As of November, the early electric and natural gas company NiSource Inc. (NI.US) released its third-quarter 2022 results. As is the case with most utility companies, the company except for relatively slow growth year-over-year, which was generally in line with what analysts expected. The company is positioned to continue this growth into the future, which should allow it to continue to make a reasonable investment proposition to conservative investors who would normally buy public service companies, or "utilities" as they are also known. The market is currently showing great favoritism towards electric companies over natural gas ones. This is largely due to the belief that natural gas will soon become obsolete as a fuel source, but as we'll explain later, this belief has no basis in reality. When we combine all of this with a reasonably attractive valuation, we can see that NiSource could be a good core position in a conservative portfolio today.
Before we begin, let's lay out the key points from the company's earnings report before we dig deeper. So that we can establish background for the resulting analysis:
- NiSource reported total revenue of $1,089.5 million in the third quarter of 2022. This represents an increase of 13.56% from the $959.4 million the company reported in the prior-year quarter.
- The company reported an operating income of $156.7 million in the reporting period. This compares quite favorably to the $147.1 million the company reported in the prior-year quarter.
- KEY TO GROWTH ASSESSMENT: NiSource reiterated its plan to invest approximately $15 billion in its infrastructure from 2023 to 2027.
- The company reported operating cash flow of $129 million in the most recent quarter. This represents a 45.41% decrease from the $236.3 million the company reported in the equivalent quarter of last year.
- Net profit attributable to common shareholders of $52 million in the third quarter of 2022. This represents an increase of 5.26% over the $49.4 million that the company reported during the third quarter of 2021.
One of NiSource's defining characteristics is that the company tends to enjoy remarkably stable cash flows over time. We can see this reflected in these highlights, as both total revenue and net income showed year-over-year growth but admittedly not as strong as the growth we sometimes see in companies in other industries. The main reason for this overall stability is that the product that NiSource provides to its customers is generally considered a necessary and essential commodity to our modern way of life. After all, natural gas utilities are typically responsible for supplying most of the heating oil used by homes and businesses in their service area, something most people don't want to live without. Also, how many people would be willing to sacrifice having electricity in their homes? As such, people will typically prioritize paying their utility bills rather than spending money on discretionary expenses during periods of time when money is tight, or is going to be tight as is the current situation. This is something that often happens during recessions or periods of economic weakness, which is a pretty apt description of current conditions in the United States. Therefore, this quality is something that can attract potential investors.
We can also see the overall stability of the company over long periods of time. The following table shows the operating cash flow of the last twelve months of the company during the last quarters:
As we can see here, there is great stability from one period to the next. However, we typically see much more fluctuation when we look at individual quarters:
This is because the majority of NiSource's business is its natural gas utilities. The main use of natural gas is for heating large surfaces, so it tends to experience much higher consumption during the winter months. After all, heating isn't especially necessary during the summer in most of the United States. Consequently, revenues tend to drop significantly during the summer months, which affects the second and, above all, the recently completed third quarter of the year. In general, however, the company's cash flow tends to be much more stable when looking at any twelve month period, as clearly shown above.
However, as investors, we are not interested in mere stability. We like to see growth, and fortunately NiSource is positioned to deliver this growth. The way the company will do this is by increasing its fee base. The base rate is the value of the company's assets over which regulators allow it to earn a specific rate of return. Because the rate of return is a percentage, any increase in the rate basis allows the company to increase the price it charges its investors to earn and at least maintain that allowed rate of return. The usual way the utility can increase its rate base is by investing money in upgrading, modernizing, or possibly even expanding its utility-grade infrastructure. NiSource intends to do exactly this. As indicated in the highlights, the company plans to invest approximately $15 billion in its fee base over the period of 2023 to 2027:
We can see that most of the planned spending occurs in the early and mid-years, during which time a fairly significant percentage of spending will go to power generation. We will see this later. The important takeaway here is that this expense should be enough to allow the company to increase its earnings per share at a rate of 6% to 8% over the period. When we combine this with the current dividend yield of 3.64%, investors should expect a total annual return of 10-12%, which is very good for a conservatively based utility stock.
Also, one thing we've been hearing lately from politicians, activists, and the media is electrification. This process refers to the conversion of things that historically run on fossil fuels to use electricity instead. The most frequently cited areas for conversion are transportation (electric cars) and space heating, which is of course the largest use of utility-supplied natural gas. This is why some people have come to believe that natural gas utilities like NiSource will soon be obsolete. However, this scenario is highly unlikely to play out the way its instigators hope. The main reason for this is that natural gas is much more efficient than electricity in producing heat. As such, it is much more expensive to heat a building with electricity, even considering the increase in natural gas prices that we have seen over the course of this year. In fact, according to the Energy Information Administration (EIA), heating a home with electricity can cost up to four times (x4) more than with natural gas:
It seems highly unlikely that many people are willing to let their heating bills escalate to this point, not to mention the cost of replacing their current HVAC (Heating, ventilation, and air conditioning) system. This is especially true for people with limited resources or who live in cold climates. As such, we can conclude that the belief about the obsolescence of natural gas utilities is wrong. There is no point in avoiding NiSource simply based on that belief, as the company's business is not going anywhere.
