Sempra: A Smart Move in Utilities

S&P likes the gas and electric utility outfit's growth prospects and valuation, and ranks the shares strong buy

by Christopher B. Muir From Standard & Poor's Equity Research

San Diego's Sempra Energy (SRE; recent price, 56) currently trades at a small discount to its natural gas utility peers' estimated 2009 price-earnings ratio, a level we think leaves ample room for expansion of the price-earnings ratio.

We expect the average price for multi-utility stocks in our coverage group to appreciate 15% over the next 12 months, assuming no changes to the fundamentals of the companies in the group. In addition, we believe Sempra's fundamentals, quickly growing unregulated operations, opportunities for growth in its regulated operations, and what we see as its compelling valuation will attract investors to the stock and help push the stock's valuation to higher levels compared with peers.

By our analysis, Sempra's business model provides it with the opportunity to achieve earnings per share (EPS) growth higher than the peer average over the next five years, starting in 2008. We see utility regulatory settlements being enacted as well as utility projects that will increase the company's rate base. Unregulated businesses growth has been and will continue to be extremely strong, in our view, helped by the company's many growth projects. We also believe Sempra's balance sheet provides it with a great deal of financial flexibility. The stock carries Standard & Poor's highest investment recommendation of 5-STARS (strong buy).

Business Profile

Sempra Energy is divided into five segments: Sempra Utilities; Sempra Pipelines & Storage; Sempra LNG; Sempra Generation; and Sempra Commodities. Sempra Utilities includes the company's two regulated utilities, San Diego Gas & Electric (SDG&E) and Southern California Gas. The other segments are mostly unregulated companies.

Sempra Utilities

SDG&E distributes gas and electricity to 1.4 million electric meters and 830,000 gas meters in a 4,100-square-mile area in and around San Diego. Southern California Gas distributes gas to 5.7 million gas meters in a 20,000-square-mile area of Southern and Central California. Both of the utilities have agreed to general rate case settlements and are waiting for regulatory permission to implement the new rates. Together, the rate hikes amount to a 7% increase in 2008 ($197 million), and average annual increases of 3% through 2012 ($96 million). Sempra expects the segment to increase net income at a 6% compound annual growth rate (CAGR) through 2012.

Sempra plans utility capital expenditures totaling $1.2 billion in 2008 and about $1.6 billion in 2009. We believe most of the expenditures should expand the company's rate base, leading to future growth in net income.

Sempra Pipelines & Storage

Sempra Pipelines & Storage owns several pipelines and a number of gas and electric distribution utilities in Argentina, Chile, Mexico, and Peru. The company owns 100% of Gasoducto Bajanorte, a 140-mile, 0.5-billion cu. ft. per day (Bcfd) pipeline that stretches across northern Baja California, Mexico; a 25% interest in the $4.9 billion, 1.8-Bcfd Rockies Express Pipeline (REX) pipeline; and 100% of Transportadora de Gas Natural de Baja California, a 23-mile, 0.3-Bcfd pipeline that extends from the Pacific Coast to the western end of the Bajaducto pipeline and then north to SDG&E's gas system. The existing portion of the REX pipeline stretches 1,041 miles from Rio Blanco County, Colo., to Audrain County, Mo., the western 713 miles of which opened for business in December 2007. The REX pipeline is fully contracted through 2019.

Part of Sempra's largest project, REX-East, is expected to start construction in the near future and be completed by mid-2009. Construction has been completed on the $215 million Gasoducto Bajanorte expansion, which includes a 2.6-Bcfd extension to connect Sempra's Energia Costa Azul LNG station to the pipeline, and is preparing to become commercially operational. Sempra also expects to complete the 0.6-Bcfd $170 million Cameron Pipeline in the third quarter of 2008.