Essential Utilities, Inc. (NYSE:WTRG) Q1 2024 Earnings Call Transcript

Essential Utilities, Inc. (NYSE:WTRG) Q1 2024 Earnings Call Transcript May 3, 2024

Essential Utilities, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and welcome to the Essential Utilities Q1 2024 Earnings Call. My name is George. I’ll be your coordinator for today’s event. [Operator Instructions] I’d like to hand it over to your host today, Mr. Brian Dingerdissen, to begin today’s conference. Please go ahead, sir.

Brian Dingerdissen: Thanks, George. Good morning, everyone, and thank you for joining us for our first quarter 2024 earnings call. If you did not receive a copy of the press release, you can find it by visiting the Investor Relations section of our website and the slides that we will be referencing and the webcast of this event can also be found there. As a reminder, some of the matters discussed during this call may include forward-looking statements that involve risk, uncertainties, and other factors that may cause the actual results to be materially different from any future results expressed or implied by such forward-looking statements. Please refer to our most recent 10-Q, 10-K and other SEC filings for a description of such risks and uncertainties.

During the course of this call, reference may be made to certain non-GAAP financial measures. Reconciliation of any non-GAAP to GAAP financial measures is posted on the website. We will begin the call with Chris Franklin, our Chairman and CEO, who will provide an update on the company. Mike Huwar, the President of our Gas Business, will then provide an update on the gas business. And then Dan Schuller, our CFO, will provide an overview of the financial results before Chris closes the call and opens the call up for questions. With that, I will turn it over to Chris Franklin.

Christopher Franklin: Hi. Thanks, Brian, and good morning, everyone. Thanks for joining us. Let’s begin with some highlights from the quarter so far. First, Dan’s going to discuss in a lot more detail our financials. We posted GAAP earnings of $0.90 to $0.97 per share, which includes the significant gain on sale from the energy projects, which closed in January. Now at the start of the year has been unusually warm, underscoring our real need for weather normalization at our gas utility. Operationally, this was another very strong quarter for both gas and water, and we continue to achieve industry-leading operational metrics in both gas and water. You’ll hear more about the gas division from Mike Huwar in just a few moments. Now, related to our acquisition program, we have seen real progress on the (c) motion, which was introduced by Chairman, D.

Frank. We understand that more than 30 people have contributed to the process of the (c) motion comment period, and we expect the PUC to vote on the motion relatively soon. We will continue to monitor the progress here and we hope the process is completed soon here in Pennsylvania. Now, as you probably saw, the EPA published the first-ever limits on PFAS last month. These were largely in line with what we were expecting, and I’ll get into some detail in a moment, including our CapEx spending on PFAS. Now, speaking of CapEx, our significant infrastructure investment program continues to upgrade our pipes and plants, which enhance our ability to deliver on our mission of providing reliable water and natural gas service to customers. Through March 31st, we have invested approximately $253 million and as a reminder, we expect to invest between $1.3 billion and $1.4 billion this year, which will be a record capital spend for us by the way.

You’ve heard me say that many times, and I can’t tell you how proud I am of the company’s leadership and what they have accomplished in terms of our work to improve customer reliability. Now, as part of our continued focus on operational excellence in 2024, I thought you might enjoy hearing from Mike Huwar, our President of our Natural Gas Division. And later in the year, you’ll hear from Colleen Arnold, who runs our Water Business. But we are leading – we have some leading efforts going on in our natural gas business. I think you’ll find it interesting. And finally, on this slide, it’s been a busy week for the company. On Wednesday, we held our Annual Meeting of Shareholders, which was on all agenda items received over 90% of shareholder support.

Notably, I’m pleased to report that Tamara Linde and Chris Bruner have been elected to the Board. If you take a look at the next slide, I think you’ll agree that they’ll be great additions to the Essential Board. Over the last 10 years, we’ve really focused on corporate governance. And as a result, I think we have one of the most what both would consider best-in-class corporate governance guidelines. And I believe we’re really a leader in that part of our business. For example, our corporate governance includes tenure limitations and retirement ages. In fact, Ellen Ruff, our longest-tenured board member, and she was a former Duke executive and Lee Stewart, our longtime Audit Committee Chair, reached retirement age over the past year and formally retired from the Board this week.

