Background

The COVID-19 health crisis has resulted in a swift market crash, followed by a partial recovery, all in a little over a month. Exaggerated volatility has moved the market up and down by 5% or more on many days.

The blue dot on the graph above marks both the stock market’s all-time high AND the last day of the 11-year bull market that started in March, 2009.

Since then, the market has run down 34% (from February 20 to March 23), followed by a run-up of 21% as of late morning on Wednesday, April 8.

The jags in the daily closing prices tell the story of extreme volatility.

Just compare the placid period to the left of the blue dot to the violent swings to the right of it.

There is no telling, frankly, what the market will do on any given day.

The only thing, in my observation, that has been consistent since February 19 is that the market overreacts to everything.

There is a great deal of speculation, greed, and fear controlling stock prices during the pandemic.

As I explained last month, I believe that in the long run, valuations matter, even when the market is experiencing extreme volatility, as it has been.

So this month, I am returning to my regular practice of presenting one stock at a time. The caveat is that macro conditions are changing so fast that every investment has a significant element of speculation.

Capital Group, addressing sectors that historically have done better or worse in recessions, displays the chart below, which shows what sectors have historically done better and worse during periods of broad market declines. This month’s stock is from the Utility sector, which has historically done better.

UGI Corporation (UGI) is a Pennsylvania-based holding company that distributes and markets energy products and services through its subsidiaries both in the USA and internationally. The company operates through four segments:

  • UGI Utilities
  • UGI Midstream & Marketing Services
  • UGI International
  • AmeriGas

The top two categories (utility and midstream) account for the vast majority of UGI’s total revenue. UGI Utilities operates gas and electric utilities in Pennsylvania and Maryland. Midstream sells natural gas across several states through its own processing, pipeline, and storage facilities. AmeriGas is the largest propane distributor in the country. UGI International is the largest LPG (liquified petroleum gases) distributor in several European countries.

UGI was founded in 1882 and is headquartered in King of Prussia, Pennsylvania.

Quality Snapshot and Dividend Record

I derive Quality Snapshots from the following sources, which I have come to trust and respect over the years:


UGI’s Quality Snapshot is acceptable.

  • Three of the five factors are green “Above Average” or “Excellent” grades. Its dividend grades out as being extremely safe.
  • The Value Line Financial Strength grade (B++) is weak, but the company has maintained that grade since 2008 with no apparent ill effects.
  • There is no S&P credit rating for the consolidated UGI Corporation, because it is a holding company. Moody’s has ratings for UGI’s subsidiaries (see company description below). The ratings comprise a mixture of “upper medium” grades (low credit risk) and speculative grades. Overall, I give this factor a yellow “OK” rating.

On the scoring system described in DGI Lesson 20, UGI gets 18 points on its Quality Snapshot, which makes it an acceptable investment-grade company.

UGI has been hitting most of its targets for earnings growth and dividend growth for many years.

UGI’s yield is 4.6% as of the close of trading on Tuesday, April 7. Usually I wouldn’t be that specific as to time of day, but stock yields are changing constantly with the price volatility in the stock market.

UGI usually increases its dividend in October. Last year’s total increase was 25%, spread over two declarations. Its 5-year dividend growth rate is 7.3% per year. It has stated a commitment to shareholders to increase its dividend annually by about 4%.

For stocks with yields above 4%, I consider 4% per year growth to be fine. Therefore I would describe UGI as a high-yield, mid-growth stock based on its 4%+ yield and stated target of 4% annual dividend increases.

UGI is a Dividend Champion, having chalked up a 32-year streak of raising its dividend. The company increased its dividend straight through the last three recessions. Recessions are marked by the gray bands on this graph.

UGI in the Valuation Zone

To value a stock, I use four different valuation models, then average them. For more details on my approach, see Dividend Growth Investing Lesson 11: Valuation.

Model 1: FASTGraphs Default Valuation

The first model checks the stock’s current price against FASTGraphs’ basic estimate of its fair value.

FASTGraphs uses the historical average P/E ratio of the whole stock market (which is P/E = 15) to represent a fair valuation. That P/E = 15 value is used to draw the orange fair-price reference line on the following graph. I circled that value along with UGI’s own P/E ratio of 11.5.

After UGI’s recent steep price drop, its P/E is well below the orange reference line.

Formula for Measuring Valuation on FASTGraphs
Actual P/E divided by Reference P/E = Valuation Ratio
11.5 / 15 = 0.77

That valuation ratio suggests that GD is 23% undervalued. We use that ratio to calculate a fair price.

Formula for Calculating Fair Price
Actual Price divided by Valuation Ratio = Fair Price
$28 / 0.77 = $36

Model 2: FASTGraphs Normalized Valuation

FASTGraphs offers another fair-value reference line. This one is based on the stock’s own long-term valuation rather than the market as a whole. That is, this model “normalizes” the valuation to UGI’s own historical record.

In the following graph, UGI’s 5-year average P/E ratio (circled) was used to draw the blue fair-value reference line. UGI’s price is the black line.

This model presents an even more extreme picture of UGI’s indervaluation, because the company’s long-term average P/E, at 20, is much higher than 15 used in the first model.

The formulas for the valuation ratio and fair price are the same as above. Applying them, we get:

Valuation ratio: 11.5 / 20 = 0.58, or 42% undervalued
Fair price: $28 / 0.58 = $48

Model 3: Morningstar’s Valuation

Morningstar takes a different approach to valuation. They ignore P/E and other valuation ratios.

Instead, they construct a discounted cash flow (DCF) model. Using conservative projections, they discount all of the stock’s estimated future cash flows back to the present to arrive at a fair value estimate. The idea is that a stock’s fair price is equal to the net present value of all of the company’s future cash flows.

Here is Morningstar’s conclusion:

Morningstar also calculates UGI’s price as far undervalued. Their valuation ratio is 0.61, which leads to a fair price estimate of $46 per share.

Model 4: Current Yield vs. Historical Yield

The 4th and final valuation method is to compare the stock’s current yield to its historical yield.

If a stock is yielding more than its historical average, that suggests that it is a better value than usual, because you are paying less for the stock’s dividends. That is, with a well-valued stock, you can buy more shares with your money. Because dividends are paid per share, you will get more dividends for your money.

UGI’s current yield of 4.6% is 112% higher than its 5-year average of 2.2%.

[Source: Simply Safe Dividends]

That suggests the stock is significantly undervalued.

Formula for Measuring Valuation by Comparing Yields
5-Year Average Yield divided by Current Yield = Valuation Ratio
2.2% / 4.6% = 0.48

When I use this yield-comparison model, I put a floor under the valuation ratio at 0.80, because I think that this model is an indirect way to measure valuation.

Using that floor, UGI is 20% undervalued. Then applying the same equation for fair price as in the other models, we get a fair price of $28 / 0.80 = $35.

UGI’s Valuation Summary

Now we average the 4 approaches.

All four models agree that UGI is undervalued. The average of the four models suggests a fair price of $41, compared to its recent price of $28.

Closing Thoughts

UGI has an investment-grade Quality Snapshot, a stellar dividend record, and its dividend is rated as extremely safe by Simply Safe Dividends. The stock appears to be very undervalued at the moment.

All things considered, I see UGI as an attractive dividend growth opportunity, especially selling at the extreme discount that is now available.

This is not a recommendation to buy UGI Corporation. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future. Also consider your tolerance for risk, plus how well the company fits (or does not fit) your long-term investing goals.

— Dave Van Knapp

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