Having said this, we see that the company is investing a significant sum of money in the generation of electricity. Mainly, it is investing in the construction of renewable generation plants as part of its goal to reduce its greenhouse gas emissions by 90% by 2030 and methane emissions by 50% by 2025 compared to 2005 levels. To that end, the company is retiring most of its coal-fired generating capacity by the end of the decade, but has begun construction on a number of renewable generation facilities to replace the plants already:
As we can see, the company has a number of projects in various stages of construction that are expected to come online by 2025. This seems unlikely to attract the incredibly wealthy environmental, social and governance (ESG) funds, though as a company natural gas utility, it still accounts for the majority of NiSource's revenues and profits. However, there are still likely some outsiders who think the company is making at least some effort to attract these funds.
One of the main reasons investors buy utility company stocks is because of the high yields these companies typically have on their dividends. In fact, NiSource is no exception to this, as the company's current 3.64% return is significantly higher than the S&P 500 (SPY) Index's 1.55% return. In addition to boasting above-market performance, NiSource also has a long history of increasing annual dividends:
The fact that the company increases its dividend annually is quite attractive in inflationary environments, such as the one we find ourselves in today. This is because inflation constantly reduces the amount of goods and services that we can buy with the dividend that the company pays (purchasing power). This can make it seem like the investor is getting poorer and poorer over time. The fact that the company increases the amount it pays helps to offset this somewhat and helps maintain the purchasing power of the dividends we receive from the company. However, as is always the case, it is critical that we make sure that the company can actually pay the dividend that it promises. After all, we don't want you to be forced to reverse the decision and suddenly cut the dividend, as that would reduce our income and most likely cause the stock price to fall.
The usual way a company's ability to pay its dividends is assessed is by looking at free cash flow. A company's free cash flow is the amount of money generated from its ordinary income that remains after the company pays all of its invoices and makes all necessary capital expenditures. This is the amount of money that is available to do things like reduce debt, buy back shares, or pay dividends. During the most recent twelve month period ending September 30, 2022, NiSource had negative leveraged free cash flow of $704.2 million. Obviously, this isn't enough to pay any dividends, but the company still paid out $427.5 million over the period. At first glance, this is worrying.
However, it is common for utility companies like NiSource to finance their capital expenditures by issuing equity and especially debt while paying the dividend from their operating cash flow. This is due to its overall stability and the incredibly high costs involved in building and maintaining utility-grade infrastructure over a wide geographic area. During the most recent twelve month period, NiSource had operating cash flow of $1,314.8 million. This was more than enough to cover the $427.5 million that was paid out in dividends with a lot of money left over for other purposes. Overall, this dividend appears to be quite safe, and investors should not worry about a haircut here.
Also, let us remember that in the United States, corporate debt increases the potential to do business and therefore, to generate profits. While for individuals taxes are levied on income, for companies taxes are levied on profits. Therefore, if the growth potential or generated growth in profits amply covers the interest payable (or coupons), the company will have made efficient use of leverage.
It is always essential that we do not overpay for any asset in our portfolios, it is the same for companies. This is because overpaying for any asset is a surefire way to underperform on that asset. In the case of a utility like NiSource, we can usually value it by looking at the growth ratio of its P/E ratio. This is a modified form of the familiar price-earnings ratio that takes into account growth in a company's earnings per share. A price to earnings growth ratio of less than x1.0 is a sign that the stock may be undervalued relative to the company's earnings per share growth and vice versa. However, very few stocks index as low in today's overheated market, so the best way to use this index is to compare the company against several of its competitors to see which offers the best relative valuation. attractive.
According to Zacks Investment Research, NiSource will grow its earnings per share at a rate of 6.82% over the next three to five years. This gives the stock a price to earnings growth (PEG) ratio of x2.61 at the current price. Here's how it stacks up against some of its peers:
As we can see, NiSource generally compares quite well with its competitors, being cheaper than all the companies here except Atmos Energy when earnings per share growth is considered. Therefore, an investor looking at these metrics will have NiSource in their crosshairs.
Technical analysis
NiSource (NI.US) has a positive behavior if we compare it with other sectors and has fallen from maximums to 30%. However, the good performance and investor sentiment during the months of October and November have allowed it to recover strongly and reach a key resistance zone.
However, this move has the potential to continue as its relative strength (RSI) is still far from the overbought extreme it showed at the most recent 3 highs, but more importantly from the overbought generated in April 2021 for some similar price levels.
Therefore, NiSource could have a movement closer to that seen in late 2021 (yellow rectangle), than described in the sideways range for most of 2021.
In conclusion, NiSource's latest earnings report went a long way to show us what we can typically expect from this company. It posted relatively modest year-over-year increases in revenue and profit and presented a plan that is likely to allow it to continue this growth in the future. Despite the noise about the disappearance of natural gas utilities in the near future, this is unlikely to happen and most likely people will continue to use natural gas for cooking and space heating inside their homes for many years to come. many years. When this is combined with a reasonably attractive dividend yield and valuation, we can see that NiSource looks like a solid opportunity for any utility investor.
Darío García, EFA
XTB Spain
