Northwest Natural (NWN) Q3 2023 Earnings Call Transcript

Northwest Natural (NWN -0.88%)
Q3 2023 Earnings Call
Nov 03, 2023, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning or good afternoon, and welcome to the Northwest Natural Holdings Company Q3 2023 earnings call. My name is Adam, and I'll be your operator for today. [Operator instructions] I will now hand the floor over to Nikki Sparley to begin. So, Nikki, please go ahead, when you are ready.

Nikki Sparley -- Director, Investor Relations

Thank you, Adam. Good morning, and welcome to our third-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 it 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, chief executive officer; and Brody Wilson, CFO, vice president, treasurer, and chief accounting officer. David and Brody 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.

David Anderson -- Chief Executive Officer

Well, thanks, Nikki, and good morning, everybody. Welcome. I'll start today with highlights from the quarter and then turn it over to Brody to cover the financials. I'll wrap up the call with a few updates on our decarbonization initiatives in our gas utility and recent news at our water and renewable companies.

The company continues to operate very well during the year and posted strong financial results. We reported net income of $1.37 per share for the first nine months of 2023 or a 20% increase, compared to $1.14 per share for the same period last year. New rates in Oregon drove results of the natural gas utility along with customer growth and lower pension expense. A few comments on the economies where we serve.

We continue to see positive momentum in the local job markets related to our gas utility service territory. Oregon's unemployment rate remained at 3.5% in September 2023, below the national rate of 3.8%. Unemployment rates in our highest-growth water service territories range from 2.7% in Idaho to 4.6% in Texas. Both of those are from August 2023, the latest date that we have that information.

The county where we operate in Texas experienced a 4.3% population growth in the latest census data in Coeur d'Alene, Idaho posted nearly 2% growth. These factors translated into good customer growth. Collectively, our gas and water utility customer base grew by 4% or approximately 33,000 meters over the last 12 months ending September 2023, that included more than 5,200 gas customers and approximately 28,000 water customers, mainly driven by six water acquisitions that we closed during the year. Last week, we received approval for a rate reduction through our annual purchase gas adjustment in Oregon and Washington, which related to lower natural gas prices.

For Oregon customers, rates included reimbursement for two renewable natural gas facilities and three offtake RNG agreements. For this upcoming heating season, the average Oregon residential customer will see a 9% drop in rates, while Washington customers will see a 14% drop. On top of that, Oregon customers can expect to see a bill credit of approximately $30 million in February 2024. Over the last 20 years, we've credited Oregon customers' bills with savings totaling almost over $235 million.

Despite inflation nearly $3 billion of investment in the system, customers will be paying 8% less for their natural gas bills this winter than they did 15 years ago. You can't say that about many things these days. It is gratifying to be able to provide these savings and continue to provide affordable energy to our customers. And finally, this morning, I'm pleased to report that in the fourth quarter, the Board approved a dividend increase making this the 68th consecutive year of annual dividend increases.

Northwest Natural Holdings is one of only three companies on the NYSE with this outstanding record. With that, I'll turn it over to Brody to cover the financials. Brody?

Brody Wilson -- Chief Financial Officer

Thank you, David, and good morning, everyone. I will begin by discussing the highlights for the quarter and year-to-date 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%. As a reminder, Northwest Natural's earnings are seasonal with a majority of revenues and earnings generated in the first quarter and fourth quarter during the winter heating months.

For the third quarter, we reported a net loss of $23.7 million or $0.65 per share, compared to a net loss of $19.6 million or $0.56 per share for the same period in 2022. At the gas utility, earnings reflected higher operating expenses and interest expense, partially offset by new rates in Oregon and Washington. Utility margin in the Gas Distribution segment increased $5.3 million, mainly from new rates, a gain on gas costs and customer growth. Utility O&M increased $5.5 million, reflecting higher payroll costs, information technology and contract labor costs as well as the amortization of deferrals.

The majority of these incremental costs were anticipated and are being recovered through our new rates. Other income increased $3.2 million, primarily from lower pension expense and higher interest income from invested cash. Interest expense increased $3.3 million due to higher debt balances and interest rates. For the first nine months of 2023, we reported net income of $49.2 million or $1.37 per share, compared to net income of $38.4 million or $1.14 per share for the same period in 2022.

