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Summary After years of performance, the stock slumped in 2015. Investors didn’t like Q3 results due to poor outlook for the natural gas division. The construction segment has a secular tailwind at its back, but there is no telling when it will go away. Southwest Gas Corporation (NYSE: SWX ) is a utility company that specializes in natural gas distribution and construction. It’s primarily services customers in Arizona, Nevada, and California. The company is the largest distributor in Arizona and Nevada. With its scale and the relative stability of the utility business, the stock has steadily climbed throughout the years. In 2015 however, the stock has hit a bump. Year to date, shares have fallen by 10% from $61.81 to $55.70. The Business Let’s first talk about the natural gas division. It consists of the company’s distribution and transportation business. The majority of customers is made up of residential and small commercial customers, which accounted for 85% of the company’s operating margin (defined by the company as operating revenue minus the cost of gas, which is more similar to gross margin) in 2014. The other 15% is broken down into two parts: 4% from other customers and 11% from transportation. The transportation segment acts like a midstream company, transporting gas that is sourced by the customer instead of Southwest. Interestingly, although transportation only accounts for a tenth of overall operating margin, it does occupy a significantly larger portion of total system throughput. Transportation accounted for almost half of the total throughput in 2013 and 2014. This discrepancy between transportation margin and the capacity occupied by the transportation segment shows that the company can improve profitability if it can shift more of its business to distribution, which earns much higher profits. The other half of the business is the construction division. This segment’s main focus is on energy distribution related systems, so it acts as a complement to the distribution and transportation business. A typical project could be as small as maintenance or as big as piping the entire community, for that reason, earnings could be quite lumpy. Recent Performance It would appear that the market didn’t like the company’s Q3 results. After releasing earnings on November 4th, the stock has declined by 9% in a matter of weeks. Both segments continued to grow. While natural gas operations’ revenue declined from $226 million to $219 million, this was the result of lower gas prices in general. After subtracting the cost of gas, the natural gas segment’s operating margin increased from $153 million to $155 million. However, it should be noted that the company is not expecting growth in the natural gas division in the near future. The management stated during the Q3 earnings call that they believe future margin increases will be offset by higher expenses. The construction segment experienced higher growth, increase revenue from $206 million to $286 million. Can you count on the construction segment to hold up? Recently the segment benefited from higher demand for pipe replacement projects as the result of regulatory pressure by the U.S. Department of Transportation to enhance safety. While projects may continue to ramp up in the short-term, I don’t think that the construction segment can continue to perform at the current level over the long-term. Conclusion In the near-term, I believe that the stock can only recover if the construction segment continues to perform well. Because the outlook for natural gas operation is not great (i.e. no growth), the only way that the company can create value is by winning more contracts through the construction segment. The aforementioned secular trend of increasing regulatory pressure could help, but there is no telling when the increase in demand will fade away. Scalper1 News
Scalper1 News