CPK - Chesapeake Utilities: Energy Distribution Small Competition And Cheap

Summary

• With operations centered in the Mid-Atlantic region as well as North and South Carolina, Florida, and Ohio, Chesapeake Utilities is an energy sales and distribution company.
• I believe that management will successfully optimize its operations, and expand its territorial offer and product offering.
• New distribution lines, both state and interstate, growth of the Marlin Gas Services, and potential acquisition of new facilities could bring significant economies of scale.

Energy sales and distribution company Chesapeake Utilities Corporation ( CPK ) enjoys little competition in certain areas in the United States, and expects to open new distribution lines and acquire new facilities. I believe that the number of products and services offered and the number of customers served represent an attractive feature. Under conservative assumptions, my financial model resulted in a higher stock valuation than what the market currently reports.

Chesapeake Utilities: Geographic Diversification In the United States, Many Products, And Different Types Of Clients

With operations centered in the Mid-Atlantic region as well as North and South Carolina, Florida, and Ohio, Chesapeake Utilities is an energy sales and distribution company. The company’s activities include natural gas, electric power, and propane distribution, natural gas transmission, electricity generation, and other related services for its customers.

The company’s non-regulated energy segment is focused on the sale of propane to residences, shops, other businesses, and service stations. The service is provided through two sales channels for its customers: delivery by weight of propane and customers who have a meter for their activities. The customers of the first category receive the product at their address, and the income for the company is given immediately. Metered customers are part of a distribution network. Also, through the Alliance AutoGas, the company installs propane tanks in vehicles as part of its services.

I believe that the company’s operations are geographically diversified. In the last annual report, the company reported operations in Delmarva, Florida, Ohio, and Pennsylvania.

The Company Enjoys Lack Of Competition In Certain Business Segments

Competition for the company varies by product and segment. Regarding natural gas, CPK has other competitors in the distribution for homes and residences since management has agreements with the state governments of each region, but it does compete with alternative suppliers for supply to industries. In the same way, some of the company’s main consumers could be disconnected from the distribution lines and connected to other state or interstate lines. In this regard, the company gave some commentaries in the last 10-k:

Our natural gas transmission and distribution operations compete with interstate pipelines when our customers are located close enough to a competing pipeline to make direct connections economically feasible. Customers also have the option to switch to alternative fuels, including renewable energy sources. Source: 10-k

CPK does not experience a lot of competition in the distribution of electrical energy. There are no competitors in the energy distribution for establishments, homes, and commerce. A clear example of a market without a lack of competition is Florida.

Our Florida electric distribution business has remained substantially free from direct competition from other electric service providers but does face competition from other energy sources. Source: 10-k

Chesapeake Utilities: Strong Residential Revenue Along With A Lot Of Sales From Commercial Sales

The company’s most relevant activity is offering residential natural gas distribution. In Delmarva, the company reported $83 million in revenue from residential natural gas distribution and $46.82 million from Florida.

Commercial natural gas distribution includes $40 million from Delmarva and $38 million in Florida. Industrial operating revenue was strong in Florida, where the company reported $59 million, but it was not that relevant in Delmarva. Electric distribution was also relevant with a total operating revenue of $81 million.

Balance Sheet

As of December 31, 2022, regulated energy assets stood at close to $1.80 billion along with unregulated energy assets of $393 million, which implied total property of $2.226 billion. If we also include accumulated depreciation and amortization of $462 million, net property would stand at $1.81 billion.

CPK also reported cash worth $6 million, trade and other receivables of $65 million, net trade receivables close to $62 million, and accrued revenue of $29 million. Regulatory assets stood at $6.36 million along with prepaid expenses of $15 million. In sum, total current assets stand at $193 million, a bit below the total amount of liabilities, which may not look that ideal.

Goodwill stood at $46 million along with other intangible assets worth $17 million, operating lease rights of use assets of $14 million, regulatory assets worth $108 million, and total assets of $2.215 billion. The asset/liability ratio stands at more than 2x-3x, and the total amount of assets increased in 2022, so I believe that the balance sheet stands in very good shape.