The $0.23 or 20% increase in earnings per share is largely the result of a $0.35 increase for our gas utility related to new rates in both Oregon and Washington. This was offset by a $0.12 per share decline in our other businesses. A few more details on the gas utility results. Utility margin increased $46.1 million related to new rates in Oregon and Washington, which contributed $36.2 million.

Gains on gas costs added $4.8 million and customer growth provided $3.1 million. Gas Utility O&M increased $22.6 million, reflecting higher payroll information technology and contract labor costs as well as the amortization of deferrals. Again, the majority of these O&M increases are being recovered through rates. Utility depreciation and general taxes increased $7.3 million due to additional capital investments.

Other income increased $8.9 million, driven by lower pension costs and higher interest income. Interest expense increased $9.4 million primarily due to incremental long-term debt financing. Net income from our other businesses decreased $4.1 million from higher interest expense. For the first 9 months of 2023, cash provided by operating activities was over $300 million.

Year to date, we've invested $243 million in our systems related to safety reliability, and technology. Nearly 90% of those capital investments were for the gas utility. Cash provided by financing activities was $80 million. Like many companies, we're managing higher financing costs in the current inflationary environment through a variety of measures, including carefully prioritizing work and diligently managing our costs.

Overall, we continue to be in a solid financial position. Our objective remains to keep our balance sheet strong with ample liquidity to support working capital needs and growth. 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.

With that, I'll turn the call back over to David.

David Anderson -- Chief Executive Officer

Thanks, Brody. Turning to an update on the gas utility decarbonization activities. As we've said numerous times, we believe climate change requires rapid innovation but doing so in a way that ensures energy system reliability and frankly, true emissions reductions. It's important to remember our starting point.

Northwest Natural has one of the tightest systems in the nation, and we use that system to deliver 50% more energy than any other utility in Oregon. In fact, during winter peak demand periods, our system delivers about twice as much energy as the electric system. Natural gas, our residential commercial customers use accounts for just under 7% of Oregon's greenhouse gas emissions, which are low to begin with. We believe that's an efficient starting point, but we're working to reduce that number even further.

We believe the combination of decarbonization measures that include energy efficiency, renewable energy, carbon offsets, and carbon capture are needed in a low-carbon future. Replacing conventional natural gas over time with renewable natural gas and clean hydrogen is central to achieving that vision. I'm proud that for the third year in a row, renewable natural gas as part of our energy stack and we've begun procuring -- excuse me, begun recovering those costs through our purchased gas adjustment for Oregon customers. Most recently, our investment in the Dakota City renewable natural gas facility was approved by the Oregon Commission and included in rates on November 1st.

Our team continues to pursue renewable natural gas investments and offtakes for our customers. We're seeing other countries make promising headway here, too. One available is Denmark. Impressively, Denmark is already delivering nearly 40% renewable natural gas in its system.

By 2030, it expects 100% of the natural gas system to be sourced entirely from renewable natural gas and other green gas resources, something that we hope to achieve to do. We believe hydrogen is also part of the long-term energy future. To that end, we're working on several clean hydrogen pilots with partners based in the United States and in Europe. Currently, our focus is on implications for industrial and commercial customers to help them meet their decarbonization goals.

Hydrogen blending is also viable. Several utilities have operated for decades with blends in their pipelines. For example, Hawaii Gas routinely reports an approximately 12% blend and Singapore gas company touts consistently over 40% hydrogen in their system. Right now, our engineering team is working on blending 20% hydrogen at our Sherwood operations and training center after achieving 15% blending levels last year.

So far, our testing has been positive. Our team is also looking at new technologies, including carbon capture and sequestration and ground source heat pump systems with natural gas backup, just two additional ways to support key heating needs while reducing emissions. I'm excited about these advancements. We'll continue to work on multiple fronts to advance decarbonization efforts for our customers.

