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Summary Atmos Energy operates in highly favorable operating and regulatory environment. The company is a Dividend Aristocrat, having raised its dividend for over 31 years now. However, the company is overvalued. The yield is too low compared to historical averages and the company’s overspending of its cash is worrisome. Atmos Energy Corporation (NYSE: ATO ) operates primarily as a regulated natural gas distributor, in fact it is one of the largest pure play natural gas operations in the United States. Based out of Texas, he company has operations stretching across eight states serving over three million customers. Given its location, Atmos Energy has access to cheap natural gas sourced from the Val Verde and Barnett shale plays. Further bolstering the company is a favorable regulatory environment. Both Texas and neighboring Louisiana have company-friendly utility policies in the form of annual rate filing mechanisms. These allow Atmos Energy to put in requests to modify its rates on an annual basis without filing a formal rate request. What this means is that the company can recover a majority of capital expenditures and commodity prices from customers quickly. These two factors have created a prime situation for Atmos Energy’s utility operations. Overall, Atmos has been a consistently profitable business that has rewarded shareholders greatly over the years. The company is a member of the oft-observed Dividend Aristocrats index (companies with 25 or more years of consecutive dividend increases), which has led to Atmos Energy finding itself in many retail investor portfolios due to its strong yield and proven track record. But is the future for Atmos Energy as bright as the past? Company Track Record (click to enlarge) Total revenue has grown at a 3.74% pace since 2011. In reality, this understates growth as the company sold some of its natural gas distribution operations in four states as part of a streamlining initiative (Missouri, Illinois, Iowa, Georgia). Investors can see that this divestiture was wise as it likely contributed to improved operating margins from fiscal 2013 forward. Like I do with most utilities, I like to see how cash flow is used by the company. Dividend-paying companies have two main uses of cash outside of operational activities; capital expenditures and dividend payments. At worst, I like to see cash flow from operations = capital expenditures + dividend payments. As you can see, Atmos Energy has traditionally run a deficit on this metric. What this means is that the company has to raise cash to meet all of its obligations, either through debt or a dilutive stock offering. As should have been expected, Atmos Energy raised $386M net cash in 2014 from a stock issuance (9.2 million shares), the announcement of which sent shares plunging (shares have since recovered). Atlas has no plans to slow down capital expenditures, which the company has said is needed primarily to maintain pipeline integrity and general system improvements. In fact, capital expenditures may reach $1.1B annually by 2018 according to company estimates. I would expect Atmos to raise some funds in the debt markets in 2016 or 2017, possibly in the range of $500M, given its solid credit ratings. Application of the Dividend Discount Model As I highlighted in a prior article , the dividend discount model is a great way for conservatively valuing dividend companies, especially those with stable and proven track records. We can generate a valuation of Atmos Energy with the following assumptions: $1.65 expected dividend next year, an 8% discount rate, and 2.5% average annual dividend increases going forward (below the current three year average of 2.9% but below the ten year average of 2.0% increases). P = 1.65 / (.08 – .025) P = 1.65 / 0.055 P = $30/share This gives us a fair value of $30.00/share, indicating that shares might be overvalued based on the expected future cash flows to be generated from our investment. Further support of this relative overvaluation can be found in the five year dividend yield average for Atmos, which has historically averaged 3.80%, which would put fair value of shares at the $44-45/share range. Given the yield currently stands at 2.81%, I believe that shares may have appreciated in value too much compared to recent company earnings. Conclusion Atmos has a strong set of operations in a highly desirable area. Management history of rewarding shareholders is healthy. However, this status has made the company’s stock a bit crowded, especially given the risks related to the expected continued leveraging given the operational cash flow deficit. In my opinion, for investors that want safety, there are better picks in the utility or dividend aristocrat space that would present less material downside risk. At current prices, I simply could not become a shareholder. Scalper1 News
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