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Avinash Gandhi

ATO AT A GLANCE

P/E ► 12.5 AVG EV/EBITDA ► 6.64 AVG ROA ► 5.7% AVG ROE ► 9.7% AVG Debt to Equity ► 1.78 AVG Current Ratio ► 1.24 AVG Interest Coverage Ratio ► 3.13 AVG

 

 

 

 

 

 

Atmos Energy is the largest gas utilities company in the U.S. The company operates gas utilities in 12 states: Texas, Kentucky, Louisiana, Mississippi, Colorado, Kansas, Tennessee, Georgia, Illinois, Iowa, Missouri, and Virginia, though it has more customers in Texas than in the other 11 states combined.

As a utilities operator, Atmos' businesses are subject to government price regulations, which vary from state to state; generally, these regulations put a ceiling on the price that utilities companies can charge customers, as well as on the returns a company is allowed to gain from its holdings. Regulation is meant to ensure that utilities services are accessible but can still turn a profit, but they don't allow utilities like Atmos to pass cost fluctuations on to consumers as quickly as they occur. Utilities companies can lobby and negotiate with regulators to gain more favorable rules, but unfortunately for Atmos, the company's main operating areas are in Texas, where regulations are strict.

Volatile natural gas costs can make Atmos's margins unpredictable, since the company's costs change while regulations keep prices fixed. The weather also plays a large part in demand for natural gas, which is used for heating, so unseasonable weather patterns can lead to demand fluctuations as well. Fortunately for Atmos, the company operates one of the largest pipelines in Texas, with links to major oil and gas reserves like the Barnett Shale. The production business insulates the company against the effects of good weather and fluctuating gas use on its utilities segment. Atmos doesn't have any real competition in its service areas, but the company competes on a large scale with other utilities companies like AGL Resources.

Business and Financials

Atmos energy is a holding company engaged in the transportation, storage, marketing, and distribution of natural gas; its gas utilities business is the largest in the U.S., operating in 12 states and serving over 3.1 million customers. In 2007, the company moved 432.4 Bcf of natural gas, and operated over 76,000 miles of pipeline that carried 699 Bcf of natural gas.

The company's operating revenue fell from 2006 to 2007 by almost $300 million, thanks to milder weather and lower gas use. Operating income, however, grew by around $16 million.

Modern Gas Utilities Pay Lower Dividends

In the past, utilities paid high dividends because stringent government regulation kept them from having much growth potential. This made them very sensitive to short-term interest rates, as higher interest rates made government bonds more attractive as investments; more people investing in government bonds meant less people buying utilities stock, causing shares to fall. Now, however, the combination of deregulation and the diversification of gas utilities into energy trading, generation, and other businesses mean that the companies have greater growth potential and less exposure to interest rate effects. Now, though utilities still pay dividends, these are lower than in the past - because utilities companies now have a chance for strong share growth, so high dividends are no longer necessary to serve shareholder interests.^[1][2]

Table Breakdown of ATO's Revenue Streams

Trends and Forces

Atmos Inherited the Potentially Lucrative Texas Intrastate Pipeline

Atmos's 2004 acquisition of TXU Gas for $1.9 billion made it the largest gas utilities company in the country. It also allowed the company to acquire 26,400 miles worth of intrastate pipeline, 6,800 of which are within Texas, and deliver 400 Bcf of natural gas annually.^[3] This infrastructure network is a boon to Atmos because it diversifies the company's revenue mix; pipeline operators are less vulnerable to natural gas use fluctuations because pipeline operators can still charge companies to move their gas to storage facilities in times of low demand. Furthermore, the violent nature of the Gulf makes onshore reserves in the region more valuable, as they risk fewer natural damages. The Texas intrastate pipeline is connected to some lucrative onshore reserves, including the Barnett Shale, which reached an annual natural gas production 1,078 Bcf in 2007.^[4]

Government Regulation of Gas Distribution Gives the Company less Control over its Margins

Utilities tend to be highly regulated business in the U.S., with the national government setting transmissions rates and state governments setting electric and gas distribution rates. These rules are designed to ensure both profitability for the company and accessibility for the consumer; since most utilities are natural monopolies, thanks to the high cost of infrastructure installation, government regulation is in place to prevent utilities companies from hiking up rates for a good which can be considered a necessity (especially in the winter). Unfortunately for gas utilities, these regulations often hold them back from achieving potential revenues and profitability by preventing them from charging delivery rates that the level of demand would really allow. Regulation can also cause the company's margins to be very volatile, as lobbying the government is the only way the company can control its prices. Unfortunately, natural gas costs fluctuate very rapidly, but it takes a long time for Atmos's lobbyists to convince state and regional regulators to raise the price ceiling. For the most part, regulators will only raise rates if the company can show that something, whether rising costs or inflationary pressure, is causing their margins to shrink to unfair levels.

Atmos's Geographic Spread Reduces its Exposure to Regulatory Risk

Utilities regulations vary from state to state and, sometimes, region to region. Atmos operates in Texas, Kentucky, Louisiana, Mississippi, Colorado, Kansas, Tennessee, Georgia, Illinois, Iowa, Missouri, and Virginia - twelve different states with twelve different regulatory structures. Most regulatory schemes limit the amount a gas company can charge for a unit of gas (such as a cubic foot). They also assess the value of the assets and property owned by a utility and determine what rate of return on this "rate base" is fair both to the company and the consumers. If Atmos wants to raise rates or its allowed rate of return in any given state, in order to pass on rising costs or earn higher profits, the company must work with state regulators. On the other side of the table, consumer groups lobby the same regulators to prevent rate hikes and work toward lower prices.

