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Unitil Is Becoming Overvalued On A Forward Basis

Summary Northeastern electric and gas utility Unitil Corp. reported Q3 earnings last month that beat expectations on net income despite missing on revenue. The share price declined in the wake of the earnings release, due to a combination of profit-taking and concern over the company’s outlook over the next 6 months. A strong El Nino is developing across the U.S., and such events in the past have resulted in warmer-than-average winters across the company’s service area. With natural gas demand expected to be low through April, diminished earnings expectations, and high P/E ratios, I do not recommend Unitil as a long investment at this time. Small Northeastern electric and gas utility Unitil Corp. (NYSE: UIL ) reported Q3 earnings late last month that beat slightly on net income despite missing on revenue. The company’s shares have lost almost 10% of the value since the earnings report’s release, however, suggesting that even the beat didn’t meet investors’ expectations. In a bullish article on the company written back in June, I highlighted management’s plans to increase the penetration of its natural gas services in an area that has historically been dominated by heating oil, concluding that current investors should maintain their positions. The company’s share price rose by 17% over the subsequent four months, as an expected Federal Reserve interest rate hike failed to materialize. The company’s short-term outlook has diminished somewhat since then, as an especially strong El Nino has begun to make its presence felt. This article reconsiders Unitil Corp. as a long investment opportunity. Q3 earnings report Unitil reported Q3 revenue of $74.7 million, down by 2.5% YoY (see table) and missing the consensus analyst estimate by $7.4 million. The decline and miss were attributable to the company’s electric utility segment, which reported a revenue decline of $2.8 million YoY to $51.4 million due to lower rates. An increase in kWh sales of 1.1% over the same period, split between the company’s residential, commercial, and industrial customers, was insufficient to prevent the revenue decline. The natural gas utility segment’s revenue increased slightly by $0.8 million YoY to $21.7 million despite the presence of lower rates during the quarter, with gas therm sales increasing by 4% over the same period as strong demand from commercial and industrial customers offset weakness from residential customers. The gas utility segment also reported a 1.4% increase in customers compared to the previous year, further offsetting the impact of lower rates. Finally, Unitil’s non-regulated Usource segment reported revenue of $1.6 million, virtually unchanged from the previous year’s result. Unitil Corp. Financials (non-adjusted) Q3 2015 Q2 2015 Q1 2015 Q4 2014 Q3 2014 Revenue ($MM) 74.7 77.5 172.2 119.8 76.6 Gross income ($MM) 40.0 40.1 61.6 50.7 39.3 Net income ($MM) 1.7 1.7 13.6 9.4 1.6 Diluted EPS ($) 0.12 0.12 0.98 0.68 0.11 EBITDA ($MM) 18.7 20.1 39.8 31.3 18.5 Source: Morningsta r (2015) The company’s electric sales margin came in at $22.2 million, down slightly YoY, as a large decline to the segment’s cost of revenue resulting from the presence of lower fuel prices during the quarter offset the aforementioned revenue decline. The gas segment’s margin came in at $16.7 million, up YoY by $1 million, as a similar decline to its cost of revenue complemented its revenue increase. O&M and income tax expenses both fell over the same period, although the impacts were offset by higher depreciation and interest expense costs. Unitil reported net income of $1.7 million, up by 11.1% from $1.6 million in the previous year. This generated a diluted EPS of $0.12 for the most recent quarter, up from $0.11 in the previous year, and beating the analyst consensus estimate by $0.01. EBITDA came in at $18.7 million, up slightly from $18.5 million over the same period. Including the Q3 results, the company is on pace to report a 9.7% allowed return on equity for the TTM period, an achievement that management attributes to the presence of cost trackers. Unitil also reported a number of positive developments during Q3 in addition to its earnings beat. First, it extended the duration of its credit facility by two years to 2020, while simultaneously reducing its interest rate by 0.125%. With sufficient liquidity in place following this move, management announced a 1.4% dividend increase compared to the previous year. While lower than those increases reported by many of its peers, the increase does leave it with an attractive forward yield of 4%. The company stated that the penetration of its natural gas utility segment into its service area increased to 60% during the quarter. While this is low relative to its system potential, natural gas is a relatively new arrival in the Northeast as a heating fuel, with heating oil having a lengthy history there instead. The company’s future earnings expectations are based on the assumption that natural gas