Chesapeake Utilities Corp (CPK) 2017 Q2 法說會逐字稿

Good morning.

My name is Andres, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Chesapeake Utilities Second Quarter 2017 Earnings Call.

(Operator Instructions)

I would now like to turn the conference over to Beth Cooper.

Please go ahead.

Good morning, everyone, and welcome to our second quarter earnings conference call.

We're hosting today's conference call live from Wesley College here in Dover, Delaware, where our corporate headquarters is located.

And I'd like to just say a special thanks to Dr. Gibson and Dr. Jacobs, who are here in the room with us, for enabling us to hold our conference call here today.

In the room with us are several members of our management team as well as several of our key employees, some of which are alumni of Wesley College.

Turning to Slide 2. Before we begin, all of you know that this presentation may include forward-looking information.

We would ask that you take a look at our SEC reports, including our Form 10-Q that we filed yesterday as well as our annual report on Form 10-K that we filed in February, where we discuss those factors and those risks that could cause our actual results to differ from the forward-looking information.

Turning to Slide 3. This is a summary for the quarter.

Really there's 3 things on here that we wanted to highlight.

First, just overall from a top level, we continue to have strong gross margin growth in the second quarter, both -- operating expenses did overshadow that gross margin growth, I'll talk about in just a minute, but still a strong quarter overall in terms of gross margin growth.

Secondly, at just a high level from an EPS standpoint -- and we'll talk in a little more detail later on in the presentation, you'll see that the weather and also the wind-down of Xeron represented a reduction in earnings per share of about $0.04.

You'll see that gross margins from our businesses, including Eight Flags and some of the areas where we had growth, also basically added about $0.01 per share for the quarter, including overcoming operating expenses for those operations.

Higher depreciation represented about the $0.05 per share.

The equity issuance and our refinancing of about $70 million of short-term debt to long-term debt basically represented another $0.04 and then, lastly, some other expenses, change of tax rate, those types of things, represented $0.03 per share.

During the quarter, there were several significant events that occurred.

First, I want to talk about 2 significant Eastern Shore projects were completed.

Those were the White Oak project and also the System Reliability project.

And then in addition to that, we also just after the second quarter as we announced an acquisition of a small natural gas marketing company that will complement both those growth strategies.

In addition, we're well underway on our Eastern Shore rate case, with interim rates going into effect earlier this week on August 1, and our construction continues, and we're expecting -- and we'll talk about later on, for that project to be in service in the second quarter next year.

Digging into the number a little bit more.

Turning to Slide 4, you'll see that for the quarter we reported EPS of $0.37 per share.

That compares to last year's second quarter of $0.52 per share.

Operating income overall declined by $2.1 million, basically that was a result of -- I mentioned we had gross margin growth -- very strong gross margin growth coming from Eight Flags, coming from our natural gas service expansion, coming from GRIP, coming from our organic customer growth and also from long-term supply agreements that -- where the pricing in those agreements had been amended.

That was (inaudible).

Very strong gross margin growth on the expense side.

We saw an increase of $4.7 million.

When you dig and look at that operating expense growth, what you find is about 85% of that operating expense growth came as a result of depreciation because of the capital that we've invested as a result of Eastern Shore and the growth that it had and is projected to experience and, then lastly, because of Eight Flags.

We also took a look at -- based on going back and looking at over time the expense ramp-up that we've seen, and we saw that ramp start to decline in the second quarter, which shows that as we're moving forward to some of these future projects coming along that our margins and our expense growth are converging, and they're becoming more of an alignment.

Year-to-date, when you take a look at those results and see that we were down like $0.31, half of it from the second quarter, half of it from the first quarter.

Weather on a normalized basis would represent about $0.16 per share in terms of the lower results that we achieved for the year.

In addition, the financing with the stock issuance is another $0.10, and the write-down on the wind-down of Xeron business represented another $0.03.

Taking a look at a little more detailed level from an EPS standpoint, you'll see that the unusual items once again were $0.04; Eight Flags when you look at the expenses as well as the margin growth added $0.03; margin from our Other Businesses was $0.04; and in our other expenses -- or the other operating expenses were $0.06; depreciation, $0.05; and then I mentioned the other 2 earlier, the $0.04 and the $0.03 from the financing and then the other items.

What's been important for us over time as we've been growing, many of you know, is to have a strong balance sheet, and that continues to be the case this quarter.

We ended the quarter with book capitalization of about $820 million.

In terms of equity as a percentage of total capitalization, very strong at 56%.

When you look at equity as a percentage of permanent capitalization, at about 70%, just shy of that.

In terms of being able to support our future growth, we've got a strong capital budget this year, and we've got some dollars that are actually rolling into next year.

