Chesapeake Utilities Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Chesapeake Utilities Corporation is a diversified energy company engaged in regulated and unregulated energy businesses, primarily focused on natural gas distribution, but also expanding into electric distribution, propane, and other energy-related services.

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

Chesapeake Utilities Corporation (CPK) operates across the mid-Atlantic region, with a significant presence in Florida. Their business model includes two primary segments:

  1. Regulated Energy: This segment primarily consists of the regulated natural gas distribution and transmission operations, including interstate transmission, serving residential, commercial, and industrial customers. Key components here include natural gas distribution (primarily in Delaware, Maryland, Florida, Virginia, and Pennsylvania) as well as the interstate natural gas transmission operations in Florida. This is a rate-regulated business, which results in fairly stable and recurring revenue.
  2. Unregulated Energy: This segment is focused on non-regulated activities, including energy-related services, such as propane distribution and supply and electric power generation and distribution, mostly in Delaware and Florida. The unregulated business is not bound by rate regulations, but depends largely on the company’s ability to generate margins in the marketplace. It encompasses a diverse array of activities from propane supply, electricity generation, and distribution, and other energy-related services.

CPK’s strategy is focused on achieving sustainable value creation through both organic growth, acquisitions, operational improvements, and an emphasis on clean energy solutions.

Key revenue streams for CPK:

  • Regulated Natural Gas Distribution: Fees collected from residential, commercial, and industrial customers for the distribution and delivery of natural gas. These fees are typically stable due to being based on fixed-rate structures.
  • Regulated Natural Gas Transmission: Revenue from transmission fees are also rate-regulated, and the demand for gas transportation services.
  • Unregulated Propane Operations: Revenue stems from sales of propane to homes and businesses as well as the related service fees.
  • Unregulated Electricity Generation and Distribution: Revenue stems from the sale of electric power, capacity payments, and associated services.
  • Other non-regulated: Provides various energy-related services and investments.

Industry Trends:

  • Transition to Clean Energy: The energy industry is undergoing a significant shift towards cleaner energy sources. Government regulations and consumer demand are driving investments into sustainable and renewable energy solutions. CPK participates in such activities, including those involving compressed natural gas (CNG) and renewable natural gas (RNG).
  • Demand for Natural Gas: Despite the push towards renewable, natural gas remains an important fuel. Natural gas will likely be used in both electric power generation and as a heating source in the near-term. In some areas (Florida and Maryland for example) conversion to natural gas from other heating and power sources is gaining popularity.
  • Infrastructure Investment: There’s a growing need for the modernization and expansion of existing energy distribution infrastructures. Pipeline replacement and expansion are needed for reliable delivery of natural gas. The electric system is also in need of upgrades.

Competitive Landscape:

  • Regulated Natural Gas: These businesses are monopolies in the geographic areas they serve. However, regulators can be quite restrictive on the amount of profitability these businesses can attain.
  • Propane: This is a more competitive environment, where customer service, reliability and pricing influence the choice of suppliers. There are many suppliers and the supply is generally not limited.
  • Electricity: This industry has many participants and varies according to each region, however, CPK’s is very small with respect to the wider electric industry.

CPK’s economic moat depends heavily on regulations, customer lock-in and switching costs, and niche markets. But these moats are not wide because the regulated businesses are very limited on profit potential, and the other business lines do not have any true advantage in price or cost.

Moat Analysis: 2/5

Chesapeake Utilities possesses some elements of an economic moat, however, it is not strong or clearly defined. Here’s a breakdown:

  • Narrow Moat: The regulated operations of CPK benefit from economic moats like exclusive geographical rights, long-term capital contracts, and the essential nature of its services. However, it’s not “wide” since the profitability of the regulated businesses is limited by the government and does not have a competitive edge in price.
  • Switching Costs: Natural gas and electricity distribution often create high switching costs for the customers since they are usually not easy for customers to switch to a different provider. However, these are also limited by competition.
  • Geographic Barriers: CPK’s position in Florida and the mid-Atlantic gives it a regional advantage, with difficulty for others to compete, especially in areas that need regulatory approval to operate in. But the competitive market and the rate regulations limit the economic moat it offers.
  • Intangible Assets: They benefit from the brand reputation for reliability, but this isn’t large enough to qualify for a wide moat.

Overall, CPK has a narrow moat. While it has some protection from competition in its core business, and has some opportunities in other areas, it doesn’t possess a long-lasting superior advantage.

Risks to the Moat and Business Resilience

Several risks could impair the moat and business resilience of CPK:

  • Regulatory Changes: Changes to rate regulation or environmental policies could negatively affect CPK’s profitability. New regulations might also force investments that diminish returns on capital.
  • Competition: Increased competition, particularly from renewable energy providers, could undermine CPK’s market position, especially in unregulated business segments.
  • Technological Disruption: Technological shifts, especially those relating to the generation and storage of energy, could significantly change the competitive landscape of the sector, potentially making the existing infrastructure obsolete.
  • Weather and Climate Change: Extreme weather events and changes to weather patterns could impact revenue and operating costs, and have a disruptive impact on the company’s customers.
  • Economic Downturns: Since energy costs will always be linked to inflation, higher interest rates and an economic downturn could hurt sales and increase financing costs for the company, potentially leading to negative margins.
  • Acquisition Risks: CPK’s acquisitions can have a lot of impact if they fail to deliver the expected gains, which can be caused by overpayment or poor integration.

CPK is likely to maintain its core business, but there is always a risk of declining returns in a competitive and rapidly changing sector.

Financial Analysis

Chesapeake Utilities’ latest financials show a mixed picture, revealing some of the challenges and opportunities in its business segments.

  • Revenue: In the latest earnings call for the quarter ending September 30, 2023, they reported operating revenues of 131 million. For the 9-months ended, the total revenue was 670 million, indicating a higher revenue trend this year.
  • Gross Margins: There’s been a significant trend of rising margins, particularly in the regulated gas division and the unregulated operations. The gross margins for regulated and unregulated operations are approximately 64.6 million and 75.6 million for the nine-months ended.
  • Net Income: Net income for the nine-months ended was 81.4 million. But most of the income has come from the regulated operations segment. The unregulated segment was nearly break-even, even with an increase in revenues.

A concerning detail is that even though revenues have grown rapidly over the past few years, profitability has fallen in recent quarters. This is due to the increase in operating expenses, and an increase in interest rates.

  • Leverage and Debt: From the balance sheet, we can see that the long-term debt stands at $1,475 million. Long-term debt is a concern, as higher interest rates are cutting into profits.
  • Share buybacks: There have been minimal share repurchases, and the company’s priority is to use profits to grow the company with strategic investments and acquisitions.
  • Dividends: CPK has a long history of paying a stable and predictable dividend. However, there may be no further increases if profitability continues to decrease.

The financials indicate a company that’s growing through acquisitions and expansions, but at the cost of increasing debt and diminishing profit margins.

Understandability: 3/5

The overall business model of CPK is relatively easy to understand. It has 2 clear segments which operate mostly on energy sales and distribution. The rate regulations do make the valuation more difficult, but the core operations are easy to understand. However, the company’s financials and accounting, and the way to value the company, can be complicated and hence it is placed in the 3 out of 5 scale.

Balance Sheet Health: 3/5

CPK’s balance sheet reveals a mix of strengths and weaknesses. Here’s a breakdown of what’s visible:

  • Debt: The company’s high leverage is a cause for concern as interest rates are high, which has a big impact on profits. The debt to equity ratio and debt-to-asset ratio are high. This also shows the company’s financial flexibility might be limited.
  • Liquidity: The company has a reasonable amount of cash in hand and can pay off short term obligations without any issues.
  • Pension Obligation: The pension is a significant non-current liability for the company that will limit its future cash flexibility.
  • Goodwill & Intangible Assets: The company has increased its goodwill and intangibles because of acquisitions, however, the quality of these assets are questionable because these companies are now struggling to be as profitable as before.

A rating of 3 out of 5 is given, because even though the company is not in immediate danger, there is a definite weakness that has been increasing over the past year or two. In particular, rising debt and declining profitability make the business financials worse.

Recent Concerns, Controversies, and Problems

  • Acquisition Integration: CPK continues to make numerous large acquisitions which they hope will fuel their growth, however, the integration of these companies into the company structure have not been seamless. They need to improve the operational efficiency and profitability of the acquired units.
  • Margin Compression: Increasing expenses and rising interest costs, plus limitations in regulated businesses are cutting into the company’s profits. They need to find a way to increase their revenues and reduce their costs in order to return to sustainable profitability.

CPK is not immune to the challenges in a rapidly changing sector. Management needs to manage costs carefully, look for revenue opportunities, and be prepared for any regulatory or technological disruptions.