ONE Gas, Inc. (OGS) Earnings Call Transcript & Summary

Good day, and welcome to the ONE Gas 2023 Financial Guidance Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Brandon Lohse. Please go ahead, sir.

Good morning, and thank you for joining us for our 2023 financial guidance conference call. This call is being webcast live and a replay will be made available later today. After our prepared remarks, we'll be happy to take your questions. A reminder that statements during this call that might include ONE Gas expectations or predictions should be considered forward-looking statements and are covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and the Securities Act of 1933 and the Securities and Exchange Act of 1934, each is amended. Actual results could differ materially from those projected in any forward-looking statements. For a discussion of factors that could cause actual results to differ, please refer to our SEC filings. Joining us on the call this morning are Sid McAnnally, President and Chief Executive Officer; Caron Lawhorn, Senior Vice President and Chief Financial Officer; Curtis Dinan, Senior Vice President and Chief Operating Officer; and Chris Ignalfi, Vice President of Corporate Development. And now I'll turn the call over to Sid.

Thanks, Brandon, and good morning, everyone. The financial guidance we released last evening reflects a steadfast commitment to operational excellence, ongoing investments to enhance the safety and reliability of our distribution systems and the continued focus on capturing the strong organic growth we see across our service territories. This plan also incorporates fundamental shifts in baseline financial conditions since our last forecast, including higher interest rates, employee-related costs, contractor costs and the price of natural gas. As expected, the structural lag inherent in our 100% regulated business model is accentuated when conditional factors move as rapidly and as dramatically as they have this year and it will take time to fully reflect these new operating realities in our rates. Assuming a tempered pace of future economic change as major U.S. financial institutions currently project, we expect the impacts of this regulatory lag to affect the front end of our 5-year forecast, but we see out-year growth rates remaining consistent with those we articulated in last year's outlook. As a result, while our 5-year growth guidance has been adjusted to reflect macro-economic impacts, our positive view of the demonstrated longer-term growth embedded in our business remains unchanged. Transparent communication with our stakeholders has always been a hallmark of ONE Gas. And consistent with that tradition, we offer this guidance using the same framework that we've provided in the past, anchoring to the prior year, in this case, our 2022 guidance midpoints to give you a clear picture of our 5-year plan. We issued guidance earlier this cycle and scheduled a call to provide information related to our plan, context regarding our assumptions and to field your questions. With that, I'll turn it over to Caron to discuss the details of our 2023 and 5 year financial outlook. Caron?

