National Fuel Gas

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

National Fuel Gas is a diversified energy company engaged in the production, gathering, transportation, storage, and distribution of natural gas, primarily within New York and Pennsylvania.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

National Fuel Gas (NFG) operates as a vertically integrated natural gas business, with a diversified portfolio spanning upstream (exploration & production), midstream (pipeline and storage), and downstream (utility) operations. This integration helps stabilize revenues and allows for multiple profit sources, making the company somewhat resilient. However, it is not entirely resilient to price fluctuations of natural gas.

Business Overview:

  • Exploration and Production: NFG explores and produces natural gas in the Appalachian region of the United States. This is its most upstream operation.
  • Pipeline and Storage: NFG owns and operates pipelines and storage facilities to transport natural gas. The network operates in NY and PA and links NFG to markets in other states.
  • Gathering: The company also has gathering assets to get gas from wells to pipelines.
  • Utility: NFG distributes natural gas to customers in western New York and Pennsylvania, with a strong concentration on residential and industrial areas.

Revenue Distribution:

  • The majority of their revenue is attributed to the Utility segment, which is a regulated portion of their business.
  • NFG also generates revenue from the Exploration and Production, Pipeline and Storage and Gathering segments but these are much smaller segments of their business.

NFG’s revenues are dependent on the price and demand for natural gas. The utility business is more stable, since it’s a regulated one, with a guaranteed return on capital. The commodity businesses such as Exploration & Production are subject to volatile pricing.

  • Natural Gas Production Growth: Increased production in recent years has put pressure on prices, affecting the profitability of companies in the upstream sector. NFG also faces competition from other gas producers in the Appalachian Basin, as stated in their latest 10-k form.
  • Environmental Regulations: The natural gas industry is facing scrutiny from federal and state agencies due to increasing focus on limiting carbon emissions. This may lead to the company making large capital expenditures to comply with new regulations.
  • Renewable Energy: Increasing adoption of renewable energy sources like solar and wind are putting pressure on the oil and gas industry. However, NFG is not impacted much by renewables, since natural gas is seen as a bridge to renewable energy.
  • Infrastructure Development: There is an increasing focus on improving the existing gas pipeline infrastructure to ensure reliable and efficient transportation of gas, which opens up opportunities for the pipeline and storage segment.

According to NFG’s recent 10k (Filed November 22nd 2023), the company acknowledges ongoing regulatory scrutiny and the potential negative impacts of these on its operations. The company further acknowledges the uncertainties related to future gas prices, the volatility of demand, and the risk associated with new pipeline projects.

Competitive Landscape:

NFG is a regional player and is impacted by the economic dynamics within the region. The company operates in a capital-intensive industry, competing with a range of different players, depending on its operating segments.

  • Exploration and Production: They compete with other companies producing natural gas in the Appalachian Basin, where the company operates.
  • Pipeline & Storage: NFG competes with other regional transportation and storage companies.
  • Gathering: The company faces competition from other midstream companies that facilitate the gathering of natural gas from wells.
  • Utility: This segment faces a lack of competition, as the company has a regulated monopoly in its specific service area.

Financials:

NFG has three operating segments: Exploration and Production (E&P), Pipeline and Storage, and Utility.

  • For the full fiscal year of 2023, the company reported a total revenue of $2.12 billion, which came from:
    • $678.1 million (31.9%) from the Utility segment.
    • $940 million (44.3%) from the Exploration & Production segment.
    • $468 million (22%) from the Pipeline & Storage segment.
  • Net income was $479.8 million for fiscal 2023.

NFG’s recent financial performance has shown that its utility segment is the most dependable, while profits from the E&P segment tend to be more volatile.

Analysis of Financials

  • Revenue: There has been an increase in revenues in both the Exploration & Production and Utility segments.
    • This increase was primarily due to high natural gas prices and increased sales in the Utility segment respectively.
  • Profits: The company had a net profit of $480 million for fiscal year 2023 which is a great improvement from $163 million last year.
    • This improvement was due to increased revenues and lower exploration costs. However, the company’s earnings are still vulnerable to fluctuations in natural gas prices.
  • Expenses: Operation and maintenance expenses were up from last year, and there were increased production expenses.
    • However, the company has managed to control costs in other aspects, like interest and taxation.
  • Profit Margins: The company’s operating profit margins are about 40% for the Utility segment, and around 20% for the Production segment.
  • The volatility in the price of natural gas impacts the margins of NFG. If prices go down substantially, profits will take a big hit.
  • Leverage: NFG has a debt-to-equity ratio of approximately 1.2, indicating that the company does not have an over-reliance on debt financing. However, it is essential to monitor this ratio moving forward, as rising debt can affect profitability and credit rating.
  • Debt Schedule: NFG has a substantial amount of debt maturing in 2024, and it’s important to see how this debt is going to be handled and if this increases interest expense. However, most of this debt is fixed, and the average interest rate is low.
  • Cash Flow: The company reported strong cash flows in its latest earnings reports, with strong cash from operations. However, the company also mentions that it is facing high volatility, and may require additional funds to stabilize its capital structure and for its strategic projects.

