Business context and reporting period
ONE Gas filed its first annual report for the year ended December 31, 2013. The operating results and comparative financial statements are for ONE Gas Predecessor, the natural-gas distribution business historically operated within ONEOK; they are not standalone results for ONE Gas as an independent public company. ONE Gas was incorporated in August 2013, became independent on January 31, 2014, and began NYSE trading on February 3, 2014. The separate-company balance sheet at December 31, 2013 showed only $1 of cash, assets and equity and no operating activity.
The regulated utility serves more than 2.1 million customers in Oklahoma, Kansas and Texas. It earns delivery margin; purchased natural-gas costs are generally passed through to customers.
Financial performance and liquidity
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Revenue | $1,690.0 million | $1,376.6 million | +22.8% |
| Net margin | $813.0 million | $756.4 million | +7.5% |
| Operating income | $220.3 million | $215.7 million | +2.1% |
| Net income | $99.2 million | $96.5 million | +2.8% |
| Cash from operations | $154.2 million | $196.6 million | −$42.4 million |
| Capital expenditures | $292.1 million | $272.0 million | +7.4% |
Natural-gas cost was $876.9 million, up 41%, so revenue growth substantially reflects higher gas costs passed through to customers. Net margin excluding other revenues was $780.3 million, up 8%. Approximate operating margin was 13.0% of revenue versus 15.7% in 2012; the percentage comparison is affected by pass-through gas costs. Net income margin was approximately 5.9% versus 7.0%.
2013 operating cash flow was below net income plus noncash adjustments primarily because working-capital movements reduced cash generation; changes in operating assets and liabilities reduced cash flow by $157.4 million. Investing cash use was $290.8 million, principally capital spending. Predecessor year-end cash was $3.2 million. At February 3, 2014, the company reported approximately $60 million of cash and no borrowings under its new revolving facility.
At December 31, 2013, the predecessor reported $1.028 billion of long-term credit from ONEOK and $445.0 million of short-term notes payable to ONEOK. ONEOK contributed these balances to capital immediately before separation. In January 2014, ONE Gas issued $1.2 billion of senior notes: $300 million due 2019 at 2.07%, $300 million due 2024 at 3.61%, and $600 million due 2044 at 4.658%. Net proceeds of about $1.19 billion funded an approximately $1.13 billion payment to ONEOK, with the balance retained for liquidity and investment needs. A $700 million unsecured revolver became effective at separation, with a 70% maximum debt-to-capital covenant. Ratings at January 31, 2014 were Moody’s A2 and S&P A−, both Stable.
Changes, outlook and material items
- Net margin rose $56.6 million in 2013, driven mainly by new rates in all three states (+$36.8 million), colder weather and higher sales volumes (+$12.5 million), and transportation volumes (+$5.9 million). Total delivered volumes rose 8.6%; customers increased to 2.114 million from 2.101 million.
- Operating costs increased $37.4 million, including higher employee-related expense, share-based compensation, property taxes and bad-debt expense. Depreciation and amortization increased $14.6 million.
- Fourth-quarter 2013 revenue was $522.7 million, net margin $223.7 million, operating income $65.0 million and net income $30.3 million. Fourth-quarter 2012 net income was $38.6 million.
- Unusual 2013 items included a $10.2 million pretax, noncash charge to expense remaining regulatory costs associated with ONEOK’s 1997 Kansas Gas Service acquisition, under the separation settlement, and a $1.2 million accrued one-time contribution to Kansas charities for low-income customer weatherization.
- Management forecasts approximately $263 million of capital expenditures for 2014, focused on system integrity, safety, reliability, replacements and extensions. It cited a target dividend payout ratio of 55%–65% of recurring earnings, subject to board approval and financial, regulatory and covenant constraints.
- Oklahoma received approval to defer its 2014 rate case; it expects a PBRC filing in 2014 and a rate case in 2015. Kansas Gas Service agreed not to change base rates before January 1, 2017, while retaining access to approved riders. Management reported an achieved 2013 regulatory ROE of 8.0% versus a weighted-average allowed ROE of 9.9%, attributing the gap mainly to regulatory lag.
Risks, contingencies and investor verification
Key risks include rate-case outcomes and recovery of costs and capital investment; weather and seasonal demand; competition from electricity and other energy sources; natural-gas supply, storage and working-capital needs; pipeline safety and environmental compliance; labor, pension and benefit costs; access to capital and interest rates; and the costs and execution risks of operating as a newly independent company. Historical financials include ONEOK corporate-cost allocations and may not reflect standalone expenses. Transition services are generally limited to specified periods, and costs may change as services move in-house or to third parties.
The company retains responsibility for environmental conditions at 12 former manufactured-gas sites in Kansas; remediation or closure work was underway at the sites, but management did not expect material future expenditures. Management considered ordinary-course litigation losses not material. Pipeline-safety rulemaking could require additional spending, but the potential amount was not clear in the filing.
Most important facts to verify:
- Confirm that 2013 operating results are predecessor carve-out figures, including ONEOK allocations, and distinguish them from ONE Gas’s post-separation capital structure and costs.
- Track cash generation, working-capital swings, capital expenditures and the effect of the new $1.2 billion debt issuance and $700 million revolver on leverage and liquidity.
- Monitor rate recovery and regulatory lag, particularly the Oklahoma 2014–2015 filings and Kansas base-rate restriction through 2016.
- Assess the recurring earnings impact of the Kansas settlement charges and whether management’s 2014 capital-spending and dividend plans are achieved.
- Review transition-service exit costs, pension and postretirement obligations, and progress or cost changes at the 12 Kansas environmental sites.