Thanks Sid, and good morning, everyone. As I noted on our third quarter earnings call, when we initiated 2022 guidance and provided a 5-year outlook last January, our plan contemplated an increase in operating expenses as we worked to build operational capacities to support our system expansions as well as higher financing costs associated with our increased capital spend. However, as Sid noted, the challenges presented by elevated inflation and rising commodity and debt costs have pressured these expectations. While we remain on track to achieve our 2022 financial targets, the significant shift in baseline economic conditions has affected our near-term earnings forecast. For 2023, we project net income to range from $224 million to $238 million with earnings per diluted share of $4.02 to $4.26. Our capital investments for the year are expected to be approximately $675 million with expenditures on system integrity continuing to anchor our capital plan. These investments are expected to produce an average 2023 estimated rate base of $5.15 billion and support an anticipated 1% customer growth rate. Total capital spending for the next 5 years is anticipated to be approximately $3.6 billion, underpinning compound annual rate base growth of 7% to 9%. Our forecasted 5-year compound annual growth rate for net income is also expected to be 7% to 9% with EPS growing from 4% to 6%. To be clear, our CAGRs are calculated consistent with prior practice, which in this case means we're basing off the midpoint of our most recent 2022 guidance. We anticipate settling our equity -- our existing equity forward sales by year-end and expect 2023 to 2027 long-term financing needs of approximately $1.8 billion with roughly 35% of this amount in the form of equity. We expect compound annual growth dividend growth of between 4% to 6% through 2027 with a target payout ratio of 55% to 65%, subject to Board approval. As Sid noted, our financial projections have been reduced, not because of major alterations in operating our growth assumptions, but rather due to the significant changes in baseline financial conditions, which have occurred since our last 5-year forecast, and the timing of recovery mechanisms intrinsic to our 100% regulated business model. For example, higher interest rates impact the assumed cost of future long-term debt issuances as well as the cost of short-term borrowings used to finance our working capital. In turn, our working capital need has increased due to our incremental storage capacity and the rising cost of natural gas. Our need to scale operational capacity to meet the growing demands of our service areas naturally renders our forecast more susceptible to the impacts of inflation, which recently eclipsed a 40-year high. As economic activity continues to spool up across our territories, supported investments in our overall capabilities remain as important as ever, but now carry a higher initial cost due to alterations in the macroeconomic landscape. Slide 5 in our accompanying presentation illustrates how a variety of economic metrics have changed during the last year, and we think it provides useful context for this discussion. Importantly, we have a history of not making projections about future financial conditions that would favorably bias our forecast. As an example, for inputs such as interest rates and natural gas prices, our practice is to incorporate projections published by major financial institutions and commodity futures markets at the time of our planning cycle. We will be strategic about the sequence and timing of our regulatory activities to ensure new operating realities are prudently reflected in rates and expect our earnings growth to be consistent with the levels communicated last year once economic inputs stabilize. I think that point bears repeating. While our range-bound 5-year forecast reflects changed assumptions regarding input costs and the time required for these items to be reflected in our regulatory model, our view of the long-term sustainable growth of our business has not changed. And now I'll turn it over to Curtis to speak further about the drivers which underpin our confidence in these longer-term expectations. Curtis?

Thank you, Caron, and good morning, everyone. Despite the near-term financial challenges Caron has noted, we operate in desirable service areas and remain confident in our future growth opportunities. Our territories enjoy constructive regulatory frameworks, pragmatic, all of the above political approaches to addressing climate change and affordable housing and cost of living metrics, which are increasingly relevant amid decades high inflation. Add to these attributes, ongoing announcements of significant new economic development investments and the result is accelerating net migration to our regions. As evidence of this, U.S. [ Synthes Bureau ] Data detailing migration between regions in the United States continues to favor ONE Gas service territories. And we see this confirmed by our own metrics as the number of new meter sets in a trailing 12-month record in November and our backlog in future meter set has never been larger. A recent housing market update from Zonda indicated Austin as the top destination for net millennial migration in 2021 and the I-35 corridor from Kansas City to San Antonio has been recognized as the fastest population and job growth region in the U.S. 5 of the 8 largest metros in that corridor are in our service territory. As we mentioned on our recent earnings call, rising interest rates are leading to some slowing in the national housing market and to some degree in our service areas. However, we remain optimistic given the continued population growth and economic development we are experiencing across our service territory. And despite the rise in wholesale natural gas prices over the last year, we maintain a sizable cost advantage versus alternative fuel sources for the applications we primarily serve. Finally, I want to provide a quick regulatory update to cover items concluded since our third quarter call. Last week, the Kansas Corporation Commission approved our August GSRS filing resulting in an increase in rates of approximately $7.7 million to take effect of this month. And earlier this week, the Oklahoma Corporation Commission approved the PBRC filing that was filed in March formally authorizing the $19.6 million rate increase we implemented subject to refund in July. And now I'll turn it over to Sid for closing remarks.

Thank you, Curtis and Caron. As we approach year-end, we're navigating the near-term challenges posed by a dynamic financial landscape as we continue to build for the long-term opportunities in front of us. While the magnitude, volatility and direction of future changes and business conditions are always uncertain, we remain focused on managing our business with sustainable value creation in mind. Moreover, our consistent track record of delivering results gives us confidence that the experience of our team, the strength of our service territories and the value of our long-term strategy will successfully guide us into the future. In closing, I extend my gratitude to each one of our coworkers for their dedication to safety and service to our customers. I'm privileged to work alongside them every day. Thank you all for joining us this morning. Operator, we're now ready for questions.

