Business Context and Reporting Period
Chesapeake Utilities Corporation filed its Form 10-K for the fiscal year ended December 31, 2016. The company operates regulated and unregulated energy businesses across the Delmarva Peninsula, Florida, Pennsylvania and Ohio, including natural gas distribution and transmission, electric distribution, propane distribution, natural gas marketing and gathering, and electricity and steam generation.
Reportable segments were Regulated Energy and Unregulated Energy. The fourth quarter was seasonally significant, with fourth-quarter 2016 net income of $11.9 million and diluted EPS of $0.73, compared with $8.6 million and $0.56, respectively, in the fourth quarter of 2015.
Key Financial Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Operating revenue | $498.9 million | $459.2 million | +$39.6 million |
| Operating income | $84.1 million | $77.8 million | +$6.3 million |
| Net income | $44.7 million | $41.1 million | +$3.5 million |
| Diluted EPS | $2.86 | $2.72 | +$0.14, or 5.1% |
| Operating margin | 16.9% | 16.9% | Approximately flat |
| Net margin | 9.0% | 9.0% | Approximately flat |
| Operating cash flow | $103.4 million | $104.1 million | -$0.8 million |
| Capital expenditures | $169.4 million | $142.7 million | +$26.7 million |
| Cash and cash equivalents | $4.2 million | $2.9 million | +$1.3 million |
Regulated Energy generated $305.7 million of revenue and $69.9 million of operating income, compared with $301.9 million and $61.0 million in 2015. Unregulated Energy generated $203.8 million of revenue and $13.8 million of operating income, compared with $162.1 million and $16.4 million, respectively.
Regulated Energy gross margin increased to $196.1 million from $179.1 million. Unregulated Energy gross margin increased to $65.0 million from $60.3 million, but higher operating expenses more than offset that improvement. Consolidated income before taxes was $73.0 million, income tax expense was $28.3 million, and the effective tax rate was 38.8%.
Debt, Capitalization and Liquidity
- Long-term debt, including current maturities, was $149.1 million; long-term debt net of current maturities was $137.0 million.
- Short-term borrowings were $209.9 million, up from $173.4 million, with a weighted-average year-end rate of 1.43%.
- Total capitalization including short-term borrowings was $805.0 million, comprising 55.4% common equity, 18.5% long-term debt including current maturities and 26.1% short-term debt.
- The company had $320.0 million of aggregate short-term credit facilities, of which $118.7 million was available at year-end, before considering other liquidity factors.
- The company issued 960,488 common shares in September 2016 for net proceeds of approximately $57.4 million, primarily used to reduce short-term debt.
- Cash provided by operations substantially funded capital investment, but investing activities used $170.0 million, resulting in reliance on financing activities and short-term borrowings.
- The company reported compliance with all debt covenants. It had $8.5 million of outstanding letters of credit and $57.2 million of corporate guarantees for subsidiary supplier obligations.
Material Changes Versus the Prior Comparable Period
- Net income increased 8.6% and diluted EPS increased 5.1%, supported principally by regulated infrastructure investment, service expansions, customer growth, Florida GRIP recovery, and the new Eight Flags combined heat and power plant.
- Regulated Energy operating income increased 14.5%. Key gross-margin contributions included $7.2 million from service expansions, $4.0 million from Florida GRIP, $2.7 million from natural gas customer growth, $1.5 million from Delaware rate implementation and $1.4 million from services to Eight Flags.
- Unregulated Energy operating income declined 15.4%, despite higher gross margin. Aspire Energy and Eight Flags contributed positively, but retail propane margins declined by $2.8 million, warmer weather reduced gross margin by approximately $1.4 million, and Xeron reported a $0.5 million negative gross margin.
- Aspire Energy contributed $5.9 million of incremental gross margin because 2015 included only nine months of operations following the April 2015 acquisition.
- Eight Flags completed its Florida CHP plant in June 2016 and generated $7.0 million of electricity revenue and $1.3 million of steam revenue during the second half of the year.