will continue to make inroads. Finally, Unitil is asking Maine to approve the implementation of a rate surcharge mechanism for the natural gas segment that will enable proactive expansion and replacement of its existing distribution infrastructure, thereby minimizing regulatory lag and maximizing the company’s ability to initiate its planned capex spending. Outlook Unitil’s management expects the natural gas utility segment to be the major driver of its earnings growth moving forward, stating during the Q3 earnings call that it anticipates annual rate base growth of 10% for the gas utility, compared to only 4% for the electric segment. This expectation is, in turn, being driven by the continued presence of low natural gas prices, especially compared to those seen in previous years. While natural gas has already begun to replace heating oil in many Northeastern buildings, the percentage of residential homes using natural gas in Massachusetts, for example, is still lower at 44% than the U.S. average of 51%. Maine, which is home to most of the natural gas utility segment’s service area, has natural gas penetration of only 4% . Likewise, the percentage of homes heating with electricity in both states is also well below the national average. Inexpensive natural gas provides consumers with a major incentive to convert from heating oil, which is both relatively dirty and a fire risk, to natural gas. This incentive becomes especially pronounced when natural gas prices exhibit low volatility, as has been the case for the last two quarters. Increased adoption of natural gas by utility customers presents Unitil with a substantial future growth opportunity, primarily due to the relative lack of natural gas penetration within the gas segment’s own service areas. The company can bring in new customers without needing to build additional pipelines or move into new service areas and potentially unknown regulatory schemes; instead, it just needs to build the necessary distribution infrastructure within the existing service area. While Unitil’s long-term growth drivers remain in place, its share price is at risk of a decline in the near term due to weather-related impacts. This year’s El Nino event is now expected to be an especially strong one, and its effects have already begun to be felt across the U.S. Unitil’s service area has experienced warmer-than-average temperatures between October and April during previous El Nino events, resulting in fewer heating degree days than average. The timing of this impact could not be worse for the company’s earnings given that the large majority of its annual earnings are reported in Q4 and Q1 due to its heavy exposure to natural gas, which is primarily utilized for space heating in the service area. This impact could be partially offset by higher-than-average precipitation in the Northeast coastal states, with humidity making it feel colder than it actually is. Overall, however, I expect Unitil’s Q4 earnings in particular to come in under expectations and fall on a YoY basis. Valuation The consensus analyst estimate for Unitil’s EPS in Q4 has held steady over the last 90 days, although the FY 2016 consensus estimate has declined. The FY 2015 estimate has remained at $1.89, while the FY 2016 estimate has decreased from $1.96 to $1.91 over the same period. Based on a price of $34.79 at the time of writing, Unitil’s shares are trading at a trailing P/E ratio of 18.3x and forward ratios of 18.4x and 18.2x, respectively. All three of these ratios are above their long-term averages, with the latter, in particular, approaching a 3-year high. High ratios could be justified in the event that the company offered either an especially high forward dividend yield or strong near-term earnings growth potential. While the forward yield is relatively attractive at 4%, this is offset by a lack of near-term earnings growth potential (a mere 1% in FY 2016 if the consensus estimates are correct) and a negative short-term outlook due to El Nino. Conclusion Unitil reported Q3 earnings that beat on net income despite missing on revenue, although investors were ultimately not impressed. While some of the share price’s subsequent decline can be attributed to profit-taking in the wake of its earlier Fed-induced increase, the fact that the company’s winter outlook has been diminished at the same time due to El Nino is also likely weighing on shareholders. With minimal earnings growth expected in FY 2016, the likelihood that warm Q1 and early Q2 temperatures will have a disproportionately negative impact on Unitil’s earnings, and higher-than-average forward P/E ratios, I cannot recommend the company as an attractive long investment opportunity at this time. El Nino and a potential interest rate hike early next year provide too much potential downside risk, although they could also create a potential buying opportunity given the company’s more favorable long-term outlook. Dividend investors should wait for a falling share price to make the company’s forward yield even more attractive before placing any buy orders.

