Sempra Energy: An Energy Powerhouse with Utility Risk Profile and Superior Growth Upside
Sempra Energy (SRE) is a San Diego, California, based energy powerhouse; it is a holding company with two utility subsidiaries (San Diego Gas & Electric Co. and Southern California Gas Co.), a clean power division (Sempra U.S. Gas & Power) and an international subsidiary (Sempra International) with natural gas and electricity operations in Chile, Mexico and Peru, and liquefied natural gas operations in the U.S. and Mexico.
Altogether, Sempra serves 20 million gas and electric utility customers (retail, commercial and industrial) in southern California, and about 11 million customers through its other subsidiaries.
Sempra Shareholders Have Done Very Well Over the Past 10 Years
At $97.13 (as of April 17, 2014), Sempra shares trade near their all-time high of $98.56 with a quarterly dividend of $0.66, or $2.64 annually (yielding 2.72%), and a trailing 12-months price-to-equity ratio of 24.5x. As the graph below shows, Sempra has steadily increased dividends since 2004, including the recent 5% hike in annualized dividend relative to 2012.
Sempra shares have delivered a total return of 301% over the past 10 years, including solid growth in dividends, and have handily outperformed the S&P 500 Index over the past 10 years.
More recently, over the past five years, revenues have recovered well from a sharp dip in 2009 following the financial crisis, and are on a solid growth trajectory with several exciting projects in the pipeline, including a large LNG export project (Cameron LNG) in Louisiana that received U.S. Department of Energy approval in February 2014.
While Sempra’s shares appear to have risen significantly over the past year, increases were tangibly related to solid
operational achievements such as the Department of Energy’s recent permit for LNG exports at Cameron.
But Current Valuation Bakes-In Near-Term Upside
However, shares appear fully valued with a forward PE ratio of 21.5 which is 50% above Sempra’s own 5-year average, 9% above the S&P 500 average and well above the 18.6 average PE of Sempra’s peers. Sempra’s forward PEG ratio (PE/Growth) of 3.4 is 44% above Sempra’s 5-year average. So current valuation, while not excessive, reflects Sempra’s strong growth prospects.
(Source: Thomson Reuters)
Wall Street analysts have an average 12-month price target of $100 for Sempra shares, with a high estimate of $108 and a low of $95. Consequently, shares currently have limited upside but the company’s multiple growth projects make this a compelling play, with dividends served on the side.
Operational Performance Well Above Peers
Operationally, Sempra is well ahead of its peers with a net margin of 10.4% that is 68% above its peer average of 6.2%. And while Sempra pays a solid quarterly dividend of $0.66, its yield is depressed relative to peers because of Sempra’s excessive share price performance (21%) relative to its peers (up 16%) over the past year.
Growth Platform with Utility Risk Profile
Sempra offers long-term EPS growth of 9% to 11%, well above the S&P 500 Utilities Index long-term growth of 5% but with a relatively low risk profile that is closer to that of a traditional utility.
Sempra is focused on generating stable, predictable earnings and cash flow through regulated assets in demographically vibrant and growing geographies, and with infrastructure that is supported by long-term fee-based contracts with little exposure to commodity prices or flow-through volumes.
Sempra’s growth strategy is supported by increasing production in America’s Marcellus and Utica shale fields, California’s increasing dependence on clean fuels (such as natural gas, wind and solar) and the opening up of LNG exports by the U.S. Sempra is also strategically positioned to benefit from Mexico’s increasing thirst for inexpensive U.S. natural gas for electricity generation and industrial production and energy reform in Mexico that will open up infrastructure needs from shale-based liquids production.
Sempra Knows How to Capitalize on Growth Opportunities
In 2012, Sempra’s share price did not reflect the value and growth potential of the company’s Mexico operations which led Sempra to spinoff these assets (through the IEnova IPO in March 2013) in a timely manner. Sempra’s $2.5 billion stake in IEnova has doubled over the past year to $5 billion. Buoyed by this success, Sempra is evaluating a potential MLP structure that could maximize value if structured and timed appropriately, in a way that would enhance long-term value for Sempra shareholders.
Sempra’s near-term growth will be driven by projects that are due to be completed in 2014. These include the Broken Bow 2 wind unit, the Copper Mountain Solar 3 farm, the Los Ramones 1 and Sonora pipelines and Santa Teresa Hydro projects.
Longer term, Sempra’s 8-10% EPS growth and cash flow will benefit from additional utility, solar, wind and infrastructure projects, and the Cameron project that recently received DoE approval. Cameron alone is projected to increase EPS growth to a CAGR of 9-11% by 2019.
In addition, Sempra is pursuing a suite of opportunities that could further boost earnings such as $350 million of transmission projects in San Diego Gas & Electric’s service territory; a natural gas pipeline, hydro-generation and energy infrastructure projects in Peru and Chile; a 300 MW wind farm and two natural gas pipelines (about 750 miles) in Mexico and additional renewables projects in the U.S.
Cameron LNG Facility in Louisiana Gulf Coast – Strong Project Fundamentals
Cameron LNG is an LNG receiving terminal in Louisiana, near the Gulf of Mexico, and is being upgraded with natural gas liquefaction and export facilities to create bi-directional flow capability. With the U.S. possessing over 100 years of natural gas supply, there’s been a market shift towards exports, especially with recent uncertainty in Russia – a source of natural gas to much of Europe.
