Essential Utilities, Inc. quarterly report, Q1 FY2021

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Essential Utilities, Inc. — Q1 2021 Form 10-Q

Reporting period: Three months ended March 31, 2021. Essential Utilities provides regulated water, wastewater and natural gas services. Results include a full quarter of Peoples Natural Gas in 2021, versus only 16 days in Q1 2020 following its March 16, 2020 acquisition; year-over-year comparisons are therefore substantially affected by the acquisition. Unless stated otherwise, figures below are in millions of dollars.

Financial performance and position

  • Revenue: $583.6, up $328.0 (128%) from $255.6. Management attributed most of the increase to Peoples, which contributed $343.1 in revenue in Q1 2021 versus $38.5 in the 16 days included in Q1 2020.
  • Profit: Operating income was $232.4, compared with $73.5; net income was $183.7, compared with $51.8. Diluted EPS was $0.72 versus $0.20. The reported operating margin was 39.8% versus 28.8%, and net margin was 31.5% versus 20.3%; the acquisition and gas-cost pass-throughs affect comparability.
  • Natural gas: Regulated gas gross margin, a non-GAAP measure defined as revenue less purchased gas, was $220.2 versus $25.8. Purchased gas expense was $122.9 versus $12.8; these costs are generally passed through to customers and, management says, do not affect gross margin.
  • Cash flow: Operating cash flow was $255.5 versus $95.5. Capital expenditures were $178.0 versus $118.7. Investing cash use was $177.7, compared with $3,564.6 in Q1 2020, which included the Peoples acquisition. Financing used $64.6, versus providing $1,632.0 in the prior-year quarter. Cash ended at $18.0, up from $4.8 at year-end 2020.
  • Debt and liquidity: Long-term debt carrying amount was $5,665.6 at March 31, compared with $5,630.2 at December 31; loans payable were $74.9. Current assets of $348.1 were below current liabilities of $503.4. The company reported $536.5 available under its $1.0 billion revolving facility and $160.6 available under short-term credit lines, which are subject to annual renewal.
  • Capital and distributions: Total assets were $13,821.9 and stockholders’ equity was $4,810.3. Dividends declared were $0.2507 per share; cash dividends paid were $61.5.

Material changes versus Q1 2020

  • Revenue growth principally reflects a full quarter of Peoples gas operations in 2021 compared with 16 days in 2020. Peoples segment net income was $119.3 versus $13.4 for the partial prior-year period.
  • Operating expenses increased to $351.2 from $182.1. Purchased gas rose by $119.4, while depreciation increased by $26.1 and interest expense by $15.6, mainly reflecting the acquired business and higher average borrowings.
  • Q1 2020 included $25.4 of Peoples acquisition transaction costs in operations and maintenance; there were no further such costs after that quarter. Q1 2021 operating and maintenance expense also benefited from $4.0 lower insurance expense.
  • The effective income tax rate was 2.5%, compared with a tax benefit rate of 16.0% in Q1 2020. Management cited qualifying infrastructure tax deductions and other tax effects; the rate is well below the 21% federal statutory rate.

Outlook, commentary, risks and unusual items

  • Outlook and funding: No quantified earnings or revenue guidance is provided. Management expects internally generated funds, credit facilities and debt and equity issuance to fund operations and financing needs for at least the next 12 months. It intends to continue its capital investment program.
  • Acquisitions: Several water and wastewater acquisitions were pending, subject to regulatory approvals and closing adjustments. The proposed DELCORA acquisition for $276.5 faces ongoing litigation and a stayed regulatory proceeding; the company anticipated a possible Q4 2021 closing, subject to those matters. Other pending acquisitions were expected to close from the second half of 2021 through Q1 2022.
  • Financing after quarter-end: Aqua Ohio issued $100.0 of first mortgage bonds on April 15, 2021. On April 19, the company issued $400.0 of debt due 2031 at 2.40%, using proceeds to repay revolving borrowings. A new universal shelf registration was filed in April. The company’s 6.7 million-share forward equity sale agreement had not been settled at quarter-end and was scheduled to expire no later than August 10, 2021.
  • Rates and obligations: Approved rate increases and infrastructure surcharges were expected to add annual revenue, while Virginia interim rates remain subject to refund; $0.2 had been collected by March 31. Peoples acquisition commitments included an estimated $120.0 gathering-pipe replacement program over seven years, recoverable through customer rates; the $23.0 one-time rate-credit commitment had been fulfilled in 2020.
  • COVID-19: Management said it had not identified material supply-chain risks and did not then anticipate a significant financial impact. It monitored customer collections, bad debts, operating costs and regulatory deferrals; the ultimate effects remained uncertain.
  • Contingencies: The company had accrued $17.6 for loss contingencies, with approximately $3.3 considered recoverable through insurance. An Illinois water-quality advisory and related putative class action remain unresolved; class certification had not been granted. Management could not estimate a potential fine or penalty related to the advisory and said the final outcome could not be predicted.
  • Other uncertainties: A dispute with the seller over Peoples acquisition capital-expenditure adjustments remains unresolved. The Pennsylvania utility commission approved a settlement on May 6, 2021 providing for a five-year customer return of a $160.7 tax catch-up adjustment; that approval occurred after quarter-end.

Investor verification priorities

  1. Assess the underlying year-over-year trend after accounting for Peoples’ partial-quarter inclusion in Q1 2020 and the 2020 acquisition costs.
  2. Review cash conversion, capital spending and the company’s ability to fund its investment and acquisition pipeline given negative working capital and reliance on credit and capital markets.
  3. Track DELCORA litigation and regulatory proceedings, other pending acquisitions, and the unresolved Peoples purchase-price adjustment.
  4. Verify the effects of the Pennsylvania tax settlement, future customer credits or recoveries, and the very low reported effective tax rate.
  5. Monitor the Illinois water advisory and lawsuit, COVID-related customer collections and costs, and renewal terms for short-term credit lines.