Analyst Insights

Citi Highlights Atmos Energy's Q3 Potential Amid Favorable Gas Price Spreads

Citi sets a price target of $125, maintaining a Neutral rating due to stable earnings and regulatory risks

By Harrison Wall

7/10, 07:08 EDT


Stock Rating: Neutral
Revised Price Target: $125.00
Previous Price Target: N/A
Stock Price (July 8, 2024): $114.08

Summary Points

  • Atmos Energy poised for strong Q3 results due to favorable gas price spreads, with Citi maintaining a $125 price target.
  • Citi's Neutral rating reflects stable earnings and dividend outlook, balanced against regulatory and market access risks.
  • Atmos faces increased uncertainty in FY24, with potential impacts from population growth and capital market conditions.

Strong Setup into Q3 Results

Citi's latest equity research report on Atmos Energy Corp (ATO.N) is centered around the company's upcoming Q3 earnings release. The report highlights the potential for Atmos to benefit from recent movements in gas price spreads, particularly between the Waha and Henry hubs. This dynamic could lead to a positive earnings surprise for the quarter. The main takeaway is that while the short-term outlook appears favorable, there is increased uncertainty looking into the next fiscal year.

Neutral Rating with a $125 Price Target

Citi has maintained a Neutral rating on Atmos Energy, with a price target set at $125. This valuation is based on a combination of methodologies, including Net Asset Value (NAV), Dividend Discount Model (DDM), and Price-to-Earnings (P/E) analysis. The Neutral rating reflects the company's stable earnings from its regulated utility asset base, which supports mid- to high-single-digit EPS growth and a solid dividend outlook. However, the rating also considers potential risks and uncertainties that could impact future performance.

Gas Price Spreads and Regulatory Environment

The driving factors behind the updated price target and stock rating include recent favorable movements in gas price spreads, which are expected to positively impact Atmos's Q3 earnings. The company's exposure to these spreads is a common occurrence, but the current market conditions are particularly advantageous. Additionally, the regulatory environment plays a crucial role in Atmos's valuation. The company's ability to recover capital investments through future rates is essential for maintaining and expanding its pipeline and utility systems. However, a politicized commission could delay or jeopardize this recovery, posing a significant risk.

Citi's analyst notes, "Given the strong movement in Waha to Henry hub gas spreads, Atmos is more exposed to these movements that is common for the company." This statement underscores the importance of gas price dynamics in the company's short-term performance.

Macro Influences and Model Adjustments

Macro influences such as population growth and capital market conditions also significantly impact Atmos's valuation. An unexpected increase or decrease in population could substantially affect earnings, either positively or negatively. Additionally, as a relatively small utility in terms of market cap and trading volumes, Atmos faces challenges in accessing capital markets, which could affect its liquidity and attractiveness to institutional investors. Volatile derivatives markets and dislocated hedges also pose risks, potentially leading to earnings losses or liabilities.

Valuation Recap & Outlook

Citi's valuation of Atmos Energy at $125 per share is derived from a blend of NAV, DDM, and P/E analyses. The NAV value is calculated as a multiple of 1.6x of the rate base for utilities, offset by the company's net debt. The DDM valuation is based on forecasted cash flows discounted by a WACC/CAPM-based discount rate, considering regulated capital growth, authorized returns, and cost of equity. The P/E analysis uses multiples of 20x for the company's distribution and transmission businesses, while the EV/EBITDA analysis applies multiples of 12x.

Key risks to this valuation include the potential for delayed capital investment recovery, unexpected changes in population growth, and challenges in accessing capital markets. Additionally, volatile derivatives markets could lead to earnings losses or liabilities. Despite these risks, the company's stable earnings from its regulated utility asset base and solid dividend outlook provide a foundation for mid- to high-single-digit EPS growth.

"We rate ATO a Neutral (2). Our Neutral rating on ATO is premised on the company's growth profile and current regulatory environment," states the Citi Analyst.