We continue to maintain our long-term Neutral recommendation on Southern Union Company (SUG), supported by a Zacks #3 Rank (Hold).
The Houston-based company is one of the U.S.’s leading diversified natural gas companies, engaged primarily in the transportation, storage, gathering, processing and distribution of natural gas. The company owns one of the largest interstate pipeline networks in the U.S. and one of the largest LNG import terminals in North America.
However, valuation continues to be restricted by the company’s dependence on outside funds to finance its expansion programs, as well as seasonality in its pipeline business and re-contracting uncertainty for its percent of proceed (POP) contracts. Thus, in the absence of further positive motivation, we feel the company is adequately valued, leaving little room for upside in the near-term.
Southern Union is a low-cost natural gas player with a strategic midstream presence. The company’s regulated asset base of transmission pipelines, storage assets and natural gas utilities generates stable earnings that will help alleviate concerns related to struggling natural gas prices. The company is also focusing on long-term contracts for its fee-based transportation and storage business.
Southern Union has been smart enough to identify and invest in capital expansion projects across its base of transmission, storage, gathering, processing and distribution assets in the evolving North American natural gas markets.
Management has taken several measures to improve financial stability and reduce the overall risk profile of the company, which includes opportunistically monetizing assets that are no longer a strategic fit, focusing on the fee-based transportation and storage business, and being proactive in hedging to mitigate volatility in commodity margins.
However, Southern Union’s unregulated business of natural gas gathering and processing is mostly conducted through percentage-of-proceed (POP) natural gas processing contracts.
Under these arrangements, the company gathers raw natural gas at the wellhead, transports the gas through its gathering system, processes the gas and sells the processed gas at published index prices. However the POP contracts fluctuate with volatility in natural gas prices, exposing the performance of the company to the risk of market swings.
Most of Southern Union’s gas volumes are generated from assets owned by third parties located in the Permian basin. As a result, the volume of natural gas or NGL to be transported, stored, gathered and processed is beyond the control of the company. Any sharp reduction in production volumes will force the company to renegotiate contracts to offset the loss of revenues from lower volumes.
Southern Union is investing a significant chunk of resources into ongoing capital expansion projects. However, compared to its peers, the company’s debt pile is heavier, as evidenced by its high debt-equity ratio of 139.3% at the end of the fourth quarter of 2010 (Zacks Industry Average 66.2%). But dependence on borrowed funds is a risk since the company will not be able to enjoy the expected investment return in the event of a downturn in the demand for natural gas, delay in expansion projects and regulatory bottlenecks.
In the near-term we would advise investors to focus on its Zacks #2 Rank (Buy) peers like Energen Corporation (EGN) and WGL Holdings Inc. (WGL).
ENERGEN CORP (EGN): Free Stock Analysis Report
SOUTHN UNION CO (SUG): Free Stock Analysis Report
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