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Gas utility projects should fuel Q3 earnings growth despite industry hurdles

Most natural gas utilities are forecast to post year-over-year profit increases in the third quarter, even as the sector grapples with growing concerns over opposition to gas infrastructure and city-level efforts to electrify buildings.

A sense of unease settled over the gas industry in the third quarter, underscored by efforts to ban natural gas in new buildings in California, Seattle and Massachusetts. Disputes over pipeline projects in the U.S. Northeast have also deepened, punctuated by a bill to block infrastructure linked to gas exports, co-sponsored by leading 2020 presidential contender Sen. Elizabeth Warren, D-Mass.

Yet these long-term concerns are not clouding expectations for near-term earnings. Analysts expected six of eight natural gas utilities with comparable earnings to report higher profits in the third quarter compared with a year ago. And eight of 13 multiutilities are expected to top their third-quarter 2018 earnings when they report in the coming weeks.

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"These are heady times in the natural gas utility industry, which sports visible, attractive EPS growth at rates above electric peers," Mizuho Securities energy equity analyst Gabriel Moreen said in an Oct. 16 research note.

More than a decade of low U.S. interest rates have bolstered equity performance for regulated utilities, and Moreen believed that is likely to continue. "Although utility valuations have strengthened to the point where dividend yields are nearly at par with the 10 Year U.S. Treasury, we do not see this relationship breaking down as long as interest rates remain below 3% given visibility into regulated earnings growth and total return potential," Moreen wrote.

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A rush into the utility space by investors seeking safe, steady returns in a low-rate environment means many stocks are now overvalued, Morningstar energy and utilities strategist Travis Miller said. Yet low interest rates are also a boon to utilities aiming to finance capital projects, which underpin rate increases and future profits, Miller added.

"The gas sector still has a lot of core growth in demand as well as infrastructure needs," the strategist told S&P Global Market Intelligence. "So even though we're seeing some of the larger projects face some hurdles, there are many little projects that utilities are pursuing to drive their earnings growth."

Regulatory hurdles are on display in New York, where the state ordered National Grid USA to provide gas service to customers despite the state's refusal to permit new interstate gas pipeline capacity. National Fuel Gas Co. and Consolidated Edison Inc. are feuding with the state over blocked pipeline projects.

Meanwhile, New Jersey Natural Resources Company said in August that it would shift spending on the PennEast Pipeline Co. LLC system to 2021 amid a legal challenge. A U.S. appeals court has since ruled PennEast cannot take state land, leading New Jersey to deny key permits for the PennEast pipeline project.

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The utility industry's focus on pipeline replacement and maintenance has featured prominently in recent earnings conference calls. "Regulators have really been focusing on safety projects and reliability projects that are going to drive earnings growth for almost all the gas utilities across the country," Miller said. "These are projects that have broad public support among customers and regulators, and they can be done in a flexible fashion."

Second-quarter earnings showed that some utilities have struggled to control the cost of accelerated safety programs.

NiSource Inc. said in July that it did not expect any more upward revisions to costs tied to a 2018 chain of explosions and fires linked to a gas distribution system in Merrimack Valley, Mass. But NiSource-subsidiary Columbia Gas of Massachusetts' restoration program has come under scrutiny since then, prompting new investigations and inspections of hundreds of service line replacements.

Atmos Energy Corp. reported that the deployment of new safety technology following a deadly blast in Dallas contributed to higher-than-anticipated costs.