Business Context and Reporting Period
Chesapeake Utilities Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2020. The company distributes natural gas, propane and electricity; transmits natural gas; generates electricity and steam; and provides related energy services primarily in the Delmarva Peninsula, Florida, Pennsylvania and Ohio.
The company reports two principal segments: Regulated Energy and Unregulated Energy. Results are seasonal, with typically higher revenue and earnings during the first and fourth quarters. PESCO’s natural gas marketing business was sold in 2019 and is presented as discontinued operations.
Financial Performance and Key Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Operating revenue | $101.4 million, up 9.5% from $92.6 million | $351.2 million, up 1.0% from $347.6 million |
| Gross margin | $79.5 million, up $12.2 million | $253.4 million, up $17.2 million |
| Operating income | $17.4 million, up 21.2% from $14.4 million | $77.5 million, up 1.1% from $76.6 million |
| Net income | $9.3 million, versus $5.6 million | $49.1 million, versus $42.6 million |
| Diluted EPS | $0.56, versus $0.34 | $2.97, versus $2.59 |
| Operating margin | 17.2%, versus 15.5% | 22.1%, versus 22.0% |
| Net margin | 9.1%, versus 6.1% | 14.0%, versus 12.3% |
Regulated Energy generated third-quarter operating income of $20.5 million, up $2.9 million, and nine-month operating income of $66.4 million, up $1.1 million. Unregulated Energy reported a third-quarter operating loss of $3.1 million, modestly improved from a $3.2 million loss, and nine-month operating income of $11.1 million, down $0.3 million.
Other income was $3.0 million for the nine-month period versus an expense of $0.7 million in 2019, primarily reflecting gains on property sales and lower pension expense. Interest charges declined to $15.5 million from $16.6 million. The nine-month effective tax rate was 24.7%, compared with 25.9%; the company recognized a $1.7 million tax benefit from CARES Act net operating loss carrybacks.
Cash Flow, Capital Spending, Debt and Liquidity
- Operating cash flow was $115.9 million for the first nine months, up from $103.9 million.
- Capital expenditures were $123.4 million in the cash-flow statement, while reported total capital expenditures were $143.9 million; investing cash flow was negative $136.6 million.
- The company paid $20.0 million of common dividends and used $15.6 million for the Elkton Gas acquisition.
- Cash and cash equivalents were $3.1 million at September 30, 2020, down from $7.0 million at December 31, 2019.
- Long-term debt, net of current maturities, was $520.0 million; current maturities were $15.6 million. Short-term borrowings were $216.4 million, down from $247.4 million.
- The company entered into a new $375.0 million unsecured revolving credit facility, with $154.7 million of availability at September 30, 2020. Management reported compliance with all debt covenants, including a funded-indebtedness ratio limit of 65%.
- Stockholders’ equity was $616.7 million. Equity represented 45% of capitalization including short-term debt at quarter-end; management stated that October equity issuances increased this ratio to approximately 50%.
Material Changes Versus the Prior Comparable Period
- Third-quarter earnings benefited materially from the Florida PSC settlement of Hurricane Michael recovery proceedings. The settlement produced $8.3 million of incremental gross margin and $1.0 million of net income in the quarter, including recognition of amounts previously billed under interim rates.
- Pipeline expansion projects, natural gas customer growth, Florida GRIP investments, Elkton Gas and increased Marlin Gas Services demand contributed to higher gross margin.
- COVID-19 reduced customer consumption, increased bad-debt expense and added pandemic-response costs. Management estimated an earnings impact of approximately $0.7 million in the third quarter and $1.9 million for the nine-month period; elsewhere in the MD&A, it estimated unfavorable operating-income impacts of $1.9 million and $6.7 million, respectively.
- Milder weather reduced gross margin by approximately $1.0 million in the third quarter and $3.1 million for the nine-month period versus the prior-year periods.
- The company acquired Elkton Gas in July 2020 for approximately $15.6 million, adding about 7,000 Maryland customers. It also benefited from the December 2019 acquisition of Boulden propane assets.
- The company issued $50.0 million of Prudential Shelf Notes at 3.00% and $40.0 million of New York Life Shelf Notes at 2.96% during 2020. It also began issuing common stock under ATM and dividend reinvestment programs.
- Discontinued PESCO operations contributed $0.2 million of pretax gain during the first nine months of 2020, compared with a $2.0 million pretax loss in the comparable 2019 period.
Guidance, Outlook, Commentary and Risks
Management projected 2020 capital expenditures of $195 million to $215 million, including pipeline expansions, Florida GRIP investment, system improvements, information technology and other strategic projects. The filing does not provide consolidated earnings or revenue guidance.
- Management estimated gross margin from identified projects and initiatives of approximately $49.8 million in 2020 and $63.5 million in 2021, including pipeline expansions, CNG services, acquisitions, Florida GRIP and Hurricane Michael recovery.
- The Del-Mar Energy Pathway project is expected to be fully in service by early fourth quarter 2021 and is designed to add 14,300 dekatherms per day of firm service.
- The Callahan intrastate pipeline entered service in June 2020 and is expected to generate approximately $6.4 million of annual gross margin thereafter.
- In October 2020, after the reporting date, Sharp acquired Western Natural Gas Company propane assets for approximately $6.7 million. Management estimated gross margin of approximately $0.3 million in 2020 and $1.8 million in 2021 from the acquisition.
- Florida’s Hurricane Michael settlement authorized $45.8 million of regulatory assets, a $7.7 million annual storm-cost surcharge and a $3.3 million annual base-rate increase. The new rates became effective November 1, 2020.
- COVID-19 remains an ongoing risk through reduced commercial and industrial demand, customer nonpayment, supply-chain disruption and incremental operating costs. Although Delaware, Maryland and Florida authorized potential regulatory-asset treatment, the company had not recorded regulatory assets for these incremental costs as of September 30.
- Key other risks include regulatory and environmental outcomes, weather and hurricane damage, commodity and interest-rate volatility, access to capital, cyberattacks, counterparty credit, project execution, competition and integration of acquisitions.
- Environmental liabilities related to certain manufactured-gas-plant sites were approximately $6.2 million at September 30, 2020. Management expects costs to be recoverable through insurance or customer rates, but remediation estimates remain subject to change.
Important Facts for Investors to Verify
- Reconcile the different COVID-19 impact measures disclosed for earnings and operating income and assess the portion of 2020 earnings attributable to nonrecurring Hurricane Michael settlement effects.
- Evaluate liquidity after considering only $3.1 million of cash, $216.4 million of short-term borrowings, the $154.7 million revolver availability and planned capital expenditures of up to $215 million.
- Confirm the timing, cost and rate-recovery status of the Del-Mar Energy Pathway, West Palm Beach, Callahan and other pipeline projects.
- Assess whether COVID-19-related bad debt, lower consumption and unrecovered incremental costs could remain material after September 30, 2020.
- Review regulatory-asset recoverability, including the $45.8 million Hurricane Michael asset and any future COVID-19 deferrals.
- Consider the effect of October 2020 equity issuances and the Western Natural Gas acquisition on leverage, dilution, earnings and 2020 guidance.
- Monitor environmental remediation estimates, corporate guarantees of approximately $7.9 million, and $4.8 million of outstanding letters of credit.