Wells Fargo Raises Valuation on Propane/Heating Oil Sector, Raises Rating on NRGY & SPH to Outperform

October 22, 2009 6:56 AM EDT

Wells Fargo raises valuation on Propane/Heating Oil Sector, raises rating on NRGY & SPH.

Wells analyst says, "We are increasing valuation ranges across our MLP coverage universe by 12% (median). Our revised valuation ranges suggest MLPs still have moderate upside potential with an estimated median total return of 13% (target yield of 8.0% and 2010E distribution growth of 2.8%). Specifically, we are lowering the required rate of return (ROR) in our distribution discount models (DDM) by 100-200 bps in recognition of investors’ increased risk appetite. This more than offsets the impact of a 125 bps (median) reduction in our long-term growth rate forecast to account for the effects of the GP’s incentive distribution rights (IDRs). We are also increasing our median price/DCF multiple to 11x from 9.5x. As a result of our valuation adjustments, we are making the following rating changes. We are upgrading Inergy, L.P. (Nasdaq: NRGY) and Suburban Propane Partners, L.P. (NYSE: SPH) to Outperform from Market Perform. Our top picks with-in this sub-sector include: NRGY and SPH."

NRGY:Our valuation range is based on a blend of (1) our three-stage distribution discount model, which assumes a required ROR of 10.0% and a long-term growth rate of 1.25%, and (2) a price-to-distributable cash flow multiple of 11.5x our 2010 estimate. Risks to NRGY trading in the valuation range include (1) failure to identify and/or integrate attractive acquisitions; (2) unseasonably warm weather; (3) profit margin erosion in response to higher energy prices; (4) stagnate new home construction; and (5) rising interest rates.

SPH:Our valuation range is based on a blend of (1) our three-stage distribution discount model, which assumes a required ROR of 10.0% and a long-term growth rate of 2.5%, and (2) a price-to-distributable cash flow multiple of 11.0x our 2010 estimate. Risks to SPH trading in our valuation range include: (1) abnormally warm weather; 2) economic weakness could negatively impact industrial/commercial demand; (3) profit margin erosion in response to energy prices; and (4) rising interest rates.

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