Atmos Energy Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Atmos Energy Corporation is a natural gas distribution company, primarily serving residential, commercial, and industrial customers in several states, with a focus on providing regulated services, making it a relatively stable business.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Atmos Energy Corporation (ATO) is one of the largest natural gas distributors in the United States, operating primarily in eight states: Texas, Colorado, Kansas, Kentucky, Louisiana, Mississippi, Tennessee, and Virginia. The company operates in two main segments, the Distribution segment and the Pipeline and Storage segment.

Distribution Segment: This segment involves the regulated distribution and sale of natural gas to residential, commercial, and industrial customers. It’s the company’s core business, focused on reliability and safety.
Pipeline and Storage Segment: This segment comprises the transportation of natural gas on the interstate pipeline system and managing gas storage assets. These are also regulated operations.

Atmos Energy’s operations are entirely regulated by federal and state entities. The company operates in a mature industry that is essential to consumer’s daily life. The company’s operations are also very localized, providing a barrier to new entrants.

Competitive Landscape

The natural gas distribution industry is characterized by regional monopolies or oligopolies due to the high infrastructure and regulatory barriers. Key features include:

High Infrastructure Costs: Building a pipeline network is capital intensive and requires substantial investment in physical assets such as pipelines, meters, and other infrastructure.
Regulatory Barriers: The business is highly regulated by state and federal agencies, which dictate allowable returns, pricing structures, and safety standards. This creates high barriers to entry and limits competition.
Regional Monopolies/Oligopolies: Due to the capital and regulatory barriers, specific service areas tend to be dominated by a small number of established players. Atmos Energy primarily has regional monopolies in the states it operates.
Stable Demand: Demand for natural gas in the residential and commercial sectors tends to be stable, making the industry less susceptible to economic cycles than some others.

The industry is inherently a low-growth and low competition industry due to the nature of the business. These factors combined, give some defensive characteristics and allow companies like Atmos to exist comfortably.

What Makes Atmos Energy Different?

Geographic Focus: The company’s focused geographic presence provides them unique insights in their area and creates a difficult situation for new entrants, given the regulatory and geographical complexity.
Operational Excellence: The company has a focus on minimizing its operating cost by controlling labor and improving the efficiency of the existing infrastructure.
Reliable Service: Atmos provides a reliable and stable gas service to its consumers, which is a must-have for the energy utility.

Moat Analysis: 3 / 5

Atmos Energy has a narrow economic moat, based primarily on:

Regulatory Moat: The regulated nature of the utility business, which restricts competition and limits new entrants, thereby creating stability in revenue and margins. This provides a predictable earnings and cash flow stream. Also, since the prices are heavily regulated by the state bodies, these regulations serve as a barrier against new entrants.
Location-based Moat: The company benefits from being one of the primary infrastructure providers in a defined location for a fixed line utility. This aspect is almost impossible to recreate and is a very sustainable moat.

However, the moat is not as wide as some might believe due to the following factors:

No Real Pricing Power: Due to regulations, companies cannot materially increase their profitability by arbitrarily raising prices for their gas.
Dependence on Regulatory Approvals: Regulatory agencies can also impact the business negatively. These agencies can limit rate increases, impose cost-cutting measures, or deny expansion projects, reducing the company’s growth potential.
No Technology Advantage: There is no notable technological difference between how the utilities work, thus there is no major difference in terms of efficiency, performance or cost.

Therefore, the overall rating for moat is 3 out of 5.

Risks

While Atmos operates a relatively stable business, it is exposed to specific risks that can negatively impact its profitability:

Regulatory Risk: Changes in regulations can limit the company’s ability to recover its costs or earn a sufficient return. The regulators are always changing and that could affect the business.
Interest Rate Risk: The cost of borrowing is a key component of the capital for expansion and other activities. Therefore, high interest rates can make the business unattractive and unprofitable.
Fuel Price Volatility: The cost of acquiring natural gas can fluctuate based on supply and demand which may affect the profitability of the business.
Weather Sensitivity: The demand for natural gas is affected by weather. Milder winters can reduce demand, thus hurting the volumes and ultimately, the earnings.
Environmental Regulations: More and more environmental regulations are being implemented that may require heavy investments for the company to be compliant.