Now, through a formal board succession search process, we identified Tammy and Chris, who I believe will fit seamlessly into what is already a very strong board. Tammy is someone you may already be familiar with as a longtime industry executive, General Counsel at PSEG in New Jersey. She brings a great utility, legal and regulatory mind to our Board. Chris is a retiring audit partner, EY, and he previously served as the Head of the Philadelphia Office of EY, and he brings a depth of knowledge and experience participating in audit committees and board discussions. Chris will retire from EY at year end and has passed the independence test of the New York Stock Exchange and the SEC, and of course, declared independent by our Board. We welcome Tammy and Chris to the Board and look forward to their service.

And I’ll just mention one other thing. We disclosed through 8-K this morning that the Board has offered me, and I’ve accepted a new three-year contract that will commence on July 1st this year, go through 20 – mid-2027. That will be my fourth three-year contract since I’ve been CEO. Now moving to Slide 7, I want to spend a little bit more time on PFAS, given the final EPA rule that was published last week – last month. As we’ve been discussing for more than five years, Essential has been an industry leader in setting company-wide standards for PFAS in publicly disclosing all of our sample results where we find PFAS, and certainly in creating innovative solutions to address the PFAS issue. As a result, we are well-positioned to comply with the EPA limits that were just set.

Unlike many other utilities in the country, we have tested all of our water sources, identified the sources that need treatment, and we’ve been implementing mitigation solutions now for years. In fact, Aqua has installed nine treatment systems to date and mitigated another 10 sites by optimizing the use of its supplies and removing wells from service. For 2024, we estimate that more than 10 systems will go online by year-end and by using our modular design tailored to small systems, we anticipate ramping up our capability to mitigate as many as 100 systems in a single year. Just last month, we held the groundbreaking for a site in New Jersey. The final rule that came out was largely in line with our expectations, so no surprises there. Without getting into too much detail, one of the most significant changes we saw was that the period of compliance was changed to five years.

You may remember that previously we were all thinking that the compliance period was going to be a three-year period, and we think this was a very prudent approach and may be able to ease some of that potential pressure on the supply chain for many of us utilities rush in to implement our mitigation solutions. Recently we named one of our internal experts to a newly created role solely focused on the rollout of the treatment technology. And one of its primary charges is to standardize our approach and minimize design and construction costs. There was a leading – there’s leading this work from headquarters to ensure that our standard is adopted across all of our subsidiaries, no matter what state and all impacted operations. And we’re seeing the benefits of this structure already.

Our work to mitigate PFAS, the PFAS-related cost to our customers also continues as we pursue lawsuits against the manufacturers and apply for state and federal loans and grants. We’re going to stay focused on keeping costs down for our customers. Now while our costs may change as we move through the process, we currently estimate that we’ll spend at least $450 million to complete this PFAS mitigation. I’ll leave you one final thought on this topic. We were a pioneer on our PFAS commitment five years ago. We have a plan, we expect to remain a leader in this area, and we also see opportunities to help other utilities with their PFAS mitigation plans, which obviously could help some of our corporate development work. So next, it’s really my pleasure to introduce the President of our Natural Gas division, Mike Huwar.

Mike has over 38 years of industry experience, and joined us from NiSource back in 2020, when we completed the transaction with Peoples. He’s been a tremendous addition to the team. And I’ve asked Mike to join us today and provide some details on our Natural Gas utility that he leaves. And by the way, just to give you a sense of size, we provide service to 750,000 customers in Pennsylvania and Kentucky. Mike, do you want to take it away?

