CorEnergy Infrastructure Trust Inc (CORR) 2017 Q4 法說會逐字稿

Greetings, and welcome to the CorEnergy Fiscal Year 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Lesley Schorgl, Manager of Investor Relations. Thank you. You may begin.

Thank you for joining CorEnergy Infrastructure Trust Fiscal Year 2017 Earnings Call. Today, we have with us David Schulte, CEO and President; Rick Green, Executive Chairman; and Nate Poundstone, Chief Accounting Officer. As a reminder, the presentation materials for this call as well as information included in our press release issued Wednesday and an audio replay of this conference call will be available on CorEnergy's website.

The statements made during the course of this presentation that are not purely historical may be forward-looking statements and are subject to the Safe Harbor protection available under the applicable securities laws. Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in our filings with the SEC. These documents are available on the Investor Relations section of our website. We do not update our forward-looking statements. Reconciliations between GAAP and the non-GAAP results, which we discuss on this call, can be found in our related earnings release and 10-K filing.

President and CEO, Dave Schulte, will now speak to you about CorEnergy's 2017 year.

Thank you, Lesley, and good afternoon, everyone. We exited 2017 in a much stronger position than we entered it, both on a portfolio standpoint and on a financial basis. On Slide 3, we illustrate the positioning of our asset mix and how the market has responded after a significant test over the last few years. In the upper left-hand corner, you see a classic, efficient frontier curve measuring the long-term relationship between investment risk and return. Generally, asset classes can be plotted along this curve. On the one end, you may have a treasury bond or bank debt, an investment, which is viewed as low risk but also relatively low return. At the other end of the spectrum exist investments such as venture capital, generally higher risk but with commensurate potential rewards.

Now CorEnergy's REIT model for owning infrastructure assets was intended to enable our portfolio of assets to achieve solid returns with lower risk for each unit of return. And to execute this strategy, we target asset-level returns of 10% to 12% by creating long-duration lease contracts with predictable cash flows. Our leases have participating rent features, which can increase those returns with higher asset utilization. And finally, we purchase pipelines and storage terminal assets in negotiated transactions, thus, receiving a premium for the illiquidity of those assets.

Now the other half of our strategy is risk mitigation. We acquire assets which are critical and long-lived via a rigorous screening and due diligence process. We strive to have a portfolio that is diverse in asset type, tenant, geography and commodity exposure. We believe our structure as a REIT and the use of real property leases promotes contractual protections and credit priority versus other infrastructure use contracts, such as service or tolling agreements.

The bottom chart is CorEnergy's report card. It depicts the total returns of CorEnergy versus the REIT and the Alerian MLP Indices since we adopted the REIT strategy in December of 2012. As you can see, CorEnergy has significantly outperformed the 2 indices, largely thanks to our stable dividend. Now that is not to say investors have always perceived CorEnergy as a low-risk investment, as illustrated by the dip in our share price in 2016. However, even in the harshest time such as the energy downturn, enabled us to demonstrate the durability of our revenue model, which is the hallmark of the infrastructure asset class.

On the next slide, I'd like to provide updates to our current portfolio, which we believe is a steady base for this risk-reward proposition. On Slide 4, the Grand Isle Gathering System, which is our largest asset, is leased to Energy XXI Gulf Coast, continues to serve production from the Gulf of Mexico. Energy XXI announced that they will continue as a stand-alone company following their strategic analysis by Morgan Stanley, and they recently released their 2018 capital budget. And they anticipate drilling 6 new wells in 2018, which is the most robust drilling plan for that company in the last 4 years. Drilling will be focused in the West Delta and South Timbalier fields, both of which are located in what Energy XXI deems its core properties. And each field is partially served by our liquids gathering system in the Gulf of Mexico.

Ultra Petroleum has had much success in the Pinedale field this past year, particularly with its horizontal drilling test announced this week. In 2017, CORR received approximately $0.5 million of participating rents from UPL based on higher levels of production. And given our conviction in the reserve profile of this field and the demonstrated level of utilization of our asset, we purchased a minority equity interest in the Pinedale LGS, which was previously held by our partner, Prudential Capital, for $32.9 million. PRU also was willing to remain involved in the asset and provided us with $41 million of asset-level debt, which we utilized for the equity buyout. Now PRU continues to be a valuable partner in the acquisition and oversight of this asset, and we're very pleased they chose to continue their relationship with us in the Pinedale LGS asset.

