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Q2 gas utility earnings could flip investor sentiment on the sector

Industry observers say second-quarter gas utility earnings could look relatively strong, even as they anticipate downward revisions to guidance and continued headwinds for fossil fuel infrastructure.

Earnings reports from gas distributors stand to unsettle investors by offering a view into COVID-19 impacts that was not available in the first quarter. However, the reporting period also presents an opportunity for executives to highlight the sector's slow-but-steady growth at a time when surging coronavirus cases have raised fresh concerns about the U.S. economy.

Analysts expect six of nine gas utilities to report higher earnings per share during the second quarter, compared with the year-ago period. Nine out of 15 selected multi-utilities are tipped to report higher EPS, according to S&P Capital IQ consensus estimates.

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Investors will be focused on forward-looking commentary after many executives took a wait-and-see approach in the first quarter.

"While there were a few exceptions, most utilities were unwilling to change guidance that they had previously communicated. They simply stated that it was too early to truly understand the depth or length of the impact," Greg Waller, director at management consultant ScottMadden, said during a June 18 webinar. "Most provided very cautious statements and lots of caveats, so that tells me when we look at these second-quarter earnings calls, it's going to be really notable to see how or if the situation has changed by then."

L. Joshua Wein, co-portfolio manager of the Hennessy Funds Gas Utility Fund, expects some utilities to soften guidance. "I don't see the risk of lowering guidance now when that's kind of what the layperson would expect anyway. I would think this is the perfect time," he said. "I would think that there would be a lot of erring on the side of caution and lowering expectations so that maybe you can beat them later on and maintain some credibility with your investor base."

Despite the prospect for downward revisions, Wein believes earnings season could prompt investors to reconsider gas utilities following the market's rotation into large-cap tech stocks.

While the S&P 500 surged 20% in the second quarter, the S&P 500 Utilities Index was up just 1.8%, while an index of nine select gas utilities was down 3.5%. The S&P 500 utility sector and the select index — Atmos Energy Corp., Chesapeake Utilities Corp., New Jersey Resources Corp., Northwest Natural Holding Co., ONE Gas Inc., South Jersey Industries Inc., Southwest Gas Holdings Inc., Spire Inc. and UGI Corp. — were both down more than 14% in the first quarter, outperforming the S&P 500, which sank 20% in the first three months of 2020.

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In Wein's view, the market incorrectly believes the utility sector's stability and dividend growth are at risk. Once companies begin reporting, investors will see "there's still optimism around dividends. There's still capex, there's still some modest growth, and margins are firm," he said. Meanwhile, the sector's premium valuation has disappeared, and interest rates are once again in retreat, he noted. That raises the prospect of investors once again buying into utilities to secure yield that government bonds do not offer.

Earnings reports and conference calls could still give investors pause. During the first quarter, executives stressed that the coronavirus outbreak coincided with the end of the high-revenue winter heating season. But gas utilities also reported earnings as the impacts of the pandemic were still becoming clear. Additional data could offer a more complete view of the pandemic's impact on commercial and industrial demand amid widespread economic disruption.

The pandemic has also dovetailed with a period of continued headwinds for gas infrastructure expansion. The quarter saw Williams Cos. Inc. abandon the Northeast Supply Enhancement pipeline project into New York City following a bitter dispute between the state and National Grid USA. On July 5, Dominion Energy Inc. and Duke Energy Corp. canceled the Atlantic Coast pipeline.

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Meanwhile, the building electrification movement is evolving since Berkeley, Calif., passed a pioneering building gas ban a year ago. In some politically liberal states, policymakers are seeking to limit gas use through regulatory overhauls.

Moody's has noted that while the pandemic creates cash flow challenges, it presents an opportunity for gas utilities to burnish their ESG credentials by working with regulators to extend favorable terms to financially strapped ratepayers. Wein said he will be listening for commentary on how companies are cooperating to implement long-term customer protections and later recover the resulting bad debt.

"There are these competing interests, but maybe for a little while everyone can meet in the middle and say, hey, natural gas is clean, it's plentiful, it's relatively inexpensive and we're doing our best to help the community," he said.