Mike Huwar: Sure. Thanks, Chris. And I’m happy to be here today and appreciate the opportunity to highlight the significant and important work that the team of Peoples and Delta’s Gas is doing. So moving to Slide 9, as noted on the slide, Peoples is the largest LDC and PA with over 703,000 customers and $3.5 billion of rate base as of the end of 2023. Additionally, our Gas segment includes Delta Gas, now serving over 40,000 customers in Kentucky. When you think of these two jurisdictions, it’s important to be mindful that both Pennsylvania and Kentucky are supportive regulatory environments. And in Pennsylvania, People’s service territory sits directly on top of the Marcellus and Utica Shale production zones that continue to give customers a lower-cost commodity to the national average, and that’s helping keep bills affordable.

Since the acquisition by Essential, the clear focus of our Gas segment has been the increased safety and reliability of our 15,000 mile distribution system. The best example of that focus has been the reduction of year-end outstanding leakage on our annual DOT Report, having reduced outstanding leaks by 83% over the past five years. It should also be noted, Peoples has maintained its really strong focus on customer service, continuing to lead its peer group on the annual PAPUC Customer Satisfaction Survey. Moving to Slide 10, you will recall that we filed a Pennsylvania gas rate case just before the new year, it’s the first case under Essential ownership, after staying out since 2019. And it includes a doubling of rate base from the last fully projected future test year, as compared to this case from $2.1 billion to $4.2 billion, primarily for replacement of agent bare steel and cast iron mains, work that both increases safety and reliability and reduces greenhouse gas emissions.

In this case, Peoples has included a weather normalization mechanism like many of our peers currently have available to them. The case is proceeding as planned, evidentiary hearings are scheduled for May 9th. And as you would know, this is the typical time during the rate case process, when conversations are happening between stakeholders. Finally, we expect rates to go into effect before the winter heating season. On Slide 11, beyond the operational focus and customer satisfaction performance, the Peoples and Essential teams continue to execute on aggressive pipeline modernization programs. Under the currently active long-term infrastructure improvement plan in PA, Peoples has replaced over 510 miles of pipeline or 60% of the current LTIP target, while again, enhancing the safety and reliability of our distribution system, this effort is leading our way to the target of reducing CO2 emissions by 60% by 2035.

At the conclusion of our current LTIP, Peoples will assess our progress and continue this critical infrastructure improvement work in a series of five-year plans. It should be noted the runway of needed safety and reliability enhancements continues to grow, as the industry focused on rebuilding infrastructure and reducing greenhouse gas emissions. Beyond the pipeline replacement and modernization, Peoples has been active in implementing technology improvements that have short-term and long-term benefits to system operation, our ability to reduce the potential of overpressure events and the GPS functionality of our tracking and traceability program highlight this opportunity. Lastly, Peoples will pilot a game-changing meter technology in 2024, that allows Utilities to interact with customers and have greater control over the distribution system.

At Peoples and Essential, we are excited about the progress we have made and look forward to our future and continued focus on safety, reliability, affordability, and our customers. Chris, thank you, and back to you.

Christopher Franklin: Mike, thanks for your leadership. Thanks for being with us today. View of the financial results. Dan?

Daniel Schuller: Thanks, Chris, and good morning, everyone. On this slide, let’s talk high-level, and then we’ll get into the details of the waterfalls. The quarterly performance was strong, especially when factoring in the gain on the energy project sale that was completed in January. Operating revenues were down due to the decline in natural gas commodity prices year-over-year, which positively impacted customer bills. Weather was warmer than normal, what was largely comparable to last year. We continued our focus on managing O&M expenses with a slight decline there year-over-year, and I’ll cover this more in detail when we talk through the waterfalls. These items, combined with the after-tax gain of $66 million from the sale of the three district energy projects, resulted in net income growth of 38.8% and earnings per share growth of 34.7%, compared to last year.

