Essential Utilities Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 23, 2024

There are 9 speakers on the call.

Operator

Hello, and welcome to the Essential Utilities Full Year 2023 Earnings Call. Please note this conference is being recorded. And for the duration of the call, your lines will be on listen only. I will now hand you over to your host, Brian DeGeldyssen to begin today's conference. Thank you.

Speaker 1

Thank you, Francois. Good morning, everyone, and thank you for joining us. If you did not receive a copy of the press release, you can find it by visiting the Investor Relations section of our website. The slides that we will be referencing and the webcast of this event can be found on the website. As a reminder, some of the matters discussed during this call may include forward looking statements that involve risks, 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.

Speaker 1

Please refer to our most recent 10 Q, 10 ks 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. A reconciliation of any non GAAP to GAAP financial measures is posted in the Investor Relations section of the website. We will begin the call today with Chris Franklin, our Chairman and CEO, who will provide an update on the company and then Dan Schuller, our CFO, will provide an overview of the financial results before Chris closes the call with an update on our guidance and overall company priorities. With that, I will turn the

Speaker 2

call over to Chris Franklin. Thanks, Brian, and good morning, everyone. Thanks for joining us. Let's start the call with some highlights from 2023 and some company updates. Despite the unusually warm winter weather in much of 2023, we remain focused on operational excellence and improving our water and natural gas systems by investing capital and continuous improvement measures.

Speaker 2

As a result of this good work, we're happy to report earnings per share of $1.86 which is in line with our 5% to 7% guidance. As Dan will discuss in a few moments in more detail, our team was able to make really make up for the $43,000,000 of weather related net revenue shortfall versus budget and still meet our guidance range, which was quite an accomplishment in 2023. Now last year, we invested nearly $1,200,000,000 in infrastructure improvements as compared to $1,060,000,000 in 2022. Our commitment to investing in critical infrastructure across our footprint has led to the replacement, retirement and installation of over 300 miles of pipe in 2023 alone. This improved service and reliability for our customers throughout the water, wastewater and natural gas part of the platform.

Speaker 2

As I've mentioned in the past, this investment spans thousands of projects and takes significant expertise to achieve. Excluding West Virginia, we reported year over year rate base growth of more than 10% from organic capital investment alone. We also took 2 divestiture actions last year that will really allow us to place more focus on our core utilities with fewer distractions. You may recall in Q4, we closed the sale of our West Virginia gas utility, very small unit with less than 15,000 customers. And we announced the sale of our 3 non utility microgrid and district energy projects in Pittsburgh.

Speaker 2

We recently closed on the $165,000,000 sale of those energy projects, which was as you know a very strong outcome. The proceeds of both were used to finance capital expenditures and water and wastewater acquisitions in place of external funding from equity and debt issuances. During the year, we continue to build on our 30 plus year track record of consolidation in the U. S. Water and wastewater industry.

Speaker 2

Last year, we acquired 7 systems, adding over $44,000,000 in rate base and over 11,000 new customers. We currently have asset purchase agreements signed for 6 municipal acquisitions, totaling approximately $380,000,000 in purchase price. This includes the recently signed agreement with North for sales and Yes It IS for sales to acquire their wastewater system in Pennsylvania. Later in the call, I'll update you on the latest acquisition related activity. Lastly, on this slide, I'm pleased to tell you that we have been named to Newsweek's 2024 list of America's Most Responsible Companies.

Speaker 2

This is the 3rd consecutive year that we've been on this list that recognizes the top 600 most responsible public companies headquartered in the United States that have demonstrated meaningful and impactful business practices. Now turning to the next slide, maybe it goes without saying, but at Essential, our focus is on quality and reliability for our customers and sustainable returns for our investors. Our 138 year history, 32 years of dividend increases and many, many years of continuously delivering on our environmental commitments is made possible by an organization with several competitive advantages. First, I think of the importance of operating in constructive regulatory environments. Essential operates in 9 states, most of which have received favorable regulatory rankings.

Speaker 2

Secondly, we want to operate where there is growth opportunity. We're well positioned to grow both organically being in states with high population growth like Texas and North Carolina and through acquisition and we've demonstrated our ability to do so. In the water and natural gas industry, there's a great advantage to possessing advanced technical and engineering expertise. We were and plan to continue to be leaders on issues like PFAS mitigation and lead remediation, safety issues and etcetera. Last but not least, operational excellence.

Speaker 2

We have 3,000 plus dedicated people working every day to manage the complexity of thousands of projects, which have taken us to industry leading quality and service levels.

Speaker 3

I want to

Speaker 2

share just a couple of those accomplishments of our operating team. By any measure, the numbers on this page make us a clear leader in both natural gas and water industries. The combination of operational excellence and capital investment have accelerated our quest to continue as leaders in the industry. Now the backbone of our capital program in both water and gas is our pipe replacement program. The tightening of our water and gas mains improves compliance, reduces outages and improves the environment.

Speaker 2

According to a report by the Pennsylvania Public Utility Commission, we are running a larger pipe replacement program than our peers. This large amount of gas pipe replacement combined with a refocused effort on addressing leaks has allowed us to shift to a find and fix approach to leaks. And to put this in context, when we announced the acquisition of Peoples just a few years ago, the company like most gas LDCs had a backlog of several 100 leaks. Over the period since we've acquired the company and run the company now, we have reduced outstanding leaks by 83%, so outstanding results. Our water business continues to operate at a 99.9% compliance rate, which is also outstanding.

