OGE Energy Corp (OGE) 2009 Q4 法說會逐字稿

Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to the OGE Energy Corp. fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Mr. Tidwell, you may begin your conference.

Thank you, Kim. Good morning, everyone. Welcome to OGE Energy Corp.'s fourth quarter 2009 earnings call. I'm Todd Tidwell, Director of Investor Relations. With me today I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp.; Sean Trauschke, Vice President and CFO; and several other members of the management team to address any questions that you may have. In terms of the call today, we will first hear from Pete Delaney followed by an explanation of year end and fourth quarter results from Sean. Finally, as always, we will answer your questions. I would like to remind you that this conference is being webcast, and you may follow along on our web site at www.oge.com. In addition, the conference call and accompanying slides will be archived following the call on that same web site.

Before we begin the presentation, I would like to direct your attention to the Safe Harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to date.

I will now turn the all over to Pete Delaney for his opening comments. Pete?

Thank you, Todd. I will provide an overview of our principle accomplishments of 2009, report on the status of key initiatives underway and our outlook for our businesses. Sean will review our financial results in detail.

2009 was a good year for OGE Energy from a financial standpoint as well as in terms of continuing to execute on key initiative aligned with business strategy. On the financial front, 2009 reported income from continuing operations of $2.66 per share, slightly ahead of our past record level of earnings of $2.64 of earnings reached in 2007. That higher level of earnings reflects increased investment associated with key business initiatives, electric transmission, electric generation, particularly wind, and natural gas combined cycle assets, and infrastructure upgrades in our utility business as well as gathering in interstate and natural gas transportation investments in Enogex. As I'll discuss later, the amount of increase over our prior record earnings level does not fully reflect progress made since 2007.

We entered 2009 concerned, like many others, about our economy but our service area continues to sustain itself in this challenging economic environment. Unemployment in the Oklahoma City metro area has the lowest unemployment rate in the nation at 6.8%. That's among MSA's population of over a million. That's not to say we don't have our challenges, with the state government cutting back on services, like many other states, to close a sizable deficit. We have seen a rebound on industrial sales which were down at the low point 16% from 2008 during last year, but we ended up down 13% by year end. Again, due to new loads coming online in the last part of the year. We are projecting new industrial and oil field load for 2010, as well. Customer growth for the year also came in at historic levels of slightly less than 1%. Overall, a solid economic foundation for the utility considering the larger national picture.

Let's talk about execution. As I have said throughout the year, our earnings calls have been somewhat repetitive, no surprises, getting done what we said we would, achieving milestones and executing business plans. Further confirmation to our stated belief that we are well positioned from an operating, financial, and regulatory standpoint. In terms of our utility business, we continue to move ahead on key items, transmission, smart grid and building our wind generation portfolio.

A key success in 2009 was the seven regulatory settlements. These regulatory settlements, in my opinion, reflect the quality of our regulatory effort, filing solid cases, building strong relationships and credibility with key stakeholders with positive state regulatory environment as a backdrop. The Arkansas and Oklahoma general rate case settlements allowed us to implement rate increases earlier than we had originally planned, and the OU Spirit wind farm rider avoided any regulatory lag upon its commercial operation. These achievements all contributed to strong earnings this year.

From a business strategy standpoint, the approval of the norm and smart grid project as a part of the Oklahoma rate case was an important first step towards capturing the benefits associated with the technology enhanced distribution system. We're counting on a successful demand response pilot this summer to support an expanded deployment. A part of achieving our overall goal of deferring the need for a new fossil fuel plant until 2020. We expect to file for preapproval shortly that provides for an expanded smart grid rollout, funded in part by an $130 million DOE grant awarded last year.

Conservation and efficiency programs are another ledge to our 2020 plan. With the Oklahoma Commission approving eight such programs just last month. The wind speed transmission project, key to capturing wind generation capability in western Oklahoma and meeting our wind portfolio goals, is on track, on budget despite numerous legal challenges with an operational date of March 31. Work has begun on two additional transmission lines totaling about $185 million and 144 miles. We're also ramping up to move forward on the portfolio three system reliability transmission lines approved by the Southwest Power Pool totaling around $300 million. And we continue to work hard to get the [Woodworthy Gymans] line approved by the Southwest Power Pool to support further wind development in Oklahoma.