[Operator Instructions] Our first question today comes from David Arcaro from Morgan Stanley.

Maybe could you talk just a little bit about the cadence of the EPS growth trajectory from here? The growth rate into 2023 is on the low end, obviously, below just the multiyear outlook here? And how does that then trend? It sounds like in the out years, you might actually get back up to the -- to a level that's above the 4% to 6%. So could you just help with the annual cadence of where the growth rates start stepping up?

Sure. David, let me give you a quick introduction and then throw to Caron for the details. You're exactly right. As we said before, that we're absorbing the impacts of the macroeconomic environment that we've all experienced. And as you would expect in a 100% regulated environment, that takes a bit. And so what this plan does is be very open handed about the fact that we'll move through the regulatory process, but we'll do that in a way that doesn't foreclose the opportunities that we have very clearly set in front of us. You heard Curtis speak to our meters activity over the past year and what our forward demand looks like. So we've got a pretty high confidence level in the growth picture, probably even higher than when we guided last year to those out years. So I think you -- your question poses our view accurately. We wanted to be sure to be open handed about the challenges that come with this macro environment, but also be very clear about the fact that we are not sacrificing capacity to address the opportunities in front of us as we focus on long-term value creation, particularly given the organic growth and demand created by the customer growth in our territory. Caron, what would you add?

So I think you hit all the high points. I might just elaborate a little bit. Of course, it's going to take regulatory activity in every jurisdiction in order to get all of these costs built into our rates. We'll file our annual PBR in Oklahoma, like we always do, and then it will take rate cases in the other jurisdictions. And that we can't -- that can't get done in the year. So that's why the front end of our 5-year guidance is a little bit neater, and then we pick back up on the back end.

David, the only other thing I'd add is -- as you heard from Caron, we were true to our normal structure in building this plan. And so we used November 1 data because that was the last data published before we finalized our plan as we have in the past. And there is some dynamism in the way those numbers will change. And so we think we're maybe on the conservative side of those projections, but that's the way we've done it, and it served us well, and we continue to do that going forward.

Okay. Got it. That's helpful color. And just as I think about a couple of the components of the lag, just to break that down a little bit more, it sounds like there might be some excess short-term debt that's a pressure just given the working capital needs. Should we think about that potentially easing, I guess, with gas prices declining somewhat over time, then there is O&M pressure from the inflationary issues that you mentioned is that would probably be, I would imagine like getting through kind of the PBRC filings? And then would you need to kind of go through a Kansas rate case -- or an Oklahoma rate case though in that jurisdiction to get kind of fully trued up and recovered on that basis? And then same thing for maybe long-term debt and interest expense drag. Is that more kind of full general rate cases that we'll see over time that get recovered?

Yes, David, this is Curtis. Let me just clarify a couple of things. In the PBRC that we have in Oklahoma every year when we file those what I think of as a mini rate case almost, we're updating our cost of service and our rate base at those times. So annually, we're getting that, and we don't have to go through a full rate case to pick up on increases and rate base increases. And the other 2 states, we do have to go through rate cases to be able to pick up the incremental cost, and that's what Caron was describing earlier that those don't happen in the short term, general rate cases do take a little bit longer. And so that's what you see reflected in our guidance.

Okay. Got it. Any -- is there any opportunity to accelerate just the previous plan for when you would file rate cases, I guess, I'm thinking of specifically Kansas and Oklahoma?

Again, in Oklahoma, we wouldn't have to do that from the standpoint that our cost of service gets updated with each one of those PBR filings. But in the other 2 states, our analysis is the same. You go through and you look how you're earning compared to what your allowed return is and when that gap gets to a sizable enough piece that you can -- you're going to invest in going through a rate case, you're going to do that. And in an inflationary environment, that point in time comes more quickly than in the environment we've been in over the last decade or so.