Speaker 2

You can imagine the confidence that this builds in our customers' minds as they drink and cook with the water we provide. From a reliability standpoint, our systems rarely have outages and when they experience that rare outage, it's typically because a storm disrupts the power to a plant. Now of course, we have larger our larger plants are supported with generators and we continue to position our portable generation near our smaller systems especially during storm prep. I am really proud of our operating team and they continue to raise the bar on operational excellence in both gas and water. Now speaking of operational excellence on the next slide here, given the importance of the expected PFAS regulations from the U.

Speaker 2

S. EPA and the impact on our customers, we probably need to spend a few minutes on this topic. Now we're diligently working so that we are aligned with the EPA's timeline and standards to ensure that our finished water does not exceed the federal maximum contaminant level of PFOA, PFOS and PFNA compounds. Our most recent disclosure is that we expect to spend about $450,000,000 or I should say at least $450,000,000 and that's included in the new capital investment guidance that we're providing today. Our capital spending on this mitigation effort is somewhat fluid though I have to point out and we expect that the $450,000,000 could increase as plans for construction are refined, the EPA and states timelines for compliance is determined and if any additional sites pop up and require treatment as we move forward.

Speaker 2

Now for clarity, if the EPA and the state environmental agencies require a 3 year compliance timeline, we would expect our costs to rise because it may not fit with the timelines associated with applications for low interest loans and grants, could also cause us to work overtime and cost contractor costs to rise. Having said that, we are in the process of meeting with the heads of all the agencies involved to press for accelerated approval processes for loans and grants to protect our customers and where appropriate look for extensions in time to comply with this new regulation we expect in the coming month or so. Now the effort to comply with the 4 parts per trillion standard will be significant. There's no doubt about that. Each of our 300 plus sites that need mitigation must be engineered, permitted, procured and constructed.

Speaker 2

To accomplish this in what is anticipated to be a 3 year timeline will be a huge and very expensive effort. Now make no mistake, our team is up to the task and we will meet compliance deadlines. So with that, we hand it over to Dan to talk about the year's financial results.

Speaker 3

Thanks, Chris, and good morning, everyone. On Slide 9, let's take a few minutes to review the Q4 highlights before moving into the full year. While many of you focus on the company over a longer period of time, which we believe is appropriate, we did want to provide a quick update on how the Q4 of 2023 concluded. On a GAAP basis, we had revenues for the quarter of $479,400,000 compared to $705,400,000 in the Q4 last year. As we experienced in prior quarters, the largest contributor to the decrease in revenues for the Q4 was the recovery of lower natural gas commodity prices with purchased gas costs decreasing by $209,600,000 from the same period last year.

Speaker 3

Additionally, the weather in Q4 was warmer than normal and therefore contributed to reduced gas usage by our customers. Our regulated water segment contributed $281,800,000 in revenue and our regulated natural gas segment contributed $188,700,000 Incremental revenues from regulatory recoveries and water and wastewater customer growth contributed positively. However, these impacts were offset by the lower purchase gas costs, lower volumes in both the natural gas and water segments and other items for the quarter. Operations and maintenance expenses decreased 15 percent to $157,000,000 for the quarter, down from $184,700,000 in the same quarter of last year. Decreases in other items, lower recoverable costs related to our natural gas customer rider and lower bad debt were the primary drivers of the decrease.

Speaker 3

These were offset by higher water production costs and operating expenses related to acquired systems. Net income was up year over year from $114,900,000 to $135,400,000 and GAAP EPS was up 13.6 percent from $0.44 in the Q4 last year to $0.50 for the quarter this year. Next, we'll discuss the full year financial highlights. Let's talk high level and then we'll get into the details when we go to the waterfall. We ended the year with $2,050,000,000 in revenue compared to $2,290,000,000 last year.

Speaker 3

For the year, our regulated water segment contributed $1,150,000,000 of revenue and our regulated natural gas segment contributed nearly $864,000,000 Purchased gas costs decreased by $249,700,000 or 41.5 percent compared to prior year. Operations and maintenance expenses decreased 6.2% from $613,600,000 to $575,500,000 Operating income was up 4.7 percent from $661,200,000 to $692,100,000 Year over year net income increased $33,000,000 or 7.1 percent from $465,200,000 to 498,200,000 dollars and GAAP earnings per share increased 5.1 percent to $1.86 which was solidly in our $1.85 to $1.90 guidance range for the year. And earnings would have certainly been higher were it not for the balmy December weather in Pittsburgh. Next, let's walk through the full year waterfalls, including how we successfully overcame adverse weather impacts in the 1st and 4th quarters of 2023, which caused a $43,000,000 net revenue shortfall versus budget or normal weather. Let's start with revenue on Slide 11.

Speaker 3

In 2023, revenues decreased $234,000,000 or 10 point 2% on a GAAP basis. Starting in the left hand side of the waterfall, regulatory recoveries added $69,100,000 in revenues year over year, which includes the impacts of base rate cases or other regulatory proceedings. Next, organic and acquisition growth from our Regulated Water segment provided an additional 13,100,000 dollars The largest driver of the decreased revenue was the $249,700,000 impact of lower purchased gas costs. Now this is simply a comparison of last year's purchased gas cost line on the income statement to this year's. So it reflects both a significant decline in natural gas commodity prices as well as the lower quantity of gas being purchased.

Speaker 3

Clearly, lower commodity prices are a good thing for our customers who benefit with lower overall bills for heating and cooking. As a result of unfavorable weather throughout the quarter, I should say throughout the year, lower gas usage decreased revenue by $53,100,000 from 2022. And 2022 was colder than normal. And lower water and wastewater volumes decreased revenue by $7,500,000 as well. And lastly, other items of $6,100,000 which includes the impact of lower customer assistance program recoveries also contributed to the reduction in revenues.

