Stocks

2 Natural-Gas Stocks With High Returns

Utility stocks make sense in a topsy-turvy stock market, and for investors willing to pay up for steeper valuations, One Gas and Atmos Energy offer rising dividends, “and they are very attractive businesses,” says Phillip N. Davidson at the American Century Equity Income Fund.

Utility stocks make sense in a topsy-turvy stock market, and for investors willing to pay up for steeper valuations, several regulated natural-gas utilities are a possibility, although caution is in order.

Barron’s wrote recently about two utility stocks that make sense in a topsy-turvy stock market—Dominion Energy (ticker: D) and Exelon (EXC). For investors willing to pay up for steeper valuations, several regulated natural-gas utilities are a possibility, as well, although caution is in order.

Phillip N. Davidson, a manager of the American Century Equity Income Fund (TWEIX), favors that subsector over other types of utilities, including ones focused on electricity. What’s to like about regulated natural gas utilities?

“Less can go wrong, and the majority of the spending is to either replace pipelines or to meet any growth in the service territory, as opposed to spending on an existing plant,” Davidson says.

As of June 30, the fund’s holdings included One Gas (OGS), which delivers natural gas to residential and commercial customers in Oklahoma, Texas and Kansas. It is based in Tulsa, Okla.

The stock, which yields 2.3%, has had steady dividend increases since it was spun off from Oneok (OKE) in 2014.

The shares, which have a 1-year return of about 17%, sport a rich valuation. They trade at more than 24.4 times the consensus FactSet 2020 profit estimate of $3.63 a share, well above its 5-year average of nearly 22 times.

Morgan Stanley has the stock at Underweight owing to its valuation.

Davidson, however, still likes One Gas and some others in the sector. “Fundamentally, it’s hard to see what would really derail them in the next three to five years,” he says. “Everything can get overpriced, that’s for sure. It’s fair to say that they’re not cheap.”

He points out that One Gas and another holding, Atmos Energy (ATO), offer rising dividends, “and they are very attractive businesses.”

Atmos, which yields 1.9%, has a 1-year return of about 19%. The company, based in Dallas, has a regulated natural-gas distribution segment that operates in 8 states.

The stock fetches 23.2 times the $4.61 it is expected to earn next year, according to FactSet, versus its 5-year average of about 20 times.

Compared with utilities in other sectors, he says, these companies operate “lower-risk business models that are growing but that have a lower range of outcomes.”

These regulated natural-gas stocks are defensive in the sense that their underlying businesses are fairly resilient. But their valuations are rich, making them vulnerable to a big selloff. For example, on Monday, when the S&P 500 fell about 3% amid worries about an escalating trade war with China, One Gas was down by about the same amount as the overall market.

Still, “there is underlying value to all of these businesses,” Davidson says.

A lot of it comes down to how much investors are willing to pay for yield.

Write to Lawrence C. Strauss at lawrence.strauss@barrons.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.