Executive Summary / Key Takeaways

• Texas House Bill 4384 fundamentally transforms the regulatory economics for ONE Gas, allowing deferral and recovery of all capital expenditures and lifting the long-term EPS growth target to 5-7% from the historical 4-6% range.
• The Austin System Reinforcement project, completed in Q3 2025, delivers a 25% winter peak capacity increase while providing access to lower-cost Waha Hub gas, exemplifying capital deployment into high-growth metro areas.
• Customer growth momentum remains robust with 23,000 new meters set in 2024 and 16,800 additions in the first nine months of 2025, driven by sustained in-migration and housing shortages across Oklahoma, Kansas, and Texas.
• The company's 100% regulated model, fortified by 41,600 miles of pipeline infrastructure and 51.4 Bcf of storage, generates predictable cash flows that support a 3.4% dividend yield while funding a $750 million annual capital program.
• Trading at 18.4x earnings and 7.9x operating cash flow, the stock offers a reasonable valuation for a defensive utility with accelerating earnings drivers, though execution risks around cost inflation and regulatory implementation remain.

Setting the Scene: A Pure-Play Regulated Gas Utility

ONE Gas, founded in 1906 as an Oklahoma corporation, operates as a 100-percent regulated natural gas distribution utility serving approximately 2.3 million customers across three divisions: Oklahoma Natural Gas, Kansas Gas Service, and Texas Gas Service. The company generates revenue through tariffs and rates approved by state regulators, with natural gas sales to customers representing the core revenue stream at $1.57 billion for the nine months ended September 2025, up 22.7% year-over-year. This growth reflects both customer additions and rate recovery mechanisms that reduce regulatory lag.

The natural gas distribution industry operates as a collection of regional monopolies, with each utility holding exclusive franchise territories granted by state public utility commissions. Demand drivers extend beyond residential heating into commercial applications, industrial processes, and increasingly, utility-scale power generation to support data centers and advanced manufacturing. The company's service territory benefits from powerful demographic tailwinds: Oklahoma and Texas have experienced net positive in-migration for several years, with Oklahoma City and Tulsa averaging 7% population growth, while a housing shortage across all three states forces new construction that requires natural gas service.

ONE Gas occupies a distinct niche among publicly traded gas utilities. Atmos Energy (ATO) serves over 3 million customers across eight states, leveraging greater scale to drive procurement efficiencies and faster rate recovery. Spire (SR) operates in Missouri and Alabama with 1.4 million customers, pursuing aggressive territory expansion that introduces execution risk. Southwest Gas (SWX) serves 2 million customers in Western states, facing California's stringent regulatory environment and construction segment volatility. New Jersey Resources (NJR) balances 600,000 utility customers with clean energy ventures, diluting its pure-play exposure. ONE Gas differentiates through geographic concentration in lower-regulatory-risk states, deep local relationships, and operational focus that avoids the diversification pitfalls of its peers.

Infrastructure Moat: The Foundation of Predictable Returns

The company's strategic differentiation rests on a century-long accumulation of physical assets and operational expertise. ONE Gas maintains 41,600 miles of distribution mains and 51.4 Bcf of storage capacity, creating a network effect where each additional customer leverages existing infrastructure with minimal marginal cost. This footprint enables supply reliability that competitors cannot easily replicate, particularly during winter demand peaks when the system performed well during early 2025 storms.

System modernization programs have systematically reduced operational risk and environmental exposure. The company completed its cast iron replacement plan in 2019, eliminating the most leak-prone pipes, and finished bare steel service line replacement in Kansas by 2024. These investments contributed to a 51% reduction in leak-related emissions, positioning ONE Gas to achieve its 2035 target of 55% reduction from distribution pipelines. Such proactive asset management reduces future regulatory penalties and maintenance costs while enhancing the company's social license to operate.

Operational efficiency initiatives further strengthen the moat. The in-sourcing of line locating services reduced excavation damages by 13% year-over-year despite an 8% increase in ticket volumes. Management is now applying this model to its "Watch and Protect" program, creating long-term cost savings that offset near-term training expenses. These programs demonstrate a culture of continuous improvement that supports the company's 4% target for O&M expense growth, even as labor costs rise industry-wide.