With the approval of the two wind PPAs earlier this year, our wind portfolio at year end should be about 550 megawatts. In 2007 again we set out a goal of 737 megawatts in about five years, and we have made great progress towards that goal considering just 107 megawatts was in operation coming into 2009. The OU Spirit wind farm completed on time and on budget last year increases our own portfolio to 220 megawatts. We continue to see value in wind in terms of balancing our generation portfolio to address natural gas price volatility and potential carbon emission costs.

We're excited about these and other utility investments, but we're also focused on growing our utility business but not on the back of our rate payers. We're focused on cost control and on investments that create earnings for shareholders and create a level of savings for our customers that mitigate the impact on prices. Examples of such investments are smart grid, our wind farms, and demand side management investments. All these investments should bring savings to our variable costs. Our portfolio of 3E and other base reliability transmission projects will be recovered primarily through charges to other utilities. Our rates are currently 27% below the national average and 18% below the region, the lowest in Oklahoma. We intend to maintain that position.

Enogex has seen a rebound in activity in several key natural gas plays in Oklahoma where we are well positioned versus our competition. Last spring on the earnings call, we talked about our known and committed expansion projects of $50 million in 2010. Today that number stands at $135 million reflecting the increased level of activity and we do have a list of viable prospects we continue to work on. Of course, the returns on these projects are at levels that meet or exceed our risk adjusted return requirements. These activities driven by higher natural gas prices today, higher initial production rates at the wells, and rich natural gas liquid streams boosting margins at $70-plus oil prices. The rich liquid well profile should continue to support growth and processing volumes as well as provide an environment constructive to our efforts to secure attractive fixed fee rate processing agreements.

As I reflect back on the last several years, 2009 results demonstrate the progress we have made in regard to our key financial objective of growing utility in Enogex while reducing our commodity exposure. We've grown earnings at OGE at $2.06 versus $1.75 in 2007 despite weather that was more favorable to the tune of about $0.15 per share of operating income that year. The growth continues with OG&E 2010 earnings projected to be $2.15 at the mid-point of our guidance. Despite recovery of increased levels of investment that provides for increased earnings, our 2009 average electric rates were $0.0821 per kilowatt hour, virtually flat versus the $0.0815 per kilowatt hour in 2007.

Since 2007, we've invested over $700 million in Enogex, more than half in gathering systems to accommodate rich gas plays in the Colony Wash and Granite Wash areas. During the last three years, we've also made significant investments in our intrastate transportation system to support delivery in the markets outside of Oklahoma. As a result of these investments, the relative contributions of our business segments have changed at Enogex. Since 2007, the gathering gross margin has grown about 22%, and the transmission gross margin has grown about 35% while processing margin's flat. Accordingly, much progress has been made towards our goal of reducing commodity exposure. The processing margin represent only 34% today compared to 68% of Enogex's gross margin 2007.

As I noted at the beginning of the call, record level of earnings of 2009 is only one part of the story. The composition of our 2009 earnings has changed significantly with the electric utility and fee based revenues at Enogex accounting for 95% of consolidated earnings versus approximately 84% three years ago. To us, it's a significant improvement from a risk-adjusted return standpoint and from a standpoint of potential earnings growth if commodity spreads word of return to levels of previous years. This was not happenstance. It's a result of our taking actions consistent with the portfolio objectives we established years ago. And we continue to focus on sustaining this position for the upcoming years with electric transmission playing an increasing role.

Positioning the business to have the right investment opportunity is only one aspect of growing earnings. Having the right operating and expansion capabilities is another. Our ability to manage our own capital projects, and our ability to reduce our capital program in response to market or regulatory concerns, and to fund investments largely through internal generation of funds due to a low payout ratio are important attributes. I would note we're improving our credit profile of meeting our growth objectives. Our plans are to continue on the same path in the years ahead. In anticipation of the Q&A session, that path does include continuing to look for ways to maximize shareholder value, as shown we've been willing to do with our past attempts at MLP and partnership transactions. That said, we believe Enogex offers us great growth opportunities, fits well within our strategy and business objectives.

