ONE Gas, Inc. (OGS)

Executive Summary / Key Takeaways

• Texas House Bill 4384 creates a permanent structural earnings boost by expanding regulatory deferrals to all capital expenditures, widening the gap between GAAP and regulatory earnings to $12 million (4% of EPS) in 2026, a recurring benefit the market has yet to fully price.

• Operational excellence through in-sourcing initiatives has reduced excavation damages by 14% despite 8% higher ticket volumes, demonstrating management's ability to control O&M expenses while improving safety metrics, supporting the 3-4% long-term O&M CAGR guidance.

• Post-Winter Storm Uri investments have transformed system resilience, with storage capacity exceeding 60 Bcf and over 80% of supply shielded from price spikes, creating a durable competitive moat that competitors in less-prepared regions cannot replicate.

• The company trades at 19.4x earnings with a 3.2% dividend yield, a discount to peers like Atmos Energy (ATO) (23.9x) and CenterPoint Energy (CNP) (26.5x), while offering comparable customer growth and superior regulatory relationships in its core three-state footprint.

• The 1.5 GW utility-scale power generation pipeline and data center opportunities represent a call option on growth beyond the steady 23,000 annual residential customer additions, with disciplined capital allocation ensuring returns exceed cost of capital.

Setting the Scene: The Regulated Utility Model Reimagined

ONE Gas, Inc., headquartered in Tulsa, Oklahoma and tracing its origins to the Oklahoma Natural Gas Company founded in 1906, operates as a 100-percent regulated natural gas distribution utility serving approximately 2.3 million customers across Oklahoma, Kansas, and Texas. This regulatory structure is the foundation of its economic moat. The company earns revenue from delivering natural gas through an exclusive franchise network, with rates set by state commissions to provide a defined return on invested capital. The business model involves investing in rate base , earning an authorized return, recovering prudently incurred costs, and growing through customer additions and capital projects.

The convergence of three factors makes this model particularly attractive. First, the regulatory environment in Texas has improved through House Bill 4384, which expands deferral and accrual mechanisms previously limited to safety-related capital to now encompass all capital expenditures. Second, operational execution has reached an inflection point, with in-sourcing initiatives delivering measurable safety and efficiency improvements. Third, post-Winter Storm Uri investments have created a system resilience that competitors in less-prepared regions cannot match, as evidenced by the company's ability to deliver over 3 Bcf of gas during peak storm conditions with no supply disruptions.

The competitive landscape reveals ONE Gas's focused strategy as both a strength and a limitation. Atmos Energy serves 3.3 million customers across eight states with operating margins of 38.9% versus ONE Gas's 20.3%, but trades at a premium valuation (23.9x P/E) that reflects its scale advantage. CenterPoint Energy's integrated electric-gas model provides diversification but adds complexity that ONE Gas avoids. Spire Inc. (SR) operates a similar pure-play gas model but lacks ONE Gas's geographic diversification. Southwest Gas (SWX) offers comparable scale but with higher payout ratios that limit financial flexibility. ONE Gas's three-state concentration allows deeper regulatory relationships and operational focus, creating "foundational energy" delivery with top-quartile safety performance.

Operational Differentiation: The In-Sourcing Advantage

ONE Gas's operational strategy centers on bringing critical functions in-house to build long-term capability while reducing external dependency. By Q4 2025, employees performed approximately 40% of line locating services company-wide, a shift that delivered a 14% decrease in excavation damages per 1,000 locates despite an 8% increase in ticket volumes. This matters because excavation damages represent both immediate repair costs and potential regulatory penalties, while also impacting customer service reliability. The 14% improvement directly reduces O&M expenses and enhances the company's safety profile, which recently earned the American Gas Association Safety Award for the lowest rate of significant injuries among peers for the eighth consecutive year.

The company plans to in-source the "Watch and Protect" program by Q3 2025, extending this strategy to another critical operational area. While onboarding and training temporarily increases costs, the long-term benefits are clear: teams operate more efficiently, deliver stronger performance, and create a pipeline of future talent. This approach counters a primary risk facing utilities today—attracting and retaining skilled technical employees—by building institutional knowledge rather than relying on contractors. The result is a more resilient workforce capable of executing complex projects like the Austin System Reinforcement, which was completed ahead of schedule, under budget, and without lost time injuries.

