 of which are highly prospective;
*about 300 MMCF/D of firm transportation capacity.
These assets are expected to generate about $125 million in incremental EBITDA in the year following closing, based on existing hedge portfolio, $2.50/MMBTU natural gas prices, and $25.00/barrel oil prices (West Texas Intermediate).
NFG’s guidance for its fiscal 2020 production (October 1, 2019-September 30, 2020) is 245-255 BCF (680-700 MMCF/D) and lower lease operating and administrative expenses of $0.84-0.87/MCF and $0.26-0.28/MCF, respectively. The company has also updated its fiscal year earnings guidance by about $0.05/share to $2.80-3.00/share.
The macro environment comprises several cross currents.
First, pandemic shut-ins in the U.S. and globally reduced natural gas demand, reduced demand for liquefied natural gas (LNG) exports, and reduced demand slightly for (natural gas-fired) electricity.
Second, an oil price war decreased the price for LNG because outside the U.S., LNG prices are tied to oil prices. Thus lower demand and lower prices have combined to reduce U.S. exports of LNG, which has otherwise acted as something of a safety valve for U.S. gas oversupply.
Third, in the first quarter of 2020 (the company’s second quarter for financial reporting), National Fuel Gas suffered the same challenging circumstances as other Appalachian gas companies: too much supply exacerbated by a warmer-than-normal winter (winter is the major demand season for natural gas) and much more associated natural gas from the Permian and Bakken oil basins.
However, an offset is that since a sizeable percentage of natural gas is “force-produced” with oil (as associated gas), temporarily reduced U.S. oil production has reduced the volumes of associated natural gas. This effect appears to be quickly attenuating, however, with Marcellus production increasing again to replace it.
The gas market has been improving somewhat due to increasing substitution of natural gas for coal in utilities, such that gas use now outweighs coal. The charts show that gas and renewables growth offset declining coal use starting in about 2015.
Detail for understanding: Million British Thermal Units (MMBTU) and thousand cubic feet of gas (MCF) are same for standard-quality gas, in which one thousand cubic feet contains one million BTUs.
Quarterly and 6-Month Results
In NFG’s second quarter (January-March 2020), its net loss was -$106.1 million, or -$1.23/share, compared to net income of $90.6 million for the same quarter a year ago. For 2020, the difference includes a net -$129.3 million impairment for oil and gas properties and a -$56.8 million deferred tax valuation allowance.
For the six months ended March 30, 2020, NFG’s GAAP net loss was -$19.5 million due to these same items. For the six months ended March 30, 2019, NFG’s GAAP net income was $193.2 million.
Adding back these items gives adjusted operating results of $84.2 million for the quarter, compared to $92.9 million for the same quarter a year ago. Similarly, six-month operating results for the period ending March 30, 2020, are $171.6 million, compared to $190.4 million for the six-month period ending March 30, 2019.
Adjusted EBITDA for the quarter, a non-GAAP measure, was $231.1 million, a slight increase from the same quarter a year ago.
The company’s average natural gas prices were $2.12/MCF, lower by $0.46/MCF from a year ago. About 2.7 billion cubic feet of production was curtailed due to low Appalachian natural gas prices. Thus production was 59.8 BCF-equivalent (includes some oil) or 664 million cubic feet equivalent/day for the quarter (MMCFe/D).
The chart below gives the January-March 2020 snapshot of NFG’s adjusted EBITDA by segment.
(Note that the following are based on NFG’s reserves in October 2019 and do not include the recent Shell acquisition.)
National Fuel Gas, through its Seneca Resources Company, has total proved reserves of 24.9 million barrels of central California heavy oil and 2.9 trillion cubic feet of Marcellus and Utica (Pennsylvania) gas.
The SEC PV-10 value of the future revenue of company’s proved developed and undeveloped reserves at October 21, 2019, was $2.16 billion. This value derives from an oil price of $64.73/barrel and a natural gas price of $2.42/MCF. It does not include production costs, and as noted, does not include the recent Shell asset acquisition.
U.S. Gas Production and Prices
The June 1, 2020, natural gas price was $1.78/MMBTU at Henry Hub, Louisiana.
Meanwhile, the recent price for Marcellus natural gas at Tennessee Zone 4 was $1.38/MMBTU, a difference of $0.40/MMBTU. The price at the Dominion South hub, also a benchmark for Appalachian supply, was $1.46/MMBTU. Earlier this year, when prices were lower, producers – including NFG – shut in some production and may have to do so again.