Yes. Okay. No, understood. I hear you. And I guess just thinking about the rate base growth outlook is just a little bit lower than the previous 5-year guidance, but obviously, the EPS growth outlook now has a bigger kind of lag component, even though it seems the back end of the growth outlook. And so I'm wondering, is there a bigger structural lag that you're still expecting to kind of stick around even toward the back end of the plan? Or is there -- I would have thought just as you get through rate cases, you might be able to step up the growth and get back to the previous run rate unless there's something new and kind of structurally still driving that lag?

Yes, David, this is Caron. We do expect, as we said, to get back to our previous growth rates. So on -- let me talk rate base growth first. So we have added $100 million to our anticipated expected capital spend over the 5-year period. And we believe we've got an upside for that. We're still seeing a lot of opportunity in our service territories, but of course, in the front end, we're mindful of the impact of inflation on builder behavior as well. We're very confident in the rate base growth. The structural lag is exacerbated initially because of the things we've been talking about inflation and interest rates, but we expect that structural lag to return to that 100 to 125 basis points over the long term as we've been discussing. There's really anything that should cause that to be any different.

[Operator Instructions] Our next question comes from Gabe Moreen with Mizuho.

Maybe if I could pivot a little bit talking about your O&M assumptions in a higher commodity backdrop environment. Can you just speak to kind of what you're assuming, I guess, both in the near term as well as over the medium to long term on O&M within your forecast?

Yes. Gabe. Let me give you an overview around how we're thinking about O&M and then ask Caron to fill in some details. One of the important decision point for us as we built this plan was how do we continue to prepare for and support our ability to respond to customer demand. As you know, in our business, once infrastructure goes in or fail to go in, it is a long-term either decision or lost opportunity. And so we felt strongly that it was important for us to maintain and to build on our capacity to be prepared to respond to the growth that we're seeing, particularly in Tulsa, Oklahoma City, Austin, El Paso, we're seeing some in Kansas now particularly on the economic development side. And what we were not willing to do was sacrifice long-term value creation for the company and for our shareholders. In response to what we believe to be a relatively short-term macroeconomic dislocation in the scheme of things. Now I'm not trying to predict for you how the economy will behave in the shorter term. I've shared with you how we built the assumptions that we've made, but we think this really hits the sweet spot in terms of responding appropriately from a management standpoint, to the environment that we work within in the short term while also preparing to pursue opportunities that we really think are fairly unique to us in the long term given the end migration in our service territory. So Caron, let me throw to you for details.

Yes. So as I've already said, we -- our O&M and as you've seen in 2022, our O&M is running a little bit higher than what we predict our future long-term rate to be as we're building this capacity to manage and serve more customers and to manage more infrastructure. So we continue to see, as inflation persist, our assumption is that both inflation and interest costs kind of remain elevated through 2023, start to taper off in '24 and kind of are at the said long-term target in '25. I think our O&M follows sort of that same pattern. So a little bit stronger, higher O&M on the front end and getting to our longer-term growth rate on the back end.

Gabe, one more component of that. We've talked a lot about growth, but it's important that we don't forget our commitment to safety and the integrity of our system. Maintaining qualified and experienced workforce in this environment has got to be a priority for anybody in our business. And what we're not going to do, in the same way that we're not going to sacrifice growth opportunities, we're not going to sacrifice our commitment to safety and system integrity in an environment where we have some wage inflation. And we think we're making the right long-term decision there as well.

Great. Sid and Caron, and maybe if I can ask about cost of capital and kind of how you're thinking about it, particularly going into some rate cases that should be over the next couple of years? First, just on kind of cost of capital ask. I'm just curious how you think you may reflect kind of a higher cost of capital within rate cases and where you see, I guess, ROEs to as potentially going? And then also, how you're thinking about cost of debt capital, you've been really good about locking in longer-term issuances and a low interest rate environment. But I'm just curious what the strategy is considering, I guess, the very uncertain interest rate outlook, whether you'll try to go shorter term on maturities or longer term and thinking about the debt cost of capital. So long-winded question, but just curious about your thoughts there.