Speaker 3

I'd like to remind everyone that we currently do not have weather normalization for our Pennsylvania natural gas business. In these results, we're seeing the significant impact of 2023's warmer than normal weather. However, had it been equally colder than normal, our customers would have seen significantly higher bills resulting in higher revenues. Now as many of you know, we recently filed the first Pennsylvania gas rate case since our acquisition in 2020. And in that case, we proposed a weather normalization mechanism.

Speaker 3

Next, we'll review the operations and maintenance expenses. Operations and maintenance expenses 2. Increased production costs primarily related to chemicals, purchased water and purchased power contributed $12,200,000 and operating expenses from newly acquired systems in our regulated water segment added another $5,800,000 These were offset by other items including lower outside services costs and the prior year impact of a lease related charge as well as lower contributions to our foundation, which decreased operations and maintenance expenses by 27,600,000 dollars The gas customer rider, which is recoverable through a revenue surcharge, decreased 18,700,000 again due to lower commodity prices in the regulated natural gas segment. Employee related costs decreased by $5,400,000 partly due to the incremental pension contributions and an accrual for one time inflation related incentive compensation for non officer level employees back in 2022. And finally, lower bad debt decreased operations and maintenance expenses by another 4,400,000 dollars Next, let's spend a minute on the earnings per share waterfall.

Speaker 3

Beginning on the left side of the slide, GAAP EPS for 20.22 was $1.77 Regulatory recoveries contributed 0 $0.19 lower O and M expenses contributed another $0.08 and organic and acquisition growth from our regulated water segment added $0.02 These were offset by decreased volume from our regulated natural gas segment of $0.14 and other items of $0.03 as well as decreased volume from our regulated water segment of $0.02 The result is GAAP EPS of $1.86 for the year and given the fact that weather in Pittsburgh was approximately 16% warmer than normal for 2023, we believe this is an outstanding result. Now in this waterfall, the other bar includes the impacts of increased interest and depreciation, offset by an increased tax benefit. This increased tax benefit is the result of both increased pipe replacement capital and the ongoing and one time benefits related to the IRS's natural gas safe harbor, which we've discussed previously. The one time benefit related to the IRS change was about $0.045 So all of these impacts along with the pickups from the O and M items we discussed earlier and the purchase water pass through in Texas, so as a tax related change in New Jersey, these were all critical in offsetting the impact of the unfavorable first and fourth quarter weather.

Speaker 3

I will note that regarding 2024 financings, you may have seen that last month we completed a $500,000,000 issuance of 10 year debt at a rate of 5.38. We also expect to raise approximately $250,000,000 in 2024 through an ATM equity program. And given this, we'll file soon for an ATM of up to $1,000,000,000 which should be viewed to cover our equity needs for multiple years. Now moving to regulatory activity and other matters. In 2023, we completed rate cases or surcharge filings in all 9 states in our footprint with total annualized revenue increases of $47,200,000 for water and $21,300,000 for natural gas.

Speaker 3

So far in 2024, we've completed rate cases or surcharge filings in 3 of our water states with total annualized revenue increases of $9,100,000 and achieved $22,100,000 in our regulated natural gas segment. We have a busy but manageable regulatory calendar in 2024 with base rate cases or surcharge filings underway in Illinois, New Jersey, Texas and Virginia for our regulated water segment. And just before the end of 2023, we filed a base rate case for our regulated Pennsylvania natural gas utility, which I'll discuss in more detail on the next slide. Now this is the first Pennsylvania natural gas rate case that we filed under our ownership. It's also the first since the adoption of tax repair in the gas business and also the first case in which there's a request for weather normalization, which is a mechanism that a number of our peers in Pennsylvania have today.

Speaker 3

As a reminder, as part of this case, we expect the tax repair benefit to shift from the shareholders to the customers as a tax benefit is incorporated into rates. Tax repair allowed us to stay out of rates for 5 years and we would likely have stayed out longer, but the commission order associated with our repair election required us to file by the end of 2020 3. And in this case, as you see on the slide, we've requested an increase of $156,000,000 or 18.7 percent in terms of revenue. Now through the fully projected forward looking test year, we'll have replaced over 1,000 miles of gas mains in Pennsylvania since the last rate case. And therefore, rate base growth at Peoples is significant.

Speaker 3

The $4,200,000,000 in rate base in this case is up from $2,100,000,000 in the prior case. So that's a doubling in a 5 year period. This investment has made our system safer and more reliable, while significantly reducing our greenhouse gas emissions since 2019. Given the fully projected future test year, we anticipate recovering the impact of rising interest rates and inflation through much of 2025. And in addition, we did want to mention that we expect to file a rate case for Aqua Pennsylvania in the Q2 as it's been nearly 3 years since our last filing.

Speaker 3

We believe our rate activity, especially in Pennsylvania, is very different than some of what you may be seeing across the industry. We've been out of rates for nearly 3 years for Aqua Pennsylvania. Our plans are known by the regulators in advance and we've maintained a strong focus on affordability. We will also take a responsible approach to our proposed Act 11 subsidization. And with that, I'll hand it back over to Chris.

Speaker 3

Chris?

Speaker 2

Hey, thanks, Dan. And it's hard to believe it's been 5.5 years under your leadership as CFO and I want to thank for that. I also want to recognize the great work done by Dan and his team in achieving our 2023 financial results. It was a challenging year on the weather front. Thank

Speaker 3

you, Chris.