Moving now to an update on Northwest Natural Renewables. Through this business, we're focused on providing cost-effective solutions to help a variety of sectors decarbonize using existing waste reframes and renewable energy sources. The renewable natural gas business represents an opportunity for us to add earnings and cash flows under long-term term contracts commensurate with our overall strategy. As you may remember, Northwest Natural Renewables first project is with EDL, who is developing Two production facilities designed to convert landfill waste gases to renewable natural gas.

Northwest Natural Renewables has contracted to invest approximately $50 million in this facility and obtain a 20-year supply of renewable natural gas produced by these facilities once they are commercially operational. Construction on both facilities has been completed, operations have begun and the commissioning phase is underway. Right now, the team is working through unexpected issues with the conditioning equipment. And unfortunately, that's causing a delay in achieving full operations.

Once operating, we still expect steady cash flows and earnings from the long-term offtake agreements and we've negotiated with investment-grade parties. Turning to an update on Northwest Natural Water. We continue to execute on that growth strategy. In October, Northwest Natural Water closed the acquisition of Rose Valley Water Company located in Peoria, Arizona, a major suburb of Phoenix.

That acquisition added 2,400 connections and provides another entry point into a high-growth region. Recently, we also closed -- or we closed another O&M service business acquisition called Hiland Water, which supports approximately 6,400 connections across Oregon. And in April this year, we launched a water services business and today, we support over 16,000 connections. This is a strong platform that can be scaled in the coming years.

At the same time, we continue to invest in our existing water and wastewater utilities to provide clean water and reliable service. To support these investments we're filing general rate cases as necessary. To date, we've successfully completed multiple rate cases in Idaho, Oregon, and Washington, building constructive relationships with our regulators. Recently, we filed a general rate case at our largest utility, Foothills in Arizona.

We look forward to working with the Arizona Commission and SAP in the coming months. We continue to see the increased levels of business development activity and remain excited about the investment potential for this business. In summary, I'm pleased with this management team and our employees. We've made substantial progress on major initiatives in 2023.

I look forward to our strong team executing on these opportunities, not only for the remainder of this year but for years to come. So thanks for joining us this morning. With that, Adam, I'd be happy to open it up to questions if there are any.

Questions & Answers:

Operator

[Operator instructions] And our first question today comes from Julien Dumoulin-Smith from Bank of America. Julien, your line is open. Please go ahead.

Unknown speaker

Hi. Good morning, team. This is Tanner stepping in for Julien. Could you talk about the acquisition pipeline or rather kind of the availability of attractively priced opportunities you're seeing in the marketplace on the water side? And what's your sort of run rate appetite perhaps for these types of opportunities?

David Anderson -- Chief Executive Officer

Yes. In general, I'll turn this over to Justin, and if I need to, I'll come up with some other comments. Justin, I'll turn it over to you.

Justin Palfreyman -- Vice President, Strategy and Business Development

Yes. Thank you. So we continue to have a robust pipeline of acquisition opportunities on the water front. I think our run rate, if you look over the last five years, we're executing on somewhere between five and eight acquisitions per year, and they range in size.

Most of them are relatively small, and then some of them are a bit larger and we expect that to continue. We still see robust activity there even throughout this market.

Unknown speaker

Great. And then kind of more of an actuarial question here. Could you provide some color on the other income line with respect to the pension? Obviously, you had the lower pension expense. This quarter, what is the type of treatment of the expense in rates? Is it smoothed out over five years? Could you just kind of provide some color there?

Brody Wilson -- Chief Financial Officer

Yeah. This is Brody. As far as the ratemaking goes, we do put in the past year for the rate cases, what our expected pension costs will be and that then gets approved in the rate case. So that would have been effective for us last November.

As we look forward in the current year, we are experiencing a bit of a benefit and that really is quite technical actuarial calculation issue that relates to how gains and losses get amortized through pension expense. And it so happens that gains and losses being amortized in the current year there aren't any being amortized because of the fact that the gains and losses didn't fall outside of a corridor that the actuaries calculate. So for us, we're seeing a bit of a benefit there. Historically, we would say that typically, there are some gains and losses that would flow through that number.

