Recently, this month’s Dividend Growth Stock of the Month increased its dividend by 8.8%. That extended its unbroken annual dividend growth streak to 38 years, which makes this a fine time to write about this solid utility.
The company is Atmos Energy (ATO), a natural gas utility that serves a geographical swath that covers parts of Texas, Louisiana, Mississippi, Kentucky, Tennessee, Virginia, Kansas, and Colorado.
Atmos’ Dividend Record
Atmos Energy is a very solid mid-yield, mid-growth DG stock.
Its most attractive dividend feature is its very safe dividend safety score from Simply Safe Dividends, which is near the max at 97 / 100 points. Atmos’ dividend is very unlikely to be cut. That score was just reaffirmed in August after the company’s quarterly earnings release.
Atmos’ dividend growth has been accelerating over the past few years, as shown clearly in the graph below. ATO’s rate of dividend growth has improved from 4% per year over the past 20 years to 8% per year over the past 5 years. This year’s 8.8% increase continues the more recent faster trend.
Business Model and Company Quality
Atmos Energy and its subsidiaries are engaged in the regulated natural gas distribution and pipeline and storage businesses. Atmos traces its roots back to an oil and gas company formed in 1906. It has grown to today’s giant through mergers and acquisitions. The company is headquartered in Dallas and incorporated in Texas and Virginia.
Atmos is the country’s largest natural-gas-only distributor based on number of customers. It has more than 3 million residential, commercial, public authority, and industrial customers in eight states located primarily in the South.
ATO also operates one of the largest intrastate pipelines in Texas based on miles of pipe.
Since 2011, Atmos’ operating strategy has focused on modernizing its distribution and transmission system while reducing regulatory lag. In recent years, ATO has increased its capital expenditures approximately 13% per year to improve safety and reliability and to reduce methane emissions from the system.
Atmos manages its operations through two reportable segments:
- Distribution. This business consists of regulated natural gas distribution and related sales operations in eight states under six regulatory entities.
- Pipeline and Storage. This segment is comprised primarily of pipeline and underground storage operations in Texas and natural gas transmission operations in Louisiana. These operations are also subject to federal and state regulations.
This slide shows the economic breakdown between these two segments.
(Source: Fiscal 2021 4th Quarter Presentation)
ATO’s distribution business operates through six regulated sales and transportation divisions: Louisiana, West Texas, Mid-Texas, Mississippi, Colorado-Kansas, and Kentucky/Mid-States.
Within the divisions, ATO operates under non-exclusive franchise agreements granted by the various cities and towns that it serves. The company currently has about 1,025 such agreements with terms generally ranging from five to 35 years. Some of the franchises expire each year. Historically ATO has successfully renewed these franchises.
Revenues in this operating segment are established by state regulatory authorities. The agencies regulating Atmos are generally considered to be “constructive,” meaning that the agencies tend to allow rates that are sufficient to cover the costs of conducting business, including a reasonable return on invested capital. The constructive nature of ATO’s regulators is one of the reasons for ATO’s high dividend-safety score.
In addition, ATO transports natural gas for others through its distribution systems for rates that are established by regulatory authorities. Through these rate mechanisms, distribution operating income is generally not affected by fluctuations in the cost of gas.
ATO’s supply of natural gas comes from a variety of sources, including independent producers and marketers. The gas is delivered into ATO’s system by various pipeline companies as well as withdrawals of gas from proprietary and contracted storage assets as needed.
ATO’s Pipeline and Storage Segment consists of the pipeline and storage operations of the APT division and natural gas transmission operations in Louisiana. APT is one of the largest intrastate pipeline operations in Texas. This shows the pipeline system in Texas.
Through its system, APT provides transportation and storage services to its Mid-Tex Division, other third-party local distribution companies, industrial and electric generation customers, marketers and producers.
As part of its pipeline operations, APT owns and operates five underground storage reservoirs in Texas. The natural gas transmission operations in Louisiana are comprised of a 21-mile pipeline located in the New Orleans area that is primarily used to aggregate gas supply for distribution in Louisiana under a long-term contract and, on a more limited basis, to third parties.
Atmos spent $2.0 B on capital expenditures in fiscal 2021, 88% of which was directed to spending on safety and reliability measures. Much of the spending was focused on system modernization (replacing miles of transmission and distribution pipeline), eliminating cast iron from the system, installing wireless meter readers, and reducing methane emissions.
ATO’s third-party ratings on quality factors are very good, and I give the company an overall quality grade of B+.
Atmos Energy’s Financials
Like many utilities, ATO is a slow-growth business in terms of revenue. Nevertheless, it has a steady upward record of growing its earnings per share. EPS has grown for 19 straight years, the last 10 of which are shown on the right-hand graph below.
(Source of all graphics in this section: Simply Safe Dividends)
Atmos’ earnings are fairly predictable due to its constructive regulators and steady demand for its products and services. The company is generally not exposed to commodity risk as gas prices are passed through to customers. Analysts are currently forecasting 6% growth in 2022. The company offers guidance of 6-8% annual EPS growth over the next 5 years.
