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From the Survey: Laclede Group
The Laclede Group (LG) has a very long trading history. Indeed, it was one of the original Dow Jones Industrial Average companies. General Electric (GE - Free General Electric Stock Report), meantime is the only original Dow-30 component left. The Laclede Group is a natural gas distribution company, which engages in regulated and unregulated businesses. The company distributes gas to the city of St. Louis and the ten surrounding counties in Missouri, covering more than six hundred thousand customers. The company has a gas storage business and operates main and service lines. This utility has been paying a solid dividend for several years. Like most utilities, the company is very stable and has limited vulnerability to recessions. Long term strategies of the company have recently changed, as the utility has been purchasing assets from Southern Union, an Energy Transfers Equity (ETE) subsidiary, including Missouri Gas Co. and New England Gas Co., the latter of which it hopes to turn around and sell to Algonquin Power and Utilities Corp.
Tech advances in natural gas have changed the landscape for natural gas distributors. Hydraulic fracking has produced vast quantities of natural gas at a much lower cost. Due to the declining commodities costs, state run utilities have had to lower prices, causing sizable decreases in revenues. In order to stabilize earnings, companies have argued for different rate structures that largely shift importance away from the price of natural gas. These new rate designs are reducing earnings volatility and increasing the strength of the companies who can use them.
Laclede Group’s strengths are based on the new model for revenue. The company’s purchased gas adjustment significantly reduces changeability of earnings based off of natural gas prices. Another factor that normally changes the total amount of gas sold is the weather; however, Laclede has a weather mitigation clause, which enables the company to do well during warm winters. Lastly, the company has an Infrastructure System Replacement Surcharge, which allows it to be reimbursed by customers for costs related to replacing and improving the company’s pipelines. Combined, each of these programs allow for increased stability. The company is also a regulated monopoly, which makes it the only provider of natural gas to customers in its Missouri location.
The Laclede Group has some problems associated with its business. Though certain costs related to weather mitigation and infrastructure recovery are successfully passed through to the customers, the company is still on the hook for some of them. This can be a problem as margins are generally regulated by the states. Growth comes very slowly for most utilities as well. Industry balance sheets tend to be highly leveraged to boost returns, taking advantage of their high amount of stability. That said, in periods of rising rates, increasing interest costs can hurt a company’s earnings. Meanwhile, increasing rates to pay for these increases in interest costs take time as rate cases generally are not filed annually. Lastly, the company needs to have rate increases approved, which can hamper Laclede during the time it takes for the state to examine its proposals.
The Laclede Group has many opportunities ahead. Compressed Natural Gas is quite nascent as a fuel for vehicles. Though the economics of individuals driving natural-gas-fueled cars may take a few years for individuals, corporate vehicle fleets have a much higher mileage total and it makes more economic sense to convert. Laclede is building new stations for these companies like AT&T (T - Free AT&T Stock Report), which is converting a fleet over to the new fuel. It also has recently partnered with Siemens (SI) to build a new station at the St. Louis Airport. This segment is not regulated, so the company can generate much higher margins and much greater growth, if it does well. In the future, there may come a point when it makes sense for individual cars to run on natural gas, and having existing stations like the ones Laclede Group is building will put the utility in a prime position. Other opportunities include the housing recovery, which also should add a boost in the short term, as new homes generally mean the addition of natural gas lines and new customers. Lastly, more appliances, such as hot water heaters and stoves, are being powered by natural gas, meaning a larger proportion of a household's bills will be paid to the gas company.
The Laclede Group has recently purchased assets from Southern Union, including Missouri Gas Energy and New England Gas Co. These acquisitions will cost $1.035 billion, including $20 million of NEGasCo debt that is to be assumed. The acquisitions will increase EBITDA by $96 million and add 500,000 customers in MO and 50,000 in New England. However, the company recently received an unsolicited offer from Algonquin Power to purchase NEGasCo. Terms of the deal have not yet been disclosed. If the acquisition falls through, the Laclede Group will still be required to purchase the company as per its original agreement with Southern Union.
This is a massive strategy change for the company for several reasons. First, it doubles its size. Also, since Missouri Gas & Energy is the main provider of natural gas for Kansas City, the company will control natural gas distribution for the two largest metro areas in Missouri, servicing an estimated 80% of Missouri’s population over the two cities. This allows for the possibility of increased synergies between the Kansas City and St. Louis markets, especially in storage and pipeline building. Lastly, this gives the company additional opportunities to file rate base cases with the Missouri Public Service Commission. Any gains in one base case are likely to be approved for the other company as well when it next files.
The Laclede Group is the provider of natural gas to many of Missouri’s residents. Long-term growth in natural gas usage, whether from vehicles or otherwise, will likely remain for some time. From a stock perspective, the acquisition will lead to increases in earnings and long-term dividend growth. The combined synergies will allow for stronger operations, and solid operations are what make a good utility.
At the time of this article’s writing, the author had positions in AT&T (T).