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Expansion and Acquisitions in the Gas Industry
Posted by: Vanin Aegea (IP Logged)
Date: October 7, 2013 05:20PM

Investors are very often turned off by a cyclical business. Nonetheless, such behavior gives investors the chance to take a position in a profitable business model at a low entry price. With a recent boom in the U.S. market, prices are not expected to be in the low end. Let us look at AGL Resources (GAS) and Suburban Propane (SPH) to see whether any of them offer a profitable business model at a low entry price.

Intelligent, Less Risky Acquisition

Hit by adverse weather and merger expenses during 2012, AGL Resources continues to recover from an abnormal 2012. Also, its storage facilities and marketing business was affected by the change in gas flows generated by developments in the Marcellus shale. The acquisition of Nicor Gas is also thought to have reduced the company’s competitiveness. In line, the business model is considered to be a healthy cash producer albeit minor adjustments are required.

AGL Resources’ latest acquisition was criticized because it shot the company’s valuation to the top rankings, reducing the interest shown by prospective investors'. On the upside, the operations gave the firm a new opportunity to expand geographically. Additionally, the firm turned into the largest pure gas distributor, with access to eight interstate pipeline connections. On top of it all, the business continues to operate at one of the lowest production costs.

Future prospects for AGL Resources are also fed by a range of retail energy-related products and services, natural gas wholesale marketing, and other gas supply management services. The contribution made by these segments continues to improve, and is expected to do so for the long-term. Services are further pushed by the firm’s safety and reliability record.

Like the competition, AGL Resources' customers face high switching costs due to unavailable energy alternatives, and propane-ready appliances. However, in order to secure profits in the long-term, stable prices and favorable weather is required because captive clients’ consumption is sensitive to price hikes and weather changes.

AGL Resources is financially moderate because debt has risen considerably and cash flow stood at precious levels. The stock is trading at 17.2 times its earnings, or a 20% discount to the industry average. I feel bearish about the stock because the US gas boom has past. Also, gurus have not been moving much on this stock. The last two transactions on the stock are Steven Cohen and Jim Simmons option out.

Acquisitions Are Not Enough

Suburban Propane expanded into new geographies looking to increase revenue and profits. However, the business strategy did not turn out as expected. On one hand, operated volumes improved thanks to the Inergy acquisition. But, future outlook remains obscure by the incremental losses per distributed unit. Hence, the overall balance of the acquisition does not offer a positive future outlook.

As with AGL Resources’ customers, Suburban Propane´s are pretty much captive for the same reasons: ready appliances and no alternative energies. Hence, customers control consumption levels very warily, and respond strongly to price and weather changes.

For the third quarter, results include a one-time $6 million charge concerning merging costs. It is worth noting that Suburban Propane annually reports losses on the third quarter due to propane purchases to replenish inventory to face rising summer demands. Hence, performance should improve at least slightly when compared to previous quarters.

Additionally, cost efficient policies have helped to improve Suburban Propane´s performance. However, the strategy seems to have reached exhaustion. Employees have been stretched to their fullest through dismissal and retirement, the distribution fleet has adjusted to current needs, and low profit customers were dropped. In the near future, improvements seen during the last six years will be hard to replicate, and rising costs per unit are the telling evidence.

Suburban Propane´s balance sheet is moderate, especially due to a declining cash flow. The stock currently trades at 32.5 times its earnings, packing a 51% premium to the industry average. I remain bearish about the future prospects of the company since acquisitions have not significantly improved performance. Last, the largest guru holding a position, Jean-Marie Evelliard, does not register changes since September of last year, and the last transaction is Jim Simons option out.

Closing Thought

I feel bearish about bot stocks but prefer AGL Resources because it pays a higher dividend, and acquisitions have improved performance. In comparison to competitors, the firm has been able to increase market share without having to expand into new and risky geographies. However, I would like to wait until the issues concerning expansion into Illinois are resolved.


Disclosure: Jodor Jalit holds no position in any of the mentioned stocks.




Guru Discussed: Jim Simons: Current Portfolio, Stock Picks
Stocks Discussed: GAS, SPH,
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