Does this Deal Make this Marcellus Driller a Buy?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Natural gas driller EQT Corp. (NYSE: EQT) announced plans to sell its regulated gas utility business, Equitable Gas Co., to privately held Peoples Natural Gas.  The $720 million deal also includes select midstream assets and commercial agreements.  The sale will enable EQT to focus on its rapidly growing natural gas production business in the Marcellus Shale.

The deal accomplishes several things for EQT.  First, it provides the company with the capital it needs to accelerate its drilling program.  Three years ago the company was spending just $200 million system-wide on capital projects and it had more than enough cash flow to support that spending.  More recently it has been spending $300 million more than its cash flows, which has necessitated several asset sales and capital raises to make ends meet.  With a $1.4 billion capital budget for next year, the company needed to do more.     

Aside from the liquidity injection, EQT is receiving 200 miles of regulated transmission pipelines as well as four storage pools with 15.1 Bcf of working gas capacity.  Further, the two companies signed long-term contracts for gas transmission, supply and storage services, which will supply locally sourced Marcellus gas of 35 Bcf per year to Peoples.  Together these will generate around $40 million in annual EBITDA for the company. 

The midstream assets are an important part of the deal.  These assets could eventually be dropped down to the company’s recently spun out EQT Midstream (NYSE: EQM) as another source of capital.  EQT Midstream’s assets currently consist of a transmission and storage system as well as a gathering system.  A crucial part of its strategy is to pursue accretive acquisitions from EQT, meaning it’s quite possible some of these assets are eventually dropped down.

Finally, by offloading the Equitable Gas business the company is freeing itself of a slow-growth utility.  A few years ago EQT tried to grow the business by signing a deal to acquire Peoples from its former owner, Dominion (NYSE: D), but the deal fell through after the Federal Trade Commission wouldn’t give its blessing. Peoples was later sold to a private investment firm. 

EQT CEO David Porges doesn’t think the companies will have the same problem with the FTC this time around.  He noted that both EQT and Dominion were unfamiliar with the FTC process the first time around and now Peoples and EQT have a better idea of how to deal with any concerns the commission will raise.

Now that EQT won’t have the cash flow from the gas utility it’s slashing its annual dividend from $0.88 cents a share down to just $0.12 a share annually.  With a capital-intensive production business to fund it needs to conserve every penny.  Porges noted that, “the markets don’t like us raising equity and you can only raise so much debt.”  The sale helps to take care of that problem through 2014. 

This is a deal that makes a lot of sense for EQT.  While the Equitable Gas assets provided stable cash flow, it’s simply a more perfect fit with Peoples.  With the growth opportunities in the Marcellus, EQT needed more capital and the cash flow from the utility simply wasn’t going to be enough.  Now the company is able to grow both its natural gas production business thanks to the cash infusion while adding to its midstream business by picking up additional midstream infrastructure. 

As much as I like the deal, I’m not sure it makes EQT a buy just yet.  It does make the company one to watch.  With an industry leading cost structure, excellent Marcellus economics and extensive reserves, there certainly is a lot to like about EQT.

latimerburned is an Equitable Gas customer and has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Dominion Resources. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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