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Summary Laclede doubled its enterprise value in two years via acquisitions. Debt and leverage has ballooned, but so has cash flow from operations. I’m not fully sold on recommending the shares for income investors until I see a solid bump in the dividend. The Laclede Group (NYSE: LG ) is a regulated natural gas utility that has begun making waves in the utility industry over the last several years. Through the acquisitions of Missouri Gas Energy from Southern Union in 2013 and Alagasco from Energen (NYSE: EGN ) in 2014, Laclede Group has shifted from a relatively small utility serving just a portion of the Missouri natural gas market to serving millions of customers, holding dominant market positions in both Missouri and Alabama. Shares in the company have rebounded nicely off early September lows and now trade at all-time highs. Are investors putting too much faith in the future of the company, especially given its less-than-stellar service area? Business Environment Utilities can add incremental revenue in two ways. They can either have customers consume more of the commodity, raise rates on current customers, or add new customers. The first method is unlikely, given that U.S. consumers are consuming less electricity per capita now than in prior years. The advent of energy conservation, more efficient appliances, and less household formation has ensured that the trend is going to remain in a slow slide downward outside of freak weather years increasing demand. With that off the table, utilities like Laclede Group could raise prices on consumers. Not going to fly, because as we know these are regulated operations and public utility commissions set the allowed returns. So the third option (influx of new customers) is really the only source and is something completely out of the utility’s control. This is why there is such a focus on market analytics when valuing utilities. Analysts look at all sorts of factors in the company’s service area: unemployment, average wages, past years’ population growth, etc. Sadly for Laclede, there won’t be much to like here. Missouri and Alabama rank average or below average on nearly every metric you could look at. Unemployment, salary averages, labor participation, poverty, etc. are all below average compared to other states. This scares away many investors, and rightly so. Until these states turn the corner and can draw in new inflows of people, Laclede should likely trade at a discount compared to better positioned peers. Operating Results There has been a lot of change for Laclede Group over the past three years. In fiscal 2011, the company switched CEOs to current leader Suzanne Sitherwood, who made quick work of making changes within the company. Within a few short years under her leadership, the company had sold off its propane assets, made $2.2B worth of acquisitions, and driven up profit/operating margins. Acquisition and expansion don’t come for free, however. Long term debt has spiked from $340M in 2011 to over $1.7B today. Net debt/EBITDA has expanded from a low of 2.1x in fiscal 2011 to what should be around 4x in fiscal 2015. While this is a manageable level of debt for a utility, long-time holders of Laclede should be aware that the risk profile has changed dramatically under the new management style. Excluding the impact of the acquisitions on the cash flow statement ($2.2B paid for with approximately two thirds long-term debt, one third stock offering) things actually look pretty good. Cash from operations is set to fly high in 2015, with the business generating more cash in 2015 than in the prior three years combined. Capital expenditures, like is the case for most natural gas utilities, are comparatively low and under control compared to other utilities that operate in power generation. Results here are ideal and indicative of how I want to see a utility being managed in respect to cash in/cash out. Conclusion Ballsy moves aren’t something the utility industry is known for. Laclede has bucked this trend by engaging in acquisitions that doubled its size in just a few short years. There will be growing pains associated with the acquisitions that may impact short-term results, but I think thus far it looks like company management has made the right play and acquired some solid assets that will easily be folded under the Laclede umbrella. I think investors see the potential here, which is why shares have performed so strongly. For income investors considering entering a position, however, I think this is a “show me” story. Historical dividend growth has been lackluster and I think investors considering going long should wait to see what the next dividend increase pans out to be in fiscal 2016, which should be announced over the next few months. A bump in the 5%+ range would show that management is hitting their targets while also being shareholder friendly. Scalper1 News
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