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Another Cross-Border Gas Grab

By Ari Charney on January 27, 2017

With rates heading higher, most investors are focused on yield. But that fixation causes them to miss out on another phenomenon—one that offers the possibility of big short-term gains.

In recent years, historically low interest rates have spurred a wave of mergers and acquisitions (M&A) across a number of sectors, especially considering how elusive organic growth has been during the recovery.

That’s given shareholders of takeover targets some nice windfalls in a relatively short span of time. And we think there are more to come.

Beat the Fed

At the end of 2015, the Federal Reserve had expected to raise rates four times in 2016. Instead, financial market turmoil got in the way, and the central bank waited until December to make its only rate hike of the year.

This time around, the Fed forecasts three rate hikes for 2017. If the market doesn’t yank away the football again, then the upper bound of the Fed’s benchmark federal funds rate would be at 1.5% by the end of the year, up three-quarters of a point from where it is presently.

Investors are betting that the next quarter-point increase will come at the central bank’s May meeting, based on futures data aggregated by Bloomberg.

That means there will be another mad scramble of M&A activity this year, as companies look to line up deals before the cost of borrowing goes up.

Our Latest Win

Indeed, at Investing Daily’s Utility Forecaster, one of our recent picks is set to be acquired at a nearly 44% premium to the price at which we bought it at the end of October. Not bad for less than three months of work!

This week, Washington, D.C.-based gas utility WGL Holdings Inc. (NYSE: WGL) announced it has agreed to be acquired by the Canadian utility holding company AltaGas Ltd. (TSX: ALA, OTC: ATGFF) in a $4.5 billion all-cash deal, or $88.25 per share.

In fact, five of the 12 stocks that we’ve added to our Growth and Income Portfolios over the past year-and-a-half have now been the target of takeover offers, with three deals having since closed. Beyond that, one longtime holding was also acquired during this period.

The Predators’ Ball

As income investors, we don’t normally select a stock on the basis of its takeover potential. Instead, we look for companies with strong earnings and dividend growth that trade at reasonable valuations. Those just happen to be the same criteria that attract corporate suitors. WGL is an excellent example of this approach.

One of the major themes in the utility space has been what we like to refer to as the Great Gas Grab. Basically, utility giants are trying to offset weak or declining electricity demand by buying growing regulated earnings streams.

Thanks to the Shale Revolution, natural gas is cheap and abundant. And the fact that burning natural gas produces roughly half the carbon emissions of coal means that it’s rapidly becoming the fuel of choice for utilities and industrials that need to comply with environmental mandates.

That’s made natural gas utilities the belles of the M&A ball. Indeed, five of the six companies in our portfolios that have been acquired over the past year-and-a-half were essentially natural gas plays—two midstream pipeline companies and three gas distributors.

As you might imagine, the Great Gas Grab has caused gas utilities to periodically trade at ultra-premium valuations, especially following each deal’s announcement. Since we don’t like to overpay for stocks, that’s forced us to be extremely patient.

Admittedly, sometimes our stinginess causes us to miss out on opportunities. But every stock inevitably corrects. And when WGL finally sold off, we picked up the stock near its low for the year.

To be sure, such takeovers can be bittersweet for income investors. As a standalone, WGL was targeting earnings growth of 7% to 10% annually along with dividend growth of 5% annually.

While we’re happy to book a big capital gain, we would have been even happier to collect WGL’s growing dividend for years to come. Now, we’ll have to go out and find a new income stream—at the right price, of course.

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  1. avatar
    Jan Å¡prlak Reply January 28, 2017 at 8:06 AM EDT