South Jersey Industries deal reinforces lofty gas utility valuations – analysts

The $8.1 billion buyout of South Jersey Industries Inc. presents further evidence that local gas distribution companies will continue to command strong valuations in the mergers and acquisitions market, analysts said.

The strength of local gas distribution company valuations has been top-of-mind for industry watchers since April 2021 when CenterPoint Energy Inc.'s Arkansas and Oklahoma gas utilities fetched premium value. The market has also seen the valuations as a bellwether for sector sentiment at a time when pipeline project headwinds and building gas bans have unsettled investors.

"The acquisition represents a significant premium to current market prices and validates that LDCs will continue to play a significant role in U.S. energy and evolve with the energy transition," Stifel analyst Selman Akyol said in a Feb. 24 research note.

LDC valuations remain strong

The deal values South Jersey Industries, or SJI, at 21 times Stifel's 2022 EPS estimates for the company and 20 times its 2023 EPS estimates, Akyol said. Guggenheim Securities LLC said the deal carried a multiple of 17.9 times consensus estimates for SJI's 2024 EPS. SJI's stock had been trading at 12.1 times the company's 2024 EPS, Guggenheim said in a Feb. 24 research note.

Dominion Energy Inc.'s recent sale of Hope Gas Inc. valued the West Virginia gas distributor at 2 times its 2021 rate base and 26 times 2021 EPS, Guggenheim said.Expressed as a multiple of utility rate base, the deal value did not quite match CenterPoint's 2021 sale, though the SJI announcement reinforced recent strong valuations. The CenterPoint deal valued the assets at 2.5 times their combined 2020 rate base, while the SJI buyout penciled out to 2 times its 2021 utility rate base, according to Guggenheim.

In interviews with S&P Global Market Intelligence shortly after the CenterPoint deal, gas utility executives were optimistic that the valuation would telegraph to investors that gas distribution systems remained valuable assets. But they also saw those lofty valuations as hurdles to strategic M&A among utilities seeking to bolt on complementary territory.

Financial buyers may drive M&A

The multiples may not put a stop to deal-making, according to Guggenheim analyst Shahriar Pourreza. The SJI deal cemented Guggenheim's view that financial sector buyers will bid on LDC deals of all sizes.

"Over the past two years we have seen financials begin to pay-up for gas LDC assets," Guggenheim said. "While transactions of late have been generally on the smaller side, we believe this latest data point opens up the environment for larger deals and increases the funding optionality for gas/electric hybrids in the space."

SJI's acquirer, Infrastructure Investments Fund, was the buyer behind CenterPoint's blockbuster LDC sale, through one of the fund's portfolio companies, Summit Utilities Inc. The buyer in the Hope Gas acquisition was also an infrastructure fund, operated by Ullico Inc.

In Guggenheim's view, future LDC sellers could be multi-utilities that need to finance electric power investments and execute decarbonization policies, similar to CenterPoint's strategy. During a Feb. 23 conference call, NiSource Inc. President and CEO Lloyd Yates said the company would consider selling LDC assets and rebalancing its portfolio toward electric operations.

Potential for additional LDC sales

SJI's sale could also hint at M&A among other small gas utility operators, such as New Jersey Resources Corp., Northwest Natural Holding Co., Spire Inc. and One Gas Inc., Guggenheim said. However, those companies either have larger nonregulated business lines or multi-state footprints that differentiate them from SJI, the analyst report noted.

Guggenheim speculated that SJI's management and board of directors may have tired of gas utilities' persistent valuation discount to electric peers and other parts of the market. Guggenheim said it did not see an opportunity for SJI to reset its valuation based on fundamentals, which drove Guggenheim to downgrade SJI's stock recently.

Asked about the SJI deal and the difference between private and public market valuations of LDCs, One Gas President and CEO Sid McAnnally acknowledged the dislocation during a Feb. 24 quarterly conference call. However, the executive suggested the company's five-year, $3.5 billion capital plan across its three-state footprint would drive shareholder value.

"Given the opportunities that we have going forward on both the growth and the system integrity-slash-maintenance side, we feel like we're really well positioned to execute this plan," McAnnally said.