Now I'll turn the call over to Sean to discuss our financial results. Sean?

Thanks, Pete. For 2009, we reported net income of $258.3 million or $2.66 per average diluted share as compared to net income of $231.4 million or $2.49 per average diluted share in 2008. The contribution by business unit on a comparative basis is listed on the slide. 2009 was shaping up to be a good year and then we reached December and it became a really good year because of three key items. First, commodity prices were stronger than expected. Realized processing spreads were $5.84 per MMBTU and we were projecting back in October realized spreads of $3.72. In addition, we expected liquids prices to average $0.82 per gallon and they came in and they were $1 per gallon in the fourth quarter. The new Clinton plant has allowed to us extract more NGLs from the gas stream which also improved margins. In December, we produced a record 63,000 barrels of condensate.

Moving to the utility, at the end of October, we were looking at a very mild weather quarter. October and November combined were over $10 million below normal, and we made up $4 million of that in December alone, which was one of the coldest on record. Finally, the O&M was not nearly as high as anticipated in October as the entire organization remains strongly focused on O&M. These items accounted for approximately $0.16 improvement in fourth quarter earnings from our October projections.

Now turning to the earnings details. At OGE, net income for 2009 was $200.4 million, or $2.06 per share, as compared to net income of $143 million or $1.54 per share in 2008. Some of the primary drivers are as follows. Gross margin increased $110.3 million or 13.1%, and I'll provide details of gross margin on the following slide. Operation and maintenance expense decreased by $3.6 million, primarily due to a focus on cost control due to the current economic conditions. Depreciation and amortization expense increased $32.4 million, primarily due to the Redbud facility being placed into service and amortization of several regulatory assets.

Other income and expense created a positive variance of $33.7 million, in part due to higher allowance for equity funds used during construction in 2009 and higher participation in the Guaranteed Flat Bill program. Interest expense increased $14.5 million, primarily due to higher levels of long term debt that were issued in 2008, partially offset by lower short-term interest borrowings and higher levels of (inaudible) debt.

Now, turning to gross margin. You can see the drivers on this slide for the increase in gross margin at the utility. The key point here is that we've begun the recovery process on the $1.8 billion of capital expenditures made at the utility over the past three years. These include the Red Bud plan, OU Spirit Wind farm, wind speed transmission line, and the hundreds of millions of dollars spent on system infrastructure. Another significant point is we have been able to increase our earnings with little to no impact on customers as fuel costs decreased nearly 26% compared to 2008. We did have a mild weather year, which negatively impacted gross margin by just over $18 million compared to 2008. Cooling degree days were nearly 11% below last year and 3% below normal.

We also were challenged on the industrial sales part of our business with sales down approximately 13% year-over-year. The good news is that industrial sales increased in December 1% compared to December last year so we think we've turned that corner.

Now, turning to Enogex, earnings per share decreased $0.30 per share in 2009 compared to 2008. The largest variance was gross margin which decreased by $33.2 million. I'll discuss the details on the next slide. Operation maintenance expenses decreased by $7.4 million in 2009 primarily as a result of cost reduction efforts in response to the depressed natural gas environment. Depreciation and amortization expense increased $9.7 million primarily due to higher levels of depreciable plant placed into service. Interest expense was $3 million higher compared to 2008 primarily due to the prefunding of long-term date which matured on the 15th of last month.

Turning to gross margin. You can see some of the primary drivers on the slide. The drop in commodity prices was the main culprit as realized spreads decreased by 33% from $6.15 per MMBTU to $4.12 per MMBTU. The average liquid prices also decreased 39% from $1.26 per gallon to $0.77 per gallon in 2009. I want to point out that although commodity prices fell over 30% in 2009, gross margins fell by less than 6% on a consolidated basis and just over 18% at Enogex compared to 2008. This highlights the transition of our portfolio to a more fee based type business.