We're not seeing that this year. We're seeing just a large portion of -- or just our service cost hitting us right now.

Unknown speaker

All right. Great. Thank you very much. Have a great weekend, guys.

Brody Wilson -- Chief Financial Officer

Thanks, Tanner.

Operator

The next question comes from Selman Akyol from Stifel. Your line is open. Please go ahead.

Selman Akyol -- Stifel Financial Corp. -- Analyst

Thank you. Good morning. Just a couple of quick ones for me. So as we think about the hydrogen opportunity that you guys are pursuing, I guess, you've been doing some testing for a while.

You obviously referenced a couple of other utilities that have it. And I'm just wondering how long do you think before you introduce it into the system if things keep going the way you anticipate?

David Anderson -- Chief Executive Officer

Kim, do you want to take that?

Kim Rush -- Senior Vice President, Operations and Chief Marketing Officer

Well, we've expanded the work that we're doing on hydrogen. As you may know, we've been doing blend testing at our Sherwood facility for a couple of years. Now we started out at a 5% plan, and we consistently step that up, both testing on our own system but testing on end-use equipment as well. We're at 15% now and our goal by the end of this year or the first quarter next year is to step that up to 20%.

And we're doing that to demonstrate not only sort of the efficacy of the blends. We're not seeing any kind of issues and we didn't expect too based on the blending we know that's already taking place around the world. But we're also doing it to invite an elected official and other stakeholders to see the blending in action so that they can sort of touch and feel this new approach and new technology. In addition to the blending extra -- as we've mentioned before, we're pursuing a number of pilots to test out methane pyrolysis equipment, so that turquoise hydrogen where you're basically taking natural gas producing hydrogen and then through methane pyrolysis that creates a solid carbon output.

And that's basically sequesters the carbon. You can then use that output at solid carbon in a secondary market like asphalt. And so we're really excited about that technology because we're seeing a number of different companies coming into the market with solutions that range in sizes. The first pilot, we're actually installing the equipment next week is with modern hydrogen at our central facility.

We're really excited about getting that off the ground. But we're also looking at a new technology from a Finnish company called Hycamite. And the reason we're excited about that is it has the potential to blend -- or to blend and to produce that solid carbon at a much larger scale. So it could be a really nice solution for our large customers.

So I guess the bottom line is, our view is that we're going to have hydrogen blending directly into the system, but we're also really excited about this methane pyrolysis because you don't have to change in use equipment, and it has the potential to have a pretty low-cost point. So a number of pilots underway. We're also continuing with the CarbinX pilot that we've talked to you about. Similar, but the byproduct is kind of a pearly substance that you can put in soaps.

Again, that has the potential to be a smaller end-use equipment solution. So I think that there's no doubt, hydrogen is going to be part of the solution set. I mean, we're already looking at hydrogen opportunities for procurement for our existing customers. And to the extent that hydrogen can be in a measurate price point with RNG procurement we're going to be looking at that.

So I would say over the next five to seven years, we expect hydrogen to be more of a solution for our system. But we have to start now, and that's what we're excited about.

David Anderson -- Chief Executive Officer

We're going to move as quickly as we can Selman to be just very frank, and I would be disappointed if it took that long personally.

Selman Akyol -- Stifel Financial Corp. -- Analyst

Understood. And then also, you talked about where you -- I thought you were doing some pilot tests on small industrial scales with EDL. Anything coming out of that?

Kim Rush -- Senior Vice President, Operations and Chief Marketing Officer

Just the technologies that I mentioned, we have two or three of our industrial folks that were under NDA to test some different kinds of hydrogen applications. We did pull up a new team, a decarbonization services team that really are going to be specializing in sort of bespoke solutions for our industrial customers because, as you know, every process and equipment on an industrial customer site is different. They need their sort of own solution set. So we're excited about that team and already working with a handful of customers on some potential pilots.

Selman Akyol -- Stifel Financial Corp. -- Analyst

Got it. All right. Thank you very much.

Brody Wilson -- Chief Financial Officer

Thanks, Tom, and have a great weekend.

Operator

The next question comes from Chris Ellinghaus from Siebert Williams Shank. Chris, your line is open. Please go ahead.

