Investing in the IBEX 35 — Enagas
I’ll be looking at potential investment opportunities in an array of IBEX 35 companies, the benchmark index for the 35 most liquid and largest firms in Spain in terms of market cap.
Introduction to the company
Enagas is a $5.7bn utilities company involved primarily in the transport, storage, and regasification of natural gas. With 50 years of experience in midstream operations, the company is certified as a Transmission System Operator (TSO) by the European Union and is present in eight countries (see below).
The company is divided into 3 business segments: Infrastructure, Technical Management and Unregulated Activities. The majority of revenues come from its Infrastructure segment. In 2019, the firm earned a revenue of $1.16bn and net income of $437.8Mn (a 38% profit margin).
Enagas operates Spain’s gas grid. The demand the firm saw for natural gas at the end of 2019 was the highest ever recorded in the last decade, sitting at 398TWh, a 14% increase in comparison to 2018. In Spain, it has currently established a diversified network of gas infrastructure including; more than 11k kilometres of high pressure gas pipelines, 19 compression stations and 416 regulation and/or measurement stations, strongly positioning it as the leading supplier of this commodity.
The firm began its international expansion in 2011 and can be found in Spain, Mexico, Chile, Peru, Greece and the US. Furthermore, it has a 16% ownership of the Trans Adriatic Pipeline (TAP), an 878km gas pipeline that will link Turkey with Italy through Greece and Albania.
The following image helps understand the company’s reach and diversified global operations. Enagas currently owns 30% of Tallgrass, a US energy company.
The primary reasons why I would see Enagas as a potential investment opportunity include; i) the dividend income ii) the defensive nature of the firm to protect one’s portfolio against market downturns iii) the low’s it has reached provide an attractive entry point (currently down 20.4% from recent highs).
Financial Performance
Enagas’ defensive nature, strong industry positioning and high current yield of 7.5% makes it an attractive investment for income oriented individuals. However, it’s important to break down a set of financial ratios to comprehend it ability to sustain this yield and long-term performance.
The average yield of Enegas for the last 10 years has been of 6.16%. Whilst the firm has been increasing the dividend, EPS cover every time a smaller proportion of it. And no, EPS hasn’t been inflated by share repurchases, warrants or any sort of actions that can affect the EPS formula denominator: Outstanding shares have stayed constant the last 10 years at 240 million. With this being said, Enagas’ pay-out ratio exceeds the generally accepted standard of 60% at 87%. While this extremely high pay-out can put in jeopardy the firm’s ability to sustain its dividend, it’s important to put it into perspective;
- Financial health: 2019 D/E ratio: 1.37
This is the lowest D/E ratio of the last decade (highest was 2.55 in 2021), indicating the firm’s working to reduce the proportion of debt in its capital structure and reliance on leverage to fund operations. Its closest competitor in Spain, Endesa, sits at a D/E ratio of 0.73 as of 2019.
- Profitability: Return on Invested Capital: 6.65%
How effective is management at putting capital to good use in the business? Unfortunately, this metric has been decreasing over time and sits at its lowest level for this last decade. It’s understandable that if the firm doesn’t see projects where it can obtain a satisfactory rate of return it can distribute the majority of cash to shareholders, as it has been doing.
- Valuation: Current P/E ratio: 12.38 — 10 year average P/E: 12.3
Based on P/E ratio, Enagas seems to be fairly valued. In addition, a 12.38 P/E ratio means an earnings yield of 8%.
Challenges & Risks
From an investor’s perspective, probably the most urgent risk facing the investment is the high pay-out ratio and ability of Enagas to sustain it. However, it is important to remark that recently, the company CEO Antonio Llardén, assured its commitment to the dividend until 2026. We will have to hope the Covid19 recovery helps demand pick up and ease lockdown and transportation restrictions, which currently constrain the firm’s operations.
From a business perspective, the firm has done well in diversifying its midstream portfolio across a variety of geographies. However, some of the risks that the firm outlines would have the greatest impact on the business include;
- OPERATIONAL: Industrial risk of infrastructure operation breakdown and cybersecurity risks
- STRATEGIC: Risks of obtaining licenses, permits and authorizations, legal/regulatory risk and variability in earnings
- FINANCIAL: Change in rates of interest, access to liquidity and FX risk
Invest or not?
In essence, if an investor is looking for a low volatility dividend paying investment and wishes to diversify its portfolio with a company that has global exposure and pioneers the sector in its local market (Spain), Enagas is the choice to make. The company follows sustainability practices and it is strategically expanding. Things to watch out include the dividend payout ratio, the changing economic landscape and the level of debt of the company, which could hinder its ability to sustain LT performance. Personally, I would wait 2/3 months for the Covid19 induced volatility to decrease and ensure movement restrictions and demand both improve. Also, despite of the income generating capacity of this firm, I’d purchase it at a lower price level to limit the downside risk of the investment and hedge against any adverse event to the firm, which unfortunately has a higher probability of occurring given the extraordinary circumstances.
Thank you,
IO
