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Southwest Gas Holdings (NYSE:SWX) is an often-overlooked natural gas LDC utility, utility construction, and interstate pipeline operator. However, it has not been “overlooked” by activist and corporate raider Carl Icahn. SWX’s lack of investor appreciation reminds me of Irish singer-songwriter Foy Vance, who wrote and recorded a wonderful song, Let it Rain, in 2014. However, it was not until the song was recorded by his good friend and touring partner, Ed Sheerin, that it received the attention it deserved. This is my 10th Southwest Gas article for Seeking Alpha since Jan 2018, just prior to starting a long and strong stock position.
Southwest Gas Holdings is a 3-part company: one part is state regulated, one part is FERC-regulated, and one part is not regulated. SWX is the main natural gas local distribution company LDC for Arizona and Nevada. SWX recently purchased Questar natural gas pipeline assets from Dominion Energy (D) and SWX operates a utility construction company, Centuri.
State regulated Southwest Gas, with $3.9 billion of rate base assets, is the largest natural gas distribution utility in Arizona (49% of their rate base, 9.10% allowed ROE), as well as Nevada (37% of rate base, 9.25% slowed ROE) with a sliver of service territory in the Lake Tahoe areas of California (11% rate base, 10.00% allowed ROE). Southwest Gas services 2.1 million customers. Southwest Gas has one of the best population growth profiles for its service area and is manifested by consistently strong annual new hookups, which grew by 1.8% in 2021. Underlying customer growth should be a key matrix for most utility investors and, while seemingly minuscule, 1.8% annual customer growth in today’s utility environment is considered exceptional. Population migration to the Southwest US does not seem to be letting up anytime soon, which creates a nice tailwind for SWX’s future growth.
One key element of all natural gas utilities is the level of leak-prone pipes in their system. Both cast iron and naked steel pipes need to be replaced and this is a national problem. The National Association of Regulatory Utility Commissioners estimates there are nationally 66,000 miles of cast iron and bare steel gas mains in need of replacement, in addition to over 2.5 million service lines. The Infrastructure Investment and Jobs Act of 2021 provides $1 billion for the newly established Natural Gas Distribution Infrastructure Safety and Modernization Grant Program to jumpstart leak-prone pipe replacement. I had a LDC investors relations spokesperson tell me years ago that cast iron pipe replace for LDC utilities is similar adding generating capacity and upgrading the electric grid for electric utilities. Nevada does not have any remaining cast iron or bare steel pipes, and Arizona has one of the smallest amounts of leak-prone pipes in need of replacement at just over 400 miles, compared to NY with over 8,000 miles of leak-prone pipes. This is a double edge sword as the utility lacks a revenue and profit source through rate base additions, but ratepayers enjoy lower utility rates. In addition, some state regulators do not consider leak-prone pipe replacement as being on equal footing to new service expenditures. Interestingly, Arizona regulators last year reprimanded Southwest Gas for being too aggressive in replacing its leak-prone pipes.
Other critical LDC industry issues are future availability of natural gas and individual state’s political climate. AZ and NV are at the crossroad of major pipelines from Texas to California and from the upper Mountain states of Utah and Wyoming also to California. These are active drilling basins that should provide ample natural gas supplies for years. With the advent of municipalities (Seattle and San Francisco), and possibly whole states (proposal under consideration in New York), making new gas hookups illegal in new construction, investors should rightfully feel they have become the whipping boy of the Climate Change crowd. I find it “entertaining” that when two NY utilities issued a moratorium on new hook ups in 2020 due to concern over long-term availability of pipeline capacity, they were threatened with revocation of their operating licenses. But in 2022, when the same moratorium is recommended by the government with a climate change agenda, it’s hailed as a fantastic and forward-thinking plan. I don’t see climate change moratoriums on new natural gas service to be an issue in either AZ or NV.
From a regulatory perspective, Southwest Gas’ profitability gatekeepers are rated as “Average” compared to other states, according to Regulatory Research Associates RRA, an S&P company. RRA evaluates each state’s regulatory support of utilities under their jurisdiction, and rates them from Below Average to Above Average. Arizona is rated as Average – Low, or 2-3, and Nevada is rated as Average – Average, or 2-2. I prefer to invest in states with higher ratings for regulatory support. These low ratings are offset by SWX service population growth and management’s quality rating, as described below.