2 Big Investments Begin To Pay Off For The Laclede Group

Summary Natural gas utility holding company, The Laclede Group, has seen two recent acquisitions pay off in the form of earnings growth following a period of stagnation. The acquisition of Alabama utility, Alagasco, has proven especially valuable due to that state’s favorable regulatory scheme and a likely colder-than-average upcoming winter there. Economic weakness in Missouri and Alabama could reduce the firm’s consolidated earnings growth, however, if it proves to be sustained. A solid dividend history aside, the company’s 3.4% forward yield is not sufficient to overcome economic weakness and high share valuations in making it an attractive investment at this time. The Laclede Group (NYSE: LG ) is a St. Louis-based public utility holding company that operates both regulated and non-regulated natural gas distribution and marketing operations via wholly-owned subsidiaries. In addition to distributing natural gas to more than 1 million customers across its subsidiaries, the company also has 48 Bcf of natural gas and propane storage capacity. The Laclede Group has been on a buying spree in recent years, purchasing in-state peer, Missouri Gas Company, in 2013 and Alabama utility, Alagasco, in 2014. Both moves required it to greatly expand its debt load and caused its earnings to decline on a non-adjusted basis. More recently the acquisitions have begun to deliver earnings growth of their own, however, and the company’s share price is well above its 52-week low (see figure), defying broader sector performance. This article evaluates The Laclede Group as a potential long investment. LG data by YCharts The Laclede Group at a glance The Laclede Group distributes natural gas to customers via three regulated subsidiary utilities. The original is Laclede Gas Co., which is the largest natural gas distribution utility in the state of Missouri with 16,000 miles of main and service lines. It has 642,000 customers in St. Louis and east Missouri as well as 30 Bcf of natural gas and propane storage capacity and a propane vaporization facility. Missouri Gas Energy, which was purchased in 2013, provides natural gas to another 500,000 customers in Kansas City and west Missouri. Finally, Alagasco (aka Alabama Gas Corp.), which is the largest natural gas utility in the state of Alabama, distributes natural gas to 419,000 customers in 200 Alabama communities. The Laclede Group also operates several unregulated subsidiaries, the largest of which is Laclede Energy Resources, which provides non-regulatory natural gas services including marketing, and Laclede Pipeline Co., which transports propane between storage facilities in Missouri and Illinois. The regulated subsidiaries generate the overwhelming majority of the parent company’s earnings, however, reaching 98% in the TTM period. Laclede Gas Co. and Missouri Gas Energy both operate under the same favorable regulatory scheme. The Laclede Group has benefited from this consistency and reported a natural gas utility adjusted EPS CAGR of 14.8% between FY 2010 and FY 2014, with the increase being mostly driven by heavy investment in natural gas infrastructure. The holding company has reported adjusted EPS growth in four of its last five fiscal years, with flat growth being reported for the fifth year. This consistent performance goes back beyond the last five years, with The Laclede Group boasting 70 consecutive years of dividend payments, although its most recent performance has enabled it to provide 12 consecutive years of dividend increases. Its most recent increase of 4.5%, which was announced last November, resulted in a quarterly dividend of $0.46, or a 3.4% forward yield at the time of writing. The company targets a dividend payout ratio of 55%-65%, a range that it has largely maintained over the last five years even as its dividend as increased by 16% over the same period (see figure). LG Payout Ratio (NYSE: TTM ) data by YCharts FQ2 earnings report The Laclede Group reported the results of its fiscal Q2 for the period ending March 31, 2015, in May. The company reported revenue of $877.4 million, up 26.3% YoY, due to the fact that the Alagasco operations appeared on the latest quarter’s income statement. The result missed the consensus estimated by $90 million , however. The strongest performers were the subsidiary utilities, with natural gas utility revenue increasing by 53.5% YoY to $847 million, or 96.4% of total consolidated revenue as a result of the Alagasco acquisition. Natural gas marketing revenue fell by 49.4% compared to the previous year $30.4, however, mainly due to the presence of normal weather (FQ2 temperatures