The company faces increased interest expense, due to higher interest rates as well as the need to pay down a large portion of debt in 2024. They are also facing inflationary pressures.

Dividends and Payouts:

  • NFG has a long track record of paying dividends.
  • The company has a target dividend payout of 60 to 70 percent of earnings, highlighting its commitment to returning profits to shareholders, it has been increased a lot in the recent years and is almost at the higher end of the payout ratio.

Moat Assessment

  • NFG has a narrow moat. This is primarily due to a few factors.
    • Limited Scaled Distribution Moat: The utility segment benefits from the regulatory environment, which provides NFG some local protection, but this is limited, and other companies can compete with them.
    • Unique Asset Moat: The company also benefits from its ownership of energy resources in the Appalachian Basin, and its pipeline network, which are somewhat difficult to replicate.
  • Brand: NFG has some brand recognition and customer loyalty in its market segment, especially in NY & PA.

  • However, the company’s economic moat is limited by the inherent nature of the commodity business, as the exploration and production segment depends on factors like commodity prices, and access to resources, and is always subject to competition. Even the regulated utility business can have margins squeezed down by regulators.

    A moat rating of a 2/5 is assigned, reflecting a limited but recognizable competitive advantage that offers some degree of protection but is not fully impervious to competition.

NFG benefits from a diversified vertically integrated business, which provides stability to earnings. However, reliance on prices of natural gas and an exposure to regulatory risks reduce the overall strength of the moat.

Risks that can hurt the moat and the business resilience:

  • Commodity Price Volatility: The revenues in the production segment are highly correlated with natural gas prices, causing increased volatility.
  • Regulatory Changes: Changes in regulations or rulings can impact revenue of both the Utility segment and the Production segment.
    • The company faces risks from changing regulatory policies for environmental, pipeline, and gas gathering processes.
  • Pipeline Disruptions: Pipeline and storage assets are important for the company’s operations, as such any disruption to these would cause problems in profitability.
  • Capital Requirements: Expansion plans, including potential acquisitions, might require higher capital spending, and they have a substantial debt payment due in 2024. This is very important to consider.
  • Competition: The company has competition in their production, and their services are subject to different factors.
  • Weather and Demand: The demand for natural gas is impacted by weather conditions. Unusual weather patterns could reduce customer demand and impact the financial performance of the company.

The company is undertaking several projects to help with operational efficiencies. But they are also undergoing regulatory changes, particularly in NY, which is a risk. They are also dependent on long term natural gas prices, if prices decrease, this could cause massive damage to them. The high debt obligations, which are due in the near term, combined with rising rates and inflationary pressures, makes their finances more vulnerable to a downturn in the economy.

Understandability: 2 / 5

NFG’s business operations are complex due to its diversified nature across different segments. The regulatory aspect of its business makes it difficult to grasp for investors without a strong understanding of energy regulations. Also, there are a lot of factors that are at play here. A rating of 2/5 is given due to the complexities surrounding the interplay of factors such as prices of natural gas, government regulations, economic cycles and environmental issues. This requires significant effort to grasp for the typical investor, and most of the details are very sector specific.

Balance Sheet Health: 3 / 5

NFG’s balance sheet has some areas of weakness and some areas of strength, leading to a rating of 3/5.

  • On the positive side, the company has a large base of assets that include pipelines, storage units, and production wells.
  • However, the company’s debt load is quite high, with a significant chunk of it maturing in 2024.
  • There has been an increase in working capital requirements as well.
  • While the company has a sizable cash reserve, the debt obligations combined with rising interest rates, makes the balance sheet somewhat risky.

In Conclusion, NFG has a decent, but not fantastic financial position. It is neither extremely unhealthy or extremely healthy.