John Lee Hooker, Ry Cooder, Carlos Santana, Robert Cray, Bonnie Raitt, and Charlie Musslewhite are fantastic blues, rock, and country musicians, but when playing together they create a very unique sound. In 1948, musical great John Lee Hooker released the blues anthem “Boogie Chillen” as his debut recording and it became his signature song. Initially recorded as a solo with Hooker’s vocal, electric guitar, and bottle-cap-enhanced rhythmic foot stomping, in 1992, these six musicians played a live set, creating a one-of-a-kind musical experience. Similarly, the assets of National Fuel Gas (NFG) are intriguing as separate entities, combined they offer a very unique investment opportunity.
Source: Investor Presentation
National Fuel Gas is a natural gas energy company focused on Appalachian shale with assets reflecting the various steps in the natural gas supply chain. NFG fee-owns almost a million acres of land in the fairway of the Marcellus shale plus another quarter million acres under lease, operates an E&P subsidiary, owns various field gathering pipeline networks and natural gas processing facilities, manages FERC-regulated pipelines, and operates a NY/PA PUC-regulated natural gas local distribution company LDC for the Buffalo, NY, to Erie, PA, service territory. One could say NFG has it fingers in every slice of the natural gas “pie”.
National Fuel Gas operates an E&P subsidiary, Seneca Resources. National Fuel Gas owns outright 912,000 acres in the Marcellus fairway, known as their Western Development Area, plus has the mineral rights to an additional 270,000+ acres, known as their Eastern Development area. As it is company owned, the WDA has no royalty costs and produces ~378 MMcf/d while the EDA carries the expense of 15% (midrange) royalty and produces ~328 MMcf/d. Seneca management has identified 1,100 potential drilling sites in the WDA, 500 in the Marcellus and 600 in the Utica. At least half of WDA future expansion will utilize existing field gathering pipeline assets, well pads, and water infrastructure, maintaining above peer returns. The EDA leasehold acreage has an expected 500 wellhead locations. Combined, without further delineation, NFG has multiple year inventory of drilling locations. In addition, Seneca produces crude oil in California, and it should be considered a draw-down asset. In 2018, Seneca produced 8,300 Boe/d with production looking to decline to 6,900 Boe/d by the end of 2021. Company-wide, 2020 production is expected to be ~240 to ~245 Bcfe, and is expected to grow by 25% to ~305 to ~335 Bcfe in 2021.
National Fuel Gas operates a network of gathering pipelines whose service map overlaps with Seneca drilling activity. Management’s goal is to have 100% of future production growth flowing through company-owed gathering pipelines, offering a 10% sustainable pipeline growth profile. The ability to move product through company pipes adds another layer of profitability to NFG missing in many peer E&P footprints. In addition, NFG owns FERC-regulated pipelines bring Marcellus gas to the Canadian border by Niagara Falls. NFG is actively battling the NY Dept of Environmental Conservation in permitting an expansion of field exit pipeline capacity to the north, with 75% of the disputed added capacity destined for export to Canada. However, like most pipelines in the Northeast and along the eastern seaboards, the permitting process is mired in the courts. Last month, National Fuel Gas purchased Marcellus upstream and midstream assets from Royal Dutch Shell plc (RDS.A) (NYSE:RDS.B), expanding its field footprint. The purchase price of $541 million adds 200,000 net acres of leasehold land, active gas production and reserves, gathering pipelines, and additional exit pipeline capacity. This should prove to be a great bolt-on acquisition to NFG’s current extensive asset base in the same geography.
National Fuel Gas is the local gas distribution service utility for about 740,000 customers in Western New York and Northwest Pennsylvania, with about 70% of its customers residing in NY. Regulatory Research Associates, a division of S&P, rates NY and PA as Average Support in its Regulatory Environment of State PUC Commission ranking. The latest 2017 ruling of the NY PUC for allowed ROE is a low 8.7%, vs. a national average during the 4th quarter 2019 of 9.7%, about the same as the national average in 2017 when the rate was last set.
Of interest to investors should be that 45% to 50% of earnings are derived from regulated activities: natural gas LDC utility plus natural gas pipelines and natural gas storage. E&P and gathering pipeline businesses are not regulated. The regulated businesses generate sufficient cash flow to cover the $1.78 annual dividend. Importantly, management has a 50-year history of dividend increases combined with a 118-year history of paying a dividend, adding to the belief the current 4.0% yield is relatively safe.