Chris Ellinghaus -- Siebert Williams -- Analyst

Hey, everybody. Just a question on water. Nevada has some sort of troubled systems there. Is that a viable state for you? And have you looked at it in the past?

Justin Palfreyman -- Vice President, Strategy and Business Development

Hi, Chris. This is Justin. We have looked at that state in the past and certainly something that's on our radar. To date, we have not found anything that's been met our investment criteria, if you will, but that doesn't mean that in the future, an opportunity won't emerge.

Chris Ellinghaus -- Siebert Williams -- Analyst

OK. David, you talked about Singapore being at 40% for hydrogen. Do they have significant embrittlement issues there? And what is the longer-term outlook for how do you mitigate the embrittlement question?

David Anderson -- Chief Executive Officer

I'll let Kim take that one.

Kim Rush -- Senior Vice President, Operations and Chief Marketing Officer

Sure. I think that there's a lot of work that's been done and being done on embrittlement. And it really -- there's a lot of factors that you have to sort of assess. It's the type of the system that's slowing hydrogen.

For example, on our system, we have a low-pressure system. About 50% of our system is Poly. We have no cast iron or bare steel, so we have that steel coated pipe. So when we're looking at the research that's been done on embrittlement, it's important to know that the research we've been seeing is its potential when you're flowing hydrogen to go from maybe a 100-year pipe life down to 80-year pipe life.

So it's not an issue of any kind of short-term embrittlement that people are concerned with. It's really what is that pipe life length. And again, if potentially you're going from 100 to 80-year pipe length, we don't see that as an issue. I don't know the Singapore system, particularly, we could certainly find those characteristics for you.

But I think the point is that hydrogen blending has been happening around the world in different systems at different volumes. We know there's several blending projects, one in the U.K., they've been blending home development with 20% hydrogen. There's a Germany project that's just started with a 30% blend. There's another U.K.

project where they're going to take a low-pressure system like ours and just begin blending 100% to test those issues around pipe and fittings and make sure that they're learning sort of what is that higher-end blend and how quickly could we potentially retrofit if we needed to, certain parts of a low-pressure system to get to those larger blend levels.

Chris Ellinghaus -- Siebert Williams -- Analyst

OK. And can you give us a little more detail about the two RNG projects with the conditioning issues? Can you give us some sense of what that's all about?

Justin Palfreyman -- Vice President, Strategy and Business Development

Yes. This is Justin. Happy to talk a little more about that. So as David mentioned in his prepared remarks, construction is complete at the two facilities what the EDL team and their contractors are working on right now is really a component of the conditioning equipment is the CO2 removal process and the technology related to that.

Trying to get that to a point where it can support the specified volumes for the facilities. And right now, they're having a little bit of a challenge getting that up to the full volume metric levels. And so they're working through some of the technical aspects there to determine exactly what the fix should be, but we expect that that will be resolved in the coming weeks.

David Anderson -- Chief Executive Officer

I think the key for is that the field is producing the gross amount of gas, it's just the amount that they can actually put on the system is not where it needs to be right now.

Chris Ellinghaus -- Siebert Williams -- Analyst

Gotcha. All right. Thank you.

Operator

This will conclude today's Q&A session. So I'll hand the call back to David Anderson for some concluding remarks.

David Anderson -- Chief Executive Officer

Adam, thank you very much. Appreciate everybody joining us on this Friday. If you have any follow-up questions, I think you know Nikki, very well. Also for media, if you'd like to talk to David Roy, he'd be happy to talk with you.

Everybody, have a great weekend. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Nikki Sparley -- Director, Investor Relations

David Anderson -- Chief Executive Officer

Brody Wilson -- Chief Financial Officer

Unknown speaker

Justin Palfreyman -- Vice President, Strategy and Business Development

Selman Akyol -- Stifel Financial Corp. -- Analyst

Kim Rush -- Senior Vice President, Operations and Chief Marketing Officer

Kim Heiting -- Senior Vice President, Operations and Chief Marketing Officer

Chris Ellinghaus -- Siebert Williams -- Analyst

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