Business context and reporting period
National Fuel Gas Company’s unaudited Form 10-Q covers the three and nine months ended June 30, 2014, the third quarter and first nine months of its fiscal year ending September 30, 2014. The diversified energy company reports five segments: Exploration and Production, Pipeline and Storage, Gathering, Utility, and Energy Marketing.
Financial performance and position
| Metric | Three months ended June 30, 2014 | Nine months ended June 30, 2014 |
|---|---|---|
| Operating revenue | $440.1 million | $1,746.5 million |
| Operating income | $127.0 million | $467.7 million |
| Net income | $64.5 million | $242.0 million |
| Diluted EPS | $0.76 | $2.85 |
| Operating margin | 28.9% | 26.8% |
| Net margin | 14.7% | 13.9% |
For the nine months, operating cash flow was $725.6 million, capital expenditures paid were $609.4 million, and cash increased by $37.8 million to $102.7 million. Long-term debt was $1.649 billion, with no current maturities or short-term borrowings at June 30. The company had a $750 million committed credit facility, no borrowings under it, and a debt-to-capitalization ratio of 0.41 against a 0.65 covenant limit. Nine-month dividends paid were $94.3 million; dividends declared were $1.135 per share.
Material changes versus prior comparable periods
- Third-quarter revenue was essentially flat year over year, while net income rose $6.0 million (10.3%). Nine-month revenue increased $255.8 million (17.2%) and net income rose $29.8 million (14.1%).
- For nine months, Exploration and Production revenue grew with higher production, especially Marcellus gas; reported segment earnings increased only $1.8 million as lower realized prices after hedging, higher production and depletion costs, and other expenses offset much of the volume benefit.
- Pipeline and Storage and Gathering earnings increased $10.6 million and $12.7 million, respectively, for nine months, supported by new pipeline capacity, contracts, and gathering volumes. Utility earnings decreased $0.4 million; Energy Marketing earnings increased $0.2 million.
- Operating cash flow increased $138.3 million year over year. Capital expenditures paid rose $96.0 million; total long-lived-asset expenditures, including accrued amounts, were $664.0 million versus $504.5 million.
Outlook, commentary, risks and unusual items
- Management expects to use operating cash and short-term borrowing as needed to fund fiscal 2014 capital needs and anticipates issuing long-term debt in fiscal 2015. No earnings or EPS guidance is provided. The company cautions that interim results are seasonal and are not a full-year forecast.
- Investment is concentrated on Appalachian development and infrastructure: $368.0 million was spent on Marcellus development during the nine months. Pipeline and gathering expansions are intended to serve growing regional production; projects remain subject to permitting, construction, cost, and shipper-demand risks.
- The oil-and-gas full-cost ceiling exceeded carrying value by about $183.1 million at June 30. Management’s sensitivity analysis indicates a $1/MMBtu decrease in test gas prices alone could cause carrying value to exceed the ceiling by about $146.2 million, potentially requiring a noncash impairment.
- Commodity prices and hedging remain significant exposures. Nine-month average gas and oil prices after hedging were below the prior year; crude-oil hedge mark-to-market adjustments included a $3.6 million loss. Derivative values, basis differentials, counterparties, and possible collateral requirements can affect results and liquidity.
- The NYPSC approved a settlement on May 8, 2014: New York customer rates remain at prior levels for at least two years from October 1, 2013; the agreement sets a 9.1% allowed return for ratemaking, includes an earnings-sharing mechanism, and authorizes $8.2 million of additional annual pipeline-replacement spending. The $7.5 million prior refund provision had been passed back to customers by June 30.
- Environmental cleanup liabilities were estimated at $14.2 million, including $12.8 million for a New York former manufactured-gas-plant site; recovery through rates is expected. Other routine legal and regulatory matters could affect earnings in the period resolved, though management did not expect a material adverse effect on financial condition.
- Unusual items included a $3.6 million life-insurance death-benefit gain in the first half and a roughly $2.8 million deferred tax benefit from a New York corporate tax-rate reduction. Energy Marketing began accruing unbilled revenue and related costs in fiscal 2014, affecting period comparisons.
- Key broader risks include hydraulic-fracturing and environmental regulation, oil and gas prices and differentials, reserve estimates and production, project execution and permits, financing and credit ratings, weather, pension funding, and derivative regulation. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether production growth and new pipeline and gathering capacity translate into durable cash flow and returns on the elevated capital program.
- Oil and gas prices, hedge settlements, and ceiling-test headroom at subsequent reporting dates, including impairment sensitivity.
- Funding needs and financing terms for the planned fiscal 2015 debt issuance, major expansions, and other capital commitments.
- Regulatory approvals, construction progress, costs, and contracted capacity for announced pipeline projects, particularly Northern Access 2016 and other proposed expansions.
- Effects of the New York rate settlement, weather normalization, and ongoing environmental and other proceedings on utility earnings and customer refunds.