Sempra Energy (SRE)

[frenchee]

Exemplary Sempra Energy
Sempra Energy (SRE: NYSE)
By Banc of America Securities ($60, Nov. 13, 2007)

WE ARE INITIATING COVERAGE OF Sempra Energy with a Buy rating and $72 price target. Despite its rally from recent lows, we believe Sempra represents a compelling investment opportunity, given its transparent long-term growth opportunity, reduced risk profile and potential to monetize assets through a master limited partnership.

Long-term growth projects are set to drive an earnings-per-share compounded annual growth rate of 7%-8% through 2011. Importantly, we believe a large portion of this growth will come from fairly predictable earnings streams (utilities, pipeline, storage and liquefied natural gas [LNG] receipt terminal fees). In line with our industry thesis, we favor transparent project-driven growth.

Sempra's announced Sempra Commodities joint venture with Royal Bank of Scotland Group (expected to close in the first quarter of 2008) lowers Sempra's risk profile while maintaining significant upside, in our view. Sempra maintains $1.3 billion of regulatory capital in the joint venture, but will no longer need to tie up its balance sheet, enabling it to pursue other shareholder-friendly initiatives (share buyback and dividend increases), while still sharing in most of the Commodities business upside until it almost doubles from 2006 levels.

Moreover, Sempra earns a 15% return per year on its capital. This return is guaranteed and should the commodities business not generate enough earnings in a given year to pay out the 15% return, there is a "catch-up" provision that enables Sempra to recoup that return in the following year in addition to that year's return. We believe the structure of this joint venture greatly improves Sempra's overall risk profile. The 15% return (or $195 million) can almost be viewed as an annuity.

Potential opportunity to drop new projects into a master limited partnership (MLP) can unlock greater value longer term, in our view. We estimate that, over time, this could add $4-$5 to Sempra's share price.


We forecast EPS of $4.04 in 2007 and EPS of $3.85 in 2008. The lower 2008 EPS reflects the new Commodities joint venture, but we expect growth to resume beyond 2008.

Sempra is currently trading at 15.6 times our 2008 EPS estimate. This is toward the higher end of its five-year trading range, but at the low end of its trading range year-to-date. Our price target of $72 implies a forward price-to-earnings multiple of 18.7 times, at the high end of Sempra's historical trading range. We believe this to be appropriate, given its lower-risk-profile post forming the commodities joint venture and transparent project-driven earnings growth.

Sempra is a diversified-energy company that operates two utilities in Southern California, and a power-generation facility. Sempra also develops and operates natural-gas pipelines (has a 25% interest in Rockies Express), storage, and two LNG receipt terminals. Sempra maintains an interest in a commodities marketing and trading joint venture.

-- Elvira Scotto