Chesapeake Utilities Corp (CPK) 2016 Q2 法說會逐字稿

Good morning. My name is Andrew, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Chesapeake Utilities second-quarter 2016 earnings call.

(Operator Instructions)

Thank you. Beth Cooper, Senior Vice President and CFO, you may begin your conference.

Good morning, everyone. I would like to welcome those again that are in the room today. We are live today again at Salisbury University. A special thanks to the Purdue School of Business for hosting us again, for our second-quarter earnings conference call. And a special hello to all of those that are joining us on the phone.

We're here today to talk about our second quarter and year-to-date results ended June 30, 2016. Before we begin, as always, I have to talk about the disclaimer that we have, that our presentation today may include discussions about forward-looking information. And we would like to refer everyone to our annual report on Form 10-K for 2015, where we discuss the factors that could cause our actual results to differ from our forward-looking statements.

Turning to slide 3 to begin, our second-quarter results were higher than last year by approximately $0.11 per share. We recorded earnings per share of $0.52 diluted earnings per share for the quarter. Both on a net income and on an EPS basis, our earnings and our net income were approximately 27% higher than the previous quarter of 2015.

You'll see that that was driven by higher operating income, both in our regulated energy segment and in our unregulated energy segment. Basically, you will see approximately $2.6 million of higher operating income, with about $1.6 million or 63% of the increase coming from our regulated energy segment, and the remaining 37% coming from our unregulated energy segment. There are a lot of things that happened during the quarter that contributed to that increase including service expansions, new services, customer growth, pricing amendments, pricing changes and terms, and a lot of things that overall contributed from a lot of our businesses for us to achieve these higher results.

Turning to slide 4, first, we'll touch on the regulated energy segment Recall that our operating income as I showed on other slide was up by $1.6 million for our regulated energy segment. That's a result of our gross margin you'll see was about $4.8 million.

There were a lot of factors that contributed to that, including $2 million that came from service expansions and new services, $1 million that was generated by our gas reliability and infrastructure program, and we've talked about that in the last couple of quarters. That's a program where we're actually replacing qualifying mains in Florida. To date, we've actually spent about $92 million, and by the end of this year, we'll have spent close to $100 million under this program.

In addition, we also had about $820,000 of customer growth that came from beyond service expansions and new services, actually from both here on the peninsula, as well as growth in Florida, and it's split about 50-50. Here on the peninsula, we're achieving anywhere from about 3.2% to 3.6% in terms of residential customer growth, and also we're achieving commercial growth as well. In Florida, we've got a lot of strong commercial and industrial growth that's occurring.

The other thing that happened, we added about $555,000 in terms of additional margin of interim rates that we've basically implemented in our Delaware Division. In February, we were authorized to implement $2.5 million of interim rates on an annual basis. So that's the quarterly impact from the second quarter.

And lastly, our CHP plant began operating in June, and actually was fully operational and selling steam to Rayonier in July. But in June, there was actually electricity and natural gas margin that we generated on the regulated side that represented about $432,000 out of a total $551,000 in margin overall from the plant.

Moving to slide 5. In terms of the unregulated energy segment, once again you'll see me talk on the very first slide, about there being 37% of the increase in our operating income came from the unregulated energy segment, of which it was about $1 million. And that really came from several different areas, including about $708,000 from our Aspire Energy subsidiary where [fall] we acquired that one last year. On April 1, they added an additional $708,000 in the second quarter of this year versus last year, because of some amendments that we made in pricing contracts and other pricing terms we had.

In addition, we generated about $464,000 of incremental margin, also from a sales agreement entered into by our natural gas marketing entity, and it was a result of the transactions that they're pursuing. This happened to be with an Ohio -- and another Ohio LDC company, and they're finding other opportunities to expand in terms of new customers.

And then lastly, our propane distribution operations also recorded increase margins of about $370,000. And that's primarily from increased deliveries, a result of the timing, but also some certain of our rate classes are also experienced higher volumes in terms of what we deliver to them.

