National Fuel Gas: Dividend King in a Highly Cyclical Sector (NYSE:NFG)

When looking for a possible investment, I like to identify companies that have demonstrated the ability to raise dividends over the long term. Ideally, a streak of dividend growth will span one or more periods of recession, as this shows that the company continued to expand distribution even during periods of economic turmoil.

While there are many such companies in more recession-resistant sectors like consumer staples or healthcare, I’m particularly interested in names that operate in more cyclical areas of the economy and have a long history of increasing shareholder payouts.

These types of companies are more affected by economic downturns, but those with decades of dividend growth have weathered the event without reducing or eliminating payments to shareholders.

To me, that speaks to overall strength companies.

One such company that I consider particularly strong is National Fuel Gas Company (NYSE:NFG), which has been increasing its dividend for over 50 years, even though it operates in one of the most economically sensitive sectors on the market, i.e. the energy industry.

Company context and latest earnings results

National Fuel Gas is a diversified energy company with five reportable business segments that include exploration and production, pipelines and storage, gathering, utilities and energy marketing.

The company’s operations include upstream, midstream and downstream assets. Of these, mining activities are the most important for the company. In total, National Fuel Gas covers more than 1 million acres in the Marcellus and Utica shales and serves more than 750,000 utility customers in western New York and northwestern Pennsylvania.

National Fuel Gas reported results for the second quarter of fiscal 2024. Revenue for the period fell 12.2% to $630 million, marking the fourth consecutive quarter of year-over-year declines. Despite lower revenues, the company’s adjusted earnings per share of $1.79 compared to prior-year total earnings per share of $1.54 and were $0.33 better than expected. The company has exceeded market earnings per share estimates in 17 of the last 20 quarters.

National Fuel Gas also provided update guidance for 2024. The company expects the average gas price to be $2.00, up from $2.40, resulting in new projected adjusted earnings per share in the range of $4.75 to $5. .05, down from $4.90 to $5.20.

Takeaway earnings

The fortunes of National Fuel Gas are highly correlated with natural gas prices, which can fluctuate.

Natural gas prices peaked in early 2008 and have not yet reached a new record high. The sharp price increase in 2022 is related to Russia’s invasion of Ukraine and subsequent sanctions imposed on the country, limiting its ability to export natural gas.

In mid-February this year, the price of natural gas hit a three-year low as an unusually warm winter dampened demand.

The market has since corrected, and at the current price of $2.89 per MMBtu, natural gas is well off its 52-week low of $1.48 but still 20% below its high of $3.63.

For its part, National Fuel Gas doesn’t expect the recent price to continue at this level. The company projects that natural gas prices will average just $2.00 per MMBtu by the end of the fiscal year (which ends September 30).^vol). The company previously estimated the price of natural gas at $2.40.

While quarterly revenues did decline by double digits, this represents a slowdown in National Fuel Gas’s revenue declines. Over the last three quarters, revenues declined by 20.3%, 15.2% and 14.7%, respectively, so the year-over-year decline rate shows some signs of slowing.

Thanks to hedging, the company saw just a 1% decline in average realized natural gas prices as prices rose from $2.58 to $2.56 in the second quarter. Without hedging, natural gas prices were 29% lower than a year earlier. Given National Fuel Gas’ expected average price for the rest of the year, this was a prudent move by management and helped mitigate the impact of the crisis in the final quarter.

Importantly, this weakness was offset by profits in other businesses. The Gathering segment saw profits increase by 18% and revenues by 12%. This section carries approximately 600 km of pipelines and connects to seven major pipelines that provide National Fuel Gas’s capacity of 1.4 billion cubic feet per day.

Pipeline & Storage also contributed to results as revenues increased by 14%, resulting in a 22% increase in profits. This segment benefits from a nearly 4,000-kilometer pipeline network that transports 3.4 billion cubic feet per day.

The Utility segment recorded a 41% increase in revenues as rate increases compared to the company’s 2023 settlement significantly translated into year-on-year profits. As a result, profits increased by 29%. National Fuel Gas is also involved in rate negotiations with regulators in New York. The company is seeking a $320 million increase over the last case. Even with these rate increases, National Fuel Gas has some of the lowest costs for utility customers in New York and Pennsylvania.

