(Published by Nick McCullum on July 12)
The utilities sector is well known for housing conservative, high-yield dividend investments.
Like many industries, it is most well known for its largest constituents. Names like Southern Company (SO, Financial), Duke Energy (DUK, Financial) and Consolidated Edison (ED, Financial) are generally familiar names among dividend growth investors.
The utility industry also harbors many smaller, less familiar companies. Because they are less well followed, they may create asset mispricings – or buying opportunities for opportunistic investors.
South Jersey Industries (SJI, Financial) could be an example of a smaller utility with investment appeal. With a market capitalization of $2.6 billion, it falls under the radar of many investors.
Despite its lack of media attention, South Jersey has a long operating history and above-average dividend yield. By all measures, South Jersey is a blue-chip stock.
The Blue Chip Stocks Excel Sheet contains pertinent investment information on companies in the Sure Dividend database with 100-year-plus operating histories and 3%-plus dividend yields (including South Jersey Industries).
The majority of South Jersey’s business model is regulated in nature (reducing its risk), and the company’s 3.3% dividend yield has the potential to generate meaningful portfolio income. These factors combine to make South Jersey a potentially attractive opportunity for retired investors.
Business overview
South Jersey Industries is a natural gas utility holding company that operates through three private subsidiaries:
- South Jersey Gas: a regulated natural gas distribution business.
- SJI Midstream: A FERC*-regulated gas pipelines and projects business.
- South Jersey Energy Solutions: a nonregulated energy production, fuel supply management and energy marketing business.
*FERC denotes the Federal Energy Regulatory Commission.
In fiscal 2016, South Jersey’s regulated businesses generated $69 million of adjusted earnings while its nonregulated businesses generated $34.2 million of adjusted earnings.
A visual depiction of South Jersey Industries’ organizational structure can be seen below.
Source: South Jersey Industries Presentation At The 2017 American Gas Association Financial Forum, slide 3
South Jersey Gas, the holding company’s largest operating unit, distributes natural gas to approximately 377,000 customers in southern New Jersey. In aggregate, South Jersey Industries has a market capitalization of $2.6 billion.
Current events
South Jersey Industries reported earnings for the three months ending March 31.
The company’s bottom line came in at 72 cents per share, a decline from last year’s result of 80 cents. The earnings decrease was primarily driven by an increase in the number of shares outstanding as the company’s businesswide earnings actually increased from $57.0 million to $57.6 million.
Details about each segment’s contribution to first-quarter earnings can be seen in the following table.
Source: South Jersey Industries Presentation At The 2017 American Gas Association Financial Forum, slide 14
All said, it was largely business as usual for South Jersey Industries. An increase in the number of shares outstanding is common practice for this business as it often issues shares to fund asset acquisitions or significant infrastructure investment.
Evidence of this strategy can be seen by investigating South Jersey’s share count over time.
So far, the strategy has been successful as the business has managed to grow earnings over meaningful periods of time.
With that said, there is some risk to this. If acquisitions fail to accrete the company’s earnings, South Jersey will suffer from the two-factor impact of (1) poor capital allocation and (2) dilution from share issuances.
Growth prospects
South Jersey Industries has a goal of achieving $150 million of companywide adjusted earnings (which they call "economic earnings") by 2020.
At today’s share count, this implies earnings-per-share of $1.88, which is a 40% increase over 2016’s figure – or an earnings-per-share CAGR of 8.8% over the next four years. This is above the company’s long-term average earnings-per-share growth rate.
Source: South Jersey Industries Presentation At The 2017 American Gas Association Financial Forum, slide 4
A key component of South Jersey’s growth strategy is the accumulation of more regulated utility assets and earnings.
This focus on growing regulated earnings can be seen by looking at the corporation’s capital investment budget.
In the next four years, about 73% of the company’s capital investments will be earmarked for its regulated utility business, with an additional 20% devoted to its FERC-regulated midstream business. In total, 93% of the company’s capital investment through 2020 will be inside its regulated businesses.