So on a year-to-date basis, you will see overall, we started out the year -- and I'll show on the next slide, where weather really hit us coming out of the first-quarter. With the results in the second quarter, we actually surpassed on a year-to-date basis where we were last year by approximately $0.02. And to me, it's pretty remarkable, specifically when we look at slide 7 in just a minute, where you'll see we had about $0.38 of what we call unusual items, and our growth was able to overcome.

But as I mentioned, turning to slide 7, $0.38 of unusual items, comprised of $0.26 of weather, $0.05 from a gain that we had last year, largely from a customer billing system settlement. And then lastly, we predicted in 2015, retail margins were very -- much higher than they had been when you look back over a period of time, and we actually expected those margins to begin to decline, and they did, and that represented about $0.07. So $0.38 that was actually impacting, where we in a sense, started this year off.

You'll see right below that, we show increased gross margins of $0.40 that we're able to completely overcome that. And then, because we don't have a full calendar year for Aspire Energy, we're also showing the full impact of Aspire Energy, which you'll see at the bottom was $0.09. So overall, we were able to fully overcome the weather and the other unusual items. And right now, we're sitting ahead of where we were on a year-to-date basis.

So with the growth that we've had, and we talked about -- I talked about a little bit that came through, certainly in the second quarter, what was there in the first quarter, that's going to accomplish because of the capital expenditures that we've been investing in for many years. When you look at our past over the last five years -- and we've actually included this year in that number, but when you look at a five-year period, we've invested -- if we fully invest the $180 million that we're looking to invest this year, about $679 million. And that's really remarkable, given where our book capitalization is as a company.

The CapEx that we have on the horizon for this year, includes well, the dollars -- work for the Eight Flags CHP plant which went fully operational. Also, an expansion of facilities to serve the Calpine Power plant in Dover. We have reliability project, both of those projects were recently approved by the FERC, and so we're moving forward, and beginning to look to the construction part of this project.

And then lastly, I talked about the Florida GRIP program, where as I mentioned at the end of this year, we'll have close to $100 million. 82% of the investments that we're looking to make are in the regulated energy business, but certainly we're also looking for opportunities to grow on the unregulated side as well.

As we continue to grow, we wanted to have a balance sheet that can support that growth. And you'll recall I talked about us investing about $679 million. When you look at where our balance sheet is at the end of June, our total capitalization, book capitalization for the Company is approximately $716 million. So we've really invested a lot to see where -- you can really see that, when we look at where our balance sheet is.

In terms of our capital structure, we're sitting at about 53% equity to total capitalization. On a permanent basis, it's about 73%. And when you look at what this shows, you'll see that our balance sheet has been growing, as a result of capital that we have been investing in.

And one of the things that we've looked to do, is to have both short-term and long-term facilities available that help us, as we're looking to finance that CapEx. We talked about this on the last quarter. We have temporary debt facilities in place, both lines of credit, as well as all revolver that represent basically about $320 million in the aggregate. We also have a long-term debt shelf facility that we've actually, partially committed to take a draw off of that facility in the amount of $70 million.

So we have put in place -- Tom has done a great job helping to build, and put in place those instruments that help us finance things both on a short-term basis, as well as over the longer term from a debt standpoint. And as we continue to make that CapEx, certainly, we will look at access to debt and equity markets, as needed to finance those capital expenditures, ultimately targeting a capital structure of 50% to 60% equity to total capitalization.

While we're certainly focused on growing as a Company, having earnings growth, we want dividend growth that's supported by earnings growth. Most recently in May, our Board increased the dividend by 6.1%. Over the last five years that is 5.8%.

Moving to slide 11. So as we think about the CapEx that we talked about, that's out there on the horizon, still yet to be done. And as we think and look forward to the future, trying to provide a picture or a snapshot of where the margin growth is going to come from, we have a couple of tables that we include in our press release that show what margin has been achieved in the past, what projects, as we've talked about the White Oak Mainline, the GRIP all of those projects that are underway, those that are in the public domain, we try to lay out what the margin growth is that we know, so that it's out for the financial community to see.