Enogex continued to perform in a very difficult business environment. The transportation grew margins by 12.5% as the MEP, Gulf Crossing, and the new Firm 311 rates all contributed to this in 2009. Gathering and processing volumes were up nearly 8% and 6%, respectively, as we continued to see the benefits of our recent capital expenditures and system expansions. The addition of the Clinton processing plant has greatly increased the efficiency of the entire processing fleet, and we've been able to extract more NGL volumes out of the Rich Gas and the Granite and Colony Wash areas. Fixed feet processing margins also increased as this contract type has become a larger part of the processing business.

Now moving onto the quarter, for the fourth quarter, we reported net income of $34.2 million or $0.35 per average diluted share as compared to net income of $21.8 million or $0.23 per average diluted share in 2008. The contribution by business unit on a comparative basis is listed on the slide. At OG&E, net income for the quarter was $19.5 million or $0.20 per share as compared to net income of $16.3 million or $0.17 per share in 2008. Gross margin increased $20.8 million or 11%, and I'll touch on the gross margin on the next slide. Operation and maintenance expense increased by $7.5 million primarily due to higher employee costs and increased spending on tree trimming which were partially offset by lower contract services related to some plant overhauls.

Depreciation and amortization expense increased $4.5 million primarily due to additional assets being placed into service and the amortization of several regulatory assets. Taxes other than income increased $1.9 million primarily as a result of higher property taxes from the new assets placed into service. Other income and expense created a positive variance of $1.7 million, in part due to higher allowance for equity funds used during construction in the quarter.

Turning to gross margin. You can see the drivers on this slide for the $20.8 million increase in gross margin at the utility for the fourth quarter compared to 2008. As with the year-to-date variance, recovery on investments was the key driver for fourth quarter 2009. The fourth quarter was a mild weather quarter which negatively impacted gross margin $5.4 million compared to last year. And a $6.1 million negative variance compared to normal. Heating degree days were above normal and above the same period in 2008. Cooling degree days in October were virtually nonexistent. December did help offset some of the weather impact as it was one of the coldest in recent history with 12 days of average temperatures below freezing.

At Enogex, earnings per share increased $0.07 in 2009 compared to 2008. The largest variance was the gross margin which increased by $20.8 million, which I will discuss in a moment. Operation and maintenance expenses increased by $2.2 million in 2009, primarily due to higher labor costs compared to the same period in 2008. Depreciation and amortization expense increased $2.4 million primarily due to higher levels of depreciable plant placed into service. Interest expense was $3.4 million higher compared to 2008 primarily due to higher levels of long-term debt associated with the prefunding of the debt maturity we discussed earlier.

Now looking at gross margin, gross margin increased across all of Enogex's business. The transportation business benefited from higher demand fees associated with the MEP and Gulf Crossing pipelines, as well as the Firm 311. The processing business saw the largest increase as higher commodity prices and processing volumes were the main drivers for the increase. Realized spreads increased by 65% from $3.53 per MMBTU to $5.84 per MMBTU. Average liquids price also increased 48% from $0.67 per gallon in 2008 to $0.99 per gallon in 2009.

We are reaffirming our 2010 earnings guidance of $2.70 to $2.95 per share based on the assumptions we set forth in our 2009 10-K filed with the SEC this morning. As you can see, the earnings ranges for each of our companies remain unchanged.

Lastly, I know some of you like to review our detailed processing assumptions, and I wanted to let you know that they've been updated and posted on our web site this morning under the investors tab. Before moving on to your questions, I would like to touch on our cash flow and financing expectations for 2010. At the mid-point of our 2010 guidance, we project approximately $636 million of cash flow from operations. Our plan assumes, as we said previously, to issue $250 million of long-term debt this year to finance a capex program at the utility. Our current shelf has available debt capacity of $200 million. Therefore, we will need to file a universal shelf registration for securities with the SEC during the first half of 2009.

While this shelf will allow for the issuance of equity, I want to stress our current forecast does not anticipate additional equity needs beyond the $15 million we normally raise through our DRIP program. However, as we stated previously, we have multiple growth opportunities that we're evaluating, especially in the transmission area, and we will issue equity if and when these additional opportunities rise. But I want to remind you that they will be accretive to earnings. The Company is committed to maintaining a strong credit rating and continuing to use our disciplined capital allocation methodology.

With that, we'll now be glad to answer your questions.