The Energy Information Administration (EIA) in its May 2020 Short-Term Energy Outlook noted U.S. dry natural gas production is predicted to average 89.8 BCF/D in 2020, but that due to pandemic-caused manufacturing closings, U.S. consumption will be less at 81.7 BCF/D. While LNG exports took up some slack in early 2020, as noted they too are now down.
The EIA projects Appalachian (Marcellus and Utica) volumes to be 32.6 BCF/day in June 2020.
The map below illustrates the Marcellus formation.
Credit: The Penn State Marcellus Center for Outreach and Research
In the Marcellus, gas-producing competitors also include Antero Resources (AR), Chesapeake (CHK), CNX Resources (CNX), Range Resources (RRC) and Southwestern Energy (SWN). The challenges these companies face can be seen not only in Shell’s sale of its assets to NFG, but also:
*Chesapeake is considered to be near bankruptcy; and
*Chevron’s (CVX) $10 billion 2019 write-down reflected in part a much lower valuation of its Appalachian gas assets.
Like Cabot Oil & Gas, with experience and ownership of infrastructure (gathering, pipelines, and storage) and its own gas utility, National Fuel Gas is better able to sell its natural gas than other producers.
As of December 5, 2019, Institutional Shareholder Services ranked NFG’s overall governance as a 2, with sub-scores of audit (2), board (4), shareholder rights (2), and compensation (2). In this ranking, a 1 indicates lower governance risk and a 10 indicates higher governance risk.
At May 15, 2020, shorts were 4.55% of the stock float. Insiders owned 2.3%.
The company’s most recent beta of 0.66 suggests the stock price moves with the market but less sharply.
Financial and Stock Highlights
With National Fuel Gas’s June 1, 2020, closing stock price of $42.52/share, its market capitalization is $3.68 billion.
Given a 52-week price range of $31.58-55.98/share, the June 1, 2020, price is 76% of the one-year high. The company’s one-year average analyst target price is $44.75/share, putting its most recent price at 95% of that level.
Trailing twelve months’ earnings per share (EPS) was $1.05, giving a high trailing price-earnings (P/E) ratio of 40. However, this low earnings number includes non-cash effects of reserves impairment described above.
The company’s guidance for its October 2019-September 2020 EPS is $2.90, for a forward P/E of 14.7.
Trailing twelve months’ operating cash flow was $745 million and levered free cash flow was -$313 million.
At March 30, 2020, the company had $4.63 billion in liabilities and $6.71 billion in assets, giving NFG a liability-to-asset ratio of 69%. The long-term debt net of the current portion is $2.13 billion.
Overall, the company’s mean analyst rating from seven analysts is 2.7, closer to “hold” than “buy.”
At March 30, 2020, NFG’s stock was held by institutions, some of which represent index fund investments that match the overall market. The seven largest institutional holders were State Street (NYSE:STT) (10.6%), Vanguard (9.8%), BlackRock (NYSE:BLK) (9.7%), JPMorgan Chase (NYSE:JPM) (5.1%), and three companies with between 3.4% and 3.7%: Gabelli Funds, Lsv Management, and Invesco.
A Note on Valuation
The company’s book value per share of $24.03, well below its current market price, suggests positive investor sentiment.
With an enterprise value $5.98 billion, NFG’s EV/EBITDA ratio is 7.7, below the preferred ratio of 10 or less and thus indicating a bargain.
Positive and Negative Risks
Potential investors should consider their gas price, gas supply competition, and future Northeast gas market demand expectations as the factors likely to affect National Fuel Gas.
The biggest negative risk is the worldwide energy demand contraction, and the pace and extent of recovery from the coronavirus pandemic shutdowns.
The company also has a relatively steep liability-to-asset ratio.
Recommendations for National Fuel Gas
I recommend that dividend investors and those interested in moderate growth consider buying National Fuel Gas. Although in the challenging Marcellus gas business, its operations are well-positioned with upstream, midstream, and downstream – including a utility – segments. The timely purchase of Shell’s Appalachian assets is also a good strategic fit.
The company’s governance ratings are strong and it offers a 4.1% dividend.
NFG will close an additional 3.8 million share offering on Tuesday, June 2, 2020, priced at $39.50/share. Its price on June 1, 2020, was $42.52/share.
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Disclosure: I am/we are long CVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.