Diversified utility NiSource Inc. (NI) posted net operating earnings of 4 cents per share in the third quarter of 2010, falling short of the Zacks Consensus Estimate of 6 cents and the year-ago quarter’s operating earnings of 7 cents. Benefits from electric industrial margins and off-system sales, as well as increased gas distribution revenues were offset by increases in operating expenses, taxes and depreciation, leading to the drop in earnings.

Revenues

Gross revenue improved 11% year over year to $1,004.5 million, outperforming the Zacks Consensus Estimate of $1.04 billion. Gross revenues increased at its three business segments – Electric Operations (highest year-over-year growth among the segments of 16%), Gas Transportation and Storage (12%) and Gas Distribution (7%). However, Corporate and Other Operations dropped 12%.

Total net revenues (gross revenues net of cost of sales) upped 4% to $708.4 million. On a net revenue basis, Electric Operations increased 9% and Gas Distribution upped 5%. However, Gas Transportation and Storage went down 2%. 

Operational Update & Segment Performance

Total operating expenses went up 9% in the quarter to $602 million. Operating expenses excluding the impact of trackers went up 2% to $565.3 million. NiSource’s adjusted operating income plunged 31% to $109.9 million in the quarter.

Gas Distribution Operations: Operating expenses, excluding trackers, increased 8% to $261 million due to higher employee and administration costs, including the impacts of the previously deferred 2009 pension costs by Columbia Gas of Ohio. The segment reported an operating  loss of $40.7 million, which aggravated from the loss of $30 million in the year-ago quarter. Revenue increase was partially offset by a decrease in commercial and residential margins as well as a decrease in off-system sales in addition to an increase in operating expenses.

Gas Transmission and Storage Operations: Operating expenses, excluding trackers, upped 12% to $128.4 million reflecting increase in maintenance and other outside service costs and employee and administration expenses, including pension costs. Operating earnings declined 24% to $76.4 million driven by a decline in net revenues and increase in operating expenses.

Electric Operations: Operating expenses, excluding the impact of trackers, increased 5% due to increased employee and administration costs, higher electric generation costs and higher taxes. This was the only segment to post an increase in operating earnings, reaching $80.0 million from $69.6 million in the year-ago quarter.

Corporate and Other Operations: The segment posted an operating loss of $5.8 million in the quarter versus a loss of $5 million in the year-ago quarter.

Financial Position

As of September 30, 2010, NiSource had cash and cash equivalents of $10.9 million, up from $16.4 million as of December 31, 2009. For the nine months ended September 30, 2010, the company generated operating cash flows of $387.4 million, substantially down from $1.31 billion in the comparable year-ago period.

NiSource successfully executed a $400 million equity offering of common stock in September. This enhances its ability to invest in new infrastructure improvements and growth opportunities.

As of September 30, 2010, the company’s debt-to-capitalization ratio increased to 60% from 58% as of June 30, 2010.

Other Updates

Management also highlighted steady progress on NiSource’s key business priorities, including the advancement of customer service, achievement of regulatory initiatives at Northern Indiana Public Service Company (NIPSCO), strategic investments in the Marcellus Shale region of Appalachia, and execution of its strategy of combining long-term infrastructure replacement programs with complementary regulatory initiatives in its Gas Distribution Operations.

Outlook

Based on NiSource’s results in fiscal 2010 so far and signs of gradual economic recovery in some of its key markets, the company hiked its fiscal 2010 net operating earnings outlook to $1.20 to $1.25 per share from the previous outlook of $1.10 to $1.20. The company reiterated its target of achieving 3% to 5% earnings growth in the long term.

Our Take

We believe the company’s regulated operations should see significant growth, as they operate in an area that accounts for nearly 50% of the nation’s natural gas consumption and where over 40% of the population is based. The recent equity issue removes a key apprehension on the stock. The issue makes way for the company to reach its $1 billion investment target while comfortably meeting its long-term 3%-5% EPS growth target. NiSource’s strategy of divesting its non-core businesses and transforming into a pure play regulated company bodes well in our view.

However, the lack of near-term earnings growth opportunities, due to multiple regulatory overhangs, continues to be a concern. We currently have a Zacks #3 Rank (short-term Hold recommendation) on the stock.

Merrillville, Indiana based NiSource is an energy holding company whose subsidiaries provide natural gas, electricity and other products and services in the U.S. Its operating subsidiaries deliver energy to customers within the high-demand energy corridor stretching from the Gulf Coast through the Midwest to New England.

 
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