Next, let’s walk through the first quarter waterfalls. On Slide 14, we have the revenue waterfall for the first quarter. Moving left to right, we have regulatory recoveries or rate increases in surcharges of nearly $14 million. Acquisitions and organic growth in the Water business contributed $3 million and had small increases due to increased volumes of both Water and Gas. This was then offset by a decline in other and a significant reduction in purchase gas costs. The decline in other reflects a positive one-time impact of contract to deposit fees in Q1 2023 and lower PNG – lower PNG Universal Service rider revenue this year due to lower customer bills. The lower purchased gas reflects the significantly lower gas commodity price that our customers enjoyed relative to 2023.

I’ll note that one thing you don’t see here is a large change in the volume of gas due to weather. This is because the same period in 2023 also had materially warmer than normal weather. For the first quarter of 2024, it was about 15% warmer than normal, which resulted in weather-related natural gas sales, net of purchase gas costs being about $20 million below projections for an earnings impact of $0.05 per share. Next, let’s take a look at the O&M on Slide 15. Here, we have the O&M waterfall. We saw increases in production costs of $2.4 million and employee-related costs of $2 million. The employee-related costs are largely in line with inflation. However, we saw some larger increases in production expenses due to purchased water, purchased wastewater, and power prices.

Next, we had an increase due to customer growth in the Water segment. These increases were offset by the lower costs from the Gas segment Universal Services rider, which decreased due to the lower gas commodity prices this year, as well as lower other expenses. Other includes a number of items, increases in bad debt and materials and supplies, decreases in year-over-year Gas segment expenses, and the impact of the sales of both West Virginia utility assets and the energy projects. This resulted in an O&M that was down slightly from last year. So overall, a positive story here. For the year, we expect O&M to be largely in line with our historic norms. Next, let’s look at the EPS waterfall on Slide 16. Starting on the left side of the EPS waterfall with $0.72 from last year and the next thing we see is the $0.20 pickup in the Other category.

This increase in EPS includes the $66 million after-tax gain on sale from the energy projects, which closed in January. This was offset by increases in depreciation, interest, and taxes other than income. Next, we have the impact of the rates and surcharges, which contributed almost $0.04. Then we have slight increases due to Water growth and additional volumes for both Water and Gas. And finally, an insignificant impact of increased expenses. That lands then at $0.97 of EPS for the quarter. If we take that $0.97 of GAAP earnings per share for the quarter and we subtract off the gain on sale of $0.24, and then we add back the $0.05 for weather that I mentioned earlier, we get to a number that exceeds our Q1 consensus. Next, let’s move to Slide 16 to provide an update on regulatory activity.

This slide depicts our regulatory activity so far this year. We continue to manage our regulatory activity to maintain safe and reliable service, earn a return on the capital we invest, and minimize regulatory lag while always considering affordability for our customers. Thus far, we received authorization to increase Water segment revenues by $13.7 million annually in Illinois, North Carolina, Ohio, and Pennsylvania and the Kentucky and Pennsylvania gas businesses have surcharges that will increase revenues by $1 million annually. We have Water segment rate cases or surcharges pending in Illinois, New Jersey, Texas and Virginia that totaled $43.2 million. A detailed breakdown of these can be found in the Appendix. And of course, Mike just covered the Peoples rate case, which is underway currently.

Finally, we expect to file a Pennsylvania water rate case during the third full week of May, which is nearly three years since we last filed. We’ll provide more details on that case on our Q2 call in August. And with that, I’ll hand the mic back to Chris. Chris?

Christopher Franklin: All right, Dan, thanks. So next, let’s touch briefly on the municipal acquisition program. As of this call, we have six signed asset purchase agreements in two states where we already have existing water and wastewater operations. These acquisitions will add over 215,000 customer equivalents and about $385 million in purchase price. We continue to see strong and healthy pipeline of opportunities for additional growth, and we’re currently engaged in active discussions with many municipalities. In fact, the customer count for those is over 400,000, and that will be on the Water and Wastewater side. As we mentioned, if Chairman, De Frank’s proposal and any of the associated bills in the legislature are successful, there should be a much clearer path to closing municipal acquisitions in Pennsylvania in the future.