We have short-term capacity available, including a revolver that's $150 million, totaling $330 million.

Similarly, we also have shelf facilities now in place for another $330 million, where we can place some of that short-term debt long term when we deem appropriate.

On the CapEx side, earlier this year we talked about our budgeted capital was right around $260 million.

We expect about half of the project costs associated with our Eastern Shore project, the 2017 expansion, to roll into next year.

And that's basically resulted in our forecast dropping to about $209 million versus the $260 million that we started the year.

But still a very strong, very high capital budget.

And if you'll recall, I mentioned our book capitalization is about $820 million.

This is about 25% of our book capitalization today.

So a lot of growth that's going on with the company.

I'm now going to turn it over to Mike, and he's going to touch on the growth projects underway.

Thanks, Beth.

I guess we'll move forward to the next slide, on Slide 8. What we're highlighting here on Slide 8 are basic 5 major projects that were currently underway or will be initiated in '18 to '19.

Basically, the Eastern Shore Natural Gas Expansion, that major project of almost $100 million of capital investment, expected generate $9.3 million in 2018 and $15.8 million in '19.

The project is expected to go to service the second quarter of 2018.

If you look next at FPU Gas Reliability Infrastructure Program.

I think everyone probably knows that that's a program to replace old, leaky pipe that needs to be replaced.

There's an automatic mechanism to recover cost associated with that.

You can see the estimate, expected to generate $14.4 million in '18 and $15.1 million '19.

Eight Flags Combined Heat and Power Plant.

That project went into service in June of last year.

This year -- well, next year it's expected to earn $8.7 million, slightly higher in '19.

There's some automatic pricing adjustments inherent in that project.

The FPU Northwest Florida Expansion project.

That's going into service we expect probably in the second quarter of next year as well in '18, $4 million and in '19, $5.1 million.

And that Eastern Shore's Natural Gas System Reliability project.

That also is a reliability project.

It's little bit different than GRIP.

But that -- you may recall in the polar vortex we had several years ago, and when that occurred, what we saw were gas pressures coming into our system from Southeastern PA had declined pretty significantly and had an impact on our system.

So we're beefing up our system so in the event that, that occurs again won't have reliability challenges.

I'm sure there'll still be reliability challenges, but they won't be in the magnitude they were, depending on what happens up north.

But in any event, $4.5 million in '18, the same thing in '19.

Now that number is really a rough estimate of the revenue requirement on the investment in that facility.

[Millions of] dollars are expected to be included.

But they are included in our rate case filing, and so we'll know the final outcome of that later on this year.

Next slide.

This is also has a lot of the growth initiatives we just talked about.

However, the key point of this slide is really at the bottom of the slide, there where you've got the triangle.

That's $9,443,000 and $13,440,000, et cetera.

That's showing the difference from year-over-year.

So we included a lot of different projects in there just so that we can capture that total difference.

Now what's interesting also, this is focused on the major initiatives.

Well, since 2013, I guess beginning 2013, our gross margin has grown $20 million every year -- approximately $20 million every year, and we're looking at the same thing in '17.

So what you're seeing here is a subset of our overall growth; and just for comparison purposes, obviously, running pretty close to about half of that.

So there's a lot of other stuff going on, and we're not pulling out of these projects.

Talk a little bit about the Eastern Shore project.

As I mentioned earlier, 9 -- $98.6 million of investment generating $15.8 million of margin for the first full year.

The project though right now have a filing on -- with the FERC.

We're waiting I guess, a quorum.

FERC's been without a quorum for some time, so they've not been able to approve the project or a lot of other projects.

They did get the quorum filled, I think yesterday.

And so there's going to be a lot of work done by the FERC, their commissioners, hopefully, the next few months trying to deal with the backlog.

But we expect -- we hope to get that pretty quickly.

There's not really any issues with our filing.

The staff just looked at it.

And it's pretty clean stuff, so we could get it approved fairly quickly.

In any event, so if we can get all that done, we'll start in the third quarter of '17 and put in service, hopefully, the first quarter or second quarter of '18.

Project description: 20 -- about 23 miles of pipeline, starting up in Pennsylvania into Maryland and Delaware; upgrades to our TETCO interconnect.

That enables us to get access to cheaper gas from the Marcellus; 17 miles of mainline extensions; upgrade (inaudible); 3,750 horsepower of new compression; we have 2 new pressure control stations to help the system.

Capacity increase of 61,162 dekatherms.

If you were to translate that to a residential customer on a peak day, that's about equivalent about to 61,000 customers.

The Florida natural gas project, Northwest Florida Expansion.