This operational discipline directly supports the financial profile. Management projects a 3-4% O&M CAGR long-term, with 2025's 5% increase attributed to opportunistic early execution of environmental remediation projects rather than a fundamental cost escalation. The ability to control O&M growth below inflation while expanding service territory is a hallmark of best-in-class utility management, creating operating leverage that flows directly to earnings.

Financial Performance: Regulatory Economics vs GAAP Reality

The 2025 financial results show solid GAAP performance and even stronger regulatory economics. Revenue increased 17% to $2.43 billion, while net income rose 19% to $264.2 million. Adjusted net income, which reflects the company's true earnings power under regulatory accounting, reached $271.0 million, a $7 million premium to GAAP that will recur and grow. This divergence is a fundamental feature of the business model that Texas House Bill 4384 has amplified.

The mechanism works as follows: under traditional GAAP, utilities expense depreciation and ad valorem taxes as incurred, creating a timing mismatch with rate recovery. Texas Rule 8.209 previously allowed deferral for safety-related capital, creating a modest $2 million annual impact. HB 4384 expands this to all capital expenditures, widening the 2025 impact to nearly $7 million ($0.11 per share) and projecting $12 million ($0.18 per share, or 4% of EPS) for 2026. This adjustment is expected to persist and grow as capital expenditures increase, effectively creating a permanent earnings tailwind that GAAP obscures.

Capital expenditures totaled $760 million in 2025, with $170 million dedicated to serving the growing customer base. The company added approximately 23,000 new residential customers, consistent with prior years, demonstrating steady organic growth. More importantly, revenue recovery from fixed charges provides stability: Oklahoma Natural Gas recovers 91% of non-gas costs through fixed charges, Kansas Gas Service 52%, and Texas Gas Service 66%. This fixed-charge recovery insulates earnings from weather volatility and consumption fluctuations, creating predictable cash flows that support the 61% payout ratio and 3.2% dividend yield.

The balance sheet reflects prudent financial management. The debt-to-capital ratio stands at 47.6%, with investment-grade ratings from S&P and Moody's. In October 2025, the company increased its credit facility to $1.5 billion and extended maturity to 2030, while commercial paper capacity rose to $1.5 billion. As of December 2025, $737.4 million of commercial paper was outstanding at a weighted-average rate of 3.94%, benefiting from Federal Reserve rate cuts. The company has fully satisfied 2025 equity needs and covered 40% of its five-year equity requirement through forward agreements, demonstrating proactive capital planning.

Outlook: Structural Growth with Disciplined Capital Allocation

Management's 2026 guidance projects adjusted net income of $306-314 million and adjusted EPS of $4.83-4.95, representing 4-7% growth from 2025's adjusted baseline. Long-term guidance calls for 7-9% adjusted net income growth and 5-7% adjusted EPS growth through 2030, implying a midpoint of roughly $6.00 per share by decade's end. These targets assume no further Federal Reserve rate cuts, conservative O&M growth of 3-4% CAGR, and disciplined capital deployment.

The capital plan supports this growth trajectory. Expenditures are expected to reach approximately $800 million in 2026, with a potential "punctuated step-up" as large load opportunities materialize. The Austin System Reinforcement project, completed in Q3 2025, boosted winter peak capacity by 25% and provides access to lower-cost Waha hub gas, demonstrating the company's ability to execute transformative infrastructure investments efficiently. The newly announced $120 million, 43-mile pipeline in southeast Oklahoma will deliver over 100 Bcf annually to Western Farmers Electric Cooperative by Q3 2028, supporting utility-scale power generation and regional economic development.

Large load opportunities represent a significant growth vector beyond residential additions. The company is actively pursuing approximately 1.5 gigawatts of utility-scale power generation across its three states, plus data centers and advanced manufacturing facilities. These projects are evaluated based on their ability to enhance system resiliency and align with customer needs. The approach is deliberate, prioritizing projects that leverage existing infrastructure for fast, cost-effective service rather than speculative greenfield development. This discipline ensures capital is deployed only where returns exceed cost of capital, protecting the regulatory compact that underpins the business model.

Regulatory filings planned for 2026 include a GRIP filing for Texas Gas Service, a PBR filing in Oklahoma, and a Kansas GSRS filing in April. No full rate cases are planned until the Oklahoma filing in 2027, providing rate stability for the next 18 months. The Texas rate case outcome, which consolidated three service areas into a single statewide division effective January 2026, will improve efficiency, reduce filing frequency, lower administrative costs, and equalize impacts across a larger customer base.

