Essential Utilities, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Unaudited consolidated results; amounts below are in millions unless otherwise noted. Essential Utilities provides regulated water, wastewater and natural gas services, serving an estimated five million people, alongside smaller non-regulated businesses.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Operating revenue | $436.7 | $448.8 | $1,163.2 | $1,148.0 |
| Operating income | $155.3 | $137.7 | $380.7 | $365.4 |
| Net income | $91.3 | $82.3 | $282.7 | $281.7 |
| Diluted EPS | $0.34 | $0.31 | $1.07 | $1.07 |
| Operating margin | 35.6% | 30.7% | 32.7% | 31.8% |
| Net margin | 20.9% | 18.3% | 24.3% | 24.5% |
Quarterly revenue decreased 2.7%, while operating income and net income rose. For the first half, revenue grew 1.3% and operating income increased, but net income was nearly flat. The water segment’s rate increases, surcharges, customer growth and warmer-weather consumption supported revenue; lower gas costs and usage reduced reported natural gas revenue. Gas commodity costs generally pass through to customers and affect revenue and expense correspondingly, rather than gross margin.
Quarterly operating expenses fell to $281.5 from $311.0, primarily reflecting lower purchased gas expense. First-half operating expenses were essentially unchanged at $782.4. Depreciation and amortization rose to $85.7 for the quarter and $169.5 for the half, reflecting capital investment and acquisitions. Net interest expense increased to $68.2 for the quarter and $140.1 for the half, driven by higher average borrowings and interest rates.
- Cash flow: First-half operating cash flow was $621.4, up from $416.3. Management attributed much of the increase to working-capital movements, especially gas inventory; working-capital and other asset/liability changes increased operating cash flow by $185.9, versus a decrease of $12.3 in the prior-year period.
- Investment and financing: Capital expenditures were $547.6, compared with $424.6; utility acquisitions used $25.8. Financing activities used $48.8, including $151.7 of common dividends. Cash ended the period at $11.6.
- Debt and liquidity: Long-term debt was $6.86 billion gross ($6.62 billion excluding current maturities, net of issuance costs). Loans payable were $48.0. The company reported $305.4 available under its $1.0 billion revolving facility and $382.8 available under short-term credit lines. Current assets of $406.7 were below current liabilities of $765.1, consistent with the company’s historically negative working-capital position.
- Equity and dividends: Stockholders’ equity was $5.61 billion at June 30, versus $5.38 billion at year-end. The quarterly dividend declared was $0.287 per share.
Material changes and developments
- Regulated Water revenue increased 9.0% in Q2 and 10.3% in the first half. Segment net income increased to $90.0 for the quarter and $167.4 for the half, supported by rate changes, infrastructure surcharges, customer growth and, in Q2, higher consumption.
- Regulated Natural Gas revenue decreased 17.1% in Q2 and 5.3% in the first half. First-half gas usage was down 16.5% year over year in Pittsburgh, used as a proxy for the western Pennsylvania service area, due to warmer weather. Segment net income fell to $137.2 for the half from $151.0.
- Effective income tax rates were negative 0.3% for Q2 and negative 12.7% for the first half, versus 9.0% and negative 3.4%, respectively. The company attributed the lower rates mainly to tax benefits for qualifying utility infrastructure. It also released some historical tax reserves and deferred the related benefit as a regulatory liability pending treatment in a future rate case.
- Gross long-term debt rose from $6.62 billion at December 31, 2022 to $6.86 billion at June 30, 2023. S&P affirmed an A rating in July but revised its outlook to negative, citing inflationary pressures and substantial capital spending. Moody’s had affirmed Baa2 with a stable outlook in May 2022.
Outlook, risks and unusual items
- Management expects inflation, higher interest rates and supply-chain pressures to continue raising operating and capital spending requirements through the remainder of 2023. It expects internally generated funds, credit facilities and debt and equity issuance to support normal operations and financing needs for at least the next 12 months. No specific earnings or revenue guidance is provided.
- The company expects the EPA’s proposed PFAS drinking-water rule, anticipated to be finalized by early 2024, to require additional treatment investment and operating costs. It is pursuing grants and low-interest loans and participating in legal actions intended to hold polluters responsible.
- The planned sale of the West Virginia regulated gas assets, serving approximately 13,000 customers, is for $37.0 million in cash at closing, subject to adjustments and regulatory approvals; completion was expected later in 2023. The company reported no anticipated impairment from the sale.
- In July 2023, the Pennsylvania Commonwealth Court reversed the order approving the East Whiteland wastewater acquisition. The company was evaluating the decision and said final resolution was not expected to materially adversely affect its financial position, results or cash flows.
- The proposed DELCORA acquisition remains subject to extensive litigation and regulatory proceedings, including a bankruptcy-court stay of the PUC proceedings. Closing timing and outcome are uncertain. Other pending utility acquisitions also depend on regulatory approvals; Willistown Township terminated its purchase agreement in April 2023.
- Loss-contingency accruals totaled $19.4, of which the company estimated $1.4 was recoverable through insurance. An Illinois water advisory-related claim remains in discovery, class certification has not been granted, and the company is defending the matter. Management said resolution was not expected to have a material adverse effect, but noted unfavorable outcomes could negatively affect the company.
- The company said it is exposed to regulatory, weather, inflation, supply-chain, capital-market, financing and acquisition-integration risks. It also warned that nonrenewal of short-term credit lines or a material credit-rating downgrade could affect borrowing costs and liquidity.
Investor verification points
- Review whether working-capital-driven operating cash flow is sustainable and how elevated capital spending will be funded.
- Track debt growth, interest costs, available credit, refinancing needs and the implications of S&P’s negative outlook.
- Verify progress on rate recovery and the timing and customer impact of PFAS-related investment and costs.
- Monitor the West Virginia asset sale, the East Whiteland reversal, DELCORA litigation and regulatory approval of other acquisitions.
- Assess the drivers and persistence of unusually low effective tax rates and the treatment of deferred tax benefits in future rate cases.
- Follow developments in the Illinois advisory-related claim and the adequacy of related accruals and insurance recoveries.