Energy Transfer LP (ET) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 Southern Union Company earnings conference call. My name is Eric. I'll be your coordinator for today.

At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session at the end of the conference. (OPERATOR INSTRUCTIONS) As a reminder, the conference is being recorded for replay purposes.

I would now like to turn your presentation over to your host for today's call, Mr. Jack Walsh. Please proceed, sir.

Thank you, Eric, and welcome to Southern Union's third quarter 2007 earnings call and webcast.

Presenting on today's will be George Lindemann, Chairman, President and CEO, Eric Herschmann, Senior Executive Vice President, Rick Marshall, Senior Vice President and CFO, and Rob Bond, Senior Vice President of our Pipeline Operations.

A replay of this call will be available for one week by dialing 888-286-8010 and entering pass code 51346116. A replay of the webcast will be accessible through our Web site at www.sug.com.

Today we will be discussing results for the third quarter of 2007, significant events and outlook. Following our presentation, we will be happy to address your questions. If you have any further questions at the end of the call, please contact me directly at 212-659-3208.

Before beginning, I would like to remind everyone that the information discussed on today's call pertains to the financial results of Southern Union Company as filed on its Form 10-Q. Certain amounts and various explanations for the Transportation and Storage segment may vary compared to Panhandle Eastern Pipeline company's Form 10-Q due to consolidating adjustments.

I would also like to caution you that many of the statements contained in our call may be based on management's current expectations, estimates, and projections about the industry in which the Company operates. These statements are not guarantees of future performance and involve risks.

The Company undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise. Such statements are intended to be covered by the Safe Harbor Provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. I would also refer you to the cautionary statement regarding forward-looking information in our earnings release.

In addition, in today's earnings release, the Company announced its intention to move forward in creating a standalone MLP for a portion of its Gathering and Processing assets. Any discussion of the proposed MLP during this call shall not constitute an offer to sell or the solicitation of an offer to buy any securities.

Any offers, solicitations of offers to buy, or any sales of securities will only be made in accordance with the registration requirements of the Securities Act of 1933, or an exemption there from. This announcement is being issued pursuant to and in accordance with Rule 135 of the Securities Act of 1933.

I'd now like to turn the call over to Mr. George Lindemann. Mr. Lindemann?

Thank you, and good afternoon.

Today we would like to discuss our third quarter earnings and update you on some key items since our last investor call. To start, we reported strong third quarter earnings of $0.34 per share. This compares to $0.06 per share in '06.

Overall, we are very pleased with our performance in this quarter. Our Transportation and Distribution segments continued to meet or exceed our expectations. Our Gathering and Processing segment showed great improvement over both the first and second quarters of this year, as well as improvement over last year.

We believe the investments that we made in our systems over the first half of the year are now paying off and that we are well positioned to accept additional growth volumes in our North System as we move into '08. We are also happy with the progression of our capital projects, which Rob will talk about in a minute.

We view ourselves as a long-term growth company and look to produce above average earnings relative to our peers. Though we often can't control the exact timing of these projects, given such things as weather, regulatory approval and construction schedules, we are confident that our existing asset base will produce viable growth projects over the next several years.

At this point, I would also like to reaffirm our annual earnings guidance range of $1.60 to $1.70 per share.

When we're through with our prepared remarks, we will address any questions you might have. I'd now like to turn the call over to Eric Herschmann, who will update you on our MLP progress. Eric?

Thank you, George, and good afternoon.

After a thorough process, we are pleased to announce that we have decided to move forward with forming our own MLP with a portion of our Gathering and Processing assets. During the last several months, we have received and evaluated numerous proposals from many interested parties. We were pleased that these proposals represented a significant increase over our purchase price of $1.6 billion just 18 months ago.

We heard earlier today that some investors thought we would announce a deal with another company. Throughout the evaluation process, we focused primarily on four key areas: Valuation, governance, future growth prospects and how the potential partners' MLPs have performed in the market.

