Chesapeake Utilities Corporation — Q1 2017 Form 10-Q Summary
Business context and reporting period
Chesapeake Utilities is a diversified energy company with regulated natural gas distribution, natural gas transmission and electric distribution operations, plus unregulated propane, natural gas marketing, gathering, processing, transportation, supply, and combined heat and power businesses. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Results are seasonal, with revenue and earnings generally higher in the first and fourth quarters.
Financial performance and key metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total operating revenue | $185.2 million | $146.3 million | +$38.9 million |
| Gross margin | Not clearly presented as a consolidated total; segment gross margin increased $6.8 million | — | +$6.8 million |
| Operating income | $34.7 million | $36.4 million | -$1.7 million |
| Income before taxes | $31.7 million | $33.7 million | -$2.0 million |
| Net income | $19.1 million | $20.4 million | -$1.2 million |
| Diluted EPS | $1.17 | $1.33 | -$0.16 |
| Income tax rate | 39.5% | 39.6% | Down 0.1 percentage point |
| Operating cash flow | $60.0 million | $44.1 million | +$15.9 million |
| Capital expenditures paid in cash | $42.2 million | $37.8 million | +$4.4 million |
| Cash and equivalents | $5.7 million | $3.3 million at March 31, 2016 | Increase of $1.5 million from December 31, 2016 |
| Short-term borrowings | $199.3 million | $209.9 million at December 31, 2016 | -$10.5 million |
| Long-term debt, including current maturities | $148.6 million | $149.1 million at December 31, 2016 | -$0.4 million |
| Cash dividend declared per share | $0.3050 | $0.2875 | +$0.0175 |
Approximate consolidated operating margin was 18.7% in Q1 2017 versus 24.9% in Q1 2016, while net margin was approximately 10.3% versus 13.9%. The decline reflects higher operating expenses, including staffing, outside services, maintenance, depreciation, property taxes and costs associated with Eight Flags and Xeron.
Regulated Energy operating income declined to $23.0 million from $24.3 million despite a $3.1 million increase in gross margin. Unregulated Energy operating income declined to $11.5 million from $11.9 million despite a $3.7 million increase in gross margin.
Material changes versus the prior comparable period
- Revenue increased 26.6%, driven primarily by higher unregulated energy revenue, including natural gas marketing and the Eight Flags combined heat and power plant.
- Net income decreased 6.0% and diluted EPS decreased 12.0%, partly because the September 2016 equity offering increased the share count.
- Warmer weather reduced gross margin by approximately $1.1 million. The Delmarva Peninsula experienced its third-warmest first quarter in the last 50 years.
- Eight Flags generated approximately $2.3 million of incremental gross margin, including $1.8 million in the Unregulated Energy segment and $491,000 from affiliated gas distribution and transmission services.
- PESCO generated approximately $2.2 million of incremental gross margin from customer growth and a supplier agreement serving approximately 40,000 end users. That supplier agreement ended March 31, 2017 and was not renewed.
- Lower retail propane margins reduced gross margin by approximately $581,000, primarily because of higher propane prices and local market conditions.
- Staffing and related costs increased approximately $3.2 million, or 18%, and the company incurred approximately $600,000 of costs related to strategic transaction opportunities that did not materialize.
- Xeron began winding down operations and recorded approximately $606,000 of pretax losses, including severance and operating losses. Additional lease termination costs may arise.
- The Delaware Division’s new rates became effective January 1, 2017, adding approximately $546,000 of first-quarter gross margin. Customer refunds related to prior interim rates were issued in March.
Liquidity, capital resources and debt
- Operating cash flow of $60.0 million exceeded cash capital expenditures of $42.2 million, but financing activities used $16.2 million, including $11.1 million of net repayments under line-of-credit arrangements.
- Cash increased to $5.7 million at March 31, 2017 from $4.2 million at December 31, 2016.
- Short-term borrowings were $199.3 million. The company had $170.0 million of available credit under four unsecured bank facilities and an additional $150.0 million Revolver capacity.
- Equity represented 57% of total capitalization including short-term debt, within management’s stated target range of 50% to 60%.
- The company budgeted approximately $241.2 million of 2017 capital expenditures, including $213.2 million for Regulated Energy, $18.7 million for Unregulated Energy and $9.3 million for corporate and other activities.
- After quarter-end, on April 21, 2017, Chesapeake issued $70.0 million of 3.25% Shelf Notes and used the proceeds to reduce Revolver borrowings.
Guidance, outlook, commentary and unusual items
- Management continues to pursue growth through regulated infrastructure investment, transmission expansions, customer additions, service expansion and unregulated energy businesses.
- The 2017 capital expenditure estimate is approximately $241.2 million, subject to regulatory approvals, permitting, customer growth, economic conditions, acquisition opportunities and financing availability.
- The System Reliability Project, estimated at $37.0 million, was expected to be completed by the end of May 2017. Management assumed cost recovery beginning in August 2017, subject to refund and the outcome of the Eastern Shore rate case.
- The Eastern Shore 2017 Expansion Project has an estimated cost of $98.6 million and is expected to generate approximately $15.8 million of gross margin in its first full year after service begins. FERC approval was anticipated in August 2017.
- Eastern Shore requested an approximately $18.9 million revenue increase and a 13.75% return on common equity in its FERC rate case. Proposed rates were suspended and were expected to become effective, subject to refund, on August 1, 2017.
- The Northwest Florida Expansion Project is expected to generate approximately $5.1 million of annual gross margin once in service.
- Management expects propane margins to return to more normal levels over the long term, but margins remain exposed to commodity prices, competition and alternative energy sources.
- Material risks include regulatory and rate-case outcomes, environmental remediation, construction costs and timing, weather, commodity prices, counterparty credit, financing conditions, competition, cybersecurity, pension obligations and changes in tax or accounting rules.
- Environmental liabilities related to FPU’s Florida manufactured-gas-plant sites were approximately $9.8 million at March 31, 2017. Management expects environmental costs to be recoverable from insurance and customers through rates, but certain matters remain uncertain.
- Corporate guarantees totaled approximately $56.6 million and letters of credit totaled approximately $7.0 million. No letters of credit had been drawn.
- Management concluded that disclosure controls and procedures were effective as of March 31, 2017, with no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether Eastern Shore’s FERC rate case produces the requested revenue increase and how any rates, refunds or revised depreciation assumptions affect earnings.
- The timing, final cost and rate recovery of the System Reliability, 2017 Expansion and Northwest Florida projects.
- Whether the $241.2 million capital expenditure plan and related short-term borrowing can be funded without materially increasing leverage.
- The sustainability of PESCO’s first-quarter contribution after the supplier agreement ended March 31, 2017.
- The pace and cost of Xeron’s wind-down, including potential lease termination obligations.
- The durability of Eight Flags’ contracted contribution and the company’s ability to absorb its related operating expenses.
- Future propane margins and the sensitivity of unregulated earnings to commodity prices and weather.
- The status and recoverability of environmental liabilities, particularly the West Palm Beach, Seaford, Cambridge and Sanford matters.
- The impact of warmer-than-normal weather on customer consumption and whether reported growth is maintained under more normal conditions.