Business Resilience

Atmos Energy’s business is quite resilient, as demand for natural gas is reasonably constant and essential. However, the company’s profit is relatively volatile since most of the regulations are on price levels and do not take in account operating and other associated costs.

Financials

Here is an in-depth look at Atmos Energy’s financials:

Revenues: Revenues are primarily driven by gas distribution to residential, commercial, and industrial customers, and a small percentage from gas storage and transportation. The Distribution Segment generates most of the revenue.
Margins: The company has consistently low operating margins. Low operating margins are expected as this is a utility with prices that are set by regulatory bodies.
Free Cash Flow: Free cash flow is dependent on the net operating profits and capital expenditures. Free cash flow can vary depending on company’s investment patterns and maintenance expenses.
Debt: The company has a high amount of debt on the balance sheet. The debt is used to maintain the infrastructure for the gas distribution. Due to the steady nature of the company’s business, they manage the debt levels fine, however a high debt level should always be seen as a risk.
Valuation: The company can be valued based on discounted cash flows and/or other comparable companies in the utilities space.

The free cash flow has improved recently and is more consistent than earlier.

For the full year of 2023, Atmos generated $1,429 million in free cash flows, a 77.9% increase from $803 million in 2022.
The net income was $903 million, a 34.6% increase from $671 million in 2022. These figures indicate solid profitability for the business.    Also, the company is constantly increasing its dividend payments, as their business is quite steady and does not require large capital investments to grow.

Understandability: 2 / 5

The nature of the business is relatively easy to understand: it is a regulated gas distributor with regional monopoly characteristics. However, accounting and its regulatory filings can be a bit complex to a normal individual. The nature of the business and the factors impacting it can be understood by an individual with not too much financial knowledge. But understanding how the company’s balance sheet and income statement work requires some understanding of accounting. Also, the regulatory filings and other industry-specific data may be a bit difficult for an outsider to understand. Therefore, the overall rating of 2 is given for understandability.

Balance Sheet Health: 4 / 5

Atmos has a reasonably stable balance sheet with a high level of debt. These are typical balance sheet characteristics of such utility companies. The company has shown improving metrics and a stable financial position. The debt is also being reduced slowly but steadily. Therefore, we are rating the balance sheet 4 out of 5.

Recent News

Here are some points regarding recent issues or changes at Atmos:

Management Change: Kevin L. Akers was appointed chairman of the board in 2023, having a deep involvement in the operations of the company previously. The company seems to be transitioning its existing operations with more emphasis on strategic and efficient deployment of the resources.
Texas rate filing: In April 2023, they received a ruling on their rate case in Texas which was less favorable than expected. The lower-than-expected rate increase might affect the earnings, but according to the company’s CFO, the return should still be adequate for the company to generate enough revenue.
Capital Investments: The company is continuously upgrading and maintaining their distribution infrastructure by investing in pipelines and other machinery to bring gas to their customers reliably and safely.
Regulatory Approvals: In recent earnings calls, the management has also emphasized the importance of regulatory approvals for their new investments.

Conclusion

Atmos Energy Corporation is a relatively stable and slow growth utility business that benefits from its geographic and regulatory advantages, and with a management team focused on strategic and profitable growth. The company has some moats that protect them from competition, but they are not too wide, nor un-breakable. The company’s financials are stable and the business model is relatively simple to understand. As such, the business presents a reasonable option for a long-term investment, with low volatility. The price must always be paid close attention to. However, due to the relatively volatile and changing regulatory environment, and the increasing reliance on infrastructure investment, the business may face problems and challenges in the future.