Innovations And Challenges Steer Gas Utility Toward Revenue And Margin Growth

Key Takeaways

• Regulatory approval for increased rates after a settlement suggests enhanced future revenue stability and growth.
  
• Strategic investments in in-sourcing and system expansions aim to reduce costs and support long-term revenue growth by catering to new markets.
  
• Diverse challenges including regulatory risks, ineffective weather normalization, and higher capital expenditures could impact earnings and operational efficiency.

Catalysts

Operates as a regulated natural gas distribution company in the United States.

• The unanimous settlement agreement in the Kansas Gas Service full rate case suggests regulatory approval for increased rates, likely enhancing future revenue stability and growth.
  
• Investments in in-sourcing services like line locating are expected to reduce operational and maintenance (O&M) expenses over time, positively impacting net margins by decreasing costs more than the expenses related to external services.
  
• Growth in the residential and commercial customer base, particularly in Oklahoma and Texas, underpins future revenue growth through expanded service territory and customer acquisition.
  
• Capital expenditure focused on system enhancements and expansions supports long-term revenue growth by catering to underserved communities and fostering new development projects.
  
• The strategy of managing interest expense via terming out commercial paper and stable dividend payouts aligns with maintaining a healthy balance sheet, potentially improving net income through controlled finance costs.

Assumptions

• Analysts are assuming ONE Gas's revenue will grow by 9.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.8% today to 11.2% in 3 years time.
• Analysts expect earnings to reach $300.1 million (and earnings per share of $4.68) by about October 2027, up from $222.5 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 17.5x on those 2027 earnings, down from 18.6x today. This future PE is greater than the current PE for the US Gas Utilities industry at 17.4x.
• Analysts expect the number of shares outstanding to grow by 4.24% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.8%, as per the Simply Wall St company report.

Risks

• The strategy of insourcing functions to control operations and maintenance (O&M) costs could fail to deliver the expected efficiencies or savings, potentially impacting net margins due to unforeseen operational challenges.
  
• Interest expenses have increased significantly due to the issuance of $300 million of 5.1% senior notes, coupled with the replacement of lower coupon notes with commercial paper, which could negatively impact earnings if interest rates rise or the company fails to manage its debt efficiently.
  
• Regulatory risks related to the approval of rate increases and the actual outcomes of filed rate cases could differ materially from expectations, impacting revenue and profit margins if regulatory commissions are less favorable than anticipated.
  
• The company's reliance on weather normalization mechanisms to mitigate the impact of weather variability on earnings may not always be effective, potentially leading to revenue volatility and affecting net income.
  
• The challenge of managing increased capital expenditures and asset removal costs, as part of the company's growth strategy, could lead to lower than expected financial performance if these investments do not yield the anticipated returns or operational efficiencies, impacting earnings and net income.

Valuation

• The analysts have a consensus price target of $69.5 for ONE Gas based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $80.0, and the most bearish reporting a price target of just $65.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $2.7 billion, earnings will come to $300.1 million, and it would be trading on a PE ratio of 17.5x, assuming you use a discount rate of 5.8%.
• Given the current share price of $72.85, the analyst's price target of $69.5 is 4.8% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.