Cameron is a joint venture between Sempra, GDF Suez, Japan LNG Investment LLC (owned by Mitsubishi and shipper NYK) and Mitsui.
Cameron recently received DoE approval for exports of up to 1.7 billion cubic feet per day, making it one of only six approved LNG export facilities in the U.S. Cameron has strong project fundamentals with LNG sourced from Henry Hub that serves as the basis for fee-based contracts and satisfied demand for U.S. gas priced LNG. The existing Brownfield site provides a significant cost advantage and has extensive community support, and capacity agreements provide high visibility into dependable cash flows with little downside risk.
Sempra has completed most major milestones at Cameron including DOE trade permits, 20-year take-or-pay capacity agreements, signed joint venture agreements for all equity providers, commitment letter from commercial banks, world-class LNG contractors for engineering, procurement and construction, and an experienced executive recently hired as CEO.
Sempra’s 100% take-or-pay contracts are similar to those for natural gas pipelines where customers pay capacity fees and fixed and variable operations and maintenance fees, with no commodity or volumetric risk to Sempra.
Cameron will cost a total of $9-$10 billion, and is expected to generate $750-$875 million in annual EBITDA to Sempra. Sempra’s equity contribution will come largely from an existing facility. The project will be financed with up to 70% leverage, and lender commitments exceed total budgeted cost. When operational in 2018, Cameron will have strong debt service coverage ratios. The project will be fully operational beginning 2019.
Beyond 2019, de-bottlenecking could increase export capacity at Cameron, with adjacent land available for expansion and limited additional infrastructure required to support expanded facility. With low startup cost, expansion will increase operating efficiencies and boost margins.
In addition, Sempra is expanding its Cameron Interstate Pipeline to receive and transport U.S. natural gas to the liquefaction project under-development at the Cameron LNG Terminal. The expanded pipeline will have bi-directional flow and is expected to be fully functional by Q2 2016.
Additional LNG Growth Prospects
Sempra plans to leverage its LNG knowhow to expand its LNG footprint through liquefaction and pipeline projects
on the west coast (Energia Costa Azul in Mexico) for locational and shipping advantages to Asian markets, and through floating and land-based liquefaction at Port Arthur (Texas Gulf Coast region) with excellent waterway access and plenty of available land for construction and expansion. Sempra also plans to supply LNG to mining and power projects in Chile (a market which is counter-seasonal to Asian demand), convert oil-fired generation to LNG in Hawaii, develop barge loading, railroad tank car loading and ISO tank loading at Cameron, and extend LNG trucking into Mexico.
Significant growth in global LNG demand will create opportunities that support Sempra’s long-term growth targets, and fit its strategy and risk profile. There is also a huge global opportunity to connect North America’s natural gas supply to markets without domestic sources. As such, global natural gas demand is expected to grow at a 5% CAGR.
Experienced Management Has Solidly Positioned the Company for Growth
Sempra is led by industry veteran Debra Reed as CEO. Reed joined Southern California Gas Company in 1981 and has since risen through the ranks to her current position, with extensive gas and electric experience. Reed is also the driving force behind Sempra’s outstanding performance relative to peer benchmarks and the strategic force behind the company’s exceptional growth plan. Reed has a full suite of highly-experienced executive managers. Mark Snell serves as President of Sempra Energy and has been with the company since 2001. Snell brings extensive strategy, engineering and finance expertise to his post. Joseph Householder serves as CFO and joined Sempra in 2001 from accounting firm PricewaterhouseCoopers.
FY 2013 Results Show 16% Profit Increase
For its fiscal year ended 12/31/2013, Sempra reported earnings of $1 billion ($4.01 per diluted share), 16.4% above 2012 earnings of $859 million ($3.48 per diluted share). 2013 results reflected a one-time benefit of $77 million from a regulatory rate decision, offset by $119 million in expenses tied to the closure of the San Onofre nuclear generating station. In 2013, Sempra completed the IPO of its energy subsidiary in Mexico and advanced several strategic growth projects such as Cameron LNG and gas and electric transmission in South America.
In FY 2013, utility revenues were up 10% to $9.31 billion while revenue from its energy related businesses gained 3.5% to $1.25 billion. San Diego Gas & Electric ($404 million) and Southern California Gas ($364 million) provided the bulk of the company’s revenues.
On an adjusted basis, the company earned $4.18 per diluted share.
Sempra ended the year with cash of $904 million and total assets of $37.24 billion. Long-term debt was $11.25 billion, down from $11.6 billion at year-end 2012, with excellent interest coverage ratios. Shareholders held $11.85 billion in equity, up 11% from a year-ago.
Sempra has an excellent track record of revenue, dividend, earnings growth and shareholder returns, with operational performance metrics that are well above peers. In addition, the company has boldly stepped out of its southern California geography and embraced projects such as the Cameron LNG facility in Louisiana and multiple projects in Mexico and South America, and leveraged its west coast presence to advantageously serve its international markets. The company has multiple growth projects in its pipeline and shareholders will do well with Sempra over the long-term. Shares have risen handsomely over the past few years and now bake in some of the company’s near-term upside, so investors should confidently buy on dips for this core long-term holding which provides low risk while still delivering 10-11% EPS growth and dividend upside.