Data Center Expansions Will Increase Gas Throughput And Drive New Capital Projects

Key Takeaways

• Lean practices and infrastructure investments aim to boost margins and earnings growth through cost reductions and operational efficiencies.
  
• Rate adjustments and weather normalization mechanisms support revenue and earnings stability amid operational and environmental challenges.
  
• Uncertain regulatory changes, investment risks, and integration challenges could impact Essential Utilities' revenue growth and shareholder value despite disciplined expense management.

Catalysts

Through its subsidiaries, operates regulated utilities that provide water, wastewater, and natural gas services in the United States.

• The initiation of lean practices in 2025 is expected to enhance operational efficiencies, potentially increasing net margins through cost reductions and process improvements across their corporate and operational functions.
  
• Successful completion of water and natural gas rate cases in Pennsylvania, which represents 75% of operations, is likely to support future revenue growth by allowing increased rates, enhancing their ability to fund infrastructure investments and maintain earnings stability.
  
• Investment in weather normalization mechanisms for the natural gas segment can mitigate earnings volatility from weather conditions, stabilizing revenue and earnings through periods of extreme weather by smoothing associated revenue fluctuations.
  
• Ongoing infrastructure investments, with $8 billion planned over the next five years, could result in an 8% annual growth in rate base, supporting long-term earnings growth through improved service reliability and expanded customer base.
  
• Potential growth opportunities from data center expansions in their service regions might provide increased gas throughput and potentially new capital projects, which could drive both revenue and earnings growth as these centers require significant utility resources.

Essential Utilities Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Essential Utilities's revenue will grow by 9.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 28.5% today to 25.4% in 3 years time.
• Analysts expect earnings to reach $700.4 million (and earnings per share of $2.4) by about March 2028, up from $595.3 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 21.5x on those 2028 earnings, up from 18.4x today. This future PE is greater than the current PE for the US Water Utilities industry at 19.9x.
• Analysts expect the number of shares outstanding to grow by 0.51% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.21%, as per the Simply Wall St company report.

Essential Utilities Future Earnings Per Share Growth

Risks

• The regulatory environment in Pennsylvania is currently in flux, with potential changes in leadership at the Office of Consumer Advocate (OCA) and uncertainty in future regulatory decisions. This could affect Essential Utilities' future rate cases and thus impact revenue projections.
  
• Although there's optimism about growth from data centers, the financial impact is uncertain as it depends on whether these projects come to fruition and how they are structured, introducing risks to future earnings potential.
  
• The potential $450 million investment in PFAS (per
• and polyfluoroalkyl substances) mitigation could strain resources, particularly if anticipated offsets from litigation and grants do not cover planned expenditures, potentially affecting net margins.
  
• The acquisition of water and wastewater systems, like the pending DELCORA acquisition, presents integration and execution risks, and any delays or regulatory challenges could impact projected revenue growth.
  
• Despite disciplined operational expense management, Essential Utilities is facing macro challenges, including underperformance in water utility stock prices, which could indicate broader market skepticism affecting future investment returns and overall shareholder value.

Valuation

• The analysts have a consensus price target of $45.0 for Essential Utilities 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 $56.0, and the most bearish reporting a price target of just $41.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $2.8 billion, earnings will come to $700.4 million, and it would be trading on a PE ratio of 21.5x, assuming you use a discount rate of 6.2%.
  
• Given the current share price of $39.81, the analyst price target of $45.0 is 11.5% higher.
  
• 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.