Atmos has 57% of its customers in Texas, making it most vulnerable to Texas regulators. Unfortunately, the average of the three authorized rates of return that Atmos is subject to in Texas, 8.31%, is lower than the average rate of return stated by most of Atmos' other states - 8.6%.^[5] The rest of Atmos' customers, however, are divided pretty well among its other states of operation, making it less vulnerable to the whims of any one legislative or regulatory body.

Atmos' Revenues Follow Seasonal Patterns; Unusual Seasons Mean Unusual Sales

Natural gas is used most commonly in home heating systems, making its demand partially dependent on the temperature outside. Since Atmos operates on a different fiscal calendar, in which its first quarter ends December 31st, its revenues follow a different quarterly pattern than competitors. For Atmos, first- and second-quarter revenues tend to be higher than third- and fourth-quarter revenues because late fall through early spring are much colder than late spring through early fall. Atmos' gas delivery segment saw 2007 revenues of $964 million (1Q), $1,461 million (2Q), $548 million (3Q), and $385 million (4Q)^[6], effectively illustrating how cold temperatures lead to higher gas revenues. This temperature dependence also means that unusual seasonality has a real effect on the company's operations; warmer winters, a predicted outcome of global climate change, will damage the company's revenues by decreasing demand at a key part of the year.

Incidentally, the gas utilities demand cycle is exactly opposite that of electric utilities, who see higher demand in warmer months because air conditioning units are electrically powered.

Fluctuating Natural Gas Prices Make Atmos' Margins Much Less Predictable

Atmos is not a natural gas exploration and production company, so it must purchase the natural gas it sells from other companies. Atmos purchases its natural gas from suppliers like Anadarko Petroleum, BP, ConocoPhillips, and Devon Energy (among others). Natural gas prices are extremely volatile; in 2007, Atmos paid an average of $8.09/Mcf, in 2006 it paid $10.02/Mcf, and in 2005 it paid $7.41, though within these years prices varied even more greatly. Though Atmos tries to hedge against these fluctuations by purchasing long-term supply contracts, most E&P companies are loath to sell at fixed prices natural gas prices are trending upwards. Furthermore, utilities regulations mean that Atmos has a harder time passing rising costs onto consumers, giving the company less control of its margins.

Competition

Atmos operates in Texas, Kentucky, Louisiana, Mississippi, Colorado, Kansas, Tennessee, Georgia, Illinois, Iowa, Missouri, and Virginia. It is not only a gas utility but also a natural gas marketing, pipeline, and storage company. In the markets it serves, the company has little real competition thanks to the high cost of infrastructure installation; government regulation, however, keeps the company from charging the rates and turning the profits that would otherwise be expected of a monopolist that sells products with inelastic demand. On a larger scale, Atmos competes with other gas utilities like:

• AGL Resources - AGL Resources operates its gas delivery services in Florida, Georgia, Maryland, New Jersey, Tennessee, and Virginia.
• Energen - Energen is an energy holding company that operates in a variety of businesses, from oil exploration and production to natural gas marketing and distribution. Its utilities business is the largest gas distributor in Alabama.
• Equitable Resources - Equitable Resources is a vertically integrated natural gas company that operates from the upstream to natural gas distribution. Its gas utilities operate in Pennsylvania, West Virginia, and Kentucky.
• National Fuel Gas Company - NFG is a diversified natural gas company that does exploration, production, transportation, marketing, and distribution of gas; its utilities segment operates in New York and Pennsylvania.
• ONEOK - ONEOK is a transport and distribution company that acts as a utility in Oklahoma, Kansas, and Texas.
• Sempra Energy - Sempra is a gas and electric utilities company in California.
• Southern Union Company - Southern Union is engaged in the storage, transport, production, and refining of [[natural gas; its utilities business operates in Missouri and Massachusetts.
• National Grid Transco - National Grid is a gas and [[utilities company that operates in the United Kingdom and the United State; in the U.S., it operates in Rhode Island and New York.

References

1. ↑ Business Week: "Utility Stocks With Plenty of Spark"
2. ↑ USA Today: "Utilities funds turn into power players"
3. ↑ BNET: "Atmos Energy Announces $1.9 Billion Acquisition of TXU Gas to Create Country's Largest Pure-Play Natural Gas Utility"
4. ↑ Business Press: "Barnett Shale hits 1 trillion cubic feet of gas milestone"
5. ↑ ATO 2007 10-K, Page 8, Calculated by averaging authorized rates of return
6. ↑ ATO 2007 10-K, Page 116
7. ↑ ATG 2007 10-K
8. ↑ ATO 2007 10-K
9. ↑ EGN 2007 1-K
10. ↑ EQT 2007 10-K
11. ↑ NFG 2007 10-K
12. ↑ OKE 2007 10-K
13. ↑ SUG 2007 10-K
14. ↑ SRE 2007 10-K
15. ↑ Equitable Resources: Equitable Utilities: Equitable Gas
16. ↑ Reuters Full Description: National Fuel Gas Co
17. ↑ Reuters: Full Description: National Grid Transco