Northwest Natural Holding Co Q1 FY2023 Earnings Call

Good morning, ladies and gentlemen. Welcome to the NW Natural Holdings Company Q1 2023 Earnings Call. My name is Jaquita and I will be your moderator for today's call. I would now like to pass the conference over to your host, Nikki Sparley with NW Natural Holdings. Nikki, please go ahead.

Thanks, Jaquita. Good morning, and welcome to our first quarter 2023 earnings call. As a reminder, some things that will be said this morning contain forward-looking statements. They are based on management's assumptions, which may or may not occur. For a complete list of cautionary statements, refer to the language at the end of our press release. We expect to file our 10-Q later today. As mentioned, this teleconference is being recorded and will be available on our website following the call. Please note, these calls are designed for the financial community. If you are an investor and have additional questions after the call, please contact me directly at (503) 721-2530. News media may contact David Roy at (503)610-7157. Speaking this morning are David Anderson, President and Chief Executive Officer; and Frank Burkhartsmeyer, Senior Vice President and Chief Financial Officer. David and Frank have prepared remarks and then will be available along with other members of our executive team to answer your questions. With that, I will turn it over to David.

Thanks, Nikki, and good morning, everybody. Welcome. We started off the year strong. Our financial results are solid, and we continue to make progress on all key objectives. This morning, I'll walk through a few financial and economic indicators and some decarbonization initiatives at our gas utility. Frank will then go through the quarter's results, and then I'll wrap up with an update on Northwest Natural Water and our renewables company. We reported net income of $2.01 per share in the first quarter compared to net income of $1.80 per share for the same period last year. These results were largely driven by higher revenues in Oregon and Washington from our natural gas utility, along with solid customer growth from our gas and water companies. So now let me cover a little bit on the economy in our service area. Related to our gas utility service territory, Oregon's unemployment rate was 4.4% in March 2023, which is on par with the 4.5% we saw at the end of the year in December and trending slightly above the 3.5% that we saw this time last year in March. As expected, single-family housing activity in our area continues to follow national trends. Overall, our gas utility customer growth added nearly 8,100 new customers during the last 12 months for a growth rate of 1%. Our water and wastewater utilities continue to operate in areas that have strong economic footing. Unemployment rates in our highest growth water service territories range from 2.8% in Idaho to 4.6% in Texas. Population growth in 2022 was over 4%, where our Texas utilities are located. The Idaho counties we do business in grew 1.1% and 1.9% last year. Overall, our Falls water utility provided 5.7% organic customer growth during the last 12 months. Texas remained solid market with our water and wastewater utilities there posting 4.8% organic growth. On a consolidated basis, our water and wastewater utilities organic customer growth rate was 3.9% over the last 12 months. Collectively, our gas and water utility, including acquisition, customer base grew 4.6% over the last 12 months. Turning to our gas utility, we continue to work on running a safe and reliable utility and on decarbonization initiatives. We continue to make progress under the landmark Oregon Senate Bill 98 legislation, which supports renewable energy procurement and investment by natural gas utilities. I'm happy to report Northwest Natural's second facility under Senate Bill 98 was recently commissioned. To date, we've invested $20 million and signed agreements with options to purchase or develop RNG on behalf of our customers totaling about 3% of Northwest Natural's current annual sales volume in Oregon. I continue to be proud of the progress we've made and the opportunities in front of us in such a short period of time. To put it in perspective, in 2022 wind and solar accounted for about 14% of our nation's electric supply, and that's after decades of investment. So I think we're off to a good start here. As we reported last quarter, we've signed contracts with several of our commercial customers to pilot new carbon equipment. This equipment captures heat and carbon from existing boilers to reduce both energy use and greenhouse gas emissions. The carbon dioxide is converted to potassium carbonate, which is blended into soap products. In March, the equipment was delivered, and installation is nearly complete at one key customer site here in Portland with another installation expected to start shortly. Emission reductions are slated to begin this summer. We believe this technology has great promise and are excited to be at the forefront of bringing it to the market. Let me turn it over to Frank to cover the financial results, and I'll wrap this up after that.