Financial Performance: Evidence of Strategy Execution

The nine-month financial results through September 2025 validate the company's strategic positioning. Net income increased 22% to $177.9 million, or $2.94 per diluted share, while operating income rose $43.1 million driven by $92.2 million from new rates and $5.3 million from residential customer growth. This top-line expansion more than offset $16.8 million in higher depreciation from capital investment, $13.8 million in ad valorem taxes, and $12.8 million in employee-related costs.

Revenue composition reveals the durability of the business model. Natural gas sales represent 91% of total revenue, with transportation services, securitization charges, and miscellaneous fees providing modest diversification. The residential customer base's significant fixed-charge component insulates revenue from weather variability, while regulatory mechanisms allow rate adjustments between formal rate cases. This structure produced operating cash flow of $368.4 million on a trailing twelve-month basis, funding capital expenditures of $750 million while maintaining a 62% dividend payout ratio.

Margin analysis shows disciplined cost management despite inflationary pressures. The operating margin of 17.3% and profit margin of 10.8% compare favorably to Southwest Gas's pressured margins and Spire's weather-dependent volatility. Atmos Energy achieves superior 30.7% operating margins through scale, but ONE Gas's focused footprint avoids the complexity costs that dilute returns for diversified peers. The company's adjusted CFO-to-debt ratio of approximately 19% sits at the upper end of the range for its A-/A3 credit ratings, providing financial flexibility.

Regulatory Tailwinds: The Texas Transformation

The enactment of Texas House Bill 4384 in June 2025 represents a structural inflection point. The legislation allows gas utilities to defer and later recover costs related to all capital expenditures placed in service but not yet reflected in base rates, including depreciation, ad valorem taxes, and a carrying cost. This provision extends the favorable accounting treatment previously limited to safety-related investments, effectively eliminating regulatory lag for Texas Gas Service.

Management quantified the impact by raising the long-term diluted EPS growth rate to 5-7% from the prior 4-6% range. This 100-200 basis point improvement reflects a durable carryforward effect, as the company can now earn returns on capital investments immediately rather than waiting for the next rate case. Texas Gas Service began applying these provisions in Q3 2025, contributing to the guidance raise that narrowed 2025 EPS expectations to $4.34-$4.40.

The Austin System Reinforcement project illustrates how ONE Gas deploys capital under this improved regulatory framework. Completed in Q3 2025, the $750 million program increased winter peak capacity by 25% while providing access to Waha Hub-indexed gas that typically trades at a discount to Henry Hub. This investment serves high-growth metro Austin, where data center and advanced manufacturing demand is concentrated, while the new deferral mechanism ensures immediate return on investment.

Customer Growth: Demographics as Destiny

Customer additions provide the volume foundation for earnings growth. The company set 23,000 new meters in 2024 and added 16,800 connections in the first nine months of 2025, with growth concentrated in Oklahoma City, Tulsa, and Texas metropolitan areas. This 2-3% annual customer growth rate exceeds population growth, indicating market share gains in new housing developments.

The housing shortage across the service territory creates a captive demand pipeline. New residential construction requires natural gas service, and ONE Gas's involvement in economic development allows the company to steer site selection toward locations with existing infrastructure. This proactive approach minimizes capital intensity while capturing high-margin residential load. Commercial and industrial customer growth, particularly in data centers and utility-scale power generation, offers additional upside that management is actively pursuing.

Competitor comparisons highlight ONE Gas's advantage in customer acquisition. Atmos Energy's larger scale yields more absolute customer additions, but its multi-state footprint dilutes focus. Spire's Tennessee expansion requires building new infrastructure in unfamiliar territory, introducing execution risk. ONE Gas's concentration allows deeper local relationships and faster service activation, creating a feedback loop where developers prefer working with a known, reliable provider.

Outlook and Execution Risk

Management's guidance for 2026 reflects confidence in the structural growth drivers. The 5-7% long-term EPS growth target assumes continued customer additions, successful rate case outcomes, and effective deployment of the $750 million annual capital budget. The company has satisfied its 2025 equity needs and covered approximately 40% of its five-year equity requirement through forward sale agreements, reducing reliance on dilutive issuances.

Interest rate normalization presents both opportunity and risk. Management's model anticipated ten 25-basis-point cuts from the 5.5% Fed policy rate, with six already achieved. Each additional cut delivers approximately $0.025 of annual EPS upside through lower commercial paper costs. However, the company's conservative guidance does not assume further cuts, creating potential upside if the Fed continues easing.