Management has offered its earnings per share guidance for 2020 and 2021. The table below outlines these estimates by segment, from their latest presentation linked above. As shown, the wildcard is the performance of their Seneca Resources E&P subsidiary. As with most natural gas E&P firms, weak commodity pricing has wreaked havoc on profitability. However, management has cut its drilling activity to one rig, down from historically 3+, and, according to their presentation linked above, has reduced its E&P cost to where management estimates its break-even (15% IRR) consolidated economics of $1.60 or less.
EPS Segment Actual Results and Guidance:
Source: Investors presentation, GMI
Management offered an upbeat tone to their FY 3rd quarter results:
“The benefits of our integrated, diversified business model are evident as we move through fiscal 2020, with strong results from our rate-regulated subsidiaries providing an important measure of stability in the face of commodity price headwinds. To the latter point, our Exploration and Production segment activity level dropped to a single rig in mid-June and we continue to voluntarily curtail a portion of our Appalachian spot market volumes, which we anticipate will continue while low prices persist through the remainder of the summer. Turning to fiscal 2021, as we integrate our recently closed, highly accretive Appalachian acquisition into our longer-term plans, we expect our Upstream and Gathering operations to immediately generate significant free cash flow. Additionally, we have line of sight on meaningful growth in our Pipeline & Storage business, driven largely by near-term expansion and modernization projects, including our Empire North project which we expect to come online in the next few months. Overall, National Fuel is well-positioned to grow our earnings and cash flows, maintain the strength of our balance sheet, and generate strong returns for our shareholders in the years ahead.”
According to thefly.com, a stock news site, National Fuel Gas has several recent positive broker research comments.
“8/12. BofA initiated coverage of National Fuel with a Buy rating and $51 price target. The analyst is positive on the company’s “unique vertically integrated business model” that is different from traditional pure play natural gas E&Ps. BofA adds that investors gain exposure to upside in commodity prices from National Fuel’s E&P segment, while its Midstream and Utility segments offer stability to cash flows while underwriting the company’s 4% dividend yield.”
“6/18. Stifel initiated coverage of National Fuel with a Buy rating and $47 price target. The company offers a business model that “substantially reduces risk,” especially in down markets, and the analyst believes the recent Shell acquisition should accelerate economies of scale leading to lower per-unit costs. Stifel believes National Fuel is a “well-run” company with some downside protection and is a “relatively defensive way” to play a natural gas price recovery.”
“6/1. Argus upgraded National Fuel to Buy from Hold with a $47 price target. The company represents a “unique long-term investment opportunity”, combining the stability of a regulated gas utility and the growth potential of an E&P and gathering business, adding that it also has “investment-grade credit ratings and a strong balance sheet”. Argus further notes that National Fuel’s 4% dividend yield may be attractive to income-seeking investors.”
Below are the most recent analysts’ recommendations, per finziv.com:
Just as the six incredible musicians listed at the beginning of this article are independently phenomenal and combining their talents produces a one-of-a kind sound, National Fuel Gas offers investors a combination of assets which could be considered as one-of-a-kind as well. I have been an NFG shareholder for many years, and while I am disappointed in the stock’s recent performance, I have been using it as an opportunity to add to my ever-growing position. If you are not yet a shareholder and are looking for an undervalued and under-followed energy stock, NFG should be on your target list.
Author’s Addendum: The legendary John Lee Hooker developed a “talking blues” guitar style that became his trademark sound. His debut recording of “Boggie Chillen” was just Hooker singing, playing electric guitar, and his signature foot tapping sound enhanced by Coca-Cola bottle tops attached to the soles of his shoes. In 1992, he joined Ry Cooder, Carlos Santana, Robert Cray, Bonnie Raitt, and harpist Charlie Musslewhite, releasing a version of “Boogie Chillen” recorded live at the American Music Hall, San Francisco, with each artist getting a spotlight. Here is a YouTube link to that session and of note is the pause before Ry Cooder’s performance. In addition, here is the same song from John Lee Hooker’s original 1948 solo recording. As a bonus track, John Lee Hooker toured France in 1969 with Sunnyland Slim on the piano (incredible blue piano on this track), Willie Dixon on bass, Johnny Shines on guitar, Clifton James on drums, and they played his 1961 blues classic “Boom Boom”. ”
Grab a libation of your choice, turn up the volume, and enjoy these offerings. Oh, and do not forget the National Fuel Gas due diligence when you are done.
Disclosure: I am/we are long NFG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.