This project it's kind of hard to tell from the graph -- from the table, I guess, but it's just about the Northwest corner of Florida, in the Panhandle; it's in the Central Time Zone.

Where we've initiated this project is just barely inside the rate zone of Florida -- from the Florida gas transmission that is cheaper than the rate zone that we're buying gas from in the rest of the North Florida project.

So it -- actually, that enables us to get lower-cost gas into this area.

It's a $36 million project, as you can see; expected to generate $5.1 million in the first full year of operation.

Construction has already started.

Again, expect to go into service the second quarter; 33 miles of transmission pipe.

And we've got the anchor test, which obviously that are -- we'll start paying for the services as soon as we can deliver them.

There's also a lot of other opportunities that present themselves from a second pipeline in the Northwest part of Florida.

Having a little difficulty with the slide here.

Okay.

Turning to Slide 11 (sic) [12].

I (inaudible).

Turning to Slide 11 (sic) 12 . We've just completed the first year of operation for the Combined Heat and Power Plant down in Florida.

The capital investment was $40 million; gross margin, $9.4 million in the first full year of operation; and $5 million were generated in the first half of 2017.

This has been a pretty significant project for us as a company.

It was our first power plant we ever constructed and owned and operated.

We've got several honors from this power plant.

Southeastern Electric Exchange, Inc., recognized Eight Flags as a plant -- the plant as a 2017 Industry Excellence Award in the production category.

Southeastern Gas Association recognized Eight Flags plant as the First Place Engineering Award, and Power Engineering recognized the plant as the Best CHP Project for 2016.

So a lot of great things that happened there with this project, very profitable, also saving customers $3 million to $4 million a year on the island where they're getting their power.

And an increase in steam production for the host.

PESCO Energy overview.

Peninsula Energy Services Company has been a company we've had since probably back in the 1980s.

So we've had this for quite some time, and we've been growing it pretty rapidly here in the last few years once we hired -- once we acquired Aspire Energy of Ohio.

A little bit about the services.

The first services -- level service is Demand Origination.

Now Demand Origination simply means we're finding customers that need gas that are, generally speaking, connected to pipeline that we're moving gas on.

And so we're looking for new customers there to deliver gas.

We have Supply Aggregation.

We also need to find the gas -- the additional gas to serve those customers.

And we make money doing that as well.

And then the Optimization.

Whenever you're doing -- moving natural gas from one place to another, the demand -- the actual demand is always a little bit different than what everybody schedules.

So that create challenges and opportunities.

And so the Optimization enables for us do things with our capacity, either sell our capacity short term or deliver more gas to other places to make additional money.

And so those 3 categories are basically what's driving things.

And you can see our territory on the right-hand side of the market area, starting on Delmarva and Florida, the first areas we started.

Then with the Aspire Energy acquisition in Ohio, it expanded our footprint to the lighter blue.

And the dark blue ultimately is where we're providing services.

I think Beth mentioned a little bit earlier the acquisition in Pittsburgh.

There's a quick summary about it on Slide 14.

Our acquisition of ARM Energy Management, we closed that on August 1. It's -- first, I guess when you think about this, we're in Ohio with Aspire Energy.

We're in Pennsylvania with our interstate pipeline, [element] and also our marketing company and also our propane operations.

And so this being in Pittsburgh kind of sits in between those 2. I guess it deepens our footprint, our commercial relationships in the area.

It complements our existing portfolio and also combines PESCO opportunities to aggregate supply, providing services similar to the [strategy] we've been using and (inaudible).

Major projects and initiatives.

As you can see, maybe I'll start with 2019.

We started with -- I'll go back to '14 -- 2014 with $7 million.

That happens to be some specific projects that have some growth thereafter, so we started with the foundation of '14 and have shown the changes going to '19.

So what you'll see in '14 to '15 is $18 million dollars growth from these major projects.

You can see going from '15 to '16, $22 million; from '16 to '17, slightly less than $10 million; and about $14 million into '18; and then another $8 million or so in '19.

But we still got work to do on '19, and we're also working on 2020 to get the -- to keep our (inaudible) [rate] in order.

Remember, a $20 million a year [free budget] since 2013.

This is a quadrant graph on Slide 16.

We show this every time we talk to anybody.

We're looking at a quick way to measure how effective we're being and how profitable we are.

We're looking at our -- what's our ability to achieve rates of return on equity that are higher than our cost of capital and higher than the medians, our peer group medians.

And we've been able to achieve that.

The second thing is that we've been able to deploy a lot of capital.

Beth mentioned 25% of our current book capitalization is in our current budget -- our current budget estimates.