Speaker 2

Yes. Let's talk for a moment about our water and wastewater acquisition program. As you know, the program has been successful and continuously evolving nearly 30 years now. I have to tell you that we're really pleased with the leadership of the Pennsylvania Public Utilities Chairman Commission Chairman, Steve DeFrank, on addressing some of the issues that have arisen associated with the use of the fair market value statute that was passed in 2016. We believe that the proposal he has made at a recent PUC public meeting will make a real difference in moderating rate increases for customers while still providing a fair price to governmental entities when they decide to sell their water or wastewater utilities.

Speaker 2

We view this as a very positive development in our acquisition program in Pennsylvania and believe that the pipeline remains strong. As I mentioned earlier in the call, in 2023 we acquired 7 systems adding over 11,000 customer equivalents to our current water and wastewater footprint. We have now acquired over $500,000,000 of rate base via acquisitions since this leadership team came together in 2015. That statistic just doesn't do justice though to the amount of work that goes into the program. I fully expect that the company will continue to be a major player in the consolidation of the water and wastewater utility industry in the United States.

Speaker 2

Now moving to the next slide, let's take a minute to review the pending transactions. As of this call, we have 6 signed asset purchase agreements in 2 states in which we have existing water and wastewater operations. These acquisitions will add over 215,000 customer equivalents and total approximately $380,000,000 in purchase price. As I noted in my opening remarks, this includes the recently signed agreement with North Versailles Township Sanitary Authority to acquire their wastewater system in Allegheny County, Pennsylvania, which is expected to add approximately 4,400 customers to our regulated water segment. Now this is another transaction that resulted from the reputation and relationships of our Peoples Gas team in Western Pennsylvania, yet another opportunity to leverage that relationship between the gas and water utilities.

Speaker 2

We continue to see a strong and healthy pipeline of opportunities for additional growth and we're currently engaged in active discussions with municipalities which have over 400,000 potential water and wastewater customers. If Chairman DeFrank's proposal is successful, there should be a much clearer path to closing municipal acquisitions in Pennsylvania in the future and that is a bright spot. Now before moving on, I just want to note that the DelCor regulatory process continues to be under a stay by the Federal Bankruptcy Court, but we remain confident that we will ultimately close the DelCora transaction. In early February, we filed another motion requesting the federal bankruptcy court judge lift the stay that has now been in place for over for 9 months. In April, there was a scheduled hearing at the Pennsylvania Commonwealth Court to rule on Delaware County's appeal of the validity of our asset purchase agreement with DelCorra.

Speaker 2

You'll recall that was upheld successfully in the lower court. Based on what we know today, we still believe we can close this transaction by mid-twenty 25. Now before I get to guidance, just want to reaffirm our strategy and visit some of our high priorities for the year. First, with regard to strategy, we're going to continue to invest in significant capital in needed infrastructure. This will drive quality, safety and reliability for our customers.

Speaker 2

We'll also drive rate based growth, which in turn also drives shareholder value. Importantly, customer affordability is always a priority. We know a key piece of driving shareholder value is continued growth in our dividend and we have a long track record of returning cash to our shareholders and that will continue. In fact, we've raised our dividend continuously for 30 years now. Lastly, we continue to see opportunities for further consolidation through acquisitions in the water and wastewater space and we'll pursue transactions that broaden the customer base in a constructive regulatory environment, allow us to apply economies of scale to manage our costs and give us the opportunity to be a solution to communities that need our expertise or financial strength.

Speaker 2

We believe that this strategy puts us in a great position to continue building and delivering value for our shareholders. As we think about 2024, we have some important work to accomplish. I share my priorities each year with the board, of course, the management team and I'll summarize them quickly for you here. First, we'll remain focused on operational excellence throughout the year. I'll continue to share examples with you on our calls and meetings and this will include increased exposure to our segment presidents, Colleen Arnold and Mike Huar.

Speaker 2

Secondly, we'll continue to look for opportunities to make tangible improvement in the service we provide to our customers. In fact, we just rolled out an exciting new customer portal to provide our water and wastewater customers with more visibility into outages and restoration as well as allow them to see the details of their usage more easily and pay their bills online. Also this year, we'll continue our leadership role in remediating PFAS and lead across our footprint and we'll share our knowledge across the industry to help others leverage what we know. Now sustainability, we're going to continue to focus on our continued commitments and sustainability and our accomplishments. We will continue to grow the company through accretive water and wastewater acquisitions.

Speaker 2

And last, we have some pretty important regulatory things in front of us this year including 2 rate cases that Dan mentioned in Pennsylvania among others, the FMV refinement and also the finalization of the PFAS regulations. It's going to be a very busy year this year folks. All right, let's get to guidance. Before we walk through this, I want to acknowledge what you read in the release last night. Now throughout this year, we will be working through 2 critical rate cases, both in our largest divisions in gas and water and both in Pennsylvania.

Speaker 2

Thus, we are refraining from providing a multi year earnings per share growth rate guidance range. Now once both base rate cases are complete, which will be around this time next year, we'll return to our normal longer term earnings per share guidance range. So let's review the guidance that we're providing, which we believe is significant and provides a clear line of sight to the opportunities in front of the company. In 2024, we expect to earn $1.96 to $2 which is a 5% to 7% earnings growth range. Through 2028, we plan to invest approximately $7,200,000,000 annually on regulated infrastructure in our existing utilities.

