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Avinash Gandhi

EQT AT A GLANCE

P/E ► 40.4 HIGH EV/EBITDA ► 8.85 AVG ROA ► 4.3% AVG ROE ► 6.7% AVG Debt to Equity ► 1.69 AVG Current Ratio ► 1.48 HIGH Interest Coverage Ratio ► 7.10 AVG

 

 

 

 

 

 

EQT Corporation, formerly known as Equitable Resources, produces and sells natural gas. It earns 28% of its revenues through its natural gas and oil exploration and production business, 26% through its marketed natural gas segment, 23% through its residential gas deliveries, and the rest through various other businesses like natural gas transportation. The income it earns from its E&P business, however, is larger than the combined income of the rest of its segments.

Its petroleum business is the largest landholder in the Appalachian basin; while other producers in the region must spend millions on exploring for new reserves, EQT has drilled no exploratory wells in the past three years and still has a reserve life of 32 years. Decreasing world production and increasing world demand have driven oil prices through the roof and caused natural gas prices to fluctuate erratically, though the general trend has been upward. The company sells its petroleum on the open market because it can get higher profits.

The company's oil and gas business reduces its exposure to the downsides of its utilities business: state-regulated rates and income that rises in the winter and goes negative in the summer. Current conditions in the oil and gas markets mean that EQT's margins are significantly higher than other gas utilities; despite the negative effects of rising gas costs on utilities' margins, regulation keeps the company's returns at a steady rate, while margins growth in the oil and gas business allows the company to keep its dividends steady. Since infrastructure for utilities companies are expensive, Equitable Utilities doesn't have any real competition; in the petroleum sector, it competes with the oil majors, as well as smaller independent production companies like Devon Energy, EnCana, and Chesapeake Energy.

Business and Financials

EQT Corporation is a holding company with two main business segments. Equitable Supply engages in onshore upstream oil and gas production and gathering, and is the largest landholder in the Appalachian basin, with reserves in Kentucky, West Virginia, Virginia, Pennsylvania, and Ohio.

Equitable Utilities engages in oil and gas transportation, and natural gas marketing and distribution. Its distribution group, Equitable Gas, operates in southwest Pennsylvania, northern West Virginia, and eastern Kentucky, serving over 274,000 customers.

In 2007, the company earned revenues of $1.36 billion, and had operating income of $257.5 million.

Equitable Pays Steady 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.^[2][3] Most gas utilities, however, pay very steady dividends because regulation keeps their income relatively steady; Equitable Resources has paid $0.22 per share every quarter for two years, up from $0.21 in 2005.^[4]

Trends and Forces

State Regulation of Gas Distribution Guarantees Equitable Utilities Profits - at the Cost of Low 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, but often hold back utilities companies, like Equitable Utilities, 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 utilities 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.

Equitable Resources Relies on its Upstream Business to Bring Up its Margins

EQT Corporation earns 28% of its revenues through its natural gas and oil exploration and production business, 26% through its marketed natural gas segment, 23% through its residential gas deliveries, and the rest through various other businesses like natural gas transportation. The upstream segment (Equitable Supply), however, earned $263.5 million in operating income while all the rest of the company's businesses, grouped into Equitable Utilities, earned just $113.4 million^[5]. The low level of utilities, marketing, and pipeline incomes are due to the regulation of those industries; the government essentially guarantees income, but keeps it at a relatively low level. Oil and gas sales, on the other hand, have much higher margins.

Since both oil and natural gas are commodities, Equitable Supply's margins are subject to the volatility of each products' prices. Oil and gas prices have fluctuated heavily over the past few years, though the most recent trend is a rise in prices, with a barrel of oil trading in international market over $100. Because both are nonrenewable forms of energy (they will eventually run out), slowing discoveries of new sources combined with increasing pricing has led to speculation that production is approaching peak oil quantities. Whether this is true or not, oil and gas are commodities: one company's gas can only be differentiated from another company's gas based on price. While Equitable Supply currently benefits from high prices, the profitability of the current market will drive increased exploration and production, which could eventually cause prices to fall and margins to drop.

Equitable is Putting its Money into Upstream Expansion

Equitable Utilities spent just $87.8 million on capital expenditures in 2007; Equitable Supply spent $715.7 million, over eight times more. This could indicate that the company is trying to shift its focus to its E&P segment, though rising oil prices have been driving oilfield services and equipment costs up, so the level of growth the company is aiming for could be overexaggerated. In the current high-price environment, though, petroleum sales are extremely profitable, and already make up most of the company's income.

Proved reserves as high as 2,682 Bcfe (45% of which are undeveloped) and a yearly production of 83 billion cubic feet equivalent^[6] mean Equitable Supply has 32 years of production left at current production; increased capital expenditures means that the company is planning in increasing output to take advantage of the current price level. As the largest acreage holder in the Appalachian basin, Equitable Supply has the ability to double production and still not need to replace reserves for another 16 years, and its large network of infrastructure for "gathering" (moving gas from wells to transportation pipelines) allows it to grow its pipeline network and remove some of the transport bottlenecks from the region. With steady cash flow coming from its regulated utilities segment, Equitable will have an easier time investing in becoming an upstream and midstream oil and gas company.

Competition

EQT Corporation competes in the upstream oil and gas business with industry powerhouses like BP, Chevron, Exxon Mobil, ConocoPhillips, and Royal Dutch Shell - the oil majors. It also competes with a number of independent oil & gas companies like Chesapeake Energy, Devon Energy, and EnCana.

The company's gas utilities operate in Pennsylvania, West Virginia, and Kentucky. In the markets it serves, Equitable Resources 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, EQT competes with other gas utilities like:

• AGL Resources - AGL Resources operates gas delivery services in Florida, Georgia, Maryland, New Jersey, Tennessee, and Virginia, and has close relationships with twelve different gas marketing companies.
• Atmos Energy - 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.
• 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 i
• 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. ↑ EQT 2007 10-K
2. ↑ Business Week: "Utility Stocks With Plenty of Spark"
3. ↑ USA Today: "Utilities funds turn into power players"
4. ↑ Business Week: Equitable Resources
5. ↑ EQT 2007 10-K
6. ↑ EQT 2007 10-K
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