At our Portland terminal, Zenith Energy completed its acquisition of Arc Logistics in December. As we've previously discussed, the lease provides Zenith with options, including an option to buy the terminal from us, which remains live through the end of the lease as well as early termination options in the fifth and 10th anniversary of the lease. On January, we agreed to extend that first notification period from February 1 to August 1 due to the recency of the acquisition by Zenith and the ongoing discussions with their new management team around long-term plans for our terminal. We continue to believe the Portland terminal's strategic locations in the Pacific Northwest as well as the versatility of that terminal make it a valuable asset. And we're not anticipating that Zenith will exercise their termination option.

The other aspect of the Zenith acquisition that impacts us is our investment in Lightfoot LP and GP. CorEnergy has held an equity interest in the Lightfoot entities since our time as a business development company. The Zenith acquisition resulted in the sale of a majority of Lightfoot's assets for which we received $7.6 million in cash plus an interest in the Joliet Terminal, which we valued at $1.2 million. This moves us closer to the final disposition of our legacy BDC assets, which has been our plan since converting to a REIT in 2013.

Regards to our MoGas Pipeline, we continue to look at options available to offset the impact of the upcoming decline in rates on the new Spire contract, which is effective in November of this year. We are anticipating filing a rate case in the second quarter of 2018, and we'll plan to update the market once filed and as the case moves forward.

On our Omega Pipeline, we received a private letter ruling from the IRS this year, which enabled us to designate the income from our contract with Fort Leonard Wood as REIT-qualifying income. We subsequently converted Omega into a REIT subsidiary from a taxable-REIT subsidiary. As the energy infrastructure real estate world continues to take shape, this PLR helps solidify CorEnergy's position as a pioneer in this front.

Lastly, on Omega, we announced that we were awarded a UESC Program at Fort Leonard Wood from the Department of Defense. The program will provide comprehensive natural gas, electricity and water efficiency improvements for the Army base, and we expect the agreement will last 4 to 5 years and provide incremental revenue for Omega.

I'll now turn the call over to Nate to cover our financial performance.

Thank you, Dave. Our quarterly financial metrics are outlined on Slide 5. You'll note that our diluted net income, NAREIT FFO and FFO adjusted for securities are each lower in the fourth quarter. These decreases relate primarily to higher income tax expense during the quarter associated with applying the new lowered federal rate to existing deferred taxes, following the tax reform enacted in December. You could see that AFFO, which adjust out as noncash tax impact, has remained steady.

Additionally, for the fourth quarter, we declared our 10th consecutive common dividend at $0.75 per share, demonstrating the consistency of our revenue model and asset base. We target a conservative AFFO ratio to dividends of 1.5x for the current portfolios in order to provide us with ample reserves for debt repayment, ARO funding as well as necessary capital reinvestment activities to allow us to sustain our business model and dividend-paying capacity over the long term.

Our coverage ratio for the fourth quarter was 1.44x, which continues to be pressured by the additional preferred dividend requirements from our offering earlier in 2017. This short-term pressure on our ratio was expected though and is the result of the financing activities that we undertook this year in order to position ourselves for growth.

Turning to Slide 6. You can see the results of the financial positioning that occurred in 2017. In April, we took advantage of the preferred market conditions and issued over $70 million of our Cumulative Redeemable Series A Preferred Stock, utilizing a portion of the proceeds to pay down the $44 million balance outstanding on our revolver at the time. Then in July, we amended our credit facility, upsizing to $160 million in commitments, subject to borrowing base limitations, and extended the term for an additional 5 years. In connection with entering into the amended facility, we paid off the outstanding balance on the term loan under the prior facility.

Then lastly in December, as Dave highlighted, we entered into an amended for the Pinedale credit facility. Recall that as an unrestricted subsidiary, leverage has been included at the asset level on Pinedale since its acquisition. In March of 2016, we and Prudential had refinanced the Pinedale facility internally on a pro rata basis. So from that point and through 2017, we really haven't had the asset-level leverage that we'd intended. With this transaction, we've reestablished a conservative level of leverage back at the asset level through Prudential's funding of a $41 million, 5-year term loan facility at a fixed rate of 6.5%.

The $41 million in borrowings under the amended facility were aligned with what was needed for us to fund the buyout of Prudential's equity interest based on our pro rata proceeds from the refinancing. This makes it an accretive, liquidity-neutral transaction for us from a consolidated perspective, whereby we acquired the remaining equity interest and were able to add back a conservative amount of leverage at the asset level.