Source: South Jersey Industries Presentation At The 2017 American Gas Association Financial Forum, slide 8
Competitive advantage and recession performance
South Jersey Industries’ main competitive advantage comes from being an existing player in the regulated utility industry, which has notoriously high barriers to entry and discourages new market participants.
This allows South Jersey to generate stable, growing cash flows over time.
As a utility company, South Jersey Industries is highly recession resistant. The company actually managed to increase its adjusted earnings per share each year through the Great Recession of 2007-2009:
- 2007 adjusted earnings per share: $1.05.
- 2008 adjusted earnings per share: $1.14 (8.6% increase).
- 2009 adjusted earnings per share: $1.19 (4.4% increase).
- 2010 adjusted earnings per share: $1.35 (13.4% increase).
- 2011 adjusted earnings per share: $1.45 (7.4% increase).
Because of its strong historical recession performance and regulated business model, South Jersey Industries can be expected to perform well during future periods of economic stagnation.
Valuation and expected total returns
South Jersey’s total returns will come from earnings growth, dividend payments and changes in the company’s valuation as measured by the price-earnings (P/E) ratio.
As a utility holding company, South Jersey should not be expected to deliver exceptional earnings-per-share growth. Regulated utilities trade the prospects of high growth for a lower risk business model, which help them to appeal to conservative investors like retirees.
Case in point: South Jersey Industries has compounded its adjusted earnings per share at a rate of just 5.5% per annum since 2001. The company’s full earnings-per-share history during this time period can be seen below.
Source: Value Line
Looking ahead, investors can conservatively expect 3% to 5% adjusted earnings-per-share growth from South Jersey Industries over full economic cycles.
South Jersey’s total returns will be further boosted by the company’s above-average dividend yield.
The company currently pays a quarterly dividend of 27.25 cents which yields 3.3% on the company’s stock price of $33.27.
South Jersey’s dividend yield is well above the average dividend yield in the Standard & Poor's 500 of 1.9%. Furthermore, the company’s dividend yield is above its long-term historical average.
Although it has declined from recent highs, South Jersey’s dividend yield of 3.3% is still slightly above its 10-year average dividend yield of 3.1%. Based on yield alone, it appears the company continues to hold appeal for dividend investors.
The company’s dividend is well covered by its earnings.
South Jersey Industries reported adjusted earnings per share of $1.34 in fiscal 2016 and paid $1.06 of per-share dividends for a payout ratio of 79%. While this would be high in certain industries, utility companies generally pay out most of their earnings as dividends. South Jersey’s dividend is covered in the present and for the foreseeable future.
Despite South Jersey’s earnings-per-share growth potential and its above-average dividend yield, the company lacks investment appeal because it is overvalued at current prices.
The company’s current stock price of $33.27 is trading at a P/E ratio of 24.8 using 2016 adjusted earnings of $1.34 per share. This is markedly higher than the stock’s average historical P/E ratio.
Unfortunately, the company is expecting earnings per share to decline in fiscal 2017. Value Line analysts are expecting adjusted earnings per share of $1.25 for full-year 2017, which implies a P/E ratio of 26.6 at today’s market prices.
The following diagram compares South Jersey Industries’ current valuation to its long-term historical average.
Source: Value Line
By all measures, South Jersey Industries appears to be grossly overvalued relative to its normal historical levels.
Thus, investors should avoid this stock for the time being.
Final thoughts
On the surface, South Jersey Industries has many of the characteristics of a high-quality investment: a regulated business model, strong historical earnings growth, an above-average dividend yield and fantastic recession performance.
More detailed due diligence reveals that the company is certainly trading at prices that far exceed a conservative estimation of its fair value. There is no margin of safety here.
Investors should look elsewhere for utility exposure for their investment portfolios.
Disclosure: I am not long any of the stocks mentioned in this article.