ATO’s profitability metrics show that it has a modest ROE, but that it generates very high operating margins.
Utilities are capital-intensive businesses, so debt levels and share issuance are always areas to check. ATO keeps its debt well under control, but it has issued new shares every year over the past decade to help finance its capital needs. Its A- credit rating is mid-investment grade, very good for a utility.
I use four models in valuing companies, then average the results. See Dividend Growth Investing Lesson 11: Valuation.
Models #1 and #2: FASTGraphs relative P/Es
The first two models use FASTGraphs. Model #1 is a basic estimate of the stock’s fair value based on common valuations in the Utilities sector, while Model #2 uses the stock’s own past 5-year average valuation rather than the market’s.
The magenta line is Model #1, which I set to P/E = 18. The blue line is Model #2, based on ATO’s own average 5-year P/E of 22.3. The company’s current P/E ratio is 18.1.
The black line is PRU’s actual price. That price is currently very close to the magenta (sector-specific) reference line, suggesting that the stock is fairly priced. The price is below the blue (company-specific) line, suggesting undervaluation.
I compute valuation ratios to compare the company’s actual price to estimates of its fair or intrinsic value. Here are the computations for these first two models:
Valuation Ratios for FASTGraphs = Current P/E divided by Reference P/E
- Model 1: Based on sector (magenta) line: 18.1 / 18 = 1.01
- Model 2: Based on company’s historical record (blue) line: 18.1 / 22.3 = 0.81
Model #3: Morningstar DCF Valuation. Morningstar uses a discounted cash flow (DCF) model for valuation. The idea behind DCF has been summarized by Warren Buffett:
Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life…. [It] is an estimate rather than a precise figure. (Source)
Morningstar makes what I believe are conservative, logical estimates and performs the necessary calculations. Morningstar converts their result into a valuation ratio, which is circled below.
Morningstar’s valuation ratio is 0.95, meaning that they see Atmos as a little undervalued.
Model #4: Current Yield vs. Historical Yield. The last model compares the stock’s current yield to its historical yield. The idea is that if a stock’s yield is higher than normal, it may mean that its price is undervalued (and vice-versa).
Atmos’ current yield of 2.9% is 30% above its 5-year average of 2.2%.
Valuation Ratio for Relative Yield = 5-Year Yield divided by Current Yield
The valuation ratio in this case is 2.2% / 2.9% = 0.76, suggesting significant undervaluation. This outcome is the result of ATO’s accelerating dividend increases combined with the stock’s price stagnation over the past couple of years.
This table summarizes the four models:
Taking the average of the four models leads to a valuation ratio of 0.88, which suggests that Atmos is 12% undervalued.
As I said at the beginning of this section, valuations are estimates. Therefore, I leave a margin for error around my calculation of fair prices. For a steady but not spectacular company like ATO, +/- 5% seems like a reasonable band around the calculated fair price for a conservative investor.
That gives me the following outcomes:
ATO’s fair price = $106
Maximum buy price = $111
Bargain price = Less than $101
At its current price of about $94 and yield of 2.9%, Atmos Energy is clearly undervalued right now. I think it’s worth a look for any dividend-growth investor.
Wall Street’s Recommendations
Many brokerage accounts provide free stock analyses from various data providers. One of the data points often available is a survey of Wall. St. analyst opinions.
Here is how the IBES survey for Atmos is summarized in the report from Refinitiv, which I get from E-Trade.
The Bottom Line on Atmos Energy
The summary for Atmos looks good, with all green rankings.
- Solid mid-yield, mid-growth DG stock.
- Reliable growing dividend, with Very Safe rating from Simply Safe Dividends. Has been accelerating its annual growth over past several years. Currently yields 2.9%.
- Benefits from constructive regulators across its 8-state service area. Gets good or excellent quality grades from a variety of third-party sources.
- Mostly good financials. Flat revenue growth, but steadily increasing EPS (19 consecutive years of EPS growth).
- 12% undervalued.
- Flat revenue growth.
Conclusion: In my opinion, Atmos would fit right into many dividend-growth investors’ portfolios. Its 2.9% yield is mid-range these days (and more than double the S&P 500’s yield), and its growth trajectory is attractive. Its dividend appears to have little risk of being cut – indeed, its annual growth rate has been rising over the past few years.
This is not a recommendation to buy, hold, sell, trim, or add to Atmos Energy. Any investment requires your own due diligence. Always be sure to match your stock picks to your personal financial goals.
Other Reading on Atmos Energy
Undervalued Dividend growth Stock of the Week: Atmos Energy (Jason Fieber, October 2021)
Top 5 Dividend Stocks to Buy Now (Jason Fieber, November 2021)
High Quality Dividend Growth Stock: A Hidden Gem! (Dave Van Knapp, September 2021)
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