Speaker 2

Let me point out that some of this increase is being driven by the regulatory requirements associated with PFAS and lead mitigation. Now in 2024, we expect to invest between $1,300,000,000 to $1,400,000,000 The annual amount may be a bit lumpy based on the needs and regulatory recovery activity throughout the 5 year period. I point again to PFAS as I mentioned earlier in the call. I also want to point out that we're providing a 5 year outlook on capital investments for the first time. We've always provided you 3 year capital outlook and we hope that moving to a longer term view of capital spending will provide a better picture of our long term opportunities.

Speaker 2

Now based on this investment, we expect rate base will grow at a compounded annual growth rate of approximately 8% for water and approximately 10% for natural gas through 2028. Fine utility base will grow at a compounded annual growth rate of over 8%. We continue to expect that together organic customer growth and growth from acquisitions will for water and wastewater will continue at a growth rate of 2% to 3% on average. We will always remind our investors that growth from acquisitions are lumpy and should be viewed over a 3 year average. We expect continued stability in our natural gas customer base.

Speaker 2

Now as Dan mentioned, we also expect to raise about $250,000,000 in 2024 using an ATM equity program. And we remain committed to reducing our Scope 1 and Scope 2 greenhouse gas emissions by 60% by 2,035 from our 2019 baseline. As you know, we've already made significant progress on this and we estimate it to be about 25% as of the year end 2023. All right. We covered a lot.

Speaker 2

That concludes our formal remarks and we're happy to take your questions. So let me turn it back to Francois.

Operator

Thank The first question comes from the line of Ryan Connors from Northcoast Research. Please go ahead.

Speaker 4

Hey, Ryan.

Speaker 5

Thanks for taking my question. I think you did a great job with the details, Dan. So thank you for that. Just a couple of bigger picture questions here. Chris, you talked about strategically about kind of rate and CapEx strategy, but tactically, lots of high profile industry noise right now in terms of rate increases in water.

Speaker 5

How does that impact your tactical thinking about rate strategy in PA in terms of the rate cycle and the cadence of CapEx going forward? Any thoughts there?

Speaker 2

Yes, Ryan. Listen, I think cadence is important. The challenge that we could face and I outlined a moment ago is if Pennsylvania for example requires us to comply with the PFAS rules over a 3 year period. It appears in the federal regulation that hasn't been formally released yet, but the draft would suggest that states can extend that by 2 years. So if they allow us to extend it, it would allow it will give us an opportunity to spread that a little bit.

Speaker 2

That's the only thing that could push us in a little sooner. But we think that the cadence we have now is a good cadence. Now there's a lot of capital before us including lead. So that could impact the cadence of future cases. But listen, I think affordability is key in how we think about things.

Speaker 2

I think how we think about Act 11 and shifting of costs is key to us. And I also think about that throttling of capital to make sure that things remain affordable to our customers is also critically important.

Speaker 5

Yes. And then relatedly, so this you mentioned your comments on the M and A environment, which I appreciate, but there was some big news yesterday, not one of your deals, but the PUC actually rejecting an ACT 12 deal. How do you view that in terms of the potential impact on the near term pipeline? I mean, will that scare off some potential sellers at least until we can get finality on where this reform process ends up?

Speaker 2

It's an interesting question. And I think what it does is it provides pretty clear guidance to sellers as to what's the multiple undepreciated original cost that they can probably expect. Now, we're probably a couple of months away from the finalization of Chairman DeFrank's motion because there's 30 days followed by 15 day comment period. But assuming it stays even close to where the Chairman's proposal is, it will give pretty clear guidance as to where those purchase prices can be. And believe me, I think that those are still really nice premiums that can be paid for these utilities while we keep rates in check.

Speaker 2

And I think yesterday's decision probably is in line with the commissioner's five-zero vote on Commissioner DeFrank's C Motion on his proposed changes. I think that given the difference in the multiples on depreciated original cost, it would have been hard for them to do this one. Now I do think and this is important as we think about acquisitions particularly in Pennsylvania, troubled systems are really differentiated from this process. And so I think the acquisitions that we have in the pipeline, many of them are troubled. And so that you have a little bit more flexibility in this for troubled acquisitions.

Speaker 2

And they may take more of a focus.

Speaker 5

Yes. I appreciate that. And one last one for me, if I could sneak it in. Just super big picture, Chris. I mean, there seems like there's been a pretty big, pretty stark role reversal for water and gas over the last 6 months or so.

Speaker 5

Water seems to be facing some headwinds now and gas utility stocks are now actually outperforming the water names. That's one of the reasons your stock has done relatively well. How does that shift your thinking, if at all, on portfolio strategy going forward? I mean, you've talked in the past about kind of staying put in gas and really growing in water. Is there a thought process that maybe gas could be more of a growth platform?

Speaker 2

Well, I'm not ready to say that yet, but I think you're exactly right in your public sentiment, including in Europe. We saw that even in the European Union, gas is not considered green again. So I think public sentiment has changed a bit. I think the realization that natural gas is going to be here for a very long time, given the critical role it plays in the energy mix is more evident in people's knowledge today. But having said that, listen, we're going to remain focused this year on delivering a really quality rate case in Pennsylvania.

Speaker 2

And so that's going to be our primary focus in the gas business in 2024.

Speaker 5

Got it. Thanks

Operator

for your time.

Speaker 2

You bet. Thank you. Take care.

Operator

The next question comes from the line of Durgesh Chopra from Evercore ISI. Please go ahead.

Speaker 2

Hey, Durgesh. Good morning, Durgesh.