In addition to its state regulated LDC, Southwest Gas Holdings recently purchased the FERC-regulated Questar pipelines from Dominion Energy for $2 billion. As discussed in my Jan 28 article Southwest Gas Holdings: Buy The Dips As Diversity Trumps Carl, SWX paid 9.8x EV/EBITDA for the assets. This valuation was in line with other pipeline valuation in Jan with Enterprise Products Partners (EPD) trading at a 9.9x valuation, MPLX (MPLX) at 9.4x, Kinder Morgan (KMI) at 15.6x, Energy Transfer (ET) at 5.7x, and DT Midstream (DTM) at 11.0x. SWX expects to invest $1.4 billion into its renamed MountainWest pipelines, increasing its rate base from $2.3 billion to $3.7 billion by 2025.
The last leg of the Southwest Gas Holdings’ tripod is its utility construction subsidiary, Centuri. SWX has built a sizeable utility construction company, mainly through acquisitions. Centuri offers a variety of utility-scale services including natural gas mains pipe replacement, electrical grid services, 5G buildout and offshore wind electrical connection services. SWX has grown Centuri critical mass to $2.5 billion in revenues and $250 million in adjusted EBITDA and carries $1.1 billion in debt on its balance sheet. With the ongoing national emphasis concerning leak-prone gas mains replacement, grid upgrades, expansion of solar and wind power generation in more remote locations, and the rollout of communication 5G networks, Centuri has a bright future.
Southwest Gas Holdings has earned an impressive SPGMI “A” rating for 10-yr consistence in earnings and dividend growth. Of the 233 utilities with a SPGMI rating, only 19, or 8.2% have an “A” rating and none have an “A+” rating. Of the total number of companies with SPGMI ratings, regardless of industry, SWX falls in the top 6%. For my due diligence, this an elite group of companies and a strong indication of Southwest Gas Holdings long term opportunities.
Enter Mr. Carl Icahn stage right. Just after the announcement of the acquisition of Questar, Mr. Icahn revealed he owned about 5% of Southwest Gas Holdings and offered to buy the company if his slate of activist directors were elected and the acquisition of the pipelines was canceled. In subsequent press releases and letter to shareholders, Mr. Icahn has said he would be satisfied to finance the pipeline purchase along the lines of the Buffett-OXY deal of a few years ago and raised his offer price to a current $82.50. SWX management has rejected each offer as insufficient and not in the best interest of shareholders.
Recently, management announced they were separating the Centuri subsidiary and will split the company into two: Centuri and Southwest Gas consisting of the LDC and pipelines. The reconfigured SWX will be 100% regulated. More information on the split can be found in the SWX 2021 Year End Earnings Presentation and in the March 1 press release.
Mr. Icahn has been quoted as saying he believes the LDC is worth $53 and Centuri is worth $36, for a total valuation, not including the pipelines, of $89 a share. Mr. Icahn also stated that under his tutelage, SWX, ex their newly acquired pipelines, could be worth between $110 and $120.
From a technical trading vantagepoint, Southwest Gas Holdings hit an important milestone on April 13 when it developed an “Ascending Triple Top Breakout” on its P&F chart. This is a very bullish trend which should not be ignored. As described by the Chart School at stockcharts.com:
An Ascending Triple Top Breakout is basically back-to-back Double Top Breakouts. These breakouts form three X-Columns that ascend with each breakout. Because there are three X-Columns and two O-Columns, the pattern is just as wide as a classic Triple Top Breakout. The ability to forge back-to-back higher highs shows underlying strength that is indicative of an uptrend.
In addition, SWX is trading above a rising 50-day moving average and is also above its 200-day MA, which, in today’s sloppy market, is noteworthy.
According to marketscreen.com, before the March 1 split announcement, 2022 earnings were expected to be $4.55 a share, with 2023 expected to be $4.79 and 2024 $4.89. Dividends were expected to be $2.47, $2.60, and $2.72, respectfully. However, with the Centuri split announcement, management withdrew all earnings forecasts and guidance.
Overall, I prefer Southwest Gas Holdings not split into two but am ready to build an equal sized position in the soon-to-be new publicly traded Centuri, when available. I would rate SWX a buy at its current all-time high of $82 but the valuation is quickly closing in on a neutral stance with another ~10% share price increase. I usually find it difficult to recommend buying stocks at all-time highs, with the exception being Southwest Gas Holdings.
Author’s Note: Foy Vance is a singer-song writer from Bangor, Northern Ireland, with a few hits under his belt. His collaborations include co-writing four cuts including Galway Girl on Ed Sheeran’s 2017 album Divide. Vance has also worked with Alicia Keys, Rag N’ Bone Man, Keith Urban, Kacey Musgraves, Miranda Lambert, Plan B, and Rudimental, uniquely and effortlessly switching between genres. An outstanding Foy Vance recording of Let it Rain live at Bangor Abbey can be found here. Enjoy and don’t forget to turn the volume up.
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