At the end of the evaluation process, we determined that a standalone MLP would best capture value for our shareholders over the long-term and controlling the general partner will put us in the best position to maximize value as our business continues to grow.

From a timing perspective, we have been diligently working on preparing audited financial statements and expect to have them completed by the end of this year. Upon completion of the audited statements, we expect to quickly move forward with the filing of our S-1.

We expect this to occur in the first quarter of 2008. After receiving final approval from the SEC, we anticipate that we will commence the marketing of the unit and will likely have the offering closed within the first half of next year.

With that, I would like now to turn the call over to Rick Marshall, our CFO, to give an overview of the numbers. Rick?

Thank you, Eric, and good afternoon.

For the third quarter of 2007, Southern Union reported EBIT of $120 million compared to $88 million in the prior year. For the quarter, net earnings from continuing operations were $45 million, or $0.34 per diluted share. This compares to net earnings from continuing operations of $12 million, or $0.06 per share in 2006.

Net operating revenue defined as revenue less cost of gas and other energy, and less revenue related taxes was $260 million for the quarter compared to $223 million in the prior year. This represents an increase of $38 million, or 17%.

In terms of segment results, Transportation and Storage, including our investment in Citrus, had EBIT of $90 million compared to $86 million in 2006, or an increase of $4 million. This increase is largely attributable to $5 million of higher equity earnings from our increased ownership in Citrus Corp. These favorable results were partially offset by $1 million decrease in EBIT from Panhandle Energy.

During the quarter, Panhandle posted higher operating revenue of $16 million, driven by an increase in reservation revenue of $7 million and an increase in parking revenue of $6 million. This was partially offset by a $12 million increase in operating expenses, including a $4 million increase in third party contract storage costs and a $3 million increase in corporate service charges. Additionally, depreciation expense increased by approximately $4 million due to an increase in property, plant and equipment.

Our Gathering and Processing segment generated $20 million in EBIT for the quarter ended September 30, 2007 compared to $12 million in the second quarter of 2007, and $17 million for the third quarter of 2006.

The $3 million year-over-year increase was driven by a $5 million increase in gross margins as a result of higher average processing spreads, increased system volumes, and reduced fuel flare and unaccounted for volumes. The gross margin increase was offset partially by a $1 million increase in operating expenses and other costs and a $1 million increase in depreciation.

As George mentioned earlier, the investments that we have made in our North System to correct our treating limitations appear to now be paying off. Our Distribution business generated EBIT of $9 million for the quarter, as compared to a loss before interest and taxes of $5 million in 2006.

The $14 million increase is primarily a result of Missouri Gas Energy's successful rate case resulting in a $27.2 million increase in annual base revenues, including a change in the Company's residential customer class rate structure to a straight fixed variable rate design. The straight fixed variable rate design mitigates the impact of weather and conservation on earnings and cash flows, and normalizes margin throughout the year.

Interest expense was down $6 million in the quarter compared to the prior year. The decrease is due primarily to the retirement of $1.1 billion of a $1.6 billion bridge loan in August of 2006 that was used to temporarily fund the purchase of the Citrus assets in 2006.

The August retirement of the bridge loan was accomplished using the proceeds from the sale of our Pennsylvania and Rhode Island distribution assets. The remainder of the bridge loan was retired in October 2006 with proceeds from the $600 million junior subordinated note offering.

The lower average balances on our revolving credit facility accounted for the remainder of the decrease, offset somewhat but the interest associated with the junior subordinated notes and higher average debt balances at Panhandle Energy.

During the quarter we invested approximately $204 million in our operations. Gross capital accounted for $128 million, and maintenance capital was $76 million. Panhandle Energy spent $182 million -- $123 million for growth and $59 million for maintenance, including compression monetization, compliance and integrity investments.

