Atmos Energy is a regulated gas utility that operates in eight states and has over 3 million customers. Last month, the company, which also operates Atmos Pipeline – Texas gas transmission pipeline network, joined the S&P 500.

Atmos Energy is a widow-and-orphan stock and specific attention should be paid to its dividends. For the past five years, Atmos’ dividend payout ratio oscillated around 50%. In 2018, however, the ratio decreased to 35.64%.

We don’t see this as a cause for concern. The decrease comes from the lower income tax expense in 2018 ($8.08 mln.) comparing to 2017 ($221.38 mln.) – a consequence of the Tax Cuts and Jobs Act of 2017. In contrast, the dividend growth rate, more important metric under the circumstance, has increased in 2018 to 7.78%.

Another positive trend for Atmos is a continuing increase in capital spending. Regulated utilities generally benefit from investments in infrastructure as it allows them to increase the rate base and maximize the profits. On November 08, 2018 earnings call, Michael Haefner, Atmos Energy CEO, promised that the company will “continue to focus our investments on infrastructure modernization, system modification, customer growth and deploying technology,” and reiterated on February 09, 2019 call that “the general theme is focused on accelerated replacement of infrastructure, which we have been doing and certainly continue to.”

Being essentially monopolies, regulated utilities have to agree rate increases with public service commissions by filing a rate case. Currently, Atmos Energy has seven rate cases in progress. The two biggest cases are Kentucky Rate Case ($14.4 mln.) and Mid-Tex DARR ($9.5 mln.).

The Kentucky Rate Case is focused on bare steel pipe replacement. Gas pipelines infrastructure in the United States is old, and many states have a Pipeline Replacement Program in place. Atmos, for instance, claims that “majority of our bare steel systems were installed in the 1930’s-1950’s, already making them 65-85 years old.” Kentucky Public Service Commission, however, insists on historic recovery, while Atmos Energy is trying to reduce regulatory lag by arguing for forward-looking treatment. We expect Atmos to win this case.

The Mid-Tex case was filed under the Dallas Annual Rate Review. The case “supports more than $465 million of total capital investment made in the Mid-Tex system with over $363 million spent on improving system safety and reliability.” It is less clear that Atmos will be able to win this case straight away given that the company is under pressure after explosions in northwest Dallas last year. Should the Dallas City Council reject proposed rate increase, Atmos will likely appeal to the Texas Railroad Commission. Under this scenario, we expect company to win the appeal.

As is often the case with utilities, the main source of Atmos’ revenues is residential market. In 2018, company’s revenues from this segment amounted to $1,916.1 million and comprised 62% of the total operating revenues.

The growth of customer base in residential market largely depends on the housing market. Roughly 70% of Atmos’ operations are in Texas where the housing market has lately been sending mixed signals. Thus, according to Home Builders Weekly, housing starts in Texas grew 10% year-over-year in 2018. Recent Texas Economic Update, however, paints a bleak picture by pointing out “elevated land, labor and construction costs” and predicts rather flat housing market in Texas in 2019. At the same time, the mortgage rates in the United States seem to be in a free fall in 2019. If lower mortgage rates provide enough incentive to potential home-buyers, Atmos is well positioned to increase its customer base.

Atmos Energy is an attractive dividend stock for investors looking for safe returns. As long as the company continues to increase capital spending and manage regulatory issues prudently, Atmos will not be significantly affected by downward economic trends.