Spire Inc.: Expensive And With A Lot Of Debt (NYSE:SR)

Spire Inc. (NYSE:SR) is included in the gas utilities industry where it focuses on both purchasing and selling natural gas to residential, commercial, and other end-users. The has a very long history which dates back to 1857. The share price so far in the last 12 months has tumbled quite a bit and right now sits at a FWD p/e of around 13. This seems to come from a difficulty for the company to consistently generate strong bottom-line growth. The last quarter alone saw a net loss of $21.6 million in total. The poor results also resulted in SR lowering the guidance for FY2023 and this is resulting in what I think is the share price deterioration in the last few months.

The risks include high levels of debt to fuel growth, which right now seems risky given that interest rates are rising at a fast rate. Interest expenses have gone up immensely to $171 million in the last 12 months and I think they will remain elevated for quite some time, resulting in suppressed earnings potential and a hold rating from me ultimately.

Market Overview

The costs are rising for SR as the industry becomes more and more difficult to navigate. As mentioned, SR is in the gas utilities industry, where it mostly focuses on selling natural gas to customers. The build-up of the company is two different segments which are Gas Utility and Gas Marketing. Though the propane pipelines the company also owns, it engages in the transportation of it as well.

One of the keynotes about SR right now I think is the high amount of debt they are taking on to fund more growth and expansions for the company. The markets the company is in are affected by various things, like harsh weather conditions. For 2023 so far the capex has totaled $483 million and gas utility spending is up by 12.5%. This is including strong infrastructure spending by the company as it seeks to build out its stake in the market efficiently over the next few years. The target however for 2023 remains to be $700 million in capex. Looking at the long-term for the company, though, they expected a 10-year capex of $7 billion. This sort of confidence in their abilities to grow efficiently over the coming years I think is remarkable and a reason for some optimism at least. What I want to see, though, is less of a reliance on debt to fund their prospects. Down the line, this might come to bite them as more FCF is necessary to pay down debt, and less is rewarded to shareholders. Of course, the bet is that SR can grow exceptionally more than they take on debt and that it won’t be an issue, however, I remain skeptical as right now the market conditions are not very favorable and result in the company posting a net loss.

Looking at the outlook provided by the company it seems that the company is reaffirming the LT growth expectations at least, but slightly lowering the FY2023 NEEPS target range to $4.15 – 4.25 instead, a decrease of $5 million. Perhaps not immense in comparison to that the company generated over $200 million in TTM net incomes. Nonetheless, deteriorating guidance is never really a good thing I think. As for the financing part of the business, they don’t expect there to be any further equity needed until FY2024, which is a slight positive atleast. But for the moment SR still has a net debt/EBITDA ratio of 4.99. This is far above where I have my threshold which is 3. This indicates the company is taking on a significant amount of debt to fund growth, but also seems to lack the capability to pay it down as well given the EBITDA is too low right now. What has me further worried is that the company cannot buy back shares and has instead resorted to diluting them instead. This brings in my opinion more risk to the investment thesis and leads to my hold rating.

Risks

Utilizing debt as a financial tool can help a company fund growth initiatives, acquire assets, and take advantage of opportunities without diluting existing shareholders’ ownership. It can also be a cost-effective way to capitalize on favorable borrowing terms, especially in a low-interest-rate environment.

However, a higher debt load can also introduce additional financial obligations, including interest payments and debt servicing costs. This heightened level of financial leverage implies that Spire has an increased responsibility to manage its debt effectively and maintain a healthy balance sheet. For SR that is exactly what has happened the last few months, the interest expense has risen quite rapidly to $171 million in the last 12 months. I find it likely this will increase further as rates have during that period not been the same. Looking at the FED policy, I think that interest rates will remain elevated for quite some time to get inflation down to their targets. For SR this could mean interest expenses of over $200 million least. Given that the company even lowered their EPS guidance for 2023 I would say they are starting to feel the impacts right now of higher interest rates. As long as rates remain quite high, then I think that the share price for SR will remain suppressed and in a downward trajectory.

Last Pointers

SR may be investing heavily into their business to fuel expansions, but right now it seems to only result in the company lacking the ability to buy back shares and pay down debt “naturally” through earnings and FCF. The high net debt/EBITDA ratio has me worried. Besides that, the earnings multiple is not exactly low either, at nearly 14. It may be slightly below the sector’s average, but the high amounts of debt are a likely culprit for the discount.

For the medium term I think the debts will weigh on the share price and with dilution in the picture I think a buy case can’t be made until the valuation based on earnings drops to the 11 – 12 range instead, indicating a further drop of 10 – 15% from here. I do like the dividend yield though and that is a factor that leads me to instead of rating it a sell, the least give it a hold rating for now.