From the Drill Bit to the Burner Tip
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There are a lot of energy companies that boast about being vertically integrated, but few companies can boast to the scope of the integration at National Fuel Gas (NYSE: NFG). Their asset portfolio runs from the drill bit all the way to the burner tip. Analysts and investment bankers might eye this company as ripe for a breakup, but I think that their diversified business of highly integrated assets provides an excellent opportunity for investors looking for a low risk company with excellent upside potential.
National Fuel Gas operates their E&P business through their Seneca Resources subsidiary. Their west division is focused on crude oil production while their east division is focused on natural gas production in the Marcellus Shale as well as conventional wells. Seneca provides about 57% of the EBITDA for the company at $377 million. A bulk of their assets and future growth will come from their Marcellus assets, as well as their acreage in the Utica and Genesee shale. Due to all the capital required to exploit these assets they had until recently been exploring a JV but have decided to go it alone. They also just opted out from some JV wells they had with EOG Resources (NYSE: EOG) while maintaining 20% overriding royalty interest in wells on acreage they contributed. In the short term, the company is taking a breather by delaying completions, curtailing production and reducing the rig count. Still production is forecasted to grow 25% over the next year and should eventually provide a bulk of the revenue and income.
As we look across the value chain at Seneca, the one asset that does seem out of place is their California oil assets. However, after having generated $118.3 million in EBITDA through the first half of 2012 it’s hard to argue as to its value to the company. They have 1,322 wells on 11,833 net acres in the state and in 2010 produced 9,655 BOEPD. They are the seventh largest producer in the state but far behind Chevron’s (NYSE: CVX) 174,856 BOEPD. While it is very unlikely, this asset would fit very nicely in an MLP like structure such as Linn Energy (NASDAQ: LINE). They already have 300 wells in the state and are always on the lookout for assets like these. If they were ever to need capital, this is the one asset that I’d look for them to sell.
The pipeline, midstream, storage and marketing segments include: National Fuel Gas Supply, Empire Pipeline, National Fuel Resources and National Fuel Gas Midstream. This segment provides $142 million of EBITDA, which is 18% of the total. The midstream gathering systems are critical to unlocking the highly productive Marcellus. Their stated goal is to first work with Seneca and then gather for third party producers. They have a similar business model when it comes to their pipeline and storage assets as 54% of their transportation and 50% of storage contracts come from National Fuel affiliates. Their system integration is a key advantage and has plenty of room to grow. The linkage between their drill bit assets and their burner tip assets are only made through this set of assets.
The final link in the value chain is found in their sleepy natural gas utility and what better place to be operating such a business than western New York, especially in the winter time. This stable segment provides $169 million of EBITDA for 25% of the total. This is a low cap ex business that projects to burn just $55 to $60 million in capital each of the next three years. This leaves plenty of capital left over to be reinvested in their higher growth businesses or returned to shareholders. By providing gas to heat the homes of consumers they’ll always have an end user for the gas they produce. This will be a very stable business for them as their growth lies elsewhere in the value chain.
At their analyst day last September management projected 2013 capital expenses to be between $1.0 and $1.3 billion but have since ratcheted down that to $610 to $785 million. They’ve also reduced their operated rig count from 6.5 to just 3 rigs in order to maintain a strong balance sheet as well as flexibility to redeploy capital opportunistically. This is down from the billion dollars they are projected to spend this year and the $850 million they spent last year. Until gas prices start moving up they’ll conserve capital. They have decades worth of future growth ahead of them and their smart capital allocation will continue to benefit shareholders.
If there is one overriding characteristic at National Fuel it is their consistency. They’ve paid a dividend for 109 years and raised it for the past 41 years. With a yield of 3% investors get a good mix of income with upside. While the sums of the parts are undoubtedly worth more than the whole, the strategic fit of their businesses is quite obvious. Investors with a long-term perspective could sit back and enjoy the dividend income while waiting for the upside as the economy improves.
latimerburned owns shares of Linn Energy, LLC. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.