Black Hills Corporation

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 3/5

Black Hills Corporation is a diversified energy company that operates through two segments: Electric Utilities and Gas Utilities. It serves customers in Colorado, South Dakota, Wyoming, and several other mid-western states.

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.

Black Hills Corporation’s (“BKH”) moat is quite narrow, rated a 2 out of 5, due to the regulated nature of its business and limited differentiation. It’s not a wide moat because although it has established operations and infrastructure in its service territories, these businesses are mostly regulated and its pricing is determined by regulatory bodies not by its business acumen or its unique brand or technology.

Here’s a more detailed breakdown of their moat, including some of its weaknesses:

  • Limited Pricing Power: BKH operates in a regulated market where prices are set by regulatory commissions, not by the competitive forces of the market. This limits its ability to increase prices to grow profit margins, even if it has a better value proposition, unless they get approval of those price increases by regulatory bodies.
  • Barriers to Entry: While the cost of building a new utility system is high and there is regulatory barrier for creating new utility companies, the existing regulations themselves create a moat for incumbents but not a necessarily wide moat, as other incumbents compete for customers. However, since all utility companies can provide the similar basic service, its easy to find new companies that can provide similar value to the customers.
  • Customer Stickiness: Once customers are hooked to the grid or gas pipelines, they rarely change their utility provider due to costs and inconvenience of switching. This could be seen as a switching cost moat. But its not unique since a provider in the same territory offers similar costs to the customers.
  • Stable, But Limited, Growth: While the demand for utilities is relatively stable, growth is capped by government regulations and limited to customer population growth. While there is some potential in expanding more into existing markets, its unlikely a utility will have significant organic growth. Also, in this business, organic growth will bring little difference to value, as compared to industries in which organic growth leads to larger future margins and profits.
  • Economic Moat based on “mini-approvals”: BKH benefits from a plethora of mini approvals such as waste haulers, because its business involves building and maintaining assets (pipelines, power plants etc) that are close to the customers, and approvals create small mini-monopolies. However, this isn’t unique to BKH, and other utility companies have the same mini approvals, hence only giving the company a limited protection.
  • Technological Disruption: The ongoing shift from reliance on fossil fuel infrastructure poses a major threat to BKH. The company’s transition towards renewable sources of energy might be slow, giving competitors time to capitalize on new opportunities in clean energy infrastructure and operations.

Regarding the business resilience: BKH possesses a good business resilience as its regulated nature ensures a predictable income stream, but this same nature of regulation prevents rapid growth that is expected to offset future risks. In an era of changing energy needs where renewables are increasingly becoming a focal point, BKH is facing both technological and regulatory risk that it should strive to address.

  • The Business: BKH operates through Electric and Gas Utilities segments.
    • Electric Utilities serves ~218,000 customers in Colorado, Montana, South Dakota, and Wyoming through a diverse generation portfolio that includes natural gas, coal, wind, and solar resources.
  • Gas Utilities provides gas to 1.1 million customers across Arkansas, Colorado, Iowa, Kansas, Nebraska, and Wyoming. The gas system also includes storage operations, natural gas gathering pipelines, processing plants and other infrastructure.
  • Revenues Distribution: As mentioned earlier, the company provides both electric and gas utility services. This suggests that any major drop in either energy prices, could hurt the company’s revenue numbers. However, because both are necessities and are regulated, this revenue is mostly stable.
  • Industry Trends: The utility sector is evolving rapidly, driven by advancements in renewable energy, grid modernization, and heightened awareness towards environmental concerns. There’s increasing focus on decarbonization and the adoption of cleaner energy sources. The recent interest-rate hikes and slow growth are a major concern for all utility companies.
  • Competitive Landscape: In their operating regions, BKH faces competition from other utilities, but the regulated nature of business creates a predictable market for the utilities. Although they compete with other utilities, they do not compete by price alone as their prices are regulated. Also, the entry for new players is highly unlikely due to the high CAPEX and regulatory barriers.
  • What Makes BKH Different: BKH stands out with its geographic diversity that lets it diversify energy mixes across a wider area as well as serve a greater variety of customers. They are also investing in sustainability and clean energy.
  • Also, BKH has a relatively small size. Most of the big power companies have a market cap multiple times that of BKH. This might make it a bit more agile and provide it the capability to pursue strategies with less fear of losing more customers, as it has a lower percentage of total market share.

Financials: While these are all things mentioned in prior reports, in the recent report for the 9 months ended September 30, 2024 there was quite significant information that needs to be considered. Overall there was an increase in Operating expenses, which caused a decrease in net income.

  • Revenues: Revenues were $1.356 billion in the past 9 months (ended September 30, 2024).
    • Compared to $1.252 billion the previous year, it is an 8.3 percent increase.
  • Operating Expenses: Operating Expenses were $1.147 billion this year vs. $1.045 billion in the previous year.
    • This is a substantial increase of 9.8 percent which offsets the income from rising revenues.
  • Net Income The net income was $176.2 million (diluted earnings per share were $2.74) in the past nine months.
    • The net income of previous year in this period was $202.7 million. This is a major 13 percent decline.
  • Cash Flows: Cash from operating activities for the period was $464 million. This is lower than $603.5 in 2023 and even lower than $804 in 2022.
    • Cash flow from financing activities increased drastically from $195 million last year to $838 million this year mostly due to increased short and long-term debt.
  • Margins: The operating margin fell to 13 percent versus the average of 16 percent for the previous 4 years. There is clear indication that margins have compressed.
  • Capex: Capital Expenditures from operations was 1720 million which is a massive increase as it was $832 in the previous year.
  • Debt: The company also has taken an increasingly higher amount of debt, and the interest expenses are beginning to creep up. The net interest rate expenses increased from $46 to $72 million. And their debt to equity is high at above 65%, while debt to assets is above 40% for the past several years.

Concerns & Problems

  • The company’s most recent earnings report showed a concerning trend of declining profits as well as cash from operating activities despite an increase in revenue.
  • BKH’s debt to equity and debt to asset ratio seem fairly high.
  • Increased interest rates coupled with the massive expansion in debt might squeeze the company’s finances in the coming quarters.

Understandability Rating BKH scores a 1 out of 5 in understandability. While the business model of a utility company is relatively simple, understanding the various factors that contribute to their revenue generation, regulations, and financial complexities requires more specific knowledge. Further, the financial statements of the company are complex and difficult to understand. For a basic investor, the business is easy to understand as it sells gas and electricity, but the financials and the technical details that drive value and costs make it very difficult to understand fully.

Balance Sheet Health Rating BKH receives a rating of 3 out of 5 for balance sheet health. While they continue to pay good dividends and have a steady revenue stream, the rise in long-term debt and decreasing income is alarming. Additionally, a decline in ROIC would mean they are utilizing their assets less productively. Though this is not something to alarm for the long term, investors should keep a close eye on company finances. Also, since they are utilities, and are considered to be very safe they can have a slightly worse financial health than other types of companies without any major effect on their investment rating.