Profit guidance shows inflation is catching up with more gas utilities

The twin challenges of persistent inflation and rising interest rates are impacting earnings for a growing number of gas utility operators.

Diversified gas utility operators began issuing profit warnings earlier in 2022, prompted by inflationary pressure, labor shortages and supply chain issues in their unregulated businesses. During that time, pure-play gas distributors and multi-utilities largely detailed steps they were taking to protect their bottom lines from rising operating and borrowing costs.

But as pure-play gas utilities began issuing profit guidance at the end of 2022, some have acknowledged that those costs will in fact drag on earnings.

The guidance highlighted the growing challenges that small and mid-cap utilities face as they navigate inflation and high interest rates, JP Morgan analyst Richard Sunderland said in a Dec. 5 research note. Weak earnings guidance is "a theme we expect to persist into [fourth-quarter] earnings, as the balance of the space initiates 2023 guidance and updates long-term plans," Sunderland said.

Inflation hits earnings, shares drop

Gas utility stocks have rallied in the fourth quarter, but shares of both Spire Inc. and One Gas Inc. pulled back sharply after the companies issued guidance.

St. Louis-based Spire has invested in technology and process improvements to prevent its annual operation and maintenance expense from rising faster than inflation, CFO Steve Rasche told analysts in November. Those tools helped the company offset most of the early headwinds in 2022, but Rasche warned that Spire would not be able to fully mitigate inflation in fiscal year 2023.

The company's 2023 earnings guidance, issued two weeks later, included an estimated 4% increase in operating costs that Spire cannot control.

Earlier in November, One Gas warned that inflation and high interest rates would increase the cost of servicing its growing customer base and funding system expansions, ultimately eating into profits. One month later, the company issued disappointing 2023 guidance and cut its five-year earnings growth forecast from 6%-8% to 4%-6%.

One Gas expected most of the earnings impact in the first half of its forecast period, forcing the company to open rate cases in Texas and Kansas to seek recovery of higher costs.

The company was not alone. National Fuel Gas Co. — which trimmed 2023 guidance in November — said it would open gas rate cases in New York and Pennsylvania, partly to account for rising compensation costs as the company seeks to attract and retain talent in a tight labor market. The increase in operating and maintenance cost has been particularly pronounced in the regulated businesses, where the company has the highest headcount, National Fuel President and CEO David Bauer told analysts.

Analysts warned that opening rate cases in the current high-commodity price environment, in which regulators are wary of customer bill impacts, creates uncertainty around regulatory outcomes. Still, rate case activity has been robust in recent weeks and will likely remain elevated as utilities seek to document and offset inflationary impacts, according to Regulatory Research Associates, a group within S&P Global Commodity Insights.

Some utilities remain bullish

In contrast, shares of Atmos Energy Corp. and New Jersey Resources Corp. held their gains after the companies issued guidance. According to analysts, the reason for the stock price divergence was clear: The companies set themselves apart by offering bullish outlooks for 2023 and signaling they could digest inflationary pressure.

Credit Suisse analyst Nicholas Campanella said Atmos "appears duly confident with managing customer bill pressure to achieve the current plan" and "continues to be well prepared for inflation impacts going into 2023." Mizuho analyst Gabe Moreen said the company "separated itself from its peers in terms of financing long-term debt at favorable fixed rates ... and hedging against rising interest rates."

As for New Jersey Resources, JP Morgan's Sunderland said the company's guidance was "a clear positive, in our view, amid broader investor attention on the group's exposure to inflation and interest rate headwinds." Analysts were also encouraged by the upside earnings opportunity at the company's gas marketing division, NJR Energy Services Co., in light of potentially volatile commodity prices and constrained gas supply in the U.S. Northeast.

One of the first gas utility operators to sound the alarm on inflation, UGI Corp., has rallied in the fourth quarter. While inflation continues to buffet its global propane business, the market responded positively to UGI's 2023 earnings forecast and its plan to right the ship.

Still, UGI issued a broad guidance range to reflect continuing uncertainties presented by inflation, commodity costs and its troubled European energy marketing business. On Dec. 2, UGI said negotiations with a potential buyer of the French branch of the energy marketing business had ended. The company reaffirmed its 2023 guidance, even though that outlook was partly premised on closing a sale of the French business.

No relief in sight

Other gas utility operators signaled that inflation would continue to weigh on earnings.

Southwest Gas Holdings Inc. posted disappointing earnings and tempered its guidance for a second consecutive quarter in November. Along with other factors, rising costs and interest expense continued to weigh on its gas utility and energy infrastructure construction business.

Chesapeake Utilities Corp. also posted a rare year-over-year decline in quarterly profit, partly due to higher interest expense. Executives previously issued a warning about rising borrowing costs and inflation. Asked where costs were moderating, Chesapeake President and CEO Jeff Householder said vehicle fuel expense was easing, but employee and project cost inflation remained stubbornly high.

"I don't think you're going to see any significant pullback in expenses anytime soon, and I am of the opinion that we are going to continue to see increased pressure on those costs," Householder said. "That's not the world's most optimistic forecast, but I think that that's probably what we are facing, and it's certainly what we're planning for."

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