And so, for 2015, we reported gross margin of basically from new projects about $25 million. And that came from Aspire Energy, that new acquisition on April 1 added $6.3 million. We had some other natural gas transmission expansion, some short-term, some longer-term, basically $7.7 million of margin from those. GRIP added $7.5 million, the electric rate case added $3.7 million. Compared to the prior-year of that $25 million, $19 million of that margin was incremental over the prior-year.

As we look at where we are sitting for 2016, with the projects that are either done or are in the process of being done, we expect to have gross margin from those projects of close to $48 million. So well in excess of $20 million incrementally from those new projects, either recently constructed or to be constructed.

We try to also show, as we're moving out to 2017 and 2018, what does it mean in terms of increased margins? And some of what you're seeing is, there's projects, for example, we have the 2017 system expansion for Eastern Shore which will replace some of the temporary services that we're providing right now.

We're still the process of negotiating proceeding agreements. So the margin that results from that project isn't reflected in the table.

But we're always focused, on trying to continue the margin growth that we've seen in the past. And you'll see there's $9 million that's had already been identified of incremental margin from 2017 over 2016, and then another $3 million in 2018 over 2017.

But there's other projects that are in the pipeline, there may be interim services also that may also recur that aren't necessarily in here, because we don't know for certain that they are going to happen.

And so, with that I am going to turn it over now to Mike McMasters, President and CEO, and he's going to talk about our strategic platform for growth.

Thanks, Beth. Good morning, everybody. I guess, turning it over to the next slide. This conversation, I guess, we have quite frequently with our investors, and I'd like to maybe go through real shortly here.

The first thing is, the bottom of the slide, the triangle, our engagement strategies provide the strategic infrastructure for sustainable growth. What we're really looking for here is that we've got highly engaged employees that are doing a lot of great things out in the field, and ultimately it's those employees that are making this stuff possible. So we have strategies of engaging our employees.

I'm going to try to get the mic here. How is that? Is that working? Anyways, sorry about that.

In any event, it's such engaged employees that are doing a lot of the great work that's making this stuff possible. And with, that we also expect a great deal of work focused on safety. And when you have that as a foundation, that provides you with the opportunity to -- I'm going to say, operate your existing systems in a reliable safe manner. And then you start adding on to that, engaging with the communities, as strategic thinking that we do, and we position ourselves for growth.

And once we've done that appropriately, then we're able to move up the chain or up the triangle, and get to developing new business lines, and executing existing business for new growth. And that's been where, Beth has just been talking about all of these growth opportunities we've been developing and executing on.

We're looking both in our existing territories, we're looking beyond our existing territories, and we're looking for new services. And then finally, once you do that properly, you get the results that we're seeing.

One, safety awards, top workplace and top leadership awards, community service awards, achieving top quartile growth in earnings, achieving top quartile growth in total shareholder return.

Moving to slide 13. This just provides a little bit more detail on the conversation we just had. But as you can see, it's the employees, the strategic alignment, the execution, and then also those results in top workplaces, which again is a key component of what we're doing.

Engagement with the customers and the communities on slide 14, safety and reliability, environmental stewardship, community service, and business partner. I guess, just a couple things here more recently, in the past month, I think we've had two different ribbon cutting ceremonies for things that we're working on.

One, Warwick Mushroom Farms, basically a customer in Cecil County that we've recently extended service to, and basically they've been able to expand their facility and save money while they're doing it. And we were there with Governor Hogan from Maryland for that ribbon cutting.

And just earlier this week, Delaware Transit Corporation purchased 50 buses they're going to convert to propane, that we'll be fueling those buses. We spent over two years working with the Delaware Transit Corporation to make that happen.

The next slide, strategic planning and thinking. The key here is that we're constantly trying to grow. We want sustainable long-term growth. And so, the process that we use to help facilitate that is outlined here.