Speaker 6

Hey, good morning, guys. Thanks for the time. Hey, just I wanted to kind of stick on the theme of the rate cases, getting a lot of questions from investors, obviously, on the Waterfront. Maybe can you just give us a sense of what kind of revenue or rate increase ask that you might seek in the upcoming water case? You mentioned affordability several times in your comments.

Speaker 6

So just trying to get a sense of how big a rate increase you might see, if you can give us a range or something along those lines?

Speaker 3

So Durgesh, we're still working through that case right now. And of course, as you indicated, affordability is a concern. So we don't have a number to share. We'll obviously share that number or we're pretty close to that number when we have our Q1 call. So we'll provide more detail at that point.

Speaker 3

I would say though and you see it in the 5 year CapEx guidance that we've shown that we're going to continue to have strong CapEx in the Water business and PFAS and latter a portion of that CapEx. So those capital expenditures here for the time period kind of through 2025 will be included in this rate case.

Speaker 2

Yes. Let me just point you to Durgesh to some of the comments I made in the call here. We're meeting with regulators as we speak, environmental regulators that is to talk about, this timeline for PFOS. We pretty much know where we're going with lead, but that timing is a key consideration even in this how we think about this case. So numbers are still moving around a bit, but as Dan said, we should be clear in the coming months.

Speaker 6

I appreciate that. And then pretty large step up in CapEx. I think if I just take the average annual capital amount, it's like 30% higher versus previous guidance, 1.4% on average versus 1.1%. Maybe just can you talk to obviously and thank you by the way for sharing the equity plan for this year, much appreciated. But then can you talk to financing needs in 2025 and beyond?

Speaker 6

Should we use that $250,000,000 as a run rate or should it be higher given the CapEx is stepping up quite a bit? Maybe just talk to that. And then I have a follow-up.

Speaker 3

Yes. We probably won't provide too many details on that beyond 2024 only because the needs in the future for equity also depend on acquisitions and how they play out. But I would say as we think about that $1,000,000,000 ATM program, generally we're thinking about that as 3 plus years, but again it depends on both acquisitions and investment needs.

Speaker 6

Okay, perfect. I appreciate that Dan. And then maybe just like one last question for me is rate base is growing at a materially faster clip or projected to grow at a materially faster clip assuming you get favorable regulatory outcomes in the PAWAY cases. Could we see a step up in long term growth rate going forward, as you're spending more money or maybe perhaps towards the high end of that 5% to 7% or how should we think about that? I don't know.

Speaker 6

I appreciate there's no long term guidance, but maybe directionally you could help us think about long term growth rate.

Speaker 2

Yes. Listen, I think we're trying to refrain from front running the commission in Pennsylvania. So I'm going to be careful in how I answer this. But listen, I think Peoples is coming out of repair, which we've I think we've talked about many, many times. And so as we think about coming out of repair and earning well before that, the step is not what would be in a normal step rate case.

Speaker 2

So I think I would be I think we're comfortable with the guidance we've given and hopefully that gives you a little bit of sense of how we think about it.

Speaker 6

Okay. I appreciate that, Chris. Thanks so much.

Speaker 4

You bet. Bye, Birkesh.

Operator

The next question comes from the line of Travis Miller from Morningstar. Please go ahead.

Speaker 4

Hey, Travis. Thank you. Good morning, everyone. Kind of going back to the again, this whole PFAS discussion and the investment needs. I think, Chris, if I heard you correctly, huge and expensive was the quote.

Speaker 4

Does that refer to the 450% and the 5% O and M or is there more potential CapEx and or O and M?

Speaker 2

Yes. Good question. So here's how we think about it. As we estimate it today, we're saying at least $450,000,000 But the timing, right, if for example, we heard this week when we were in North Carolina that we must comply with the 3 year timeline in North Carolina. And so, we're going to be all on push.

Speaker 2

In Pennsylvania, we're hoping to get, some definition around that from the regulators here. But if we have to move faster, if we have to comply with 3, which we originally were hoping for a 5 year, then it could be added cost. And the added cost come from potentially our inability to get loans, low interest loans and grants in that process because often they require us to apply and get the grant before we build and we can't wait. And so that's the conversation that we're having with the regulators now is help us help our customers. Our customers didn't put this contaminant in the water nor did we, but we are all faced with fixing it and paying for it.

Speaker 2

And so we're trying to mitigate those costs best we can. That's why that number is moving around a little bit and could go north more if we can't attain some of these grants.

Speaker 4

Okay. That partially answers. And my follow-up was how much discussion are you having with regulators in terms of getting some of those costs recovered outside of having to file full base rate cases? Would there be some kind of rider treatment potential? Have you discussed that at all?

Speaker 4

Or is that on the table?

Speaker 2

That is a discussion we are having in several locations. We had a long discussion even internally here about how to make some of those things happen last night. And I think it's important for customers to recognize that that portion of their rates is associated with compliance with a cleanup and not simply an investment in pipe or improvement that we would normally make in the course of running utility. I really want customers to understand that they're paying for some of these costs. Now I'll remind you that we are getting some recovery from lawsuits.

Speaker 2

We hope to get somewhere between $90,000,000 $110,000,000 from the polluters. But that's not going to cover clearly the costs we're talking about here.

Speaker 4

Okay. That's all helpful. Thank you. And then one other on the gas side. Any thoughts in terms of getting a weather normalization clause either in this rate case or a separate application?

Speaker 4

I know that at least one other gas utility in the state has a pretty robust weather normalization excuse me, weather normalization costs. So I wonder if that's part of the discussions in the current rate case or is that something that would come along in a separate filing?

Speaker 7

Yes, Travis.

