Business context and reporting period
Southwest Gas Holdings, Inc. filed a combined, unaudited Form 10-Q for the quarter ended September 30, 2017, with separate financial statements for the holding company and its wholly owned utility subsidiary, Southwest Gas Corporation. Holdings reports two segments: regulated natural gas operations in Arizona, Nevada, and California, and construction services through Centuri. Results are seasonal; utility earnings generally rise in winter, while construction activity typically strengthens in summer and fall.
Unless otherwise noted, figures below are for Southwest Gas Holdings consolidated and in millions of dollars. Southwest Gas Corporation’s standalone statements present Centuri as discontinued operations before the January 2017 reorganization; Holdings continues to consolidate Centuri.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Operating revenue | $593.2 | $540.0 | $1,808.4 | $1,819.0 |
| Operating income | $30.1 | $15.5 | $193.0 | $177.8 |
| Net income attributable to Holdings | $10.2 | $2.5 | $97.4 | $86.9 |
| Diluted EPS | $0.21 | $0.05 | $2.03 | $1.82 |
| Dividends declared per share | $0.495 | $0.450 | $1.485 | $1.350 |
- Natural gas operations: Q3 gas operating margin, a non-GAAP measure defined as gas revenue less gas cost, was $167.5 million versus $161.1 million. Nine-month margin was $674.0 million versus $656.9 million. Nine-month segment net income increased to $82.4 million from $67.5 million.
- Construction services: Q3 revenue rose 12% to $380.1 million, but segment net income declined to $14.3 million from $14.9 million. Nine-month revenue increased to $872.5 million from $838.0 million, while segment net income fell to $15.7 million from $19.3 million.
- Cash flow and investment: Nine-month operating cash flow was $299.2 million, down from $477.9 million; construction expenditures and property additions were $450.0 million versus $404.4 million. Investing cash outflow was $442.8 million. Cash was $59.2 million at September 30, 2017, compared with $28.1 million at December 31, 2016.
- Debt and liquidity: Holdings’ long-term debt, current maturities, and short-term debt totaled approximately $1.871 billion at September 30, 2017, compared with $1.600 billion at year-end 2016. Current assets were $538.9 million and current liabilities $656.4 million. Southwest had $150 million outstanding on the long-term portion and $83 million on the short-term portion of its $400 million credit facility; Holdings had $27.5 million outstanding on its $100 million facility. Centuri had $189 million outstanding under its secured facility.
Material changes versus the prior comparable period
- Q3 consolidated revenue and operating income increased year over year; nine-month revenue was slightly lower, while operating income and net income increased.
- Utility nine-month earnings benefited from higher operating margin, including Arizona and California rate relief and customer growth, and lower depreciation. Operations and maintenance and property-tax expenses increased.
- Centuri’s earnings weakened despite higher revenue. A customer work stoppage reduced nine-month revenue by $26.3 million and contributed to a $3.7 million pretax loss. Inclement weather and higher costs on a water-pipe replacement project also pressured results.
- Operating cash flow declined substantially, primarily because of the change in deferred purchased-gas costs, which had provided cash in the prior-year period. Holdings acquired Centuri’s remaining 3.4% interest for $23 million in August and issued shares through its at-the-market equity program.
Outlook, risks, and unusual items
- Management estimated natural-gas-segment construction expenditures of $1.6 billion to $1.8 billion for 2017–2019, including approximately $570 million in 2017. It expected operating cash flow to fund approximately 60%–70% of utility construction expenditures and dividend requirements over that three-year period, with credit facilities or other external financing for the remainder.
- The Arizona rate-case settlement, effective April 2017, provided a $16 million annual revenue increase and an expected $44.7 million annual depreciation reduction; management cited a combined net annual operating-income increase of $60.7 million. The settlement includes a rate-case moratorium through May 2019.
- Management targeted nearly 40 miles of Arizona vintage steel pipe replacement in 2017, at approximately $27 million, and about $100 million of replacement projects in 2018. The Arizona LNG facility had incurred approximately $21.7 million in capital expenditures through September; construction began in Q3, with completion expected by the end of 2019.
- Centuri is pursuing additional cost recovery on a water-pipe replacement project and has suspended accepting further work orders on it pending resolution. Results also remain exposed to bid and contract outcomes, customer work awards, labor and weather costs, and construction execution.
- Utility earnings and liquidity are sensitive to regulation, rate-case timing, gas-cost recovery and PGA balances, capital spending, financing conditions, and seasonal demand. Management reported a combined PGA over-collection of $8.7 million at September 30; refunds and recoveries affect cash flow, not directly operating margin.
- The board increased the quarterly dividend to $0.495 per share, effective with the June 2017 payment, and targeted a 55%–65% payout ratio of consolidated EPS. Litigation was described as not expected to have a material adverse effect, although outcomes were not presently determinable. Management reported effective disclosure controls and no material third-quarter change in internal financial reporting controls.
Important facts for investors to verify
- Whether Centuri can resolve the water-project cost-recovery matter and improve margins as work volumes grow.
- Actual utility capital spending, regulatory approvals, and recovery timing for Arizona and Nevada replacement programs and the LNG project.
- Future operating cash flow and borrowing needs, particularly given lower nine-month cash from operations and higher debt.
- How rate changes, PGA balances, and seasonal results affect full-year earnings and liquidity; interim utility results are not necessarily indicative of full-year performance.
- The effect of the 2017 holding-company reorganization and the differing discontinued-operations presentation in Southwest Gas Corporation’s standalone statements when comparing periods.