were 10% warmer YoY on average, albeit 6% colder than the long-term average) and lower natural gas prices in the most recent FQ2 than before. Operating income also rose strongly YoY to $157.7 million from $87.2 million. While much of this gain was again due to Alagasco, operating expense only rose by 18.5% YoY to $719.7 million, or $76.5 million less of an increase than was reported for revenue. The Laclede Group reported that its legacy operating income increased by $13.9 million compared to the previous year due to the introduction of new, more favorable rates in Missouri. Consolidated net income came in at $94.4 million, up 80% YoY from $52.2 million (see table). More importantly, EPS came in at $2.18, up from $1.59 the previous year despite the issuance of 11 million common shares to help finance the Alagasco acquisitions in the interim. Adjusted net income, which excluded $1.5 million in one-time acquisition-related expenses and $1.7 million in a fair value adjustment resulting from unrealized derivative losses, rose still higher to $97.6 million from $51.7 million YoY. Adjusted EPS (or “net economic earnings” in the company’s parlance) came in at $2.25 compared to $1.58 YoY, beating the consensus estimate by $0.12. The Laclede Group Financials (non-adjusted) FQ2 2015 FQ1 2015 FQ4 2014 FQ3 2014 FQ2 2014 Revenue ($MM) 877.4 619.6 222.3 241.8 694.5 Gross income ($MM) 394.6 254.4 (59.9) 192.5 289.2 Net income ($MM) 94.4 47.1 (14.9) 11.7 52.2 Diluted EPS ($) 2.18 1.09 (0.34) 0.33 1.59 EBITDA ($MM) 43.2 43.2 43.4 35.0 32.6 Source: Morningstar (2015). The company has been investing heavily in modernizing its existing distribution pipelines, resulting in much higher capex in the previous two quarters than before. It expects its FY 2015 capex to reach $300 million, with half of this being spent on pipeline replacement, up from $170 million in FY 2014. Due to the residual effects of the aforementioned debt increase and secondary equity offering, however, The Laclede Group ended FQ2 with $46.9 million, up from $10.9 million at the end of FQ2 2014. Its current ratio fell sharply over the course of the previous four quarters from 1.29 to 0.75, however, primarily due to a $290 million increase to short-term debt. While the current ratio isn’t nearly as important to regulated utilities with their steady cash flows than non-regulated firms, this is still something for investors to keep an eye on in coming quarters. Long-term debt increased by $903.2 million YoY to $1.7 billion to fund the Alagasco acquisition. Fortunately for investors, this investment yielded a 98% operating cash flow increase YoY, yielding a result of $314 million in the most recent quarter. Furthermore, the company has maintained fairly strong credit ratings ranging from BBB+ to A by S&P, and it has $750 million in consolidated liquidity available from existing credit facilities. $1.7 billion is also not an especially large debt load for a firm of the company’s size, mitigating concerns that rising interest rates later in the year could reduce its earnings. The Laclede Group’s most recent acquisition is more than capable of servicing the large debt taken on to complete it. Outlook The Laclede Group’s management had initially provided guidance of long-term adjusted EPS growth of 4% to 6%. The company now expects to exceed this pace in FY 2015 and possibly FY 2016 on a weather-normalized basis. This earnings growth is to be maintained via $1.5 billion in total capex through FY 2019, or $300 million in annual capex, mainly in the form of distribution infrastructure investment and expansion. The Laclede Group operates under two different regulatory schemes, both of which are favorable in their own ways. Missouri employs a traditional regulatory scheme under which rate cases are filed every three years. This lack of regulatory flexibility is offset by weather-normalization mechanisms and rapid recovery mechanisms for pipeline replacements, the latter of which allows The Laclede Group to recapture infrastructure upgrade costs every six months. The company should expect to quickly see its large planned pipeline replacement costs recaptured via higher rate bases through FY 2019 as a result. Alabama employs a very flexible regulatory scheme under which rate filings are made annually on a forward basis and multiple cost recapture mechanisms are provided. While this flexibility can result in lower allowed ROEs, the state’s scheme currently provides a substantially higher allowed ROE to Alagasco (10.8%) than Missouri provides to either Laclede Gas (9.7%) or Missouri Gas (9.8%). The Laclede Group’s overall achieved ROE has been a cause for concern of late. Missouri