Is Your Favorite Dividend Stock Overvalued?
There are lots of different ways to value a stock. Beyond the usual ratios, we also like to look at Wall Street analyst sentiment.
Of course, Wall Street analysts are hardly infallible. And sometimes their objectivity is severely compromised by their firm’s investment-banking arm.
But if enough analysts track a stock, then we think there’s real value in monitoring their sentiment in aggregate.
As value-oriented investors, we’re less concerned with Wall Street’s Buy/Hold/Sell ratings (unless they’re suspiciously bullish or unusually bearish) than we are with their consensus 12-month target prices.
Since these prices are informed by analysts’ discounted-cash-flow models, they give us some sense of a stock’s relative value based on its future earnings power.
Most of the time, however, consensus target prices seem to move higher or lower in tandem with the fluctuations of share prices. Clearly, that means they’re subject to a bit more spin than what a dispassionate earnings model might spit out.
Still, there is one scenario that deserves your attention: when the analyst consensus target price is well below the current share price.
In our observation, it’s pretty rare for a stock to outpace Wall Street’s perpetual bullishness, a bias that even the nerd herd comprising the analyst community seems to possess.
Gassy and Bloated
On that score, one of the most overvalued stocks among electric and gas utilities at present is ONE Gas Inc. (NYSE: OGS), the pure-play regulated gas distributor spun off from ONEOK Inc. (NYSE: OKE) back in February 2014.
Tulsa, Oklahoma-based ONE Gas currently trades more than 13% above Wall Street’s consensus target price. In fact, the stock has traded at a premium to consensus target prices for most of the three-year period since it was spun off. There were only five exceedingly brief periods in which analysts’ optimism surpassed that of the market.
Perhaps even more unusual, there’s not even one analyst whose current target price exceeds the share price.
However, there is a noteworthy outlier among this cohort. An analyst with Evercore currently has a target price that’s less than half that of the current share price. We think that ONE Gas would probably get scooped up by an acquirer long before it reached that ludicrous estimate.
If we dispense with that clear outlier, then the current share price is 7.1% above the consensus target price. That brings the stock’s potential valuation closer to that of its gas utility peers, many of whose valuations have been inflated by takeover speculation spurred by what we jokingly refer to as the Great Gas Grab.
What about more traditional valuation metrics?
On a price-to-earnings (P/E) basis, ONE Gas is not the most expensive stock in the gas utility space. That dubious distinction goes to Portland, Oregon-based Northwest Natural Gas Co. (NYSE: NWN), which trades at a trailing 12-month P/E of 27.3 and a forward P/E for fiscal 2018 of 25.7.
Nevertheless, ONE Gas still trades at a moderate premium to the average valuation of the 11 publicly traded pure-play gas utilities, with a trailing 12-month P/E of 25.9.
At 22.1 on a forward basis, however, the company’s premium shrinks substantially.
Deal … or No Deal?
Earlier, we mentioned that gas utilities have been pushed to premium valuations in part due to the Great Gas Grab. While higher valuations are justified in light of the potential for further consolidation, the question is whether valuations are so high that they would scare off potential acquirers.
The four recent U.S. gas-utility acquisitions had an average transaction value to EBITDA (earnings before interest, taxation, depreciation, and amortization) ratio of 12.1 times.
With an enterprise value to EBITDA ratio of 11.3 times, ONE Gas isn’t so expensive that an acquirer couldn’t offer a premium to shareholders.
But it would probably have to be a utility that’s truly willing to break the bank in order to entice ONE Gas shareholders to sell—the highest recent deal multiple is a staggering 14.8 times. That’s what the Canadian utility holding company AltaGas Ltd. (TSX: ALA, OTC: ATGFF) is willing to pay for Washington, D.C.-based WGL Holdings Inc. (NYSE: WGL).
Just Gimme My Money, Man
These valuation considerations may seem academic to those ONE Gas shareholders who were lucky enough to receive their stake from the ONEOK spinoff.
As income investors, they may be largely indifferent to whether ONE Gas is expensive or cheap, so long as the company maintains and grows its dividend.
From that standpoint, ONE Gas seems likely to continue fulfilling its dividend obligation for the foreseeable future. The company has reasonable leverage and a manageable payout ratio, along with a decent, if unspectacular, earnings-growth trajectory.
While shares of ONE Gas yield just 2.5% on a forward basis, the dividend is forecast to grow 8% annually.