Thank you, David, and good morning, everyone. I will begin by discussing the highlights of the first quarter results and conclude with guidance for the year. I'll describe earnings drivers on an after-tax basis using the statutory tax rate of 26.5%. For clarification, our primary segment is the natural gas distribution utility business housed in our subsidiary, Northwest Natural. The activities from Northwest Natural Water, Northwest Natural Renewables, Interstate Storage and third-party asset management revenues are combined outside of our primary segment and referred to as 'other.' As a reminder, the gas utility's earnings are seasonal with the majority of revenues and earnings generated in the first and fourth quarters during the winter heating months. For the quarter, we reported net income of $71.7 million or $2.01 per share compared to net income of $56.2 million or $1.80 per share for the same period in 2022, an increase of $0.21 per share. Our gas utility posted a $0.25 per share increase in earnings while results from our other businesses declined $0.04. Higher earnings at our gas utility were primarily related to new rates in Oregon and Washington and customer growth. As a result of these drivers and the amortization of regulatory deferrals approved in the Oregon rate case, utility margin increased $29.3 million. Gas utility O&M increased $8.7 million or 21%, reflecting higher payroll costs, information technology costs, contract labor, and the amortization of regulatory deferrals related to COVID and two large IT projects. Most of the increased costs and the amortization of deferrals were anticipated in the Oregon rate case. Utility depreciation and general taxes increased $3.3 million due to higher property, plant, and equipment investment. Other income increased $2.6 million, driven by lower pension costs and interest income while interest expense increased $2.8 million. Our other businesses provided a net loss of $300,000, which was lower than the prior year, primarily due to higher costs, including interest expense as we continue to invest in our water strategy. For 2023, cash provided by operating activities was $177 million. We invested $73 million into the business, most of which was for gas utility capital expenditures. Related to our financings, we've been active in the last year, issuing both debt and equity. We are starting off 2023 with a strong cash position and solid financial counterparties. Our objective remains to keep our balance sheet strong with ample liquidity. The company reaffirmed 2023 earnings guidance today for net income in the range of $2.55 to $2.75 per share. Guidance assumes continued customer growth, average weather conditions, and no significant changes in prevailing regulatory policies, mechanisms, or outcomes or significant changes in laws, legislation, or regulations. We continue to target a long-term earnings per share growth rate of 4% to 6% compounded annually from 2022 through 2027.

Thanks, Frank. I’d like to provide an update on our Renewables business. We are concentrating on delivering cost-effective solutions to assist various sectors in reducing carbon emissions through the use of existing waste streams and renewable energy sources. Our focus remains on exploring opportunities, which may involve owning or contracting renewable natural gas from established facilities, acquiring existing projects, or developing new ones. Our primary goal is to build a portfolio of projects that achieve income and cash flow growth while aligning with our overall corporate risk profile. A great example is our first project, where Northwest Natural Renewables has committed to invest $50 million into two facilities being developed by EDL in Ohio. We expect to commission the first facility later this month, with commercial operations starting in late May or early June. The second facility is projected to begin commissioning in about six weeks, with commercial operations expected to start in late June or early July. We have contracted to sell the expected volumes under long-term agreements and are pleased to see our investment thesis in EDL validated. We will keep pursuing opportunities in this area. Moving on to Northwest Natural Water, since our water strategy launched in 2017, we have expanded through more than 25 acquisitions. We have transitioned from solely owning water utilities in the Pacific Northwest to also investing in wastewater and extending our efforts into Arizona and Texas. Recently, we entered into an agreement and are set to finalize another next week, which will add new opportunities to our water business and support our strategy. Through these agreements, Northwest Natural Water is initiating a water services business via two acquisitions, supporting 15,000 connections in Oregon and Washington. This new business will provide operations and maintenance support to water and wastewater system owners while creating value through shared personnel, technology, and expertise to deliver clean, reliable water at reasonable costs. We are enthusiastic about the potential of this initiative to generate long-term value by diversifying our services, expanding our footprint, and potentially making capital and acquisition investments in smaller systems. These initial two acquisitions provide a solid foundation that we believe can be expanded in the years ahead. Lastly, I am proud to announce that Northwest Natural Holdings has been recognized as one of the 2023 World's Most Ethical Companies by Ethisphere for the second consecutive year. This honor reflects our ongoing dedication to leadership and business integrity through top-tier ethics, compliance, and governance practices. Northwest Natural Holdings is among only nine recipients in the energy and utilities sector, with a total of 135 honorees recognized across 19 countries and 46 industries. In closing, our company is financially robust, and we will continue to work diligently on your behalf to seize opportunities across all our businesses. Thank you for joining us this morning. Operator, we are now ready to take questions.

The first question comes from Tate Sullivan with Maxim Group.

On the King Water Company acquisition. Is that in your natural gas service territory or separate parts of Washington and Oregon?

I will give that to our President of the water company, Justin Palfreyman, to answer that, Justin?

It's actually located in the Puget Sound region, so it does not have overlap with our gas utility service territory. It is in similar geographic areas as our existing water utility business service territory.

Okay. In general, does your water utility business bill based on the connections or the number of people served by those connections? Or does it vary by state?

For the water utility business, yes, it's billed based on connections.

Based on connections, okay. And then shifting to natural gas customer growth data, is the growth more due to conversions still and as opposed to new home construction? And I mean the trajectory of the growth seems to be lower, or could it possibly pivot back to the higher rated growth based on trends you're seeing for natural gas?

Thanks for the question. And we are kind of unique out here that we still have a conversion market that has provided steady results. But overall, the customer growth rate has always, and in the first quarter, comes more from new homes overall. I actually don't have the numbers at my fingertips, but it usually runs around 60% is new growth and 40% is conversions, and that's probably roughly correct. But we can get back with you with the exact breakdown.