Liabilities

The list of liabilities include a current portion of long term debt of $21.483 million, short term borrowing of close to $202 million, and accounts payable of $61 million. Customer deposits stood at $37 million with accrued interest worth $3.3 million, accrued compensation of $14 million, and other accrued liabilities of $13.61 million. In sum, total current liabilities stood at $369 million.

Long term liabilities include $256 million, regulatory liabilities of $142 million, and other pension and benefit costs of $16 million, which I assumed to be debt. The company’s deferred investment tax credits and other liabilities were $1.4 million with total deferred credits and other liabilities worth $434 million.

Expectations From Market Analysts

I believe that the expectations from other financial analysts are beneficial. 2025 net sales are expected to be $832 million with 2025 EBITDA of $257 million. Operating profit would stand at $180 million with an operating margin of 21.60% and net income of $111 million. In sum, from 2023 to 2025, analysts expect net income growth, EBITDA growth, and stable operating margins.

Capex is expected to be around $198 million in 2023, with a small drop in 2024 to $194 million, and 2025 capex of $195 million. In my view, if sales growth continues, the operating margin and FCF margins remain stable, and capex does not grow, FCF would most likely increase. With this in mind, I ran my own financial expectations.

My Assumptions Include Growth Of The Marlin Gas Services, Acquisition Of Facilities, And Investments In Sustainable Energy Developments

Under my own financial model, I assumed that the company’s investments in sustainable energy developments would be successful. I also assumed that management will be able to identify midstream and downstream investments accretive to EPS. Management provided full commentary about these intentions in the annual report.

We seek to identify and develop opportunities across the energy value chain, with emphasis on midstream and downstream investments that are accretive to earnings per share, consistent with our long-term growth strategy and create opportunities to continue our record of top tier returns on equity relative to our peer group. Source: 10-k

Besides, I believe that management will, in the long run, successfully optimize its operations, and expand its territorial offer and product offering. As a result, both sales growth and the FCF margins will likely increase.

Finally, new distribution lines, both state and interstate, growth of the Marlin Gas Services, and potential acquisition of new facilities could bring significant economies of scale, which may enhance the company’s operating margins.

My Financial Model

The numbers in my financial model include 2024 net sales of $794 million and 2033 net revenue of $1.3 billion. I also assumed a sales growth close to 11% and 4% from 2023 to 2033. 2033 EBITDA would stand at $387 million with an operating margin close to 21%, capex/sales of 17%, and 2033 FCF of $129 million.

With a WACC of 8.9%, 2033 residual value of $6.9 billion, and an EV/EBITDA of 18x, the net present value of future FCF would be $3.04 billion. If we also add $6 million in cash, and subtract debt of $239 million, the implied equity valuation would be $2.809 billion with a fair price of $158.32 per share.

Risks

Among the risks that the company experiences, there is potential lack of sufficient infrastructure. This, together with the fact that most of its working land is not owned by the company, may diminish potential growth objectives. In sum, failed expansion plans could diminish the company’s future sales growth.

Chesapeake may also face significant volatility in the price of propane as well as generally unstable economic conditions throughout the energy generation and utility arena. Even if the company makes suitable investments, a detrimental economic environment and lower energy prices could bring the company’s revenue down.

Finally, it is worth considering that many regulations and laws in the energy industry are being taken into account at a national and international level. These changes in legislation could negatively and directly affect the company's business model, and impose large tax rates to sustain existing operations. Besides, we can add that growth is limited in each region by a number of residents who may be potential customers.

My Takeaway

Chesapeake Utilities enjoys little competition in certain areas in Florida and other regions. The list of products and services offered and the number of regions where the company is present are quite attractive. In my view, if management successfully invests in sustainable sources of energy, electricity generation, and distribution, revenue growth will likely trend north. Besides, acquisition of facilities, new products, and new distribution lines could bring economies of scale, which may enhance future free cash flow. Under my own assumptions, I believe that there exists upside potential in the stock valuation.

For further details see: