Unitil Corp

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 3/5

Unitil Corp is a public utility company engaged in the distribution of electricity and natural gas to customers in New England.

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

Unitil Corp (UUGRY) is a regulated public utility primarily operating in New Hampshire, Massachusetts, and Maine. Its core business revolves around the distribution of electricity and natural gas to residential, commercial, and industrial customers.

  • Revenues Distribution: Unitil’s revenue streams are predominantly driven by regulated distribution fees. Its revenue comes from regulated operations (e.g. base distribution rates) and sales of natural gas or electricity to customers.
    • Electricity: The distribution of electricity generates a significant portion of Unitil’s revenue.
    • Natural Gas: The company distributes natural gas through its pipelines, generating revenue through distribution fees and sales to customers.
    • Other Revenue Streams: While not a major driver, the company has some other sources of income such as service fees, late fees, and sales of non-energy items and equipment.
    • Geographically: Most of Unitil’s customers are in its three main service areas: New Hampshire (Unitil Energy Systems and Fitchburg Gas), Massachusetts (Northern Utilities), and Maine (Granite State Gas and Northern Utilities).
  • Industry Trends:
    • Regulatory Environment: As a regulated utility, Unitil’s operations are heavily influenced by state and federal regulations. Changes in regulation, particularly on allowed rates of return, will have a huge impact on the company’s profits.

Changes in regulations, specifically in energy transition related policies can either boost or hurt the company in a big way, and the timing of these regulations are hard to predict. * Energy Transition: There is a push to reduce the reliance on fossil fuels in the region, which could require infrastructure investments in renewable energy and affect the composition of Unitil’s assets. This push is usually good for utilities as they get a guaranteed rate of return on their investments, but is still dependent on the regulations. * Infrastructure Investments: Aging infrastructure requires large ongoing capital expenditures to maintain reliable distribution and reduce energy losses. * Demand: Demand for energy in the region might fluctuate based on several conditions like weather, economy, and technology adoption.

  • Margins: As a regulated utility, Unitil’s profit margins tend to be stable and regulated by various rate setting mechanisms that control the company’s revenue and earnings. Because of this, any significant change in margins would be driven by external regulatory changes and can not be controlled by the company.
    • The company’s net profit margins range between 5%-12% in the last 10 years.

  • Competitive Landscape: Unitil operates in a regulated environment, meaning the direct competition is limited in each service territory by regulation. The competition is not usually on price, but based on perceived reliability and customer service. This creates a natural monopoly for the serving utility and protects the company’s profits from other utilities operating outside the designated territory.

  • What makes the company different? Unitil’s advantage comes from several factors that, at least in the short run, give the company some resilience.
  • Regulatory structure: This forms a huge barrier to entry for its operating region, and protects existing profitability. While new entrants could get the same returns, the fact that it is harder to enter these markets means less competition.
  • Proven track record: For over a century, Unitil has been a pillar of utility service in its region, which has resulted in the company gaining some local preference and familiarity in its operations.
  • Stable operations: The company’s operations are extremely crucial for modern society to function, creating demand for its services that are independent of recessions or booms.
  • Geographic concentration: Its operations are limited to a few states in New England, making management’s understanding and control of regulatory bodies that oversee the company more straightforward.

Financials

  • Revenue Growth: Unitil’s revenue growth is historically slow as there isn’t much room for large volume or pricing increases. This trend continued in 2022, with revenues increasing only 11.2% as a result of increased rates in the company’s distribution territories, alongside a cold and stormy winter.

  • Profitability: The company’s profitability is largely dependent on the regulator, because the regulator controls the amount of price the company is allowed to extract and the amount the company is allowed to reinvest. This leaves less room for profitability improvement for a regulated utility, with some variation being present on efficiency improvements that might increase margins over time.

  • Cash Flow: Unitil’s cash flows have remained relatively stable in recent times. The amount of free cash flow generated is low as it is required to invest heavily into infrastructure. The company is highly dependent on external funding for capital expenses.

  • Recent concerns and problems: A major concern for Unitil has always been its large exposure to the regulated environment, which it is dependent on for profitability and stability. In 2022, the company faced significant increases in energy costs, which caused a lot of volatility in cash flow. In response, the company took up a number of strategies which increased customer rates, lowered expenses, and used tax credits and government initiatives to mitigate the impact on profitability, which was successful in increasing profitability. The management expects this to continue in the coming years, however they remain exposed to the regulations set out by the government.

  • Future outlook: Unitil plans to invest over the next five years in several projects, specifically around system integrity, expansion and efficiency improvements. The company remains cautious on the economic and environmental front. The new laws and regulations that allow tax credits are set to become a big driver of profitability, and will offset high-interest rates. It is hard to say how the company will perform in the longer term.

Unitil’s business performance can be affected by changes in tax laws and government policies that give incentives to invest in clean or renewable energy. If these policies get changed, it could severely affect the company’s financials and future prospects.

Moat Analysis: 2 / 5

Unitil’s moat rating is 2 out of 5. Its moat comes mostly from its regulatory position and its long history of operation in its region, which protects it from direct competition. However, a company that is totally reliant on regulators can not be said to have a wide moat. The regulator sets the pricing and operating structure of the company, creating no opportunity to improve profits by lowering costs or through market share gains.

  • Intangible Assets: While a local name or a brand could give it an advantage, the services that the company provides are a necessity for most consumers. This makes its brand weaker than companies in the consumer good segment, and is therefore not a source of a strong moat.

  • Switching Costs: Customers in Unitil’s area have little choice over the service provider and face substantial costs to switch or change providers. Due to that, the company is protected from customers leaving over price-related or service-related concerns. However, this alone is not strong enough to create a wide moat rating.
  • Network Effects: It doesn’t benefit from network effects as the benefits do not increase as more people use the service. The number of users do not affect the price or experience for other users.
  • Cost Advantages: While the company has certain operational efficiencies due to its scale, it does not have a significant structural cost advantage in comparison to potential competitors.

Risks to the Moat and Business Resilience

  • Regulatory Risks: Being a regulated utility is a double-edged sword. Any adverse regulation, changes to rate-setting mechanisms, or energy policies can materially hurt the company.
  • Interest Rates: The company relies heavily on debt for its capex and operating costs, so high-interest rates increase their costs and lower profitability.

  • Weather and Environment: Extreme weather can cause significant costs on repairs and the required maintenance of its infrastructure. This volatility could lead to unpredictable performance in the short term.

  • Technological Disruption: Though less likely, changes to the technological landscape could pose a threat. For example, new technologies that bring small scale cheap decentralized power sources could hurt the company in the long run.
  • Emerging Market Competitors: Although unlikely, other companies operating in nearby territories could seek a foothold in Unitil’s area of service in the long run.
  • Inaction of the Government: The fact that the government has a heavy hand in this area, there is always a chance of political interference or unexpected regulatory changes.

Understandability Rating: 1 / 5

Unitil has a very simple business model to understand. They deliver electricity and gas to customers for a profit, and their operations are strictly monitored by government regulatory bodies. There isn’t much complexity in understanding the business model and how it generates revenue, or what drives its profits.

Balance Sheet Health: 3 / 5

Unitil’s balance sheet is moderately healthy with some areas of concern.

  • Debt Levels: Unitil has a moderately high level of long term and short term debt, which is common with utilities. The company is required to use external financing to maintain operations.
    • Debt comprises approximately 45% of their total capitalization.
  • Cash: Unitil holds a moderate amount of cash relative to debt levels.
    • Cash on hand is around $100 million with short-term investments being another $200 million, compared to total debt of around $1.7 billion.
  • Coverage Ratios: Interest coverage ratio is moderately healthy at over 3x. It should be noted that the debt load and the corresponding interest rates directly affect its profitability, making its earnings sensitive to changes in interest rates.

In conclusion, while Unitil benefits from regulated operations and long-standing presence, its exposure to external risks and a moderately leveraged balance sheet means that its moat is narrow and its balance sheet health is in need of improvement. The overall long-term value and growth are also dependent on regulatory changes, rather than the company’s operating performance.