Sempra: Growth Opportunities In California And Texas (NYSE:SRE)

Sempra (NYSE:SRE) is a regulated utility that operates in California and Texas, and those states present the company with excellent growth opportunities moving forward. According to the Utilities Select Sector SPDR ETF (XLU) webpage, the Utility Sector currently represents only a 2.13% weighting in the S&P 500. To give you a sense of Sempra’s size (market cap $43.6 billion) relative to the overall sector, the graphic below shows the top 5 holdings in the XLU ETF, with Sempra holding down the #4 position with a 4.9% weight, and just between Duke Energy (DUK) and American Electric Power (AEP):

In the face of a rising interest rate environment, all these utility companies are trading toward the bottom of their 52-week ranges (at pixel time, Sempra is trading at $69.51, ~14% off its 52-week high). The company is due to report Q4 and full-year FY23 earnings on February 27th, so today I’ll preview the earnings report, take a look at SRE’s valuation, and make a thumbs-up or thumbs-down recommendation.

Investment Thesis

Sempra is a utility holding company with operations in California, Texas, and Mexico. The company runs four segments:

• San Diego Gas & Electric (“SDG&E”)
• SoCalGas (“SCG”)
• Sempra Texas Utilities
• Sempra Infrastructure

As interest rates have risen, the entire Utility Sector has been struggling because the cost of capital to fund growth projects has significantly increased. The chart below shows Sempra’s 1-year total returns (-9.1%), which are on par with the broad SPDR Utilities ETF and significantly higher than National Fuel Gas (NFG) – another gas utility but one that has significant gas producing assets in the Marcellus, and way ahead of clean-energy focused NextEra (NEE). The graphic also shows the massive outperformance of the Vanguard S&P 500 ETF (VOO) as compared to the utility stocks.

That said, as utility stocks fall, their yields rise and, with the potential of lower rates in the coming quarters, they are now at least worthy of consideration. Indeed, SRE is down almost 20% from its all-time high back in September of 2022, and its yield has risen to 3.43% (a touch below the XLU ETF’s yield of 3.52%).

Sempra has been benefiting from growth opportunities in both California and Texas relating to clean energy mandates and grid resiliency investments. Per ERCOT, in Texas, Permian Basin load requirements are expected to grow from 4.2 GW to 17.2 GW by 2032 (page 5, Q3 presentation). Base rate growth potential in both states is above average. Meantime, the company has parlayed its natural gas utility business to become a significant player in the LNG terminal market. Management’s long-term earnings growth rate is in a range of 6-8%, and in my opinion, it is likely they could come in at the high-end of that range driven by LNG investments in Port Arthur, ECA (Energia Costa Azul, an LNG storage and regasification terminal located in Baja California, Mexico), and additional trains at Cameron LNG.

I began my coverage of Sempra back in November of 2022 when I acknowledged the stock’s outperformance during the tech-led bear market (see Sempra Energy Pivots To LNG, But ConocoPhillips Is The Better Angle). In a more recent article on ConocoPhillips (COP), I pointed out how COP is the anchor partner in Sempra’s Port Arthur Phase 1 project, and that the project was not impacted by the “Biden Pause” and is still “full-on” with all necessary permits already in hand (see ConocoPhillips: Despite The ‘Pause,’ Port Arthur LNG Is Full-On).

Earnings

Current consensus estimates for Sempra’s Q4 are shown below and are from Yahoo Finance:

The average Q4 EPS estimate of $1.12 would be a nickel below Q4 of FY22. For the year, EPS is expected to come in 2 cents below FY22 at $4.59/share. It’s notable that the midpoint of SRE’s full-year 2023 earnings guidance was $4.45/share and for 2024 it was ~$4.70 (see slide 11 of the Q3 presentation). That being the case, consensus estimates are significantly above management’s previous guidance.

Consensus Q4 revenue is expected to be $3.87 billion (+11.9% yoy) and if achieved would put full-year 2023 revenue at $16.12 billion (+11.6% yoy).

During the quarter, Sempra registered a 17.14 million public share offering at a price of $70 (an estimated $1.2 billion). In addition, the company made several high-level executive management team changes – most all of which were in-house promotions, which bodes well for continuity moving forward.

Going Forward With LNG

In the previously referenced Q3 presentation, SRE gave an update on Sempra Infrastructures growth projects: Port Arthur Phase 1 (~13 Mtpa), the Port Arthur Pipeline, and the 12.5 Bcf LA salt cavern storage project are all currently under construction.

ECA LNG Phase 1 (~3Mtpa) and the ECA GRO pipeline expansion project to feed ECA Phase 1 are also under construction.

Port Arthur Phase 2, ECA LNG Phase 2, Cameron LNG Phase 2, and associated projects are all still under development.

Shareholder Returns

SRE’s 2023 dividend schedule and payments are shown below, including a 2:1 stock split on 8/22/2023:

The $2.38/share in total dividends compares to $2.29 in 2022 (+3.93% yoy). Shareholders should expect a similar dividend increase coincident with the Q4 report.

Risks

As mentioned before, higher interest expense is a headwind (Q3 interest expense was up $6 million yoy). That being the case, if you are a believer in the “higher for longer” narrative, you may want to take a pass on Sempra (and the Utility Sector in general). On the other hand, lower interest rates would be a strong and positive catalyst to the upside.

While there is no debt maturation this year, $750 million comes due next year, $550 million in 2026, and another $750 million in 2027. No doubt, investors are hoping for lower interest rates by those maturations.

Port Arthur LNG Phase 2 (trains 3 and 4, capable of producing up to 13.5 mtpa) applied for authorization from DOE in September 2023 and was impacted by the “Biden Pause” because Phase 2 had yet to be approved. The pause could delay project approval and, if that is the case, would likely lead to project development cost overruns.

Sempra’s LNG business is unregulated (relative to regulated utilities). That brings additional risks that may not be suitable for many typical utility investors. It also brings the potential for upside performance relative to its utility peers.

Summary & Conclusion

Sempra operates regulated utilities in two favorable jurisdictions: California and Texas, both of which have favorable growth prospects. Sempra’s unregulated LNG projects give it additional and significant growth potential. However, with a current P/E = 16.1x and yield of 3.43%, both of which compare slightly unfavorably with the XLU ETF (P/E=15.74x, yield=3.62%), the stock does not appear to offer a compelling case to investors. I say that because in the still high interest rate environment, and with recent CPI inflation data coming in hot, I think investors need a compelling case to invest in a utility company. That is, interest expense remains a significant headwind for Sempra (and all utility companies for that matter) given its need to fund auspicious growth projects.

As a result, I maintain my hold rating on Sempra stock.

I’ll end with a 10-year total returns comparison of Sempra versus the XLU ETF, NFG, NEE, AEP, and DUK:

As you can see, Sempra was 6% below the 10-year returns of the XLU ETF. However, Sempra’s LNG growth projects should lead to the company outperforming the broad utility sector over the coming decade.