Avista Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Avista Corporation is a utility company operating in the Pacific Northwest, providing electricity and natural gas services. It has a regulated business model and operations are geographically concentrated, making it relatively complex to analyze.

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.

Avista Corporation is a publicly-traded energy company that is based in Spokane, Washington. It primarily serves customers in eastern Washington, northern Idaho, and parts of Oregon. They provide both electricity and natural gas to their service areas.

Avista’s business is segmented into two main areas:

Avista Utilities: This segment includes the regulated utility operations, which consist of the transmission and distribution of electricity and natural gas, as well as the generation of electricity from sources like hydroelectric, thermal, and renewable facilities.
Alaska Electric Light and Power Company (AEL&P): This segment consists of the operations of AEL&P, a subsidiary that provides electric utility services in Juneau, Alaska.

Moat Analysis: 2/5

Avista’s moat is weak, with a rating of 2 out of 5. This assessment is based on the following factors:

Partial Geographic Monopoly: Avista benefits from its geographically concentrated utility operations, where it is effectively a regulated monopoly in its service areas in eastern Washington, northern Idaho, and southern Oregon. This provides some protection against competition, but other utilities do compete with the same general area.
Regulated Business: Avista’s regulated business model provides a certain level of stability, but at the same time it limits pricing power and growth potential. The Public Utility Commissions (PUCs) in Washington, Idaho, and Oregon, and the RCA (Regulatory Commission of Alaska) set the prices the company can charge, the return on investment it is allowed to earn, and the nature of costs it can pass on to customers.
Limited Differentiation: Avista’s core business of electricity and gas distribution is largely a commoditized service, where it’s difficult for them to establish significant differentiation and brand loyalty among its customers. Customers primarily chose which utility to use based on availability, reliability and price. This reduces the company’s ability to command premium prices and therefore limit competition from other utilities in the area.
Cost advantages: Avista has a blend of both cost leadership and differentiation. On the cost leadership side, it has access to hydroelectric generation facilities and an abundance of low-cost hydro, which gives them lower costs. However, other generation sources are more costly, but are needed to meet increased demand. A major portion of its operations revolves around a regulated business, where the company is allowed to pass those extra costs to consumers, so even though there is a low cost generation, that doesn’t translate into economic moat because those costs get passed onto its customers.

While some economic advantages are present, they are not robust enough to generate superior long term value.

Risks to the Moat and Business Resilience

Avista faces several risks that could potentially erode its moat and impact its profitability:

Regulatory Changes: Changes to existing regulations, including allowable rates of returns, may negatively impact revenue, earnings, and asset values, resulting in a lower profitability. The company is susceptible to changes to the regulatory environment as well as the possibility of less favorable future rulings that can affect its profitability.
For example, in 2021, the Washington Utilities and Transportation Commission’s (WUTC) approved a revised revenue plan, increasing customer rates and impacting the company’s earnings.
Interest Rate Risk: As a utility company, Avista relies on debt financing for its operations, which exposes them to interest rate risks. A period of rising interest rates would have several impact on AVA’s profitability due to the increase in the debt repayment rates.
Inflation: A rise in inflation could hurt their profits and margins, even if they are able to increase revenue. Cost pressures stemming from inflation will put pressure on the company to have good cost control to keep up their profit margins. Even though their business is regulated, it does not mean they can pass through all of the increase in expenses to the end consumers.
Competition from alternative energy sources: More companies and communities are pushing towards renewable energy sources, such as solar and wind. These new technologies could threaten Avista’s conventional and hydro operations, because they might become more affordable and preferred over the long term.
Weather and Environmental Factors: Severe weather conditions, natural disasters, and climate change may affect the operations and the availability of reliable energy sources and can also cause damages to their infrastructure and disrupt operations.
Technological Disruption: New technologies could significantly change the nature of how utility companies serve their customers. The introduction of technologies like AI and new battery technology could disrupt the traditional business model of utilities such as AVA. This is a long-term risk, and it’s highly uncertain, if or how fast it will take to disrupt the company.

However, the resilient nature of utilities, along with Avista’s operational expertise and diverse sources of energy, including a substantial amount from the reliable and low cost hydro segment, provide some level of business resilience.

Business Explanation

Avista’s revenue is generated mainly from regulated utility operations. It provides electricity and natural gas services to its customers. The primary driver of profits comes from the difference between its revenue (how much it can charge its customers), and its operating expenses. It’s therefore crucial to understand how revenues are determined. For that, a good knowledge of regulatory policies as well as the company’s strategy is required. Here’s a more in-depth breakdown:

Revenue Sources:

Utility Revenue: Avista generates revenue primarily from providing electricity and natural gas to its customers. Revenue is recognized when customers receive these energy services.
Non-Utility Revenues: The company also receives revenue from smaller activities that are not directly tied to core utility operations.
Regulatory Mechanisms: As a utility provider, the price Avista can charge to its customers is determined by state regulatory commissions. These commissions review and approve rate increases to allow Avista to recover its operating expenses and capital investments.