One, strategic thinking, it's more really about the thinking, than it is the planning. You have to have a plan, but as you know as soon as you have a plan, the next day something changes, and you have to react to that. So the strategic thinking that goes into the plan, prepares us for those types of changes.

A second change, we made this probably, I don't know 10 or 12 years ago now, we used to do strategic planning based on the top executives that get together, come up with a strategic plan, and provide everybody with their insights on what we should do, looking forward. And ultimately, and quite frequently failed.

And so, we decided to go out to the business units, and engage everyone of our business units in a strategic planning process, and asked them to tell us well, how can you grow the business? And then when you move into the second box, you're seeing that we provide targets for them, that exceed what they can do, if they continue to do the same business as usual.

And after a couple years, you would start to see all of these opportunities start to come to the table, and then executed. And so, that has been a significant change in our process, and has led to us developing these opportunities.

And then, finally the last box, we update it every year. We also, if we see changes that are significant, we'll change the plan in the midyear.

One of the key processes, only key processes that we use is the funnel. And this process, and our Growth Council, I guess, really. But the funnel, if you will, I'll talk about that first on the left-hand side. With the work that we're doing, we're obviously gathering information, conducting feasibility analysis, proposal development, et cetera. You'll see the numbers, now quite a few projects start at the top of the funnel, and a very few make it to the bottom.

And the best part of the discipline that we go through, we were in Boston a year or so ago, and they asked us a question about, well, how many projects do we reject? And it caught me by surprise a little bit, but while giving a comparative answer, I started thinking about it, it was very few actually. But their thinking was that maybe, we take everything that we see. And that's not the way that the process works.

The Growth Council, we implemented that probably two or three years ago. The thought process was that, with the complexity and the volume of projects we had coming through the business, we wanted to get more people engaged in the review. And so, we extended it out, and started including executives from operations, engineering, business development, regulatory, financial and legal backgrounds to sit in on these project evaluations and ask questions.

And Jeff Householder in Florida would be involved in those conversations that we usually conduct in Dover, But Jeff would tie in over the phone, we'd tie in outside legal counsel on the phone. Also Jim Moriarty, who's here today, General Counsel, sits on that as well, really Beth, Steve, other executives that are here in the room. And all of this supports our sustainability. If we are making smart investments and earning returns, then we can get access to the capital necessary for us to grow.

The performance quadrant on slide 17 just shows the results of what we've been doing in the last three years. And when you look at the, I guess, the vertical axis, you'll see the weighted average return on equity. The horizontal axis is capital expenditures, total capitalization. Both of these, we think are key indicators, as far as how we're going to perform. And you can see our return on equity, we're significantly above the median, which is the dark line slightly under 10%.

And if you look at capital expenditures, total capitalization, you can see we're way out there, 25% or 26% of our capitalization we're spending on average every year. And Beth mentioned a moment ago, about the capital we're deploying. And so, we're deploying high levels of capital, and earning high returns, which you think would drive shareholder return.

On slide 18, you can see shareholder return over the last 20, 10, 5, 3 and 1 year. As you get shorter, the five years 23%, three years 27%, and one year 25%. So it has been working for us.

We tried to look at this another way as well, and we've been comparing ourselves to our peer group, and we've always been performing very well. So we thought we'd look at a broader group, and we decided we'd look at all of the New York Stock Exchange companies, and do the same calculation. Where do we stand? What percentile are we for the total in NYSE?

And we're pretty shocked the first time we did this, and actually outsourced the calculations to make sure that we weren't making mistakes. But you can see the 10-year, 93rd percentile, 5-year 92nd percentile, 3-year 94th percentile, and a 1-year 85th percentile. And we're just hoping that this doesn't jinx us, when we present and talk about the numbers. But they are obviously incredibly high.

As Beth mentioned a little earlier, we have put the project, the Eight Flags energy project, is fully operational in July of 2016. This is a pretty significant accomplishment.