Approximately $10 million has been invested in Gathering and Processing with growth accounting for $2 million. We have reinvested approximately $12 million in our Distribution business, with growth capital of approximately $3 million. For 2007 we continued to expect our total capital spending to be in the range of 605 to $675 million.

Broken down by segment, we expect Panhandle Energy to spend approximately 525 to $575 million, Gathering and Processing to spend approximately 45 to $55 million, Distribution to spend approximately 30 to $40 million, and corporate and other to spend approximately $5 million.

Of the total capital expenditures, maintenance capital is expected to be approximately $155 million at Panhandle, $15 million at Gathering and Processing, $30 million at Distribution, and $5 million of corporate.

I'll now turn the call over to Rob Bond, who will discuss our Gathering and Processing and Transportation and Storage segments.

Thank you, Rick, and good afternoon.

I'd like to begin by talking about our Gathering and Processing segment, Southern Union Gas Services. SUGS produced EBIT of $20 million for the third quarter compared to $17 million in the prior year. This also compares favorably to EBIT of $12 million in the second quarter of 2007. As you can see, we've made great progress on the operational issues that we faced during the first half of the year.

As we mentioned on our last call, we built a new 16-inch high-pressure pipeline to connect our Jal and Keystone plants so that we could better utilize our treating capacity throughout the system. We also rebuilt the treating units of both Jal and Keystone. The investments that we have made will allow us to continue to accept additional growth volumes into our North System.

Operationally, our total wellhead volume averaged 665,000 MMBtu per day for the quarter compared to 589,000 MMBtu per day in the prior year. We processed an average of 422,000 MMBtu per day for the quarter as compared to 448,000 MMBtu per day in 2006. This has resulted in total product gallons per day of 1.3 million for 2007 compared to 1.4 million gallons per day in 2006.

Our average processing spread for the third quarter was $0.62 per gallon compared to $0.52 per gallon in 2006. Average natural gas prices at [Wahaugh] were $5.72 for the quarter compared to $5.70 in the prior year.

As it relates to our existing hedge positions, we continue to be approximately 56% hedged on our equity volumes through the end of 2007. These positions have a net price of $8.01 per MMBtu.

Now that we have made a decision regarding which MLP structure we will move forward with, we are evaluating the forward market and will determine what level of hedging and what instruments will be appropriate for our new MLP.

I'd now like to talk about our Transportation and Storage segment of our business, which continued to perform well during the third quarter. EBIT was up over $4 million compared to the prior year. The increase was driven by a $5 million increase in equity earnings from unconsolidated affilliates as a result of our increase investment in Citrus Corp.

Panhandle Energy was essentially flat for the year-over-year period. Panhandle saw operating revenue increase by $16 million, offset by a $12 million increase in operating expenses and a $5 million increase in depreciation and other costs.

Focusing now on our ongoing growth projects, our Trunkline Gas Company field zone expansion project, which will expand our system from East Texas into Louisiana, has been approved by FERC and construction is under way. The project will create approximately 625 million a day of incremental capacity from Texas to Louisiana, and will also create up to 1 Bcf per day of capacity into the Henry Hub.

A majority of this capacity has been contracted under long-term agreements. The project is currently estimated to cost approximately $250 million, up from our previous revised estimate of $230 million and is expected to generate EBIT between 20 and $30 million and EBITDA between 30 and $37 million on an annual basis.

A portion of the increased costs is due to the heavy rains that we experience and the impact the weather had on our construction schedule. We remain optimistic that the project can be in service by the end of 2007.

Finally, the infrastructure enhancement project at Trunkline LNG is scheduled for a late 2008 in service. This project, which is fully contracted to BG LNG Services through 2028, is now expected to cost approximately $335 million, an increase over our previous revised estimate of $280 million.

The increase is largely due to the complexity of the project engineering, as well as a general increase in materials and skilled labor costs. Because our negotiated rates are calculated based on the amount of capital spent, we now expect the project to generate EBIT of between 40 and $50 million and EBITDA of 50 to $60 million on an annual basis.

