On Dec 24, 2013, we retained our Neutral recommendation on North American energy firm Williams Companies Inc. (WMB). Our investment thesis is supported by a Zacks Rank #3 (Hold).
Why the Reiteration?
Williams Companies should be able to generate highly visible cash flow and dividend growth over the next several years. With Williams Companies now free from the capital constraints of a typical exploration and production (E&P) firm, the company’s exposure to a bullish natural gas liquids (NGL) processing market and a deep inventory of growth projects is set to unlock significant shareholder value.
However, we remain concerned about volatile natural gas prices, which are likely to dampen Williams Companies' near-term growth prospects. We also believe that upside potential will remain limited until this North American pure play energy infrastructure company has fully reaped the benefits of the spin-off.
Detailed Analysis
Tulsa, Oklahoma-based Williams Companies is a premier energy infrastructure provider in North America. The company’s core operations include finding, producing, gathering, processing and transportation of natural gas.
Williams Companies’ midstream assets, which are less sensitive to commodity prices, help the company to maintain a steady stream of revenues and cash flow even if natural gas prices stay low. Furthermore, Williams Companies is poised to benefit from the rebound in industrial activity, which will include increased natural gas demand in the form of natural gas liquids.
In Nov 2013, Williams Companies approved a raise in its quarterly cash dividend to 38 cents per share ($1.52 per share annualized), representing an increase of 4% over the previous payout. The dividend hike not only highlights the company’s commitment to create value for shareholders but also underlines Williams Companies’ new policy – a continued 20% annual dividend growth over the next few years.
Williams Companies, after the volatile and capital-intensive WPX Energy Inc. (WPX) spin-off in 2011, has transformed itself into a pure play midstream conglomerate with operations spanning from the Canadian oil sands to deepwater fields in the Gulf of Mexico.
However, Williams Companies’ extensive natural gas exposure raises its sensitivity to the commodity’s price, which continues to be volatile. This translates into an uncertain near- to medium-term outlook for the company.
Additionally, we remain concerned about Williams Companies’ high debt levels, which leave it vulnerable to an extended drop in commodity prices. As of Sep 30, 2013, Williams Companies had long-term debt of $10.4 billion, representing a debt-to-capitalization ratio of 68.4%.
Finally, we believe that transfer of the upstream assets (post-split) has left Williams with a less diversified business. As a result, the business risk profile of the reorganized Williams Companies is weaker than that of the pre-spin-off company.
Stocks That Warrant a Look
While we expect Williams Companies to perform in line with its peers and industry levels in the coming months and advice investors to wait for a better entry point before accumulating shares, one can look at Harvest Natural Resources Inc. (HNR) and Clayton Williams Energy Inc. (CWEI) as good buying opportunities. Both these domestic upstream energy operators – sporting a Zacks Rank #1 (Strong Buy) – have recorded solid growth and have the potential to rise significantly from the current levels.
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