- Warmer-than-normal weather, particularly in the first quarter, reduced gross margin by approximately $3.6 million compared with 2015. Delmarva heating degree-days were 3,979 versus 4,363 in 2015 and 4,453 normal.
- PESCO revenue increased to $95.4 million from $56.2 million, while its gross margin increased to $4.6 million from $3.6 million. Its Columbia Gas of Ohio standard-choice-offer contract generated an approximately $1.5 million loss due to fixed storage and pipeline costs and warmer weather.
- There were no business-sale gains in 2016 or 2015. The 2014 comparison included a $7.1 million pre-tax gain from business dispositions and a $6.9 million impairment charge.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal earnings or EPS guidance. Management described a strategy centered on growth from the regulated utility base, organic expansion, midstream and downstream investments, strategic acquisitions and complementary unregulated energy services.
- The 2017 capital expenditure budget is $260.3 million, including $232.0 million for Regulated Energy and $16.3 million for Unregulated Energy. Management noted that actual spending has historically averaged approximately 94% of initial budgets.
- The White Oak Mainline project was expected to enter service in March 2017 and has an estimated cost of $39.8 million. The System Reliability Project was expected to be completed by April 2017 at an estimated cost of $36.0 million.
- The proposed 2017 Expansion Project would add 61,162 dekatherms per day of firm transportation capacity, has an estimated cost of $98.6 million and is expected to generate approximately $15.7 million of gross margin in its first full year after service begins. Required regulatory approval remained pending.
- Eastern Shore filed a FERC rate case in January 2017 seeking an approximately $18.9 million revenue increase and a 13.75% return on common equity. The filing faced interventions and protests, and the outcome was uncertain.
- FPU’s electric division filed for approval of a temporary surcharge to recover approximately $59.8 million of reliability and modernization investment over five years. The outcome was uncertain and the Office of Public Counsel intervened.
- Environmental liabilities of approximately $9.8 million were accrued for FPU’s former manufactured-gas-plant sites. Management expects environmental costs to be recoverable through insurance and customer rates, but recovery of future costs is not guaranteed.
- The company had exposures at seven former manufactured-gas-plant sites. Potential remediation estimates included $4.5 million to $15.4 million for West Palm Beach and $273,000 to $465,000 for Seaford. A Cambridge, Maryland matter had no recorded liability because the outcome could not be determined.
- Commodity, weather, interest-rate, regulatory, construction, environmental, cybersecurity, supplier, counterparty, pension and credit-market risks could materially affect results. Unregulated marketing businesses remain exposed to commodity-price volatility and counterparty credit risk.
- Natural gas futures related to PESCO’s standard-choice-offer contract were de-designated as highly effective hedges during 2016 and accounted for on a mark-to-market basis. The contracts had a $0.8 million liability at year-end.
- The company adopted several accounting updates in 2016, including debt issuance cost presentation and deferred tax classification. Adoption did not materially affect results. The company was evaluating the future effects of revenue recognition, inventory, leases and cash-flow classification standards.
Investor Verification Priorities
- Verify the outcome and timing of Eastern Shore’s FERC rate case, including any approved revenue increase, rate of return and refund exposure.
- Verify regulatory approval, cost recovery and construction progress for the 2017 Expansion, White Oak Mainline and System Reliability projects.
- Assess whether the $260.3 million 2017 capital budget can be funded without materially increasing short-term borrowings or issuing additional equity.
- Monitor the refinancing or issuance of the planned $70.0 million of 3.25% Shelf Notes and the maturity of short-term credit facilities beginning in 2017.
- Evaluate the sustainability of regulated growth and whether propane margins, weather normalization and customer conversion trends offset pressure in Unregulated Energy.
- Review environmental remediation estimates and the extent to which future costs remain recoverable through insurance or regulated rates.
- Track PESCO’s contract expiration on March 31, 2017, including any residual inventory, storage or derivative-market exposure.
- Reconcile reported cash flow, debt, covenant compliance, supplier guarantees, letters of credit and pension funding requirements with the detailed notes to the financial statements.