And I think that will free some of the municipals that are currently thinking about it, but maybe standing still for the moment. We continue to believe increasing compliance requirements, such as PFAS should lead to continued consolidation in what, as you all know, a very fragmented industry with over 50,000 water systems and 14,000 wastewater systems throughout the country. All right, so in closing, let’s update the guidance we provided in February. So you have a clear line of sight to the opportunities in front of us. In February, we provided guidance for 2024 of net income per diluted common share of $1.96 to $2. And at the time, we clearly indicated that, that guidance was based on normal weather as most utilities do. As Dan has mentioned, the weather in Q1 has been much warmer normal.

So for clarity’s sake, if we assume normal weather from this point forward, we would finish the year on a GAAP basis, above our guidance range due to the gain on sale. Dan took you through the – some of the calculation there just a moment ago. Now, through 2028, we plan to invest about $7.2 billion in regulated infrastructure in our existing utilities, a really strong capital program. And in 2024, we expect to invest between $1.3 billion to $1.4 billion, and we’re on track to do this. And as we’ve said many times, this is the primary generator of more reliability and service for our customers, as well as the primary generator of earnings per share for our shareholders. Based on this investment, we expect rate base will grow at a compounded annual growth rate of approximately 8% for Water and about 10% for Natural Gas through 2028.

And the combined Utility rate base will grow to a compound annual growth rate of over 8%. We continue to expect that together, organic customer growth and growth from acquisitions for Water and Wastewater will climb at a rate of 2% to 3% per year on average. We remind investors always that growth from acquisitions is lumpy and should be viewed over a three-year average. We expect continued stability in our Natural Gas customer base. As we said before, we expect to raise about $250 million in equity this year, using an ATM equity program. We remain committed to a 60% reduction in our Scope 1 and Scope 2 greenhouse gas emissions by 2035 from our 2019 baseline. And as you know, we’ve made significant progress already on this, and we estimate it to be over 25% as of year-end last year.

I’ll note that the team feels that we are well prepared for the SEC climate rule, which is currently stayed due to various legal challenges. With that, I’m going to conclude my formal remarks for today, and we’d like to open it up for questions. I’ll send it back to the operator.

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Q&A Session

Operator: [Operator Instructions] Our first question today is coming from Durgesh Chopra calling from Evercore ISI. Please go ahead. Your line is open, sir.

Daniel Schuller: Hi, Durgesh.

Christopher Franklin: Good morning, Durgesh.

Durgesh Chopra: Hi, Chris, Dan, and good morning. Thanks for giving me time. Hi, just I wanted to kind of kick start with a gas rate case in Pennsylvania. Obviously, you guys have probably seen all the media reports around the water case that is ongoing. Just any read-throughs from there? Or any color that you can share on how that case is progressing?

Christopher Franklin: Yes. I guess I would just say, apples to oranges in many ways. And so, we feel very good about the strong case that we presented. And as Dan mentioned – I’m sorry, as Mike mentioned in his comments, that as you would expect, we’re sort of in that period of time where we can have discussions about a settlement, and we’ll see how those discussions go, but we’re prepared to see this case through. But so far, very, very creative and good relationships with the advocates and the commission.

Durgesh Chopra: Excellent. Thanks for that update, Chris. And then maybe just switching gears, Other states, and I’m sure you’ve seen this also, there have been some lawsuits filed by residents against the Utility, the Water utility related to PFAS. Can you comment if whether you’ve seen anything like that in your service territories and implications, if any, for your business?

Christopher Franklin: So, fortunately, we have not. And I’d like to think that, that’s because we’ve been so out front on this issue for so many years, their gas, you recall, five years ago, we started down this path before most people have been – even knew what the PFAS discussion was, and we started mitigation well before many others. So I’d like to think it’s because of our work we’ve been doing. And then our disclosures have been really strong. Anywhere we’ve PFAS, we have reported it publicly. And of course, we created that internal standard at 13 parts per trillion several years ago, well before the EPA came out with any standard. And so, I’d like to think that all of that proactive work is part of the reason why we haven’t been in that focus for losses. But no, at this point, we’ve not seen anything.