A few years ago, our customer approached us, and indicated that they were going to make some changes to the plant, and eliminate the need to buy electricity from us. We're the electric provider on the island. When that occurred, our team in Florida decided they needed to look into this thing a little bit harder, and figure out if they can come up with a different plan for the customer.

And so, with the effort going through the plant a few times, getting some consultants to help, and working with their customer, they were able to come up with a strategy, to fully combined heat and power plant that would save the customer money, would save the electric customers on the island money, and also generate returns on capital for us. And so, it turns out to be a very successful project, that as indicated generates about $7.3 million in margin a year.

In talking the new -- about executing on current strategies, Beth mentioned earlier a little bit, that we have a pre-filing before the FERC right now. And that project has about -- you can see about 50 miles of pipeline looping in extensions on Delmarva.

We're upgrading the interconnect with Texas Eastern Transmission Company, and also adding to our compression in Maryland -- or Daleville, Pennsylvania excuse me, and [88,000] dekatherms a day of new capacity. Now 86,000 dekatherms may not mean a lot to you, but that's the equivalent of 86,000 residential customers on a peak day. So that's a big increase in our capacity.

So again this is a pre-filing, which basically enables us to work through a lot of the permitting questions that exist. And also study -- tuning in a little bit, as we learn more about the customers. We're still in the process of negotiating those contracts.

The growth strategy, as we think about utility, the main thing that we face, there's two primary constraints on our growth. One, you get in the science footprint. That's good from one standpoint, people can't enter in your footprint. The other side of that is, it limits what you can do outside of your footprint.

And it also constrains your growth. If you're constrained within that footprint, then your growth rate will be a function of the growth rate of the community you're serving. And so, it's a pretty big constraint.

And so, what we've done is we've started saying, well, look, we to expand our ability to provide different, new and different services, and so we're looking to do that. And this [peak defliers] project is a good example of that. The second thing is we're doing, is we're looking beyond the footprint, looking for territories that are not being served, and trying to generate or develop opportunities there, and both facilities to serve new territories.

The second constraint that we face is rate of return regulation. When you think about it, a utility is basically allowed to earn roughly 9.5% on the equity they have invested in the facilities. And so, if you're doing a great job, and you're able to earn 10% 11% 12% 15%, what ends up happening, is you reduce rate to compensate for that return that's in excess of what the regulator deem is appropriate.

And so, what we are doing is, we're saying, okay. I mean, if we're doing a very good job of identifying and developing the opportunities, then we should be able to earn these higher returns, and how can we do that?

And so, we look at ways to do that on an unregulated basis, or on a lightly regulated basis. And essentially, that's what we're doing. You can see the variety of strategies that we have laid out on the slide, on growth strategies.

And with that, we will take questions.

(Operator Instructions)

Spencer Joyce, Hilliard Lyons.

Yes, hi. Good morning. Nice quarter.

Hey, good morning, Spencer. Thank you.

Beth, maybe a question for you here first. I know we saw a little bit of margin impact from the Eight Flags and Rayonier venture which was a nice little surprise for me. I was a little surprised it came on the regulated side. I know some of that is, or ultimately, I believe some of that will be unregulated margin. And the question is, what is the split between what the reg and non-reg gross margin will be, from that whole consolidated project once it's at a full run rate there?

Well, basically, Spencer, right now the $7.3 million we have out there includes the sales of the steam to Rayonier, and also includes some of the [irregulated] margin that's also occurring. So we need to provide, while we put -- because there was some incremental, or as you mentioned early margin, we're going to go back and as we lay out the third quarter, we'll actually provide more specifics about the pieces. But the pieces that you had for the second quarter included -- it was about $432,000 on the regulated side, and then a very small piece to get you to the [$551,000] on the unregulated.

Okay. Got you. So we, with Q3 and maybe Q4, we will see a little cleaner split there?

Yes.