(Operator Instructions). Your first question comes from the line of Jay Dobson from Wunderlich. Your line is now open.

Good morning. Pete, was hoping you could elaborate a little bit on the MLP comments that you brought up and just understanding that valuations have improved, how you think about that opportunity?

Sure, Jay. I knew we would probably get a question on Q&A, so I wanted to address it up front. Generally when we look at our strategy, we're going to continue down the same path of our focus that we've had in both businesses,. We've continually have said that we believe in Enogex we're not getting full value. We think that by moving down the road of having a lot more of those revenues fixed, that's more in line with our shareholder base and that we have closed somewhat the valuation gap. But it's our commitment and our job to improve our shareholder value, maximize shareholder value.

We just demonstrated it by what we've done in the past, we've been willing to go down those paths and that's still open to us if that's the right decision. We haven't made any decisions particularly as it relates to MLP is the right decision. As you know, that market has improved. I don't know if there's any IPOs that have been completed yet. I think there's some that are coming to market. But we'll continue to look at that and other opportunities if we think it's the right thing to do.

That's super. And just as a follow up to that, obviously you mentioned valuation as one trigger, but I'm wondering, the move in capex from $50 million to, I think you said around $130 million. Would we have to see capital spending continue to rise from here in order to argue in your mind that the formation of the MLP would make more sense, or is it just simply a valuation argument?

We look at a host of things. I said we were at $135 million from known committed projects, and it's clearly our hope that that number increase. We think the returns are out there, good returns that would be accretive to our shareholders. At this point in time, with our capital allocation program, Enogex has sufficient cash flow to fund that $135 million on its own, and actually that number can rise quite a bit. Enogex could still have significant cash flow from operations to fund that. So, we've got room there. So valuation is a key driver because of the financial strength that we have and liquidity we have to finance. Like I say, it is a key driver, but there are other considerations. That's the main one.

That's great. And then just one last detailed question on Enogex. I assume you were not rejecting ethane through the fourth quarter and just thought maybe you could offer some comments on where we stand right now with ethane pricing where it is.

Sure, you're correct, Jay. This is Sean. We did recover ethane in the fourth quarter. We're projecting that we would be in recovery mode this year, as well.

Thanks very much.

Your next question comes from the line of Brian Russo from Ladenburg Thalmann. You're line is now open.

Good morning. Just in terms of the strong fourth quarter and your ability to control O&M and so forth, and the momentum building in Enogex, could you just comment on the guidance range? Are we looking more towards the upper half of the range or what kind of assumptions do you need to get to the high end?

Brian this is Sean. Are you referring to 2010 or --

Yes.

Okay. No, I think our 2010 guidance, we're going to stick where we are. It's February so we're not going to pinpoint that as far as the upper end or lower end right now. We want to make sure the weather and commodity prices and things like that, those were key to our assumptions. But we did have a very good fourth quarter. We're very pleased with those results. We do believe we're growing to be able to harvest some of those O&M savings we achieved in 2009. We're excited about our opportunities in 2010.

I see here that 2010 operating cash flow outlined in your presentation is $636 million. It looks like in a past presentation you were forecasting $588 million. Can you just comment on what's driving the increase there?

I'm sorry, Brian, could you repeat your question?

Sure. In your presentation, you have cash flow from operations of $636 million. In, I think, the EEI presentation, you showed cash flow of $588 million. I was just wondering what the increase there is the result of?

I think it's a couple things. You'll probably see that there's been a change in our deferred tax balance there. We actually undertook a project, and we brought in close to $80 million of what previously were deferred tax assets. We brought that in to cash from operations. That's probably the biggest driver there.

Okay. Are you still committed to the 5% to 7% growth rate? Is that off of the new $2.60 base that was formed in '09?

Yes.

Okay. Great. Thank you very much.

Your next question comes from the line of Leon Dubov from Catapult Capital. Your line is now open.

Hi, it's David Frank. Can you hear me?

Yes, hi, David.