was hit hard by the Great Recession as its unemployment rate almost reached the double-digits and the company’s consolidated ROE ultimately peaked at 11.5% in FY 2011 before steadily declining. It didn’t even reach 7% in FY 2013 and FY 2014 and, while this was in part due to one-time acquisition costs that reduced non-adjusted net income, a period of non-existent earnings growth also was responsible. The Alagasco acquisition pushed this above 10% TTM on both adjusted and non-adjusted bases, indicating the wisdom of the move despite its risks. While it would be better still to see the company’s Missouri operations achieve ROEs closer to their allowed ROEs, Alagasco is positioned to drive overall earnings growth for The Laclede Group. This is ultimately important because both Missouri and Alabama have seen their economies weaken of late. The unemployment rate in both states recently increased and are now above the U.S. average after being well below it over the previous five years (see figure). Likewise, GDP growth in both states has slackened and their economies are no longer growing as quickly as the country’s (see second figure). This is especially a concern for the firm’s Missouri operations, as earnings growth disappeared on an adjusted basis when that state’s unemployment rate stabilized. It is too early to say that earnings growth from the Missouri operations will decrease, of course, but it is a potential concern for investors. Missouri Unemployment Rate data by YCharts Missouri Change in GDP data by YCharts Weather-related factors could cause the company’s Alabama operations to be an outsized contributor to its consolidated earnings in the coming quarters due to the presence of El Niño conditions. After missing an expected appearance in 2014, the phenomenon is now expected to be one of the strongest in the last 50 years this winter. El Niño events have historically been associated with above average winter temperatures in the northern half of the U.S. and below average temperatures in the southern half. NOAA reviewed historical events back in the 1990s and determined that Missouri experiences warmer-than-average temperatures in Q4 while Alabama experiences colder-than-average temperatures in Q1 during El Niños. The fact that all of The Laclede Group’s operations reside in the southern half of the country means that even record cold in Alabama would be unlikely to result in a tremendous surge to natural gas demand there, of course (a 47 degree F winter average temp is downright balmy for those of us raised in the Midwest), but it can be expected to boost demand. Whether this increase will offset reduced demand in Missouri remains to be seen, however, and it is possible that the net effect of El Niño on the company’s winter operations is zero. Valuation Analyst estimates for The Laclede Group have increased slightly over the last 90 days in response to the company’s better-than-expected FQ2 results. The FY 2015 adjusted EPS consensus estimate has increased from $3.16 to $3.17 while the FY 2016 estimate has increased from $3.35 to $3.38. Based on its share price at the time of writing of $53.64, the company is trading at trailing P/E ratios of 16.5x and 14.6x on non-adjusted and adjusted bases, respectively, and forward ratios for FY 2015 and FY 2016 of 16.9x and 15.9x, respectively. While lower than for some firms in the gas utilities sector, these ratios are all near the top of their respective 5-year ranges (see figure). The company’s share price does not appear to be undervalued at present, although expected earnings growth in FY 2016 prevents them from being clearly overvalued either. LG PE Ratio ( TTM ) data by YCharts Conclusion Acquisitions of peers in Missouri and Alabama provided natural gas utility holding company The Laclede Group with a substantial earnings boost in Q1 following a period of stagnation. Hindsight makes the latter investment in particular look positive due to Alagasco’s especially favorable regulatory scheme and the prospect of a colder-than average Alabama 2015/2016 winter resulting from a very strong El Niño event. This advantage could be offset by signs of economic weakness in both Missouri and Alabama, although it is too early to say whether or not this development will be sustained enough to negatively impact the company’s expected earnings growth. While consistent dividend growth, favorable regulatory schemes, and large planned capex provide support for management’s earnings growth guidance, conservative investors should require a margin of safety in the form of undervalued shares to compensate for the aforementioned economic weakness and The Laclede Group’s pre-acquisitions ROE weakness. Such a margin is not available at present, however, following share price strength, especially compared to the broader gas utilities sector over the last year. I recommend that potential investors wait for the share price to fall to 14x forward earnings ($47.32 based on the current FY 2016 estimate) before reevaluating the company as a potential long investment. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Northwest Natural Gas: A Solid Dividend Record Doesn’t Overcome Poor Growth Prospects