Okay. Perfect. Shifting over to the CapEx budget for this year, I know we usually lag the whole budgeted amount. But I was wondering if the FERC approval announced just this morning for the reliability expansion may push us a little closer to the full budgeted amount this year? Or really in general just if that FERC approval has any shift on the outlook for the rest of 2016?

As I showed on that one slide, right now the forecast is just under $180 million. What we look at, Spencer, in terms of kind of looking at month by month was the approvals that we have. I think what we're seeing right now, is we at least should come in I think, somewhere between the $150 million to $170 million. But because there is that development capital of $30 million that's also laid out on that slide, but it's going to be fairly close. We're $70 million to $72 million in for six months. And when we compare that to our spend, even looking at last year, it's tracking pretty close. So I don't think we're going to be way far off, but you could be somewhere between $160 million to $180 million.

Okay, perfect. I'll be able to update a couple things with that. And then, finally on the long-term capital side, I know we have an agreement now for the $70 million of long-term debt. I may have missed it, what is the -- or is there specific timing on that, when we should model that in?

We can take that long-term debt -- we basically have until the end of April of 2017 to pull that debt, and the debt will be at 3.25%. And so right now, Tom and I, we continue to monitor it. Part of that will be based on the spending. There is also -- we some have regulatory proceedings and filings that are underway, and so we look at an overall project strategy, and when our project is going into service, coupled with our regulatory considerations, but at the latest we can draw that down, it will be April of 2017.

Okay. Perfect. So it's just on -- essentially an as needed, or as desired basis on your end?

The $70 million is locked in. So we will draw $70 million of long-term debt before or by April 28 of next year. Then we have another $80 million that we have on a shelf with Prudential that goes out for three years from when we initially entered into that.

And so, we can basically take that $80 million, we can negotiate that with Pru at the point that we decide, based upon the timing of our CapEx. We can pull that down at a later time. But $70 million is committed, we're pulling it. The question is, between now and April 28, when do we draw?

Okay. Sounds good. Thanks for the color, and good luck with the Investor Day next week.

Thank you, Spencer. We'll miss you.

Yes. Sure thing.

(Operator Instructions)

Greg Cox, Bank of America Merrill Lynch.

Congratulations, Mike, and team on a terrific quarter. I'd say it was a great performance. My question piggybacks on Spencer's question relative to the FERC approval of the Eastern Shore natural gas $36 million reliability project. You talked a little bit about the capacity increase on slide 21. Have you had an opportunity to quantify the margin benefit that you expect from the project, it might be a question for Steve? But any color that you can provide there?

Yes. Greg, I want try and get to the slide real quick here. But on that, I think it's slide 11, let me see here. There is a slide where we have the gross margin table, and I have a line there, it's actually slide 11. And on there, we've shown that right now, our assumption in our future margin table is that it will be approximately $4.5 million on an annualized basis, and it could be approximately half of that, we're estimating for 2017. So [$2000, $250,000] (sic -- see slide 11) is right now what we've got in our margin projection.

Thanks, Beth.

I will further comment, part of that we have the rate case filing, that we're undertaking with Eastern Shore where we're required to come back in. And so, with that reliability project, it is included within the rolled in treatment. And this is our best estimate right now, but it could change as we move through that process. Steve, would you like to add anything?

No, Beth, that's is exactly right. You're exactly right, Beth. There's no new capacity associated with the project, again, it's a safety and reliability project, and will be rolled into the rate case, and the FERC did authorize rolled in treatment. So it really will be recovered through the rate case. As said, we'll be filing somewhere in the December or January time line. Thank you, Greg.

(Operator Instructions)

There are no further questions at this time. I will now turn the call back over to Mike McMasters

Thank you. Thanks everyone for joining us. We appreciate your interest in the Company. I can tell you everybody's dedicated to doing the things necessary to continue to drive our growth. We realize that we're responsible for generating returns on capital that are attractive, and we're committed to doing that. So thank you very much.

This concludes today's conference call. You may now disconnect.