Business Context and Reporting Period
Chesapeake Utilities Corporation filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2018. The company operates regulated energy distribution and transmission businesses and unregulated energy, propane delivery, generation, marketing and related services across the Delmarva Peninsula, Florida, Pennsylvania and Ohio. Results are seasonal, with generally higher demand and earnings in the first and fourth quarters.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Operating revenue | $140.3 million, versus $126.9 million | $516.3 million, versus $437.2 million |
| Operating income | $12.0 million, versus $14.6 million | $65.7 million, versus $63.8 million |
| Income before taxes | $7.6 million, versus $11.2 million | $53.5 million, versus $52.8 million |
| Net income | $5.5 million, versus $6.8 million | $38.8 million, versus $32.0 million |
| Diluted EPS | $0.34, versus $0.42 | $2.36, versus $1.96 |
| Cash dividends declared per share | $0.3700, versus $0.3250 | $1.0650, versus $0.9550 |
- Third-quarter gross margin increased approximately $3.0 million, or 5.1%; excluding customer refunds and reserves related to tax reductions, gross margin increased approximately $5.0 million, or 8.4%.
- Nine-month gross margin increased $17.0 million, or 8.3%. Excluding tax-related customer refunds and reserves, gross margin increased $24.6 million, or 12.0%.
- The third-quarter operating-income decline reflected higher operating costs, depreciation, property taxes and interest expense, partially offset by higher regulated margins.
- The effective income tax rate declined to 27.1% for the quarter and 27.5% for the nine months, compared with 39.5% for both comparable 2017 periods, primarily due to the Tax Cuts and Jobs Act.
- Cash provided by operating activities was $128.0 million for the first nine months, compared with $98.4 million in 2017. Capital expenditures were $171.4 million, producing negative free cash flow before financing.
- Cash and cash equivalents were $6.2 million at September 30, 2018, compared with $5.6 million at December 31, 2017.
- Total debt, including current maturities and short-term borrowings, was approximately $519.5 million; short-term borrowings were $268.3 million at a weighted-average rate of 3.12%.
- Stockholders’ equity was $508.3 million. Including short-term debt, equity represented 50% of total capitalization, within management’s stated target range of 50% to 60%.
Material Changes Versus the Prior Comparable Period
- Regulated Energy operating income increased $0.4 million in the third quarter and $3.9 million for the nine months. Key contributors were Eastern Shore rate-case benefits, transmission expansions, natural gas customer growth, Florida reliability investments and GRIP.
- Unregulated Energy recorded a $3.9 million operating loss in the third quarter, compared with a $1.0 million loss in 2017. The decline reflected lower PESCO margin, lower propane retail margins and higher staffing, infrastructure and risk-management costs.
- For the nine months, Unregulated Energy operating income decreased modestly to $10.2 million from $10.6 million. Higher propane and Aspire Energy margins were largely offset by lower PESCO margin and increased operating expenses.
- Interest expense increased $1.1 million in the quarter and $2.8 million for the nine months because of higher short-term borrowings and additional long-term debt.
- The company issued $50.0 million of 3.48% Series A notes in May 2018 and entered into an amended Prudential shelf agreement providing for up to $150.0 million of additional debt issuance through August 2021. The company reported $200.0 million of additional potential capacity under the Prudential and MetLife shelf agreements.
- Capital expenditures increased substantially from $130.1 million in the first nine months of 2017 to $171.4 million in 2018.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management projected approximately $216.4 million of 2018 capital expenditures, including $185.3 million for regulated energy operations.
- The $117.0 million Eastern Shore 2017 Expansion Project was substantially under construction, with approximately $103.3 million invested through September 30, 2018. Remaining facilities were expected to enter service in phases during the fourth quarter of 2018. Management estimated annual gross margin of approximately $15.8 million through 2022 and $13.2 million thereafter.
- The Del-Mar Energy Pathway Project was filed with FERC in September 2018 and is intended to add 14,300 Dts/d of capacity. Management estimated annual gross margin of approximately $5.1 million, subject to regulatory approval and construction.
- In October 2018, Hurricane Michael caused widespread damage in FPU’s Northwest Florida electric territory and disrupted service to all customers in the affected area. Management expected to spend more than $50.0 million on restoration and reliability work and estimated a 2018 negative earnings impact of $0.01 to $0.03 per share, with recovery to be sought through regulatory processes.
- Regulated customer refunds and rate reductions related to the TCJA reduced gross margin by approximately $2.0 million in the quarter and $7.5 million for the nine months. Management stated that the related reduction in income tax expense was expected to offset the impact on after-tax regulated earnings.
- PESCO’s results were affected by imbalance adjustments and unusual 2018 costs associated with the January 2018 Bomb Cyclone, pipeline capacity constraints and portfolio settlements. Management stated that additional risk-management controls had been implemented.
- Environmental liabilities related to former manufactured gas plant sites were approximately $9.4 million at September 30, 2018. The company expects most remediation costs to be recoverable through insurance or customer rates, but one Maryland site lacked a clear cost estimate.
- Corporate guarantees, primarily supporting PESCO commodity purchases, totaled approximately $73.9 million and expire on various dates through September 2019. Letters of credit totaled approximately $5.0 million, with no draws reported.
- The company identified risks from regulatory decisions, tax and environmental matters, weather and hurricanes, commodity and interest-rate volatility, counterparty credit, capital-project execution, financing availability, competition, cybersecurity and pension obligations.
- ASC 606 was adopted on January 1, 2018. The nine-month adoption impact reduced reported net income by approximately $0.2 million and reduced retained earnings by approximately $1.7 million at September 30, 2018. The company expected to recognize $4.0 million to $5.0 million of operating-lease right-of-use assets and liabilities upon adopting ASC 842 on January 1, 2019.
Important Facts for Investors to Verify
- Verify the timing, final cost and earnings contribution of the Eastern Shore expansion and other major capital projects.
- Monitor short-term borrowing of $268.3 million, interest-rate exposure and the planned issuance of up to $100.0 million of Prudential notes by August 2019.
- Assess the effect of Hurricane Michael restoration costs, regulatory recovery and the estimated 2018 earnings impact.
- Review PESCO’s margin volatility, Bomb Cyclone-related costs, risk controls and the company’s commodity-hedging positions.
- Confirm the final treatment of TCJA-related customer refunds, rate reductions and deferred tax balances across the company’s regulated jurisdictions.
- Evaluate environmental remediation estimates and the recoverability of related regulatory assets, particularly for the Cambridge, Maryland site.
- Consider seasonality and unusually warm weather relative to normal conditions when extrapolating nine-month results to the full year.