Dominion Resources (NYSE: D) announced the utility sector’s first major takeover for this year, reaching an agreement to acquire Utah-based Questar Corp (NYSE: STR) for $25 per share, or about $4.4 billion. The $1.6 billion in debt on Questar’s balance sheet brings the total deal value to almost $6 billion.
The transaction appears to be a win-win for both parties. Questar’s shareholders will be pleased by the takeover offer’s 30 percent premium to the stock’s most recent closing price, while Dominion Resources’ management team expects the deal to be immediately accretive to earnings.
Over the intermediate to longer term, management expects Questar’s gas utility and interstate pipeline assets to benefit from the Environmental Protection Agency’s (EPA) Clean Power Plan, which should help clean-burning natural gas win market share from coal in Utah and Wyoming.
The blockbuster deal also increases the visibility of Dominion Midstream Partners LP’s (NYSE: DM) growth prospects. Management estimates that about 70 percent (roughly $425 million) of Questar’s operating cash flow comes from assets that could be housed at the master limited partnership (MLP).
During Dominion Resources and Dominion Midstream Partners’ fourth-quarter earnings call, management indicated that the utility would drop down about half of the Questar Pipeline division to help the MLP achieve its targeted annual distribution growth of more than 20 percent in 2017. A follow-up transaction would contribute to Dominion Midstream Partners’ payout growth in 2018. Management reiterated the MLP’s guidance for annual distribution growth of 22 percent through 2020.
My updated ratings for all three companies will appear in the February issue of Conrad’s Utility Investor, which will post this weekend.
Dominion Resources’ acquisition of Questar also demonstrates key trends underway in the utility and energy sectors—namely, the power of a strong balance sheet and reliability of a regulated revenue stream.
Dominion Resources has more than $1.5 billion in short-term cash and receivables on its balance sheet, and its 30-year debt yields about 4 percent. Even if its common stock didn’t command a well-deserved premium, the company could easily afford to pay $4.4 billion for Questar’s stable and rising cash flows.
Contrast that with NGL Energy Partners LP (NYSE: NGL), an MLP that faces major headwinds in several business lines. The partnership’s sky-high cost of equity and debt capital presents a major impediment to financing even a low-risk acquisition or planned expansion project.
Does the partnership mint new common units at a yield of almost 25 percent? Does the MLP turn to the debt market when even its five-year bonds sport a yield to maturity of almost 15 percent? Or does NGL Energy Partners turn to the banks that fund its $2.356 billion revolver loan, on which it has already drawn $1.739 billion?
The answer is probably none of the above. In fact, NGL Energy Partners last month sold its general-partner interest in Transmontaigne Partners LP (NYSE: TLP)—a valuable piece of its business—to ArcLight Capital Partners—for $350 million in cash.
Dominion Resources and other utilities will continue to take advantage of their relatively low cost of capital and stable revenue bases to expand their presence in the midstream energy business. Meanwhile, with the Alerian MLP Index yielding almost 10 percent and many blue-chip MLPs struggling to fund future growth projects, well-capitalized utilities face less competition from established players in this space.
Other utilities used their low cost of capital to move into the solar power business, an area that should offer ample opportunity for earnings growth now that Congress has extended federal tax credits for renewable energy.
Dominion Resources, for example, today announced $1 billion in new solar-power investments—a sharp contrast to capital-constrained names such as SolarCity Corp (NSDQ: SCTY) and SunEdison (NYSE: SUNE).
Where will the big utilities strike next? Don’t be surprised if electric utilities look to acquire strategically positioned gas distribution and transportation assets to take advantage of the EPA’s Clean Power Plan.
Conrad’s Utility Investor readers have already reaped the rewards of this trend. Last fall, our model portfolio booked an 81 percent profit on Piedmont Natural Gas (NYSE: PNY) after the stock skyrocketed on a takeover bid from Duke Energy Corp (NYSE: DUK).
As the market’s performance in 2016 has underscored, the era of reaping big returns by buying a sector or industry-focused exchange-traded fund (ETF) has come to an end. With the bull market in its last throes, fortune favors savvy investors who pick the best stocks.
In his outlook for 2016, my colleague Elliott Gue tipped the utility sector as a likely top performer this year, citing its defensive qualities and appeal in an uncertain market.
Subscribe to Conrad’s Utility Investor today for instant access to my top picks and must-read special report on my Top 5 Utility Takeover Plays.
Roger's favorite utilities for investors seeking superior price appreciation by taking calculated risks.
Harness the tried and true wealth-building power of rising dividends.
Nothing compounds wealth like reinvesting a rising stream of dividends.
Warning: Falling Dividends.
Roger's current take and vital statistics on more than 200 essential-services stocks.