Sorry. I'm out of the office calling from a cell phone, just wanted to make sure you could hear me all aright. Pete, just a comment and a question on your previous comments about Enogex. You said that you didn't think that you were getting the full value of Enogex in your share price, and I think that's absolutely true. I think to say that MLPs have been doing better lately is an understatement. They've been on fire and coming close to hitting record peak stock prices again just not long ago. So what is the holdup at this point, especially if you have growth opportunities in things like transmission? Aren't there opportunities to monetize this business? I would have to imagine that there's probably MLPs out there chomping at the bit to get at this thing.

MLPs have gone up significantly. So has our stock over that same period of time, David. The market has gone up dramatically, as well. What you described MLPs also sounds like it's pretty frothy, too. So we would be concerned about that. But we have a long-term focus here on growing value for our shareholders, and we've got great growth opportunities throughout the situation with the MLP markets and the requirements for them to continue to pay out cash. We're able to manage our business very well through that difficult environment. And again, we are making progress on our valuation. There's no silver bullet as it relates to closing that gap.

If you look at companies that have MLPs, some in Oklahoma that would be structured similar to us if we had done that, you don't get, I know what you would call some of the parts, you don't close that gap. There's always some valuation gap out there. But again, if we see there's, in the whole scheme of things, looking at all of our businesses, our ability to deliver value to shareholders is something that could make a substantial difference in line with our objectives, we'll take a hard look at it. We continue to monitor those things, and we will continue to monitor those.

God willing, the markets are frothy for MLPs, as you put it. That would actually seem to me like an ideal time to go out there and try to strike a deal. My only concern is we've attempted it a couple times and the timing has always been a little late. So I'm just wondering why not strike while the iron's hot. I don't know if it's purely unrelated in any manner, but I noticed you hired a new board of --

Hello? Hello? Operator?

Yes, sir. I believe he has dropped off the line.

He was out of the office. That's correct.

Okay. Your next question comes from the line of Reza Hatefi from Decade Capital. Your line is now open.

Thank you very much. Just following up on the MLP comments, over the past few years obviously you guys have talked about the possibility and so forth. Could you review again what the positive impact is from doing an MLP? I almost feel like it's been an overhang where if you did sell Enogex, you'd take a big tax loss, or if you just contributed the assets down into an MLP from an Enogex shareholder, I'm not quite sure what the benefit is. Could you just talk about that again?

Yes. It goes back to my comment there's no silver bullet here, there's pros and cons with all these things. Overall, I would think the premise is that when you look at EBITDA multiples on which MLPs trade, and you look at EBITDA multiples on which utilities corporates trade, there's a gap with the EBITDA multiples trading higher of MLPs. So theoretically, when you do an MLP, if you could capture that same EBITDA multiple valuation and that the investor would look at and give that you same valuation for the part of your subsidiary that's in MLP form, that you would get some of the parts a higher overall stock price. That's in theory. That does occur sometimes.

I don't want to talk about other companies but we do track other companies who have that structure. There are times in the market where they do seem to -- their valuation does seem to get to some of the parts. That's usually not sustained. And usually gets back to a discount to that. So, again, there's tax implications, there's the earnings implications are not positive associated with taking these steps. So you really look at the cost of capital situation would help us compete. From our standpoint based on our competition, we do compete against MLPs in the field. We have not found that to be a problem. We've been doing that for several years. Again, we look at many factors but I think that's what a lot of the interest is from some parties.

And then since OGE is a C Corp, your taxes, if you were to contribute your assets to an MLP, it wouldn't necessarily improve OGE's cash flows because you would still pay taxes like you would as an owner of Enogex. So whether you MLP or not, it doesn't necessarily improve your cash flows. It just improves the cost of capital for the MLP. Is that really essentially the only benefit?

Distributions would be taxed at the full corporate tax rate. To the extent we were to sell MLP units, we'd be taxed on the difference between the basis and those and value received. It's a more deferral, you could defer some of that taking back debt, but generally, I think you're right.

Appreciate it. Thanks a lot.

(Operator Instructions). There are no further questions at this time. Mr. Tidwell, I turn it back over to you.

We'll turn it back to Pete for closing remarks.

I want to thank all our company members for their hard work that delivered the results. We are pleased with our 2009 results. We remain excited about the direction of this Company and the opportunities we see ahead. Thank you, very much, for your interest in OGE Energy and have a great day. Thank you.

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