Summary Northwest Natural Gas offers a favorable dividend yield and very strong dividend increase record to yield-seeking investors. The company’s growth prospects are less attractive, however, due to its poor earnings history, high dividend payout ratio, and relatively low capex plans. The presence of warm weather conditions later in the year could make it difficult for the company to achieve management’s EPS guidance for FY 2015 and FY 2016. Its shares are overvalued and do not provide potential investors with a sufficient buffer to offset its poor prospects for earnings and dividend growth. Potential investors should look elsewhere. The share price of Oregon-based public natural gas utility Northwest Natural Gas (NYSE: NWN ) recently approached a 5-year low (see figure) as investors turned bearish on dividend stocks and the company reported disappointing results for Q4 2014 and Q1 2015. Its shares have vastly underperformed the gas utilities sector as its earnings have steadily fallen since FY 2011, excluding a modest increase in FY 2013. While management’s guidance is for its non-adjusted earnings to continue this downward trend, analysts are forecasting back-to-back increases on an adjusted basis for FY 2015 and FY 2016. This article evaluates Northwest Natural Gas as a potential long investment in light of the current operating environment and these forecasts. NWN data by YCharts Northwest Gas at a glance Headquartered in Portland, Oregon, Northwest Natural Gas provides natural gas and related services to more than 700,000 customers in the western half of that state and southwest Washington. It is Oregon’s largest natural gas utility with 14,000 miles of mains and service lines. While its regulated natural gas utility operations represent its primary business segment, the company also owns 31 Bcf of underground natural gas storage capacity and 2 Bcf of LNG storage capacity, the latter of which could be expanded by an additional 10 Bcf in coming years. Its natural gas operations provide the vast majority of its revenue and earnings, however, reaching 98% in recent quarters. The natural gas operations have also benefited from the presence of a moderately favorable regulatory scheme in Oregon that provides weather normalization and decoupling mechanisms to minimize the impact of extreme weather periods on earnings. Finally, the natural gas operations have also benefited from moderate customer growth, with the total number increasing by 4% over the last five years, due to natural gas having only a 60% market share of the heating market in the company’s service area. Northwest Gas has been a stalwart provider of dividends (see figure), with the company stating that its Q4 2014 dividend increase represented its 59th consecutive annual hike. The company’s forward yield of 4.22% is higher than the gas utility sector median , although this has come at the cost of a dividend payout ratio of 0.85 in the most recent fiscal year, well above the sector average. While many utilities are actively working to increase their payout ratios, the presence of such high ratios over a sustained period indicates that Northwest Natural Gas sees few opportunities for substantial future capex, rate base, and ultimately earnings growth. Further evidence of a lack of growth opportunities is provided by the fact that the company’s annual diluted EPS peaked in FY 2010 and has steadily declined in every subsequent year but one. Dividend growth has slowed to a crawl recently as well, with the most recent increase to $0.465 on a quarterly basis representing a mere 1.1% change over the previous quarter and 7% increase over the previous five years (by contrast, peer Southwest Gas (NYSE: SWX ) recently increased its dividend by 11% ). NWN Dividend (Annual) data by YCharts Q1 earnings report Northwest Natural Gas reported underwhelming results for Q1 in May due to a combination of an unfavorable regulatory decision and warm winter weather. Its revenue fell by 10.8% YoY from $293.4 million to $261.7 million, missing the analyst consensus by $42.2 million. The decline was primarily the result of a 19% YoY decline to the company’s natural gas