Durgesh Chopra: Yes, Chris. And I can certainly attest to your leadership there. You’re kind of the first voice in the industry talking those issues. Okay. Thank you very much. That’s all I had. Thanks for the time.

Christopher Franklin: Thank you very much.

Daniel Schuller: Sure. Take care.

Operator: Our next question will be coming from Davis Sunderland calling in from Baird. Please go ahead. Your line is open.

Christopher Franklin: Hi, Davis.

Daniel Schuller: Hi, Davis.

Davis Sunderland: Hi, guys. Happy Friday. Thanks for taking my question.

Daniel Schuller: Yes, Happy Friday.

Davis Sunderland: I wanted to ask – thank you. Wanted to ask about the pending municipal transactions and the PFAS guidance for the $450 million in capital. Does this include the pending transactions? And maybe, I guess, just add on to that, how has PFAS discussions or discussions surrounding costs associated with operating systems made its way into potential discussions for new systems so far?

Christopher Franklin: Yes, it’s a good question. And what we’re largely focused on, as you mentioned at the beginning of your question is municipal transactions. And generally, I’m not talking about Los Angeles and Philadelphia, New York. But generally, the municipal systems that we’re focused on are smaller. And so, I would say more of a prevailing theme would be that they haven’t tested yet. And so, not all of them even know, whether or not they have PFAS. And so I think what we’re going to find as this MCL is put the maximum contaminant level was put in place recently. I think we’re going to find a lot of testing, we’re going to find a lot of them that find problems. So I would expect that, that discussion really ramps up in this coming year and over the next five years as everybody is forced to comply with the four parts per trillion.

But I wouldn’t say that it was a major theme at this point in what we’re in our current discussions with the municipal transaction we have today. I think your second question was – I think your second question, Davis, was around, does the $45 million include capital for acquisitions? And we don’t typically – until we close those, they wouldn’t be in our calculations. And Dan.

Daniel Schuller: Yes. That’s correct. And Davis, if you look at the acquisitions that we have pending to close, they are more biased towards Wastewater acquisitions rather than Water. And I don’t believe at this point that there’s PFAS in the Water acquisition or two that are in that list. But in any event, we think that it’s – we think of the $450 million or as we’ve said, at least $450 million, it wouldn’t be a material change on that if we have a few more sites.

Davis Sunderland: Got it. That makes sense. That’s helpful. And maybe one other question. This might be a bit hypothetical. So I guess just asking as to weather normalization and what you’ve applied for in the pending gas case, do you have any estimates or any commentary or any thoughts maybe as to what a normal season would have been for this past quarter or what the impact would have been had you been given this weather normalization clause that you guys have applied for?

Daniel Schuller: I guess, is the way I’d characterize that is if you think of the $20 million net revenue shortfall that I mentioned, that would be inside, call it, a $5 million impact, if we had weather normalization kind of depending where that weather normalization comes out exactly. But it would – as you can see, it would materially reduce the volatility that we see in a year like we had last year or this year in terms of a downside, but also in a very cold year, it would have the impact of keeping customer bills at a more normalized level as well.

Davis Sunderland: Got it. That’s helpful. Appreciate your time, guys. Thank you very much.

Daniel Schuller: Yep. Thank you.

Operator: Thank you, Mr. Sunderland. Our next question will be coming from Travis Miller calling from Morningstar. Please go ahead. Your line is open.

Christopher Franklin: Hi, Travis. Good morning.

Travis Miller: Thank you. Hello, everyone. Hi. A couple of follow-ups to some things you mentioned in the prepared remarks. One is the supply chain, I thought that was an interesting comment there and thought process there. In terms of, are there raw materials or equipment or something that you see constrained right now or you would anticipate could be constrained to your point about the short time period here – relative short-term period?