Regulatory Settlements In Kansas And Texas Will Improve Outlook For US Natural Gas Distributor

Key Takeaways

• Regulatory settlements in Kansas and Texas are expected to improve revenue and returns through recouped investments and fair equity returns.
  
• Focus on operational cost management and customer growth initiatives likely to enhance net margins and drive revenue growth.
  
• Rising interest expenses, regulatory dependency, and slow housing growth pose risks to ONE Gas's net margins and revenue growth.

Catalysts

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

• The recent regulatory settlements in Kansas and Texas are expected to positively impact future revenue by allowing ONE Gas to recoup past investments and earn a fair return on equity.
  
• The improved interest rate environment, with the Fed's recent rate cuts leading to reduced commercial paper rates, is expected to lower future interest expenses and positively impact net margins.
  
• The company's multiyear focus on operational and maintenance (O&M) expense management, including initiatives like in-sourcing line locating, is likely to moderate O&M costs and improve net margins over time.
  
• Recovery and stabilization in the housing permits market indicate potential for customer growth, which can drive revenue growth as interest rates may normalize and increase new meter set installations.
  
• The resumption of traditional disconnection activities and addressing past due accounts, combined with lower gas prices, offer a favorable outlook for reducing bad debt expenses, thus improving overall earnings.

ONE Gas Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming ONE Gas's revenue will grow by 9.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.5% today to 10.9% in 3 years time.
• Analysts expect earnings to reach $296.2 million (and earnings per share of $4.65) by about December 2027, up from $216.6 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 18.7x on those 2027 earnings, up from 18.4x today. This future PE is greater than the current PE for the US Gas Utilities industry at 18.4x.
• Analysts expect the number of shares outstanding to grow by 3.97% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.92%, as per the Simply Wall St company report.

ONE Gas Future Earnings Per Share Growth

Risks

• The increase in interest expenses, as noted in the third quarter results, could affect net margins and overall earnings if interest rates rise or if the company continues to rely on refinanced debt at higher rates.
  
• Operating and maintenance (O&M) expenses have increased by about 5% year-to-date, and while management expects moderation, any deviation from this could impact net earnings if costs are not managed as anticipated.
  
• The company's reliance on regulatory approvals and favorable outcomes for rate cases, as seen in Kansas and Texas, introduces risk if future rate cases result in less favorable terms, impacting revenue collection and profit margins.
  
• Slow growth in new housing due to high mortgage rates may lead to slower customer expansion and, consequently, limit revenue growth opportunities compared to expectations.
  
• The favorable impact on bad debt expenses due to lower gas prices and favorable winter dynamics may not persist, potentially increasing expenses in adverse conditions and affecting net income.

Valuation

• The analysts have a consensus price target of $74.06 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 $82.0, and the most bearish reporting a price target of just $66.0.
• 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 $296.2 million, and it would be trading on a PE ratio of 18.7x, assuming you use a discount rate of 5.9%.
• Given the current share price of $70.5, the analyst's price target of $74.06 is 4.8% higher. 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.