There are a few things unique to a utility company such as Avista:

Heavy CAPEX The company is always in the process of replacing its existing equipment, along with expanding its operations.
Regulated Pricing Avista can not independently determine the price it sells its utilities at.
Debt as a Tool High levels of debt are not necessarily a sign of an unhealthy company. Since a good part of the revenue is predictable, the debt is used to generate better returns.
Lack of control over the market: The company is subject to fluctuations in demand and the price of energy.

Trends in the Industry:

Transition to renewable energy: The increasing focus on renewable and clean energy alternatives forces utility companies to adapt and incorporate them into their generation plans.
Advanced Metering Infrastructure (AMI): New metering technology, such as smart meters, allows for time-of-use pricing, increased information on consumption patterns, and an increase in real-time automation of the grid.
Grid Modernization: Power grids are transforming to include renewable resources and distributed generation (e.g., solar). New technologies such as microgrids, energy storage, and increased communication systems are becoming essential.
Cybersecurity Utility companies are becoming increasingly exposed to cyberattacks. Increased digitization also calls for increased emphasis on cybersecurity in utilities.
Deregulation: In some jurisdictions, states or regions are starting to deregulate utilities and increase competition, forcing companies to compete more directly, lowering their returns.

Profitability and Margins:

Margins: Because the company is regulated and has a low-cost power supply, the operating margins should be relatively consistent and should be above average as well.
ROIC A more precise metric for evaluating utilities is return on invested capital (ROIC) as it combines revenue with invested capital to generate a single value. A consistently growing ROIC should indicate the management’s prowess in their operations.

Competitive Landscape:

Regional Competitors: Avista is not the only utility operating in the region. Avista competes with other utilities as well as new energy companies.
Limited Competition: The electricity and gas market has limited competition because these are usually geographical monopolies. However, a more liberal regulatory environment can make the situation more volatile.

What Makes Avista Different:

Geographic Focus: Avista’s focus on the Pacific Northwest allows them to have a great understanding of the local markets, customers, and its regulatory structure.
Hydroelectric Power A large portion of Avista’s generation is hydroelectric, which gives them relatively cheap energy source, compared to competitors relying on traditional sources.
Community Engagement: Avista has a long-term history in the communities they serve and an established reputation.

Financials

Analyzing Avista’s financials is key to assessing its financial stability, and sustainability of its operations. Here is a summary of their financial profile based on recent documents:

Revenues: While Avista’s revenues have a slight upward trend, it’s worth noting that growth has been mostly flat, showing slow growth.
Operating Expenses: Operating expenses tend to track revenue, but will increase as Avista incorporates new generation sources to their operations, with increases in fuel and labor costs.
Profitability: Profit margins as well as ROIC have been on a downward trend over the last 5 years. This is because the company’s operational improvements have not been sufficient to overcome the effect of high inflation, and the inclusion of expensive fuel resources into the mix.
Debt: Avista’s debt is high but it is typical for utility companies. This debt is being used to help finance the company’s operations. Avista’s debt-to-equity ratio of 1.11 in 2022 implies the company is primarily financed by debt.
Capital Expenditures: Because the nature of their business is capital intensive, Avista is required to continually invest into its infrastructure, which will likely eat into its cash flow.

Recent News and Controversies

Avista has faced a few noteworthy events recently:

Lawsuit related to S&N acquisition: In July, 2022 a jury found that Avista breached its merger agreement to purchase S&N. This resulted in a legal dispute and $250 million termination fee.
- Management has indicated that they have accounted for it and they have not had any further impact on the business performance.
Increased borrowing costs: Due to interest rate increases by the Fed, borrowing costs have risen for Avista, and has already started to affect their bottom line.
Wildfire risk Increased risk from wildfires could pose material threat to their operations and financials.
Regulatory Approvals The company is still waiting on a few regulatory approvals, in various jurisdictions which has the potential to create headwinds and delay growth projections.

The management seems to be focused on expanding its renewable capacity and improving its grid. They have reiterated the importance of customer relationship and improving their customer experience. They have taken a proactive approach on cyber security and continue to make investments to keep their systems secure from attacks.

Understandability: 2 / 5

Avista’s business model is moderately complex, and so receives a 2 out of 5 for understandability. The main reasons for this rating are:

Regulatory Aspects: The business has a strong regulatory component that is necessary to understand in order to evaluate the company’s performance.
Capital Intensity: Being a utility company, Avista is also capital intensive, which involves complicated accounting rules, which may not be familiar to most investors.
Impact of External Factors: The company’s revenue and performance is also dependent on external factors that it does not have any control over, such as weather and energy prices.

Balance Sheet Health: 3 / 5

Avista’s balance sheet has a medium health rating of 3 out of 5. This rating is due to the following factors:

Leverage: The company uses a fairly high level of debt, which in turn gives it high leverage. This can be a risky position if there is an economic downturn, or there are unexpected issues.
Cash: The company seems to have sufficient cash flow, both from operations, as well as from financing to meet its short term obligations.
Asset Composition: A good percentage of Avista’s assets are its “net utility plant”, which include its infrastructure. However, infrastructure is often difficult to value at its fair market value.
Pension Obligations: Like most other utilities, Avista has large pension obligations which are mostly unfunded. This can impact the balance sheet in the long run, if those obligations become more substantial.

While the debt load of Avista does seem high, its recurring revenue and relatively stable earnings mean that it’s unlikely to be severely impacted by it.