So if we are able to invest that magnitude of capital and maintain these solid returns, you would expect that our growth rate would be higher than peers.

These are 3-year averages, on Slide 16.

Slide 17 just shows our performance looking at the NYSE.

As you can see, most of these years about 85 to 95 percentile performance; and then the one year of 51% percentile.

And then average shareholder returns, you can see that on the right-hand side, again, 15% this year, 18.8% -- if I can get the [dollar right], last year.

So we've had some pretty high performance on shareholder return.

That's obviously driven by earnings per share growth and the ability to identify opportunities out in the marketplace and execute on these opportunities.

Our disciplined approach to reaching new heights, Slide 18.

The key here is it starts with the foundation at the bottom, all this engagement stuff that we're doing.

We have a highly engaged employee base that I would say thoroughly enjoys the work that they're doing.

I hear it all the time from employees about how much they love the company.

And a lot of that has to do with giving them the opportunity to give back to the communities that we're serving and just that enjoyment of helping individual people, whether it's food bank stuff, a whole series of things, [Dolfish, DASH], all these different programs that are -- events that people are putting their time in to help the community.

And that's really lifted up our engagement, also includes safety and reliability.

But if we get the foundation right, the engagement strategy right and giving our employees what they need to really enjoy what they're doing, then that kind of provides as a peace dividend, if you will, enables us to move up to the next level, which is developing new business opportunities.

If we're not doing a good job on the foundation, then we have to spend more time consistently working on the foundation as opposed to working on growing the company.

And so I think that's been a critical component of us -- our growth, and you can see the results, a lot of different awards.

Continue to build for the future.

We're looking at this all the time.

Every year, we update our 5-year strategic plan, and achieving there is to have aggressive -- identify aggressive growth opportunities.

So when you look at this, the left-hand side, strategic growth, expand existing pipelines to provide customers with lowest-cost supplies.

So our business unit people are doing that every day.

They're getting support from our strat development group.

What that does provide customers access to lower -- the lowest-cost supplies and ensures us with reliability.

Next line down: leverage pipeline expertise and be preferred owner and operator of pipeline systems to serve high growth and new markets.

You can see that essentially when you're looking at what we've done at Aspire Energy of Ohio; what you've seen there in Northwestern Florida; what you're seeing on Delmarva, the major pipeline expansion you're seeing there.

We're continuing to look for different places to start pipelines to move gas.

Expand market share in our 3 target growth markets through profitable organic growth.

Essentially, once we plant a foot -- put a footprints somewhere, we just look for opportunities around that footprint to continue to expand.

And I mentioned Northwest Florida as a good example where we know there's opportunities on that pipeline or just off that pipeline that we'll be developing over the years.

So you get the pipeline in place, provide service initially and then you have all these opportunities are -- that exist to grow.

Same thing Aspire Energy of Ohio, the same types of opportunities exist.

And in the Delmarva, obviously, we've got a pretty good footprint here on Delmarva, and the same thing there.

And that differentiates Chesapeake as a full-service energy supplier/partner/provider through a customer-centric model.

Essentially, what we're trying to do there we have the propane company here on Delmarva.

We have a natural gas company.

And the customers are obviously looking for the lowest-cost energy supply.

And so we're trying to be flexibility with those customers.

If our propane company finds an opportunity to serve someone but they're hesitating because they're waiting for natural gas service, and our propane company is just to upfront tell them, "Hey look, if you need natural gas, it's available, and we'll work with you on getting that taken care of." That actually helped us get Lewes, Delaware, a couple of years ago with a customer there.

And with that, I'll open it up to questions, (inaudible).

(Operator Instructions) And your first question is from Spencer Joyce.

Just a few quick ones from me.

First, want to talk about the ARM Energy Management purchase that was just announced this week.

I know you gave some color on the operations there and some of the rationale.

But Beth, perhaps from a financial standpoint, can you shed a little might maybe on the purchase consideration there?

Or just maybe in very rough terms what kind of margin or operating impact we might expect to see just incremental work in that acquisition end?

Spencer, this particular acquisition, as I mentioned in the beginning, is rather small.

But it does really complement what PESCO does.

The base purchase price of this business was just a little bit over $10 million.

Okay.

Perfect.

Also kind of sticking on the financing side, am I correct, the full short-term availability to Chesapeake is the $330 million?

Is that, right?

That's right.

We have $330 million, and of that $330 million, $150 million is a revolver.

And then the balance are less -- are lines of credit that we have with 3 financial institutions.

Okay.

Great.

Then finally, just kind of broadly, could either of you all discuss kind of how the first half of the year has stacked up versus your initial internal expectations?

I know the EPS was a little light versus kind of what we were looking for here on The Street, not that, that's your problem necessarily.

