For investors looking for small-cap yield with stable growth, a gas utility like
can add fuel to a portfolio.
UGI is in the power and gas business, distributing natural gas and electricity to about 340,000 customers in eastern Pennsylvania. It also operates an electric generation business in northeastern Pennsylvania, and markets natural gas, power and heating oil to customers in the mid-Atlantic.
That's no different than any other utility. What makes UGI different is its 51% ownership of
, the nation's largest retailer of propane. AmeriGas delivers more than one billion gallons of propane to a million-plus customers around the country. In fact, there is a pretty good chance that propane cylinder on your patio grill somehow was touched by AmeriGas. Also, UGI is expanding the propane business internationally and is now one of the largest retail marketers of propane in Austria, the Czech Republic, France, Slovakia and China.
While a small-cap, UGI's combination of utility stability with the propane business is intriguing. Add to that a 5%-plus dividend and the company looks like a good all-weather name in a stormy market.
While UGI posted solid second quarter (the company's fiscal year ends in September) earnings of $1.92 a share (vs. $1.91 in the year-ago quarter, excluding one-time items), contributions from the utility declined by 13% as a result of warmer-than-normal winter weather. Operating income dropped by 10% at the gas utility and 25% on the electric side as weather was 17% warmer than normal based on average temperature.
While there is little a utility can do about the weather, there were some good signs: the number of gas customers grew by 3%, and there was a 6% decline in maintenance expenses. That suggests that operating efficiencies should boost performance in future periods.
However, the propane business -- both domestically and internationally -- provided good earnings support. Even though propane prices declined by nearly 5 cents per gallon from the previous year, income from UGI's AmeriGas investment increased by over 10%, a result of last year's acquisition of retail propane distributor
. Propane volumes increased by over 20% compared to the second-quarter of last year, suggesting the propane business has additional room to grow.
Also, the international propane businesses controlled by UGI contributed net income of $5.5 million after posting a modest loss a year earlier.
Customer growth and improved operating efficiencies in the utility operations suggest UGI's natural gas and power operations will continue to be major contributors to the company's success. And the stability of a regulated rate base with return on equity targets provide certainty for investors.
Also, however, UGI's interest in propane could serve to fuel significant growth in future years. AmeriGas's acquisition of Columbia, for example, should ultimately boost propane volumes by 30%, and synergies between the two companies should help margins. Plus, the company's propane cylinder exchange program, whereby consumers can simply swap their empty propane grill tank for a new, full tank at a local retailer, will provide positive cash flow this year. With over 18,000 retail locations across the country in the program, revenue should continue to grow.
What's the potential of the cylinder exchange program? Consider this: over nine million new gas grills were sold in 2000, with annual sales growth of nearly 8%. That's a lot of propane! Also, new safety requirements for propane tanks means AmeriGas will likely receive a fee from many independent distributors to retrofit tanks with new safety mechanisms.
Finally, with a plethora of small operators, propane remains a very fragmented business in the U.S. With $25 million to $30 million in free cash each year after capital and dividend needs, it is probable UGI will look for other opportunities in propane, either through its AmeriGas ownership or other partnerships. Also, look for UGI to pursue more international opportunities in propane.
UGI is not without risks. The company faces the traditional utility risks: weather, fuel costs and regulatory issues. Plus, it has a small trading and marketing arm that could be impacted modestly by the tumult in the energy merchant sector. However, for the most part, UGI can hedge most of those risks and provide stable earnings and cash flow from its utility operations.
Also, while UGI's strategy to grow its propane business has been conservative and successful, sometimes success breeds the need for more success, leading to aggressive acquisition strategies that could weigh on the company's balance sheet.
But in today's market, the combination of stability with the potential for growth is intriguing. Throw in a 5%-plus yield and it's downright enticing, especially when the company has increased the dividend an average of 3% annually over the last five years.
I like UGI, especially for investors looking for stability, and give it two-and-a-half barrels and am adding it to the Bottom of the Barrel income portfolio.
For an explanation of our barrel rating system, see our
The Barrel portfolio held its own in a tumultuous market last week, with the one exception being
. The company took a big hit last week as news that sales of drug-coated coronary stents in Europe were lower than expected, largely a result of the high price, nearly $2,100 per unit.
However, I still like SurModics partnership with
Johnson and Johnson
, as well with other partners in the emerging coated stent business. And the steep correction in the shares make the entry point relatively attractive. A key date will be July 16, when both Johnson & Johnson and SurModics report earnings.
Coming next week: a recap of the quarter and a look at earnings reporting dates for all Barrel companies.
Do you have candidates for Bottom of the Barrel? If so , shoot me an email with the company's name, why you think it qualifies, and your full name and hometown. If I profile your suggestion, I'll send you a TSC gift to commemorate your pick.
Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to