Southwest Gas Holdings, Inc. annual report, FY2017

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Business context and reporting period

Southwest Gas Holdings, Inc. filed a combined Form 10-K with wholly owned utility subsidiary Southwest Gas Corporation for the fiscal year ended December 31, 2017. Holdings operates regulated natural gas distribution in Arizona, Nevada, and California, and unregulated construction services through Centuri. In January 2017, Southwest reorganized into a holding-company structure, separating the utility and construction businesses legally and providing financing flexibility.

The filing’s financial statements and MD&A are incorporated by reference from the 2017 Annual Report to Shareholders and are not reproduced in the supplied text. Accordingly, the text does not provide clear consolidated revenue, earnings, cash flow, margin, total debt, or liquidity figures.

Key financial and operating metrics

  • Utility scale: Southwest served approximately 2.015 million customers at year-end and added 31,000 net customers in 2017. Management expected similar customer growth in 2018.
  • Utility mix: Residential and small commercial customers generated 85% of 2017 utility operating margin; other sales customers contributed 3% and transportation 12%. Transportation represented 47% of system throughput.
  • Construction: Centuri had approximately $94 million of backlog on outstanding fixed-price contracts at year-end. About 90% of its 2017 revenue was earned under unit-price contracts. Southwest accounted for approximately 8% of Centuri revenue; two other customers together accounted for approximately 23%.
  • Capital assets and project: Southwest’s gas plant was $6.8 billion at year-end, including construction work in progress. It had spent approximately $34.8 million through December 2017 on a southern Arizona LNG facility, approved at a not-to-exceed cost of $80 million; completion was expected by the end of 2019.
  • Variable-rate debt exposure: At December 31, 2017, variable-rate debt excluding the specified industrial development revenue bonds (IDRBs) was $670.5 million: $391.0 million at Southwest, $256.0 million at Centuri, and $23.5 million at corporate. A 1 percentage-point rate increase was estimated to increase annual interest expense by $6.71 million. Separately, $150 million of Nevada IDRB rate fluctuations are tracked and recovered through a ratepayer balancing account.
  • Other income item: Holdings recognized $10.3 million of income in 2017 from increases in company-owned life insurance cash surrender values, compared with $7.4 million in 2016. The filing says these changes affect earnings but not cash flows.
  • Shareholder returns: The quarterly dividend was $0.495 per share throughout 2017. In February 2018, the Board raised it to $0.52, effective with the June 2018 payment, and stated a target payout ratio of 55% to 65% of consolidated earnings per share.

Material changes versus prior periods

  • In November 2017, Centuri completed its acquisition of New England Utility Constructors Inc. (Neuco). Neuco represented 2% of consolidated assets and less than 1% of consolidated 2017 revenue. Management excluded Neuco from its year-end controls evaluation and planned to complete its review and implementation of controls in 2018.
  • In August 2017, Holdings acquired the remaining 3.4% Centuri equity interest, making Centuri wholly owned.
  • The Tax Cuts and Jobs Act, enacted in December 2017, reduced the federal corporate tax rate from 35% to 21% effective January 1, 2018. Deferred tax balances were remeasured, with excess net deferred taxes reclassified as a regulatory liability. The effects on customer rates and cash flows depend on regulatory treatment.
  • Natural gas transported for customers was 97 million dekatherms in both 2017 and 2016, versus 104 million in 2015.
  • Life-insurance-related income increased to $10.3 million from $7.4 million in 2016. These amounts are not a measure of operating revenue or cash generation.

Outlook, management commentary, risks, and contingencies

  • Management cited expected utility customer growth similar to 2017. Utility earnings are seasonal and generally higher in winter; Centuri construction activity is typically lowest in the first quarter and improves with favorable summer and fall weather.
  • Utility rates and recovery of costs depend on state and federal regulators. Purchased-gas adjustment mechanisms generally allow gas-cost over- or under-collections to be recovered or refunded, but changes affect cash flows and borrowing needs rather than profit margin directly. Management said rising or volatile gas prices could increase short-term borrowing needs and expected such borrowing could be needed in 2018.
  • Decoupled rate structures in all utility service territories are intended to stabilize operating margin against changes in usage, but their continuation and design are subject to regulatory discretion. Arizona’s recent rate-case order removed a monthly winter weather adjuster; management noted possible cash-flow timing effects.
  • Key risks include regulatory delays or disallowances, pipeline capacity or gas supply interruptions, natural disasters and pipeline safety incidents, cybersecurity, interest-rate and credit-rating changes, and pension assumptions. Centuri faces weather exposure, fixed-price contract cost overruns, customer concentration, and labor-relations risks.
  • Management stated that pending litigation was not expected to have a material adverse effect on financial position or results of operations. For environmental matters, the filing described California greenhouse-gas compliance obligations and stated that no earnings impact was expected, while noting regulatory treatment of program costs.
  • Centuri’s construction business is exposed to the loss or slowdown of major customers; more than half of 2017 construction revenue came from seven customers. The Tax Cuts and Jobs Act eliminated bonus depreciation incentives for most of Centuri’s utility customers, a factor previously supporting pipeline replacement activity.

Most important facts for investors to verify

  1. Review the incorporated 2017 Annual Report for complete consolidated and subsidiary income statements, cash flows, balance sheets, margins, capital spending, and liquidity data; these are not clear in the supplied filing text.
  2. Confirm total debt, maturities, credit-facility availability, covenants, and the distinction between variable-rate debt and the separately discussed $150 million of IDRBs.
  3. Assess how tax reform and regulatory decisions will affect customer rates, deferred taxes, rate base, and cash flows in each jurisdiction.
  4. Track the LNG facility’s remaining costs, construction schedule, and regulatory recovery, as well as Neuco integration and internal-control implementation.
  5. Evaluate Centuri’s customer concentration, backlog conversion, contract profitability, and exposure to weather, labor costs, and the loss of bonus depreciation incentives.