The production of natural gas in the United States is likely to increase year over year in 2023 per the latest report by the U.S. Energy Information Administration (“EIA”) and continue driving stocks in the Zacks Utility Gas Distribution industry. Distribution companies offer services to transport natural gas from the region of production to millions of consumers across the United States. Atmos Energy Corporation ATO, with its widespread transmission and distribution lines and interstate pipelines, and significant investments in infrastructure development projects, is poised to benefit as natural gas production volumes are expected to increase in the 2023-2024 time frame. Steady investments and expanding infrastructure in key production regions should drive the performance of MDU Resources Group MDU NewJersey Resources Corporation NJR, and Spire Inc. SR.
The shale revolution has substantially increased natural gas production. Its clean-burning nature is steadily boosting demand for natural gas from all customer groups. 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 pipelines. Major concerns for the industry are aging infrastructure and increasing investment costs required to upgrade and maintain the vast network of pipelines due to the hike in interest rates. Competition from other clean sources of energy can lower demand for natural gas, and, consequently for pipelines. The expected decline in natural gas consumption in first-quarter 2023 due to very mild temperatures may impact the distributors.
Factors Shaping the Future of the Gas Distribution Industry
Aging Distribution Infrastructure: 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 the disruption of services. At present, natural gas distribution utilities provide services to over 80 million 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 in 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 rising interest rates will increase the overall project financing cost for the utilities compared with what these companies have enjoyed in the past two years. Despite the efforts of utilities to upgrade pipelines, aging natural gas pipelines also resulted in a few accidents in 2022. Production and Export Volumes of Gas to Increase: The short-term energy outlook released by the EIA indicates that domestic dry natural gas production will grow 2.6% year over year to 100.67 billion cubic feet per day (Bcf/d) in 2023 and 1.01% year over year to 101.69 Bcf/d in 2024. EIA also expects U.S. natural gas consumption to drop 2.4% in 2023, primarily due to mild weather conditions lowering demand in residential and commercial sectors. Yet, export volumes are expected to increase in 2023 and 2024, providing much relief to natural gas transporters. EIA expects U.S. liquefied natural gas (LNG) export volumes to increase nearly 14% year over year to 12.07 Bcf/d in 2023. Export volumes are expected to improve by 5.5% year over year in 2024. The resumption of operations at Freeport LNG Export Terminal and a new export terminal becoming operational by the end of 2024, will all contribute toward an increase in export volumes. Fresh Investments Create Demand: The clean-burning nature and wide availability across the United States are driving demand for natural gas. The distribution network will continue to play a major role in transporting natural gas to nearly 75 million customers in all parts of the United States. With three new LNG export terminals being developed in the United States, there should be increased demand for natural gas pipeline services to transfer the gas from production areas to these terminals. Per EIA, once completed, the three new LNG projects will increase the combined export capacity by 5.7 Bcf/d by 2025. As production and demand for natural gas are increasing, more pipelines will be required to safely transfer the natural gas to end-users.
Zacks Industry Rank Indicates Dull Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. The Zacks Utility Gas Distribution industry — a 14-stock group within the broader Zacks Utilities sector — currently carries a Zacks Industry Rank #151, which places it in the bottom 39% of the 249 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. Since Mar 31, 2022, earnings estimates have gone down by 3.6% to $4.21 per share. 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 Beats S&P 500 and Sector
The Gas Distribution industry has outperformed the Zacks S&P 500 composite and its sector over the past year. The stocks in this industry have collectively lost 5.2% in the same time frame compared with the Utility sector and Zacks S&P 500 composite that have a wider decline of 8.5% and 13%, respectively.
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 10.33X compared with the S&P 500’s 11.8X and the sector’s 18.89X. Over the past five years, the industry has traded as high as 14.71X, a low of 9.10X, and at the median of 10.41X.
4 Gas Distribution Stocks to Keep a Close Watch On
Below are four stocks that have been witnessing positive earnings estimate revisions. Three out of the four natural gas distribution stocks mentioned below presently carry a Zacks Rank #2 (Buy). The other carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. Atmos Energy Corporation: This Dallas, TX-based company is engaged in the regulated natural gas distribution and storage business. Atmos Energy is planning to invest $15 billion from fiscal 2023 through 2027, out of which more than 85% will be allocated to enhance the safety of the existing operations.The stock currently carries a Zacks Rank #3. The Zacks Consensus Estimate for ATO’s fiscal 2023 earnings has moved 0.2% higher to $6 per share over the past 60 days. The current dividend yield of ATO is 2.64%. In the past year, the stock has lost 0.5%, narrower than the industry’s decline of 4.5%. The long-term earnings (three to five years) growth rate is pegged at 7.5%.
MDU Resources Group: This Bismarck, ND-based company provides value-added natural resource products and related services to its csustomers. The company has plans to make a capital investment of $3.5 billion over the five-year period from 2023 to 2027. The capital investment will support organic growth and strengthen its electric and natural gas transportation and distribution systems. The stock currently carries a Zacks Rank #2. The Zacks Consensus Estimate for MDU’s 2023 earnings indicates year-over-year growth of 13.9%. The current dividend yield of MDU is 2.97%. The long-term earnings growth rate is pegged at 5.99%. In the past year, the stock has gained 13.8%.
New Jersey Resources: This Wall, NJ-based company provides regulated gas distribution, and retail and wholesale energy services to its customers. New Jersey Resources has plans to invest $1.1-$1.4 billion in the fiscal 2023-2024 time period to strengthen its infrastructure. NJR’s strategic investments to expand natural gas transmission and distribution pipelines will allow it to cater to increasing demand from its expanding customer base. The stock currently carries a Zacks Rank #2. The Zacks Consensus Estimate for NJR’s fiscal 2023 earnings has moved 2.8% higher to $2.55 per share over the past 60 days. The current dividend yield of NJR is 3.1%. In the past year, the stock has gained 18.8%. Its long-term earnings growth rate is pegged at 6%.
Spire Inc.: This St. Louis, MO-based, natural gas company is efficiently serving more than 1.7 million customers in the United States. In the 10-year period from fiscal 2023-2032, the company aims to invest $7 billion to strengthen its existing operations. More than 98% of the planned investment is focused on long-term pipeline replacement programs, which have good recovery mechanisms plus new business, technology and innovation, including the continued rollout of ultrasonic meters. The stock currently carries a Zacks Rank #2. The Zacks Consensus Estimate for SR’s fiscal 2023 earnings has moved 1.4% higher to $4.20 per share over the past 60 days. The current dividend yield of SR is 4.14%. The long-term earnings growth rate is pegged at 4.2%. In the past year, the stock has gained 3.7%.
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