Gas Utility Valuations Too High, Morgan Stanley Warns

Morgan Stanley’s Stephen C Byrd mentioned that gas utility valuations appear stretched, despite the presence of robust drivers for fundamental growth.

Gas Utility Valuations Too High

“P/E, dividend yield, relative to electrics, relative to their own history - no matter how you slice it, gas utilities have gotten expensive (in part due to a significant uptick in M&A within the space),” analyst Stephen Byrd wrote. Gas utilities, especially pure-play distribution companies, deserve to trade at a premium to electrics on account of several factors, including:

1. Higher average near-term growth
2. Accelerated capital recovery mechanisms
3. Long-term growth supported by structural industry trends and regulation
4. Fewer long-term business risks
5. M&A potential

“Still, many of these factors are not new, so we find it increasingly difficult to be bullish the group at today's elevated valuations,” Byrd commented.

Atmos Energy

Morgan Stanley downgraded the rating for Atmos Energy Corporation ATO to Equal-weight, while maintaining the price target at $72. The company’s shares are trading above the price target and further outperformance is unlikely.

“We consider ATO's growth outlook to be one of the strongest and lowest risk across the regulated utility sector, and management has executed extremely well on the company's targets,” Byrd said. He pointed out, however, that the company’s shares had gained around 14.5 percent in 2015, and appear fairly valued. Outside of M&A, further outperformance is unlikely.

ONE Gas

Morgan Stanley downgraded the rating for ONE Gas Inc OGS to Underweight, while maintaining the price target at $54. The company’s shares have outperformed over the past 18 months, and are now at a double-digit premium relative to gas utility peers, while estimates have been raised a number of times.

“OGS' above-average near-term growth now appears more than appropriately reflected in the stock and we view the company's ~5% rate base CAGR as a better reflection of the business' long-term earnings power. We thus have a difficult time justifying the substantial premium OGS is trading at on out-year estimates…We prefer cheaper utilities with more sustainable above-average growth,” Byrd mentioned.