We have downgraded natural gas producer and pipeline firm The Williams Companies Inc. (WMB) to Neutral from Outperform purely on valuation grounds, as we see limited near term price upside.
Tulsa, Oklahoma-based The Williams Companies is an integrated energy firm that primarily finds, produces, gathers, processes and transports natural gas primarily in the Rocky Mountains, Gulf Coast, Pacific Northwest, Eastern Seaboard and the Marcellus Shale in Pennsylvania.
The company divides its business into four segments: Exploration & Production (“E&P”), Williams Partners – that includes the company’s 84%-owned master limited partnership Williams Partners L.P. (WPZ) – Midstream Canada & Olefins, and Other.
We like Williams’ strong upstream asset base and attractive growth prospects. The company’s core E&P and midstream segments are expected to be the key growth drivers going forward. We also believe that the recent strategic restructuring should further enhance Williams’ value by improving the competitiveness of its midstream and gas pipeline assets.
Last month, the energy infrastructure entity raised its quarterly cash dividend to 25 cents per share ($1.00 per share annualized), representing an increase of 25.0% over the previous payout and double the dividend distributed in December 2010.
The dividend hike not only highlights Williams’ commitment to create value for shareholders but also underlines its new policy – a continued 10-15% annual dividend growth over the next few years – that requires it to pay out substantially all of the distributions it gets from its partnership, Williams Partners L.P.
However, we remain concerned about Williams’ high debt levels, which leave it vulnerable to an extended drop in commodity prices. As of June 30, 2011, Williams had a debt of $9.31 billion, representing a debt-to-capitalization ratio of 54.7%. The company’s exposure to volatility in prices for natural gas and natural gas liquids also remain key areas of concern, in our view.
Williams recently reiterated its commitment to proceed with the separation of its upstream unit from its pipeline business by the first quarter of 2012. Though the transaction holds the promise of unlocking significant value, there is also the risk that the transfer of upstream assets (post-split) will leave Williams with a less diversified business. As a result, the business risk profile of the reorganized Williams may be weaker than that of the pre-spin-off company.
Considering these factors, we see the stock performing in line with the broader market and prefer to remain on the sidelines at this point.