Execution risks center on cost control and regulatory implementation. O&M expenses increased 4.9% in Q3 2025, consistent with guidance but above the company's long-term 4% CAGR target. Employee-related costs rose $12.8 million year-to-date, reflecting tight labor markets and the need to staff in-sourcing initiatives. Ad valorem taxes increased $13.8 million, a cost that the new Texas deferral mechanism will help mitigate going forward.

Risks and Asymmetries

The investment thesis faces three primary risks. First, regulatory reversal in Texas could undermine the benefits of HB 4384. While the legislation passed with bipartisan support, future legislative sessions could modify or eliminate the deferral provisions, increasing regulatory lag and compressing returns. The company's concentration in just three states amplifies this political risk relative to diversified peers.

Second, weather normalization could dampen customer growth momentum. The first quarter of 2025 benefited from weather that was 5% colder than normal and 16% colder than the prior year, boosting demand and financial results. If winter temperatures revert to historical averages, usage per customer may decline, requiring even more new connections to achieve earnings targets.

Third, alternative energy competition threatens long-term demand. While natural gas remains the fuel of choice for new power generation and industrial processes, advances in heat pump technology and renewable energy storage could erode residential market share. ONE Gas's slower adoption of green technologies compared to New Jersey Resources' clean energy pivot creates vulnerability if policy preferences shift toward electrification.

Asymmetries favor the upside. Four additional Fed rate cuts would add $0.10 to annual EPS beyond current guidance. Large-scale project opportunities in data centers and advanced manufacturing, approximating 1.5 gigawatts of capacity across the three-state territory, could accelerate customer growth above the 2-3% baseline. The company's strong balance sheet, with $1.5 billion in revolving credit capacity and no senior note maturities until 2029, provides strategic optionality for acquisitions or accelerated capital deployment.

Valuation Context

At $78.83 per share, ONE Gas trades at 18.4x trailing earnings and 7.9x operating cash flow, a modest discount to Atmos Energy's 23.0x P/E despite similar regulatory environments. The 3.4% dividend yield exceeds Spire's 4.0% yield on a more sustainable 62% payout ratio, and compares favorably to Southwest Gas's 3.1% yield. Enterprise value of $8.12 billion represents 3.4x revenue and 10.7x EBITDA, metrics that reflect the stable, capital-intensive nature of the business.

Balance sheet strength supports the valuation multiple. Debt-to-equity of 1.07x sits below Spire's 1.55x and aligns with the company's A-/A3 credit ratings. The adjusted CFO-to-debt ratio of 19% provides ample coverage for the $750 million capital program while maintaining dividend growth potential. With 40% of five-year equity needs already covered through forward sales, dilution risk is contained.

Relative to historical utility valuations, the 18.4x P/E multiple appears reasonable for a company transitioning from 4-6% to 5-7% earnings growth. Atmos Energy commands a premium for its larger scale and faster growth trajectory, while ONE Gas offers a compelling combination of yield, growth, and regulatory protection. The stock's 0.78 beta indicates lower volatility than the broader market, consistent with its defensive characteristics.

Conclusion

ONE Gas stands at an inflection point where regulatory reform in Texas transforms a stable, slow-growing utility into a structurally accelerating earnings compounder. The combination of HB 4384's deferral mechanisms, robust customer growth in high-migration markets, and disciplined capital deployment through projects like Austin System Reinforcement supports management's raised 5-7% long-term EPS growth target. This represents a durable step-up from historical 4-6% rates, not a temporary cyclical boost.

The investment case hinges on two variables: successful implementation of Texas's new regulatory framework and sustained customer growth that outpaces population expansion. The company's century-old infrastructure moat, fortified by 41,600 miles of pipeline and 51.4 Bcf of storage, provides downside protection through predictable cash flows and a 3.4% dividend yield. While weather variability and potential regulatory reversals pose risks, the balance sheet strength and proactive cost management create multiple paths to achieving the enhanced growth outlook. For investors seeking defensive exposure with an accelerating earnings profile, ONE Gas offers a rare combination of yield, growth, and regulatory tailwinds in an increasingly uncertain macro environment.