With that, I'd like to turn the call back over to Mr. Lindemann. George?

Thank you, Rob. At this point, we would like to open the meeting to any questions you might have.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Harry Mateer with Lehman Brothers. Please proceed.

Hi, guys. I have a couple of questions here from the fixed income side of things.

First of all, I know in the past you've committed to investment grade ratings publicly both at the Southern Union level as well as Panhandle. But beyond that, can you give us a sense for your target leverage metrics and by that I mean debt to EBITDA, debt to cap at the actual Southern Union Company level?

Well, right now we're at a debt to EBITDA ratio of a little south of four times. We're not, you know, from a target standpoint, we don't expect that to materially, to get better in the short-term simply because of the capital expenditure projects that we have lined up for 2008.

But ultimately, you know, we see over time as these projects fall off, we see the ratio dropping to like the 3.5 times range and I think that that puts us squarely in, it shows improvement to the rating agencies and I think it puts us where we need to be to certainly maintain our rating and hopefully have the negative outlooks removed and perhaps get an upgrade.

As far as the EBITDA interest coverage ratios, we see ourselves somewhere in the neighborhood of 3.5 times eventually. Again, to put us in squarely within the rating -- where our ratings are today.

And from a total capitalization, an equity to capitalization ratio, not taking into consideration equity credit for some of the hybrid securities, we're looking at a range of 35 to 40% equity. And one thing that will occur early in the year is there is an equity convert that comes on in February and that's going to help thicken our equity ratio, along with the earnings that we retain on an ongoing basis.

Okay.

And so even with the MLP formation, you guys still expect leverage to drop down a little bit? Because I know one of the key concerns for the rating agencies was with the formation of the MLP and putting assets down at that level and presumably some debt as well, you're going to be stripping some assets from the Southern Union level.

So all else being equal, if you need something of a lower leverage metric at SUG to compensate for the fact that you have lower asset levels at that entity. So is that something you've run by the agencies?

We haven't specifically talked to them about the structure of this MLP. We talked to them about the MLP and what our beliefs are. Essentially from the -- in the -- at onset, we're going to use any proceeds from an equity offering, an IPO to pay down debt at Southern Union Company. So in a way, it could be viewed to be credit-positive for Southern Union Company.

Okay.

And then can you just update us, I know you brought up Panhandle Pipeline bond deal a couple of weeks ago, just what was the thought behind bringing that deal at the Panhandle level to pay down debt at Southern Union Company?

Well, the pay down of debt at Southern Union Company is temporary. I mean basically what we did is we issued the notes to fund our ongoing capital expenditure program at Panhandle which includes the field zone expansion that Rob spoke of earlier and the Trunkline LNG infrastructure enhancement project and for general corporate purposes at the Panhandle level.

Essentially the use of the proceeds to pay down debt, or to be loaned or advanced to Southern Union Company was just the most efficient use of the proceeds at the time. Those monies will be repaid to Panhandle as needed to complete its construction program.

Okay,

And then last, I know you have some bonds maturing in '08. I know it's early days with the MLP, but as you look through it initially at least, are you thinking you're going to take those out with any MLP proceeds or do you plan to refinance those maturities?

I think it's too early to tell. I would expect that for the most part to refinance them though, at this point.

Okay. Thank you.

Your next question comes from the line of Gordon Howald with Calyon. Please proceed.

Thanks, guys.

Could you break out the benefit of the new rate design at Missouri? Maybe this is a question for (inaudible) versus the benefit received from the higher rates? Just trying to get a better understanding--

Yes, I understand your question. Since we've, essentially the new rate design shifts revenues from the peak winter months, the peak usage months to other months in the year, you do--

How much was that benefit versus the--

Yes, I'd say in this last quarter--

Yes.

About $11 million benefit for this --

Quarter-over-quarter.

$11 million benefit for which piece?