Even with natural gas prices currently very low, National Fuel Gas is well-positioned if prices are ever to rise. The exploration and production segment covers nearly 1.2 million acres in Pennsylvania with more than 4.5 trillion cubic feet of natural gas equivalent, providing National Fuel Gas with decades of development resources at current production rates.

Overall, the quarter was very successful with lower natural gas prices. Hedging limited the damage that the decline in natural gas prices did to earnings, and most of the rest of the business performed well and posted double-digit growth in revenues and profits. Revenue decline slowed compared to the last three quarters, and earnings per share increased 16%. The company lowered its earnings per share forecast, but the new midpoint of $4.90 would be down just 5% compared to fiscal 2023. Given Natural Fuel Gas’s ability to outperform earnings estimates, this wouldn’t be a shock for the company to achieve results higher than expected.

Dividend analysis and valuation

Despite its more cyclical nature, National Fuel Gas has increased its dividend for 54 consecutive years, which qualifies the company for inclusion in the Dividend Kings Index. The company is extremely friendly to shareholders.

Overall, the company has been paying dividends for over 120 years, which is one of the longest streaks of dividend growth on the market. The current growth streak has spanned multiple periods of recession, geopolitical upheaval, and even a pandemic, and National Fuel Gas has not only maintained but also increased its dividend. This should be very reassuring to shareholders.

The dividend has a CAGR of 2.5% over the last decade and 2.4% over the last five years. Dividend growth has been slow over the long term, but growth rates are starting to trend upward. Shareholders just received a 4% quarterly dividend increase on June 13^vol2024. This follows growth of 4.2% last summer and 4.4% in 2022.

The stock yields 3.7% based on a new annual forward dividend of $2.06. The projected payout ratio for this year is a very good 42%.

While National Fuel Gas does have a utility element, in my opinion the company’s reliance on natural gas for most of its operations makes it much more of an energy company.

Currently, in the energy sector, the median trailing price-to-earnings ratio is 10.1 and the median forward price-to-earnings ratio is 10.6.

The company’s shares closed Friday’s session at $55, representing a forward price-to-earnings ratio of 11.2. Thus, National Fuel Gas shares are slightly overvalued.

However, the five-year average trailing earnings multiple is 12.7 and the average forward earnings multiple is 12.1. Historically, the company’s shares are undervalued.

Given National Fuel Gas’s ability to continue to raise its dividend even during periods of weak economic conditions, I believe a price-to-earnings ratio target of 11 to 13 is appropriate.

Based on half of this year’s earnings forecasts, I set a target price range of $54 to $64 for the stock. At the low end of the range, the stock could drop 3.6%, but could recover as much as 14.3% if it hits the high end of my target range. Given current profitability, total returns are starting to reach all-time highs.

Risk to the investment thesis

The biggest risk for National Fuel Gas is that natural gas prices could remain lower for an extended period of time. A warmer than usual winter had a significant impact on prices, resulting in the company’s full-year guidance being lowered. Last winter was, in fact, the warmest on record, with much of National Fuel Gas’s service area experiencing some of the highest average temperatures on record. If future winters are similar, long-term demand for natural gas will remain low.

Additionally, state regulatory authorities may hinder expansion. A good example of this is the ongoing fight over the company’s proposed Northern Access pipeline, which would create a 150-kilometer natural gas system through western New York state to Canada. The project was put on hold due to ligation progress.

Final thoughts

National Fuel Gas is a dividend king with an impressive history of increasing shareholder payments despite operating in a highly cyclical sector. Energy prices, particularly natural gas, are largely tied to the state of the economy and demand for resources.

Demand for natural gas is weak due to a warmer winter, which has lowered estimates for 2024. Still, the stock is reasonably valued, has the potential to deliver double-digit returns and provides solid profitability. Therefore, I rate National Fuel Gas stock as a buy due to its potential rate of return and safe dividend.