The impact of these 2017 financing initiatives had on our liquidity and our capitalization are demonstrated on the slide. You can see that at the end of 2017, CorEnergy has $156.3 million of total liquidity, which compares to $60 million at the end of 2016. Our total debt to total capitalization ratio stands at approximately 25%, which is at the very low end of our targeted range of 25% to 50%. And following the preferred offering during the year, our preferred to total equity ratio now stands at 28.2%, which is closer to our target of 33%.

We had a goal of strengthening our financial position to be able to transact quickly on opportunities that arise without being subject to market conditions. That goal was achieved in 2017, and we are now positioned to efficiently and quickly act on an acquisition opportunity when the right one presents itself.

And with that, I'll turn the call back over to Dave this speak about our acquisition pipeline and outlook for 2018.

Thanks, Nate. On Slide 7, we'd like to reiterate the stringent due diligence processes and asset criteria that CorEnergy has for our investments. And we target a 10% to 12% long-term return on critical long-lived assets, which have high barriers to entry and provide predictable cash flows with limited sensitivity to price and volume changes.

In 2017, we assessed a number of potential assets, and we issued LOIs and entered into varying stages of due diligence on 5. Two of those were eventually terminated by us for valuation or diligence reasons according to our criteria. We valuated the purchase of the remaining interest in the Pinedale LGS as if it were a new asset, subject to the same level of diligence processes and procedures as any other unrelated asset we might acquire. The last 2 remain in our pipeline as active projects for 2018.

We're often asked by investors what types of assets we're reviewing and about the financial state of our potential counterparties. Now for the most part, we are continuing to see assets that are similar to those already in our portfolio, primarily, pipelines near the wellhead as well as storage terminals. These assets are diverse in geography and in the commodities they transport and store. Given today's environment, we're not only seeing counterparties looking to strengthen their balance sheets, but also interest from large global companies who've adopted policies of spending within their cash flow.

CorEnergy offers each of our counterparties, regardless of their financial profile, an opportunity to monetize low-returning assets, enabling those companies to put that capital towards higher-returning production activities. Now even after 5 years as an energy infrastructure REIT, we still find ourselves educating potential counterparties on our value proposition, an exercise we think is worthwhile due to the large addressable market opportunity that we face. In 2018, we're targeting completing 1 to 2 acquisitions, each in the $50 million to $250 million range, with larger sizes actionable with asset-level partners, such as Prudential Capital's original role in our Pinedale LGS.

On Slide 8, we discuss our dividend outlook for the year. 2018, we believe that we'll be able to maintain our $3 dividend. This is despite the upcoming decrease in rates charged to Spire for usage of our MoGas Pipeline, which will begin at November of this year. We expect the decreased revenues to be adequately mitigated by the accretion from our increased ownership interest in the Pinedale LGS, the results of the FERC rate case for MoGas and growth from our existing contracts through CPI-based escalators as well as participating rents. Of course, additional upside could result from any acquisitions we complete during the year. And we will reassess our dividend paying capacity and our dividend levels should we complete a deal. But we will retain an appropriate amount of cash flow in order to sustain our dividend in the future. It is at the core of our strategy to make prudent acquisitions and set dividends at responsible levels so our investors can expect consistent performance and cash flow, the hallmark of the infrastructure asset class.

I would now like to take any questions from the line.

(Operator Instructions) Our first question comes from the line of Barry Oxford with D.A. Davidson.

If I could get just a little more color behind the Pinedale lease as far as percentage rent of what we might expect in 2018 from that. Because you had indicated that, that could be used to offset the MoGas.

Sure. We were able to record $587,000 or so of participating rents. And the indication of participating rents is that the volumes of utilization of that asset are very near to the levels that they were when we first did the acquisition. And we've positioned participating rents to be -- enable us to have upside from there. And for those first several years, we didn't have any participating rents. So we're pleased that the company's activity levels in the field have enabled that -- their production to start generating volumes that get us access to participating rents. However, we're completely dependent on the company's level of activity. And Dave said that their drilling program will be dependent on the direction of gas prices in the field, and they could deploy on a variable number of rigs. So we would expect that, that revenue would be utilized for coverage but not for dividends, as we've said. But we also don't try to predict that level. And until it got to be higher and sustainably higher than it is today, we don't think it's a meaningful portion of what we expect to use to offset other -- the MoGas circumstances. Now what we do have to count on is the income for noncontrolling interest, which was paid previously to Prudential. That's now staying with us due to the acquisition. So that's a material part of the makeup of that potential loss. That, plus inflation escalators, which we can predict and which have enabled us to generate an extra million dollars plus off of the Pinedale lease. And could be, at some point, if inflation does kick up, something that would also kick in on other contracts, including Energy XXI. So the -- but predicting the participating rents is not an exercise that we think is very fruitful at this point in time.