Relative to the new rate design produced approximately 10, $11 million more in this quarter.

Got you.

Than it would have in the prior quarter.

Okay. Great.

I'm sorry. In the prior year, the comparable quarter in the prior year.

Perfect. Thanks, guys.

Your next question comes from the line of Sam Brothwell with Wachovia. Please proceed.

Hi, good afternoon.

Good afternoon.

Good afternoon.

With respect to your MLP that you're forming, you alluded to some of the midstream assets. Clearly, you've got other that would qualify for that type of structure. Would you contemplate, you know, setting up another MLP down the line, perhaps once the Trunkline expansion is finished?

I think at this point it's premature for us to say exactly what we'll be doing with the remainder of the assets. As you pointed out, it is obvious that we have a significant portfolio of assets that qualify for the MLP structure, or as part of a drop down strategy.

I think once we've executed successfully on the Gathering and Processing MLPs, then we'll be able to evaluate whether or not we would drop additional assets in or potentially form another MLP with our pipeline assets or others.

Okay. Thank you.

Your next question comes from the line of Carl Kirst with Credit Suisse. Please proceed.

Hi, guys, it's Carl Kirst.

With respect to the MLP (inaudible) my strategy question, let me just follow that with the hedging. I know that's kind of under evaluation right now. Is that something that hedges, I mean, however much we decide to put on, are we going to have to wait really closer to perhaps an IPO before significant amounts of hedges would happen, or would that happen independently?

No, I don't think necessarily that it will have to wait. I think it'll be a function of, you know, number one, the cost of whatever instrument we choose to hedge with and what the underlying margin that will be hedged. You know, as we sit here and watch the market today, it continues to improve for us. So we watch it every day and we'll execute when we think it creates the greatest value for the shareholders.

Fair enough.

Now that you guys have decided to go down the path that you have, how should we think about midstream as far as management is concerned? You know, is there going to be a move to, I guess, expand management at SUGS, or are you comfortable with the structure you have now?

We're considering both internal and external options, but at this time, we're not prepared to make a formal announcement as to what we're doing.

Okay.

Maybe if I could turn to the budget for a second, and I apologize if you had already said this, but do we have kind of a first look at the '08 budget right now considering the cost inflation at Panhandle?

We're going through the budget process at this point in time and are not ready to make any type of announcements.

Okay.

Specific announcements.

The field zone expansion, that's kind of been creeping up over the last 12 months, 200, 230, 250 now. There was kind of a comment in the Q thing weather from here could impact that further. Who is on the hook for any additional cost inflation at this point? Is that you guys or Energy Transfer?

No, that would be us.

Okay.

And then lastly, looking at midstream, is it possible to say with the Keystone plant having been out for five days, is it possible to quantify that impact? And also was hoping now that everything is kind of back up and running, you know, has there been any increase as far as processing volume, say, for instance, where we are now, we're in an expected exit rate for year-end, trying to see if we're going to essentially have a rebound in processing volumes that would otherwise match 4Q '06?

Yes, right, Carl. You did point out that we were down slightly quarter-over-quarter. And Keystone plant shutdown, our turnaround would attribute for the vast majority of that. I think we were technically down for almost six days in August, and that did impact our ability to, you know, it did reduce our processed volumes and the gallons that we recovered.

We also had a little bit of high CO2 gas shut-in in the early part of the quarter prior to the workover at Keystone and the treating work that we did at Jal. So, yes, since the plant turnaround, I think we have seen recoveries in our processed volumes returned to the normal levels and I do expect to see improvement in the subsequent quarters.

Okay. So the $1.4 million range is still sort of good to use right now?

Yes, sir.

Okay. And then last question, appreciate the time.

You now, as we kind of sit here in mid-November, the full-year number is still a rather wide range and can understand not wanting to get tied down into any single number. But with respect to fourth quarter of last year, that was roughly a $0.44 (inaudible) I think the range for this year kind of implies something more anywhere from 37 to 47.

