CPK - Chesapeake Utilities Corporation: Higher Temperatures Are Hurting The Bottom Line

2023-08-18 20:00:43 ET

Summary

• Chesapeake Utilities Corporation (CPK) has a decent market share in the gas utilities industry but recently reported a miss on both top and bottom lines.
• CPK operates in the regulated and unregulated energy segments, focusing on natural gas distribution and propane operations.
• The company faced challenges in the last quarter due to weather and temperature changes, and potential risks include inadequate infrastructure and fluctuations in propane prices.

Investment Summary

Chesapeake Utilities Corporation ( CPK ) has developed very well in the gas utilities industry and generates TTM revenues of $701 million. The company released its last report in early August and it showcased a miss on both the top and bottom lines for the business. This is certainly not the news that you want to get as an investor when there are several macro headwinds like higher interest rates and wage inflation. However, when we dive deeper into the causes for it, it seems to be a result of higher temperatures which disturbed operations. However, some measures were taken like increased fees and higher CNG demand to help offset some of the otherwise decreases.

The company is however trading at a premium in comparison to the rest of the sector and that makes me slightly worried about the actual value investors are getting right now. A 23% earnings premium to the sector is too much for me and 45% sales premium aswell further pushes the company away from a buy and into a hold instead. I’d be more comfortable getting in at lower price points. With a decent yield of at least 2% though there is enough incentive I think to maintain a position for the long term and I will be rating CPK a hold as a result.

Solid Growth History Built By Expansion

As we have learned, CPK operates in the gas utilities industry where it operates as an energy delivery company. Within the business two various segments make up the operations, these are Regulated Energy and Unregulated Energy. The first one primarily focuses on natural gas distribution in areas like central and southern Delaware and Maryland's easter shore, however, they do also have some operations with gas distribution in Florida too.

Within the second segment the company the focus lies instead on propane and operations around it. The sites are scattered throughout the US. The segment does include some work with natural gas as well though, mostly from provisions of compressed natural gas and liquified natural gases.

One of the highlights and strengths of the business has been its target to continuously improve and invest in its existing operations to build growth and value for investors. As the map above showcases some of the sites and projects of the company. As CPK continues these practices they have some very solid results to show for themselves, like the ROA. The return on assets sits at 4% which is the highest in the last 5 years, indicating that CPK continues moving upwards steadily. Besides that, the ROC sits strongly at 5.65% as well.

Some of the tailwinds for the company has been the regulatory decision in Florida for a permanent rate. Which includes the consolidation of four natural gas distribution entities in Florida. The incremental revenue requirement is $17.2 million and an allowed ROE of 10.25% has been set.

Besides this, CPK has made strong progress in areas like their Eastern Shore Capital cost surcharge program which is estimated to generate gross margins of $2.8 million and $3.6 million in 2024.

Quarterly Result

In early August we got the last earnings report from CPK which displayed a YoY growth for the regulated energy segment, but a significant decrease for the unregulated segment instead. The second segment experienced an over 20% decline. Ultimately this led to a YoY decline for the overall revenues.

Some of the challenges the company has experienced in the quarter include weather and temperature changes as opposed to last year during the same period. This hurt the company's bottom line. The head load in Delmarva and Ohio and the service territories there received a significant impact. Thankfully, some of the organic growth initiatives by CPK have helped offset some of these heightened expenses. Taking necessary steps to reduce the impact of this will be crucial and I am looking particularly at this in coming reports.

As for my opinion about the quarter, I think that despite there being some resilience in parts of the program, the major challenges the comapny faced seem persistent. The company will continue taking measures to offset the impacts of weather but I don't think the impacts are going to be swift enough for a buy to be warranted. The expense premium didn't seem justified given the difficulties and results either quite frankly.

Risks

Of the variety of challenges that the company contends with, one significant concern is the potential inadequacy of essential infrastructure. This issue is compounded by the fact that a substantial portion of the working land utilized by the company isn't owned outright. This dual challenge raises the potential for impeding the realization of ambitious growth goals. Not owning the land you operate on does introduce some risks for higher fees and other related expenses to it. This a risk that one could argue should result in a lower premium, but it seems that the market still sees strength in the business which results in the current price for the shares.

CPK could encounter substantial fluctuations in the price of propane, a challenge that is often common in the energy industry. The inherent volatility in propane prices can be attributed to a range of factors, including supply and demand dynamics, geopolitical events, and shifts in consumer preferences. This uncertainty could impact the company's bottom line, requiring proactive risk management and hedging strategies to mitigate potential negative impacts. In conclusion, I think investors should be aware that some quarters might produce uneven quarterly growth. As we saw recently, the impact that higher temperatures had on the company was displayed as the top and bottom lines missed estimates.

Valuation & Wrap Up

One of the parts of CPK that keeps me from making it a buy is the premium you have to pay as an investor right now. With around a 25% premium in terms of earnings to the sector, I think CPK is starting to look quite expensive. The company experienced some pretty significant challenges in the last quarter and the price doesn't seem to reflect some of that added risk.

Until we see stability and solid results from the growth initiatives the company is taking I don’t think CPK will be a buy. However, they do have a very solid dividend at around 2%. With a fantastic history of growing as well, I think that CPK makes a lot of sense right now to be a hold for investors.

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