Gas is essential to keep people warm during the coldest months of the year and clearly these companies operate on a cyclical basis. Although, consumers need gas throughout the year, demand is understandably greater during the winter months. However, you would think that investors, having seen this cycle year-after-year would understand the cyclical nature of the business and gas stocks would not run-up so much in anticipation of the winter spike in usage. At least this year, that pattern does not seem to apply as over the last three months Gas Utility stocks have increased by 14%, while the S&P 500 declined more than three percent. The decline in energy prices might have something to do with this out-performance since they are regulated industries and the fall in input prices boosts their bottom lines. Perhaps there is also something to be said for cold weather making people and investors have heating on their minds.
In a blog posted in mid-November (Gas Utilities Heating Up for the Winter), we made the case that a Gas utility stock may make sense for certain portfolios because they are generally defensive (with betas under 1.0), they generally offer a good dividend and they are resistant to the slowdown in consumer spending. We did also mention that gas will be more in demand at this time of year but did not honestly think that this would have a large positive effect on gas stocks.
In our previous post, we highlighted one long recommendation and two short recommendations. Energen Corp. (EGN) was the stock we believed Undervalued at that time and although the stock is flat over the last two months we have downgraded it to our neutral Fairly Valued rating. Our two short calls have turned out much better as Laclede Group (LG) and Piedmont Natural Gas (PNY) are down 20% and 18% respectively. We are reaffirming these stocks as Overvalued for the time being.
As for now, we only have one stock in our Gas Utilities coverage universe that we think has an attractive valuation. That stock is Southern Union Company (SUG), which has lost nearly half of its value over the last half-year. However, its fundamentals still look fairly strong. Currently, SUG is trading at a price-to-sales ratio of just .51x, while this stock has normally received between .58x and .88x. Price-to-cash earnings valuations offer similar undervalued results. It is exceptional for one stock to stand out so far from its peers as this one does.
In general, we at Ockham Research believe that the stocks in the Gas Utilities group are overvalued as a whole. As you can tell from the chart of our Gas Utilities coverage–with the 13-week performance plotted on the y-axis and our ratings on the x-axis–that many in the sector have performed very well recently. Generally, we tend to find our best long ideas in the IV quadrant and shy away from recommending anything in the II quadrant as those stocks have appreciated and are no longer undervalued as a stock follows the “Value Stock Life Cycle.” Apart from SUG, we cannot currently recommend buying any of these stocks because they appear Overvalued compared to their historical norms, which in this market environment is saying quite a bit.