Yes. So Dave, let me divide that into parts and go to Curtis for the regulatory piece and then Caron around the long-term capital piece. Curtis?

Gabe, you're right on point with how we're thinking about the ROEs that we filed for in the rate cases. And if you look at the most recent West Texas rate case that we filed, that was definitely what our testimony was based on. That case is still underway, so I can't comment much more than that. But it was higher than our previous round of rate cases because of what we're seeing from an inflationary environment and higher cost of capital environment that we're in today. So I would absent a large change continuing down that path in our upcoming rate cases as well. I'll flip it to Caron for the interest rate question.

So just generally, as it relates to our capital structure, we're always seeking to optimize the right balance between debt and equity. There's a lot to think about. There's the credit rating and balance sheet implications as well as the implications for our regulatory construct. As you know, we've got actual capital structure built into our rates in most of our jurisdictions. So all of that -- that regulatory construct and our regulatory strategy really fits into how we think about that capital structure. We do have a fair amount of short-term debt that is at a significantly higher rate than it was last year. So thinking about how we balance short and long-term debt and the recovery of those costs is also something that we'll focus on as we go through this next phase of regulatory activity.

[Operator Instructions] Next we have a follow-up question from David Arcaro with Morgan Stanley.

Just a quick follow-up on the financing plan going forward. I noticed that the equity component picked up as a proportion of just the total financing need for the next 5-year plan. Could you talk about just the balance sheet? Is there a specific need for that? Or is that just supporting the equity ratios at the utilities and the growth outlook?

So yes, it's supporting the regulatory construct. We've also -- this 5-year plan has $100 million more of capital in it than the previous 5-year plan. And clearly, and given the macroeconomic conditions, we're anticipating, at least on the front end that the equity we may issue is going to be at a lower rate than we might have assumed in last year's plan.

Got you. Understood. And then I was also just curious, just on the rate base growth outlook. Are you finding or experiencing that there might be any pressure from commissions related to bill pressure that would cause you to pull back or ease up a little bit on the rate base growth outlook. Wondering if that's been kind of factored into the outlook from here? Or if rate base just didn't -- the outlook -- the growth outlook didn't seem to change all that much. So I was curious if that's part of the perspective of those 2.

David, of course, we talk about customer bill impact, it is a primary focus for us as we think about how we can partner with our customers to help drive their costs down. One of the things that is fortunate about the situation that we have in our service territories is that we have really 2 major targets for capital expense. One is system integrity and the safety of our system, which is always supported by regulators. And we've talked with you and others about the way that we choose to execute that system integrity program that really is based on the safety and attributes of the system, not where we might want to invest, but it's just -- it's a much more objective process. And that is supported by our regulators. The other is responding to growth demand. So we regularly have people call us asking to extend into their territories to support their economic development, to support their industrial parks. That kind of growth is supported not only because it supports our communities from an economic standpoint, it also spreads the cost of our customers by increasing the denominator in the fraction. And that's -- so we think it's a win either way, and we have heard a good bit of support from our regulators. But I think they understand that we're working hard to do what we can to control costs in this environment by working with customers at the same time being focused on having a reliable system, having a meaningful gas supply program all of the things that go into providing service at a level our customers expect.

[Operator Instructions] At this time, we have no further questions. So I'll turn the call back to the management team for concluding remarks.

Thank you all again for your interest in ONE Gas. We will be attending the Bank of America Gas Utility Conference and the Wells Fargo Midstream and Utility Symposium next week in New York and look forward to seeing many of you while in town. As a reminder, our quiet period for the fourth quarter starts when we close our books in early January and extends until we release earnings in late February. We'll provide details on the conference call later date. Have a great day. Thank you.

This concludes the ONE Gas 2023 Financial Guidance Conference Call and Webcast. You may now disconnect.