sales and transportation volumes, which was in turn due to an average Q1 temperature that was 22% warmer than the previous year and 20% warmer than the long-term average. The consolidated revenue number was also negatively impacted by last year’s steep fall in the price of natural gas, which coincided with the expiration of the company’s storage segment’s long-term, high-priced storage contracts. These were ultimately replaced with short-term contracts containing lower prices, pushing the segment’s revenue down by $2.5 million YoY from $7.8 million. Northwest Natural Gas Financials (non-adjusted) Q1 2015 Q4 2014 Q3 2014 Q2 2014 Q1 2014 Revenue ($MM) 261.7 240.3 87.2 133.2 293.4 Gross income ($MM) 136.0 120.5 55.0 74.9 138.2 Net income ($MM) 28.5 28.5 (8.7) 1.1 37.9 Diluted EPS ($) 1.04 1.04 (0.32) 0.04 1.40 EBITDA ($MM) 73.1 79.7 14.9 33.0 94.6 Source: Morningstar (2015). Consolidated operating income fell from $75 million to $53 million YoY. While the impact of the fall in consolidated revenue on gross margin was mostly offset by a 1.3% increase to the number of customers over the trailing twelve month period, the fall in operating income was primarily due to an increase to O&M expenses of $18.7 million. This increase was the result of a regulatory decision to disallow the recovery of $15 million of environmental costs, resulting in a $9 million after-tax charge to the company. The operating income result was boosted to the tune of $21.8 million by the aforementioned weather normalization mechanism, however, offsetting much of the negative impact of the quarter’s warm weather. Net income came in at $28.5 million, down from $37.9 million the previous year. Adjusted for the regulatory disallowance, however, net income came in at $37.6 million. Non-adjusted diluted EPS fell to $1.04 from $1.40 the previous year, while adjusted diluted EPS was $1.37. While only a slight decline YoY, the adjusted result still missed the consensus estimate by $0.14. The natural gas utility segment’s EPS increased by $0.04 YoY while the storage segment’s EPS fell by $0.06 over the same period. Most disappointing to investors was the continued decline of the company’s ROE,which fell to 6.3% TTM. In addition to being well below its FY 2009 level of 9.1%, the trailing result is also substantially lower than the company’s allowed ROEs of 9.5% and 10.1% in Oregon and Washington, respectively. The company’s operating cash flow fell substantially in Q1 from $220.1 million in the previous year to $118.2 million. This was attributed to the receipt in Q1 2014 of a $91 million environmental insurance recovery payment, however. While the cash reserve fell to $5.2 million from $17.9 million YoY, management stated during the Q1 earnings call that the company ended Q1 with strong liquidity, as evidenced in part by the fact that it had only $621.7 million in long-term debt and a current ratio of 0.79, up slightly YoY. Outlook Management affirmed during the Q1 earnings call its FY 2015 EPS guidance range of $1.77-$1.97 on a non-adjusted basis and $2.10-$2.30 on an adjusted basis (the annual adjustment being the same as the Q1 adjustment resulting from the regulatory disallowance). This guidance range assumes that customer growth will maintain its recent pace and that weather conditions during the rest of the year will be the same as the long-term average. Investors should be aware of the sensitivity of both of these assumptions to conditions that are outside of the company’s control, however, given their importance to its earnings. Having recently completed comprehensive safety upgrades and with little in the way of short-term capacity expansion planned, Northwest Natural Gas expects to achieve total capex in FY 2015 of $145 million, down from FY 2012 and FY 2013. Investment in storage capacity and pipeline expansions to meet possible industrial demand growth for natural gas is, in addition to not being certain, still several years out. Earnings growth in the next two years will therefore depend on the service area’s weather and economic conditions. In terms of weather, the El Niño event has finally appeared after going missing last year and federal scientists now believe that it could be one of the strongest such events on record. Great news for drought-plagued California could be bad news for Northwest Natural Gas, as El Niño events are historically associated with warm winter weather in the Pacific Northwest as the polar jet stream is pushed north. An earlier NOAA analysis found that Q1 and Q4 temperatures in Oregon and Washington were much warmer than normal during past events, suggesting that higher temperatures will be present in the company’s