Tim Winter, CFA
Gabelli & Company
On August 5, Southwest Gas Corp. (SWX) reported second quarter earnings of $0.21 per share (includes $0.05 of corporate owned life insurance proceeds, or COLI) vs. $0.22 per share (includes $0.04 of COLI proceeds) last year. Excluding COLI, earnings were $0.16 per share versus $0.18 per share.
The gas utility earned $1.8 million in the second quarter compared to $2.0 million last year, as higher customer growth (+28,000 customers) was offset by the need for California rate relief, higher operations & maintenance, depreciation and interest expense.
NPL Construction Co.’s contribution was $7.8 million, or $0.17 per share, compared with $8.1 million, or $0.17 per share, last year driven by the ongoing effect of the harsh winter weather in April and higher expenses to necessary to meet contract obligations.
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Over the trailing 12 months, SWX earned $2.88 per share compared to $3.19 per share for the previous 12-month period, including a decline in the utility contribution to $2.50 per share from $2.61 per share. NPL’s contribution declined to $0.37 per share from $0.58 per share as a result of weather-related delays. Lower utility earnings were due to higher O&M, depreciation and interest expense, as well as the ongoing delay in the California rate case.
In June, SWX was authorized to raise California rates by $7.1 million annually based on a 10.1% return on equity and 55% common equity ratio. SWX had filed the rate request in December 2012.
We lowered our 2014 earnings estimate to $3.05 per share, from $3.15 per share, to reflect a -$0.10 per share lower NPL contribution. SWX remains cautiously optimistic that NPL will meet or exceed its 2013 results of $0.45 per share and grow at 5-8% annually. NPL is one of the premier pipeline replacement contractors in the nation, and we believe the pipeline replacement cycle remains in its “early innings” of a long ballgame.
Our 2015 and 2016 earnings estimates remain $3.25 and $3.40 per share, respectively. We expect healthy gas utility growth to continue driven by rate increases, decoupling mechanisms, expanded infrastructure tracking mechanisms, customer growth and cost controls. In addition, SWX expects to implement a $9 million annual rate increase in September 2014 for its Paiute Pipeline and expand the Federal Energy Regulatory Commission-regulated pipeline.
Over 2014-2016, SWX plans gas-utility investment of $1.1 billion, including $375 million in 2014. Management also outlined further growth projects, including the potential $35 million expansion of the Paiute Pipeline with a targeted in-service date is November 2015.
SWX is also seeking approval for a $55 million, 230,000-dekatherm LNG storage facility from the American Chemistry Council. A decision is expected in 2014 and construction would be completed in 24-30 months.
SWX shares trade at 15.6 times and 14.6 times our 2014 and 2015 earnings estimates, compared to the gas utility distribution group multiples of 18.4 times and 18.2 times, respectively.
On an enterprise value/EBITDA basis, SWX appears inexpensive at 6.7 times and 6.7 times our 2014 and 2015 estimates. SWX’s common equity ratio is a strong 55%, which compares to 41% five years ago, and S&P rates SWX’s credit A-. Shares offer a current return of 3.1% on the $1.46 annual dividend, which we consider secure and growing.
Given a 48% payout ratio of our 2014 earnings estimate and reasonable capital budget, we expect well-above average annual dividend growth to continue. Our 2014 and 2015 private market values (PMVs) are $65 and $68 per share, respectively, using a 9.0 times multiple for the utility and a 5.5 times multiple for the construction company. Risks to our investment thesis include poor regulatory decisions, continued economic weakness and/or a material rise in interest rates
Christopher Sighinolfi, CFA