Right, right, right. Got you. Is there any opportunity that they could come back to you on the Pinedale lease and say, look, we won't cancel it, but we want a reduced rate type of thing? Or is that not part of the scenario?

I think you mean Portland.

Sorry, yes. I'm sorry. Yes.

Yes. We would not expect that to happen, and what -- we do believe it's a valuable asset, and we'd like to remain in an ownership posture there. We think that Zenith will like to remain in an operating status there. And at some point in the future, they will come to some decision processes around their long-term ownership strategy. And just -- it's a new senior leadership team there, and we need to just be patient to make sure that they've had time to evaluate their options. In the meantime, we're very happy to continue owning it.

Great. Last question, when you think about acquisitions and where you kind of are right now in the probability of actually doing an acquisition and the total number of targets that you're seeing out there. Can you compare that to 6 months or a year ago, just to kind of give us a sense of where you are kind of in the process? And is it -- are things better now than 6 or 12 months ago?

They're much better now. And these processes take -- they can take 6 months after you sign a letter of intent because of documentation and due diligence. But that will be the outside case. But the activity level that we've been able to generate in the last 6 months far exceeds what we're able to generate a year ago during the period where we had uncertainty, and our stock price was reflecting that, and our lenders were reflecting that. So the availability that we've...

Is it also a function of gas -- of oil prices too and where they were a year ago versus now or not necessarily?

Let me say this about the backdrop. So I think it's healthy for us. The commodity curves today really just -- are not generating a high level of conviction in expected revenue for the energy companies we're talking to. Their banks remain concerned about total leverage. We've seen companies that are willing to sell lower, less-productive assets, such as infrastructure, to fund their CapEx programs. And yet, with their production costs are declining and their productivity is growing, so volumes are going up in this environment. So there's need for capital to handle increased volumes. We think that, that macro environment is very healthy for us. The projects in our active pipeline today are responding to some or all of those conditions. And we feel very good about our prospects for 2018.

Our next question comes from Selman Akyol with Stifel.

Appreciate all that color, very helpful. So starting out with Joliet. Do you think you will end up selling that asset? Do you think you just hold it until some other liquidation event comes along?

Joliet is being managed by Zenith. So a part of the comprehensive acquisition they did was to step into the management shoes of Arc Logistics with regard to that asset. It was only partially owned by Arc Logistics and partially owned by financial partners. So what -- the transaction resulted in our retention of a small interest, less than 1%. We're valuing it at just a little over $1 million. And as long as Zenith is in there managing it and is in a posture where there's still minority equity, we're going to hold our position. And when -- if and when the whole asset sells, we'll be treated to a liquidity opportunity at that point in time. So we're not looking for any near-term liquidity option there.

Okay. Can you say what the utilization on GIGS is today?

I don't think we publish utilization rates on GIGs, nor have we ever published utilization rates on GIGS. The production levels -- and they don't separate out their activity by system or by field so you can measure exactly what might be available to us. But overall, the corporate production level has flattened out and they expect their drilling program this year to sustain production. May not grow it, but it should overcome decline. And the fields that they've mentioned specifically they're targeting are at least partially served by our pipeline. So we feel pretty good about at least sustaining production levels where they are. And if they emphasize our fields, we could have little -- potentially a little growth in utilization. Not, by the way, not to the level though that they were when we did the acquisition, so we don't expect participating rents there.

Got you. And then on the $41 million of debt, is that -- is there any paydown associated with that? Any amortization?

Yes, Selman. This is Nate. Yes, we kept the amortization steady with what we'd done before in a prior facility. So it's about $3.5 million per year for the 5-year term.

Okay. And then -- all right. So I see it there then. Okay. And then just to be clear on the taxes, that had nothing to do with you changing MoGas from a -- to a REIT status from a C-corp-status asset.

No, no. The tax impact in Q4 that we talk about is really the tax reform impact on -- just the change in the statutory rate down to 21% on existing deferreds.

Our next question comes from Michael Zuk with Oppenheimer & Co.

Could you give us a little color on the process of the Omega program at Fort Leonard Wood? I mean, are you, at the beginning, going to have site assessment and then architecture and engineering and then construction? Could you give us a little fill-in on where you are and what you're looking for in the current year?