And then I think it was the prior quarter, you talked about, I mean, a good permit environment. But I mean, can you talk about just Portland area generally? Is there any population flight? Are you seeing good population trends? Or can you just talk about – I mean, or is the outlook more around 1% going forward for customer growth?

Yes, the permitting activity remains fairly decent, but we are uncertain about how it will evolve. Given the country is facing higher interest rates, especially after the Fed's recent rate hike, we anticipate a slight slowdown. It wouldn’t surprise me if we see a 1% growth rate for a while as we navigate through this. However, on the population side, there is nothing to report that would suggest a significant change in the growth rate compared to what we observed in the first quarter.

And then lastly, I think you said earlier that was it an organic customer growth rate with the water utilities collectively at 3.9%? Or was that with acquisitions as well?

Yes. So a couple of numbers here. Organically, for water, it was 3.9%. And if you include all the gas and the water together, including acquisitions, our total customer growth is 4.6%.

Next question comes from the line of Selman Akyol with Stifel.

Can you discuss whether there is a significant roll-up opportunity with King Water Company? Do you view this as being comparable to the utilities, where we can go out and acquire various maintenance aspects?

Yes. Selman, this is Justin Palfreyman and I'll take that question. We view this as a nice starting point for a platform for water services. And really, the water services strategy is a bit different than our utility strategy. It allows us to enter into contracts and drive margin for our business in a market that we haven't necessarily been able to access historically. So serving homeowners associations, small utility districts, municipally owned utilities that aren't necessarily acquisition targets per se for our utility business. We view these first two acquisitions as a nice starting point for continuing to expand organically with these businesses. I don't think that the roll-up strategy is exactly the same for the services business as it is for our utility business because it's more of a competitive nonregulated sector. So I hope that answers your question.

Yes.

I think the positive aspect is that we have evolved from focusing on the water utility side to expanding into the wastewater side and now into the services business. This has been a nice progression. I really appreciate that the services business will provide steady earnings and revenues, even though it operates in an unregulated environment, because once you establish a relationship, they tend to be long-lasting. This is exciting, and I believe we have a promising outlook as we move forward.

Got it. So just kind of going back to the nonregulated nature of it. Can you maybe just talk about what returns you anticipate getting? I presume a premium to water utility, but any comment you could make there?

Yes. The return profile is a little bit healthier, I would say, than the regulated water utility business. But it's still a relatively low margin business, roughly 10% profit margin business. So it's a little bit different in nature. It doesn't have the regulatory lag and that kind of thing. But it is very sticky in terms of really fairly high renewal rates for the contracts that these businesses have as long as you're providing good customer service and continuing to add value to these customers, the contracts tend to get renewed, and we really like that aspect of the business.

Awesome. Just on the decarbonization front, let me just ask you, you guys didn't mention hydrogen. So I'm just kind of curious what's going on there.

Yes, we're still very focused on it. I might have Kim kind of give a little bit of update on what we're doing, especially with where we are on our Sherwood testing facility.

Yes, we are making progress with our hydrogen testing at the Sherwood facility. We have successfully increased the blend to 15% and plan to reach 20% by year-end. The results from our testing have been encouraging for both our equipment and the end-use appliances. We are also piloting various technologies, including a modern electron pilot at our central facility, which is nearing completion. This technology produces hydrogen and solid carbon before combustion, and the solid carbon can be utilized in secondary markets such as tires or asphalt. We're excited about this development and have secured participants for the pilot. Additionally, we are exploring another technology under a non-disclosure agreement that focuses on turquoise hydrogen, suitable for existing buildings by capturing flue gas and converting it into liquid carbon for use in secondary markets like concrete. From our standpoint, there is significant innovation underway in carbon capture and utilization, with technologies that can be adapted for various facilities. We are also involved in several national and international hydrogen consortiums, which have provided valuable insights. More updates will follow, but that summarizes our current status.

Got it. And then on the RNG, what's the outlook for others coming online, other facilities?

In terms of the regulated utility, we're going to continue to push efforts there. We can do another facility at our Tyson project that we're evaluating now. The focus for us, Selman, is to get as much decarbonized product as we can on our pipeline, whether that's through owning and building or contracting. So I think you'll see more areas there. And then in our unregulated business, we continue to look through opportunities across the country, whether it's an opportunity like our EDL or greenfield or just buying facilities outright.

There are no additional questions voting at this time. So I would now like to pass the conference over to David Anderson for closing remarks.

Thank you very much, Jaquita, for facilitating this. And thank you to everyone on the call. As always, if investors have questions, please reach out to Nikki. If you're attending the AGA Financial Forum later this month, we would love to see you there. Please feel free to stop by, and if you need to set up an appointment, contact Nikki for that as well. With that, we'll conclude the call. Thank you.

That concludes the NW Natural Holdings Company Q1 2023 Earnings Call. Thank you for your participation. You may now disconnect your lines.