And I guess my question is, as we sit here with what we know today in mid-November, are there any things in specific that we should be on the lookout for that might impact 4Q '07 to be lower than last year?

Nothing specific, but the bottom line is that we do have a certain level of variability to our earnings for items such as ultimate capital spend, commodity price exposure on unhedged midstream volumes and there is a certain amount of weather, albeit it's been mitigated significantly in Missouri, but with respect to commercial, industrial customers and residential customers at our other LDC, I mean there is some weather sensitivity. Right now at this point we're simply comfortable with the range that we've given.

Great. Appreciate the color. Thanks, guys.

Thank you.

Your next question comes from the line of Becca Followill with Tudor Pickering. Please proceed.

Hi, it's Becca Followill with Tudor Pickering. Any update on the Section 5 on Southwest Gas Storage?

Yes, actually, we've reached an agreement in principle with the FERC staff and with some of the complainants and we hope to be filing a settlement certainly by the end of the year.

Great. Thank you.

And then on the question of management, I know the question's been asked, but at what time do you anticipate having somebody in place to run the business? On the midstream?

I think it's too early for us to predict exactly when that will occur.

Okay. Thank you.

Your next question comes from the line of Lasan Johong with RBC Capital Markets. Please proceed.

Good afternoon.

I'm wondering about the MLP structure in a little bit more detail. You said that was a part the SUGS assets. I'm wondering if that means you're taking certain pieces out of SUG in its entirety and pushing it down to the MLP, or if SUGS as an entire entity is going to be transformed into an MLP and a piece of that will be then spun off to the public. Could you clarify that, please?

Sure. We're currently working with our financial advisors to finalize the structure of the MLP and the appropriate percentage of the assets that we contribute, and we're also working with them to finalize the optimal size of the offering.

We'd expect the initial offering to be, obviously, tax efficient for Southern Union, as well as appropriately sized for the debt and the liquidity of the market and to be consistent with other offerings that we've all seen in the market recently. And as Rick mentioned, we'd expect to pay down debt with the proceeds from the initial offering.

So are you saying that you take the whole SUGS entity and shove it down as an MLP, or do you think you're going to take pieces of the SUGS assets and put that into an MLP?

Our expectation is we begin by contributing a percentage of it into the MLP.

Percentage of the whole SUGS?

Yes.

I see. So then if that's the case, then you'd expect to generate growth by continuing to peel percentages of SUGS off and putting it into the MLP. Is that how you intend to create the growth in Distribution?

That is definitely one option.

And then there's obviously the acquisition option as well?

That's correct.

Okay.

And do you guys have a mind, something in mind in terms of incentive distribution payments, where that split will be and kind of what percent of increase you would have to see before you get there?

We have not finalized that with our financial advisors yet.

Okay.

And then lastly, you had mentioned that SUG had gotten offers for the SUGS business and it was above the $1.6 billion purchase price that SUG had received, which is great. So the question then becomes, you know, how much above was it that the bird-in-hand principle didn't apply here?

We obviously can't answer that question specifically, which offers we receive for which amounts.

Okay.

Then what kind of a discount rate did you apply to the cash flow stream relative to the price that you were receiving to analyze and compare?

I don't think I could say that without violating some of our CAs.

Okay.

Was it at least substantial? Like, you know, people would be like, yes, the difference is really nice or people will say, oh, the difference is not very big at all?

I think what I said was it represented a significant increase over our purchase price. That's about as far as we can go.

And the rational that you're rejecting that offer is because you think you can create more value on a standalone basis.

That's correct.

Okay. Thank you.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the call over to management for closing remarks.

I want to thank you all for attending the meeting, and we hope that you'll all be on our next conference call and that we can report even better earnings than we did this time. Thank you, all. Bye.

Thank you for your participation in today's conference. This concludes our presentation. You may now disconnect. Have a good day.