Speaker 2

Let me just remind you, this is our first rate case too since we've owned the company. So that's why we don't have weather norm. Go ahead, Dan.

Speaker 3

Yes. Great point, Chris. So yes, Travis, we have filed this rate case including a request for weather normalization. And to your point, a few of our peer companies here in Pennsylvania have it and achieving a similar program will be very beneficial to our company.

Speaker 4

Okay. Handicap wise, do you think given that the other utilities have it that there's a good chance? Or is there something unique about what you're discussing with regulators?

Speaker 3

I would say the fact that other utilities in the state have it bodes well for a positive decision here.

Speaker 4

Okay. Great. Thanks so much.

Speaker 2

You bet.

Operator

The next question comes from the line of David Sunderland from Baird. Please go ahead.

Speaker 3

Good morning, David. Hey, Dan.

Speaker 7

Happy Friday, guys. Thanks for the time.

Speaker 2

You bet.

Speaker 8

Two questions from me. I wanted to ask about the decision not to give long term EPS guidance. I know you guys mentioned the rate case for being the reason for this, but should we think of any pending acquisitions as playing a role in this? And then I have one follow-up.

Speaker 2

Yes. No, not at all. We're not worried about the acquisitions. It's really the fact that we have 2 major rate cases filed in Pennsylvania, which account for, as you all know, a large portion of our net income. And so, I actually had conversations with regulators who said it would be a sign of respect to be able to do that.

Speaker 2

And so I gladly comply with that. So it was really just not front running the commission in terms of how they think about returns and processing a rate case, especially given its import to the overall picture here in our company.

Speaker 8

That makes sense. Thank you for that. And then another one on just the acquisition pipeline. Broadly speaking, I guess at a high level, have you seen in light of the higher rate environment an increase in the number of systems or I guess maybe any thoughts on where valuations are? Any commentary on where you're at with the 400,000 customers too right now would be helpful.

Speaker 8

Thank you.

Speaker 2

Yes. I would say there's a lot of active conversations happening. Clearly, the news of the Chairman's C Motion and then maybe newest information on Butler that just occurred is people are processing that information. I'd say that was really, really new information both of those. So not sure exactly how the market will react.

Speaker 2

But I'll tell you what, assuming the Chairman's motion is successful and we see a clear path to actually closing these and not having to deal with the court issues and just the prolonged nature of the challenges, I think that that will actually be a very positive signal to the market. Number 1, they can be paid a premium, all to be at a controlled premium. And then 2, there's a clear path to closing, which I think in some of these cases today that path is not as clear. So now in terms of our general conversations with others in the pipeline, I would say they're steady as she goes. Municipal acquisitions are lumpy.

Speaker 2

We've talked about that many times. And so sometimes you feel like it's 2 steps forward and one step back. But nevertheless, I do feel comfortable that the pipeline is still strong.

Speaker 7

That's super helpful. Thanks guys. Appreciate it. You bet. Bye bye.

Operator

Before proceeding to the next questions. The next question comes from the line of Jonathan Reeder from Wells Fargo. Please go ahead.

Speaker 3

Hey, Jonathan. Good morning, Jonathan.

Speaker 7

Good morning, Chris and Dan. How are you all?

Speaker 4

Very well, Mike. Thanks.

Speaker 7

Hey, I just wanted to quickly clarify that the 24 guidance range doesn't include the one time gain from the non regulated sales that recently closed. Is that correct?

Speaker 3

Yes, that's correct, Jonathan. So that EPS guidance presumes normalized weather and excludes that gain on sale.

Speaker 7

Okay, great. And I appreciate that you rolled out the 5 year guidance in terms of CapEx and rate base. I'm still just a little confused why you didn't also provide, I guess, the long term EPS CAGR since there's potentially another round of PA rate cases that would fall during that 2024 to 2028 period after the pending gas and soon to be filed wire one kind of wrapped up. So I guess kind of the first part of the question is, do you just intend to provide a 3 year EPS CAGR when you do roll it out next year? And then the second part, if we were to assume no change to the current TA gas and water like return parameters, meaning the allowed ROEs and equity ratios, is there any reason the EPS CAGR wouldn't be consistent with the prior 5% to 7% range given rate base is expected to grow at over 8% even taken into account presume step down in people's earned ROE?

Speaker 2

Yes. So a lot of questions in the one question. So in terms of the guidance range and why with regulators, I kind of covered that before, Jonathan, but I'll just say again, I recognize there's a stream of cases coming through Pennsylvania. And so the way we think about it is take one case at a time. We just happen to have really heavy overlap here.

Speaker 2

The Peoples case won't conclude till really Q4 2024. The Aqua case won't conclude until Q1 probably of 2025. It's just right on top of each other. I think we have to look at the cadence and then how we would provide that respect to our regulators and guidance to our investors and evaluate it as we go. And hopefully, we can stay with largely the guidance we've always provided.

Speaker 2

I would anticipate as we return this time next year to regular guidance, I would expect a 3 year cadence, not we could probably continue to do 5 years on CapEx, but a 3 year guide. I just think there's so many things happening in the industry. That's a much clearer view of what's coming.

Speaker 3

And I think too, Jonathan, if you look at what we provided in terms of the Peoples Natural Gas rate case and rate base and equity layer and so forth, we've tried to provide some data there that would help you model a 2025, a fully projected future test year in terms of an outcome. If you need any more help on that, we obviously take your call anytime and we can have conversations. But we're just not going to provide a guidance range at this moment.