Risks: What Could Break the Thesis

The investment thesis faces four primary risks. First, regulatory uncertainty has increased following the U.S. Supreme Court's overturning of the Chevron Doctrine, creating potential for divergent interpretations of pipeline safety, environmental, and rate-setting regulations. While ONE Gas has historically received favorable treatment from Oklahoma, Kansas, and Texas regulators, there is no guarantee that future cost recovery requests will be approved. The Texas rate case's 9.8% ROE could face downward pressure in future proceedings, particularly if interest rates remain elevated.

Second, weather and commodity price volatility present ongoing challenges despite mitigation efforts. While weather normalization mechanisms adjust bills for heating degree day variations, they do not fully offset usage fluctuations. The company's diversified gas supply and 60+ Bcf storage capacity mitigated over 80% of price spikes during Winter Storm Fern, but extreme events could still pressure earnings.

Third, interest rate risk directly impacts both the company's cost of capital and customer affordability. The 2026 plan assumes no further Fed rate cuts, but if rates rise instead, interest expense on $737 million of commercial paper and upcoming debt maturities could exceed projections. Higher rates also increase the cost of capital used to set authorized returns, potentially reducing the 9.8% Texas ROE in future rate cases. The company's adjusted CFO-to-debt ratio of 19% sits at the upper end of its credit rating range, leaving limited cushion for rate-driven deterioration.

Fourth, execution risk on large load projects could pressure capital deployment and returns. While the 1.5 GW pipeline represents significant growth potential, these projects require substantial upfront investment and face regulatory approval processes that can extend timelines. The company's disciplined approach mitigates but does not eliminate the risk of cost overruns or demand shortfalls. Competitors like CenterPoint Energy are pursuing similar opportunities with greater scale, potentially capturing market share in high-growth Texas markets.

Valuation Context: Reasonable Multiple for Quality Assets

At $84.95 per share, ONE Gas trades at 19.4x trailing earnings, a discount to Atmos Energy (23.9x) and CenterPoint Energy (26.5x), while offering a superior dividend yield of 3.2% versus 2.2% for both peers.

The EV/EBITDA multiple of 11.2x compares favorably to Spire Inc. (12.3x) and Southwest Gas (11.2x), suggesting fair valuation relative to similar pure-play gas utilities. The price-to-operating cash flow ratio of 9.2x indicates the market is pricing in stable cash generation, supported by the 61% payout ratio that leaves adequate retained earnings for capital investment.

The company's balance sheet strength supports this valuation. With debt-to-equity of 0.98x and investment-grade ratings, ONE Gas maintains financial flexibility. The $1.5 billion credit facility extended to 2030 provides liquidity for the $800 million annual capex program without dilutive equity issuance, while forward sale agreements covering 40% of five-year equity needs demonstrate proactive capital planning.

The valuation does not fully capture the structural earnings boost from Texas HB 4384. The $12 million projected 2026 impact represents 4% of EPS, yet the stock trades in line with peers who lack this tailwind. As capital expenditures increase to support data center and power generation growth, this regulatory advantage will compound, creating a widening gap between ONE Gas's earnings power and GAAP-reported results. Investors focused solely on traditional metrics may miss this hidden value driver.

Conclusion: A Defensive Growth Story with Hidden Upside

ONE Gas represents a rare combination of defensive utility characteristics and structural earnings growth. The Texas House Bill 4384 regulatory tailwind creates a permanent, recurring boost to earnings that GAAP accounting obscures, while operational excellence through in-sourcing initiatives demonstrates management's ability to control costs and improve safety metrics. Post-Winter Storm Uri investments have built a system resilience that competitors cannot easily replicate, and the exclusive franchise footprint across three states provides a durable moat with high barriers to entry.

The investment thesis hinges on two factors: the compounding benefit of regulatory deferrals as capex grows, and successful execution on the 1.5 GW large load pipeline. With a 3.2% dividend yield, reasonable valuation relative to peers, and a management team that has met or exceeded guidance for 12 consecutive years, ONE Gas offers defensive income with upside optionality. The key variables to monitor are Texas regulatory outcomes and the pace of large load project approvals. If both progress as planned, the stock's current discount to peers should narrow as investors recognize the quality of these regulated earnings.