service area during the coming winter. While Oregon’s weather-normalization mechanism will mitigate the negative impact of these temperatures on the company’s earnings in the event that they are present, they are unlikely to completely offset them. On the plus side, the economies of Oregon and Washington have greatly improved in recent years after lagging behind the U.S. average. The unemployment rate in both states was higher than the U.S. average from 2010 until 2015, at which point the rates in both states fell below the national average (see figure). Likewise, GDP growth in both states recently moved above the national average (see second figure). Both developments are positive for Northwest Natural Gas since households with steady incomes consume more natural gas and are less likely to miss payments. They also indicate that housing construction will increase, resulting in more potential natural gas customers. Oregon Unemployment Rate data by YCharts Oregon Change in GDP data by YCharts These economic advantages are supported by the presence of much lower natural gas prices in 2015 to date than in the same period of the previous year. Electricity for heat has a substantial presence in Oregon and Washington and part of Northwest’s customer growth strategy is to convince residential consumers to convert to natural gas heating. This process is made easier when natural gas is expensive compared to electricity, as has been the case over the last several months (see figure). Oregon citygate natural gas prices at the time of writing are down 47% from their level a year ago, whereas Oregon’s electric retail rate is 16% higher over the same period. Cheap natural gas hurts the earnings from the company’s storage operations, to be sure, but at least this impact is offset by favorable customer growth conditions. Oregon Electric Utility Retail Price data by YCharts Valuation The consensus analyst estimates for FY 2015 and FY 2016 diluted adjusted EPS have fallen over the last 90 days in response to a recent increase to Oregon’s unemployment rate. The FY 2015 estimate has decreased from $2.24 to $2.19, while the FY 2016 estimate has decreased from $2.31 to $2.26. Based on the company’s share price of $43.37 at the time of writing, its trailing P/E ratio on non-adjusted and adjusted bases is 24.1x and 20.4, respectively. Its forward ratios for FY 2015 and FY 2016 are 19.8x and 19.2x, respectively. All of these are high relative to both the sector trailing average of 17.3x as well as the company’s own historical ranges (see figure). In fact, the upward trend of the company’s P/E ratios is incongruous with its declining earnings over the same period; unlike most of its peers, which have seen their shares’ P/E ratios follow their prices higher, the increasing P/E trend of Northwest’s share has been the result of earnings shrinkage rather than a strong share price. NWN PE Ratio (NYSE: TTM ) data by YCharts Conclusion Natural gas utility and storage company Northwest Natural Gas has been moving in the wrong direction in recent years, reporting steadily lower earnings and achieving ROEs that are well below the results allowed by its regulators. Its main attraction as a potential long investment is its extremely impressive track record of (admittedly small in recent years) dividend growth and decent forward yield. Furthermore, both the company’s management and analysts expect it to break its declining earnings streak and report consecutive annual earnings increases on an adjusted basis for the first time in several years in FY 2015 and FY 2016. I am not convinced that these attributes result in a compelling long argument, however, for two reasons. The first is that the earnings growth estimates are predicated on continued customer growth and average temperatures over the next six quarters. While the former is possible, a recent increase in Oregon’s unemployment rate aside, all indications are that Q4 and Q1 in the company’s service area will be substantially warmer than normal, negatively impacting its earnings in those quarters. Furthermore, the company’s share valuations have been pushed to an overvalued level due to its falling earnings in recent years, preventing potential investors from acquiring a buffer against El Niño negative earnings impacts. Between minimal capex growth, unfavorable weather conditions, and overvalued shares, I do not consider Northwest Natural Gas to be an attractive long investment at this time. Yield-seekers may wish to consider it, but I recommend that they instead consider those utilities with superior growth prospects such as IDACORP (NYSE: IDA ), Alliant Energy (NYSE: LNT ), or DTE Energy (NYSE: DTE ).