Sure. I'll invite Rick Green to respond to that. He's joined us for the call.

Mike, we expect that contract to be signed any day now. And that will really start to focus on the projects, which are a mix of energy efficiency projects, like lighting, as well as something as big as a cogeneration plant. All of that is going to take at least 6 months of planning and engineering before actual work starts. So when we get into that planning and engineering, we'll be able to speak more specifically to it. But right now, it's still on the path and should be signed very soon.

And is it my understanding -- you alluded to before, this is a multiyear project.

Yes. This should stretch over about 5 years.

Will there be, as the project is phased in, will there be revenue that will be generated as, say, 1 or 2 of the systems are implemented and up and running?

We expect there will be. It's hard to know how much that is. On the high side, with cogeneration, that could very well take some more natural gas, which would work as a positive to MoGas. But it's too far out and too uncertain to actually put any specific conversation around it.

Well, I appreciate that. So we're looking at preliminary work this year and then really, probably 2019 is when it really gets down to the nuts and bolts.

That's our best estimate right now.

(Operator Instructions) Our next question comes from the line of David Adams, who's a private investor.

I had a question about whether you guys felt like you're losing any deals to lower-fundings sources, private equity, et cetera.

Well, I appreciate your characterization of private equity as a lower-funding source. They are a very large and meaningful contributor to infrastructure asset development. And we believe that there's a role for us alongside them for a couple of reasons. One is that the nature of the assets that we can own don't include processing plants and things that are engaged in converting commodities from one form to another. That's not a passive activity, and those are not real property assets. But on the other side of it, we can have a very long-duration contract, whereas private equity tends to have a more limited window or horizon before they need liquidity and would then force another transaction event on the company. So we think we have some advantages, but we can't do what they can do from a breadth standpoint. Lastly, I'd say we're probably a little less expensive at the margin than private equity because we tend to take, what we believe, less risk by owning the asset outright and subjecting it to our lease contract versus private equity being completely junior to other indebtedness in their -- in the capital stack of the company. So maybe the final comment will be, we're always competing with other sources of capital, particularly with traditional sources of capital. And so that affects us more on pricing and opportunity than it does as far as direct competition for the particular kinds of financing we do. Most of our transactions have to be essentially negotiated transactions, because there's a customization requirement to fit within a counterparty's capital stack, legal posture vis-à-vis the assets, and our own treatment of the assets as real property for opinion purposes. And so we find that we generally are educating companies about overall cost of our capital versus other things. And as you suggest, there's a lot of other sources of capital available to these companies today.

Do you feel like that competition is increasing?

No. I don't think it's increasing. I think -- and that's a fair question. There's a lot written about the amount of capital that's sitting on the sidelines in private equity funds generally. And in the energy sector, there seem to be a number of private equity funds that have sponsored management teams that are competing with each other to acquire assets. They are operating business models, and we're not. So we rarely -- for assets that are suitable for an operating management team to own and optimize, we are rarely the best solution. There -- so we're not really competing directly with those kinds of sources.

Okay. And I think on -- I read somewhere about 2 of the deals that you guys got down the road a little ways with and then abandoned. Was that finding out more about the asset? Or was that from a financial structural issue? Or can you tell us?

Yes. We had one example of each. One was an assessment of the reserve profile that we engaged a third-party to advise us on independent basis as to reserve life and productivity. And we didn't do that until later in the process. And at the end of that, we just became a little less comfortable than we wanted to be regarding the prospects for the project, and so we set our pencil down on that one. The other one, we were passed the early stages of an evaluation of a project and became less comfortable with the contractual opportunity that we thought we were going to be able to get comfortable with. And so we had a financial risk assessment, not an operating risk, but a financial risk assessment that we made later in diligence. And we decided, again, to put our pencil down on that one.

If I could just ask one more follow-up question. The path that led you guys to getting the GIGS system and Pinedale system, is like you're still capable of receiving that same type of opportunity or you moved into a whole new area of trying to find new deals?

No, we're very open to direct analogies to GIGS and Pinedale and are looking at some in our current prospect list. But in addition to that, we have broadened our scope and are looking at more of -- a bigger variety of opportunities.

Thank you. There are no further questions at this time. I would like to turn the call back over to Mr. Schulte for any closing remarks.

Thanks, everyone, for joining us for our 2017 review and 2018 outlook. We appreciate your attention on the call. And we believe we spent much of the last year preparing for growth, and we're excited about the opportunities that lie ahead. If you have any further questions, please feel free to reach out to our team. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.