But I'm just wondering kind of some of the puts and takes.

I know it's been a pretty exciting first half of the year.

But just kind of open ended there, how has the first half of the year gone versus how you had hoped or expected?

We start out the first half of the year, we did have the warm weather that came into play.

And did also a bit of ramping up our cost structure.

And I think the combination of that warm weather and the cost structure ramp-up, obviously, disappointed us.

But -- and so we've stayed with the plan to maintain our growth and -- or even looking at how we can accelerate that growth.

And I guess the investment a lot of detailed knowledge.

Obviously, you can talk about (inaudible).

But I think when you look at it overall, we've had 10 years in a row of record earnings, and so we'd like that to be 11, and we haven't given up on that.

But we've had 10 years of record earnings.

So if we're sitting here halfway through the year and not being higher than last year, any time that happens we're going to be in a place where we're going to be pushing things very hard to see what we can do to make any adjustments necessary to continue that record.

So I guess with that, why don't you go (inaudible) the details (inaudible)?

Sure.

I would say one of the things, Spencer, that I alluded to earlier, last year we did the equity issuance, and we did it at a time not knowing what the market expectations were going to be around the political election and also at that time with a different expectations in terms of the timing of the 2017 expansion project.

So those 2 things we were ahead of it, and I think we -- it was a great issuance, and it was the right thing to do.

But I would say it was probably a little bit in advance of where the ultimate 2017 expansion project will come in.

Having said that though, as Mike pointed to, we have had the cost ramp.

We've had tremendous growth going on with Eight Flags, with Eastern Shore, doing 2 projects this year, plus in the middle of our rate case and then also the '17 expansion project on the heels of that.

And so there's been, in my mind, you're going to start to see, as I mentioned, the margin growth and the expense growth, I would say, the expense growth declining as the margin growth begins accelerating.

And hopefully, we come out of the third and into the fourth quarter.

That's the expectation.

And then you have the bigger ramp, as our slide shows, as you have the 2017 System Expansion next year.

That alone adding just almost $9 million in 1 year from that 1 project is significant.

And had it occurred this year, it would -- we, as Mike mentioned, we would be in a slightly different place.

But we're committed to, as Mike mentioned, trying to look and hopefully accomplish our 11th year of record earnings, and we're focused on margin growth and cost across the company.

Okay.

So I mean, just kind of setting the EPS here year-to-date aside.

I mean, it's fair to say that operationally the progress that you've made is sufficient to support kind of how you see the company in, say, 2019 and 2020 and kind of the multiyear planning horizon.

I mean the first half has been adequately constructive, if you will.

Yes, for 2019 and for 2020, yes, I think we're in very good shape.

(Operator Instructions) And our next question is from Sarah Akers.

What level of interim rate increase are you implementing at Eastern Shore relative to that $18.9 million requests?

We are, Sarah, that's something that we're still discussing at this time.

Again, we'll have more information certainly as we come through the third quarter.

We as a team are looking at that.

And as we mentioned in our disclosures, we're in the midst of settlement discussions right now.

Okay.

Got it.

And then just to clarify your comments on O&M.

So should we model O&M increases in the second half of the year similar to the 15% increase in the first half?

Or would you expect that to materially come down in terms of the second half O&M growth?

Based on -- with those products coming on and we have had -- coming from the first quarter into the second quarter, we saw a decline as we came out of first and as we came into the second.

And our thought, as I mentioned is that hopefully those 2 start to converge and align more so that, that should continue, Sarah.

Okay.

And then lastly, Beth, should we take your comments on the balance sheet to mean that you won't need equity to fund next year's capital budget?

We're doing right now, Sarah, an update.

We also go through an annual budget process.

And I would tell you that in our last year's budget process it was basically borderline when we looked as to whether or not we needed any additional equity capital.

At this time, we're updating those numbers and those budgets.

But if there's big projects that are in -- that come down the pike, certainly we would access the markets as necessary.

What Tom and I take a look at though is we do have operating cash flows today that's anywhere between $90 million and $100 million of operating cash flow that's going to come in and be available.

So that's going fund the first $100 million or so of capital.

And then, depending on the level, we'll go out in the permanent markets as necessary.

Right now, with what I know from last year and what I'm hearing, I would not expect us to be accessing those equity markets at this time.

But we'll let you know once we get through that process.

(Operator Instructions) And now we will pass this conference over to Mike McMasters.

Thank you.

Well, want to thanks everyone for your continued interest and support of the company.

We are not wavering in our efforts to grow our company and also to drive shareholder value.

Thank you very much.

And this does conclude our -- today's conference.

You may now disconnect.