Speaker 7

Yes. No, I mean, just with the step up in CapEx and even the rate base growth, the strength there, I just know some people kind of wondering like is it sending a mixed message, but if it's just purely out of difference with the regulators and the plan was just to keep the EPS CAGR at 3 years versus 5 year along with the other stuff, then I guess that makes a little more sense. So in terms of kind of I guess modeling the $7,200,000,000 like first off, that's just pure CapEx. That doesn't include anything for pending M and A or future placeholder, right, consistent with how you've done it in the past?

Speaker 3

Yes, consistent with the past. So it includes it doesn't include acquisition prices, purchase prices paid. It does include CapEx subsequent to acquisitions closing for those acquisitions where we have a signed purchase and sale agreement.

Speaker 7

Okay. Okay. And then, in terms of like modeling it out, should we just assume like gradual annual increases off of the 1.3% to 1.4% or is it going to be a little more heavy in 2025 and 2026 because of the PFOS stuff? I mean, I guess that's what you've been saying, still a little bit to be determined, but

Speaker 3

Yes, a little bit to be determined whether PFAS is a 5 year or 3 year program and by state. Otherwise, I guess I would say that if you take 72 and you divide it by 5, you're kind of in this 1.3, 1.4 range and it kind of bounces around in that range over those years. It's not necessarily a directionality to it.

Speaker 7

Okay. Can you kind of just talk about the drivers of the CapEx increase? What caused you to kind of step it up? Because I think you've kind of been relatively consistent the past few years in your budget. This is a lot bigger increase.

Speaker 7

And then along with that, what sort of impact the higher CapEx will have on the average annual customer build increases that you foresee?

Speaker 3

Yes. I'm happy to start and then Chris can chime in. But as we look forward and I think all utilities and really all companies that do construction work have experienced this, we do see higher construction costs in the future than we've had in the past. So that gets incorporated when we develop our 5 year plan. And then, of course, we've got a bit more clarity here in this 5 year plan regarding PFAS and lead than we had previously as well.

Speaker 3

And then go ahead, Chris.

Speaker 2

It's really a step up. We were 1.1% in 2022%, 1.2% in 2023 percent and now we're coming up as call it an average of 1.4%. So it's not a massive increase, but given the cost we're seeing, labor costs as well, we're seeing increased and then more clarity on PFAS and lead, it just is migrating north.

Speaker 7

Okay. And then last for me on the PFOS front. Can you provide any update on federal or state efforts to protect the water utilities from any potential liabilities related to distributing water that might have had PFOS in it prior to the EPA actually establishing a rule? I think there's some class action lawsuits perhaps in Connecticut around this issue that have been filed.

Speaker 2

Yes. I mean, listen, I think a number of people are trying to figure out ways in at the state level even to protect water utilities through legislation from that kind of liability. And as you said, there's 2 in Connecticut with the public companies there. One is both product liability lawsuits class action and which we're watching clearly very closely as the rest of the industry is as well. I'm not aware of any that have successfully passed in terms of protections.

Speaker 2

But as we think about looking for protection, we're also looking for on the waste side, right? Circular, we want to understand really how we're going to be treated going forward with the waste. So work to be done. Listen, the guys like Rob Paulson and the industry lobbyists are working hard in Washington to try and get protection. And I'll just give a quick

Speaker 7

shout out

Speaker 2

to Senator Capito, who's really done nice work in this area and leading some of the work and really understands what we're facing. The theme, Jonathan, that we're talking to elected officials about is, again, we didn't put the water there. And a matter of fact, we've taken steps even before now to put mitigation in place. And so we believe that our customers and our companies need to be protected. So I would put that in the category of work that needs to be done.

Speaker 7

Okay. Yes. No, it's definitely kind of interest, given the size of the liabilities that the actual polluters face that hopefully that doesn't come back on the water utilities, which ultimately gets passed on to the customers and bills and everything like that. So good luck with that.

Speaker 2

Yes. Thank you.

Operator

Our next question comes from the line of Greg Arell from UBS. Please go ahead.

Speaker 2

Hey, Greg. Hey, thank you.

Speaker 4

Yes, just thoughts on Aquarion and how your criteria would align with that is an opportunity, how you think about that? And I guess separate question, I guess 23% is the base year for the rate

Speaker 3

base growth guidance?

Speaker 2

Yes, that's correct. Yes, on Aquarion, Greg, it's a good question. Obviously, the asset is in the market, as announced by Eversource. Let's start with it's a strong asset in terms of the quality of the asset itself. Don Morrissey, who runs the company along with Joe Nolan, who runs Eversource, they've done a nice job in maintaining the asset, growing it a little bit.

Speaker 2

So from that perspective, I think it's a nice asset. But I also think it's challenged regulatory environment. An 8.7 ROE in the latest cases is a little bit concerning, I think, to any potential buyer. And I think the ability to grow in Connecticut is also challenging with the requirement of a referendum to grow. So I think there are some challenging things.

Speaker 2

Listen, there's a lot of people are going to look at that asset. We don't talk about what our plans are, but I think it's an interesting asset and it has some pluses and minuses to it.

Speaker 4

Okay. Thanks for your thoughts. You bet. Thanks, Greg.

Operator

There are no further questions. So I'll hand you back to Christopher Franklin to conclude today's call.

Speaker 2

Thanks for sticking with us folks. I know we went a little long today, but good questions and a lot of material to cover on the year. So many things happening in the industry. Obviously, Dan, myself, Brian and the team are always available for your follow ups. Thanks for joining us today.

Operator

Thank you for joining today's call. You may now disconnect your lines.

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Earnings Conference Call
Essential Utilities Q4 2023
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