OGE Energy Corp (OGE) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2014 OGE Energy earnings conference call. My name is Mark and I'm your Operator for today. At this time, all participants are in a listen-only mode and we'll conduct a question and answer session later in the conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes. I'd like to now hand the call over to Todd Tidwell, Director of Investor Relations.

Thank you, Mark, and good morning everyone, and welcome to OGE Energy Corp.'s second quarter 2014 earnings call. I'm Todd Tidwell Director of Investor Relations, and with me today, I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp,, and Sean Trauschke President of OG&E, and CFO of OG&E Energy Corp. In terms of the call today, we'll first hear from Pete, followed by an explanation from Sean of second quarter results, and finally, as always, we'll answer your questions.

I would like to remind you that this conference is being web cast and you may follow along on our website at OGE.com. In addition, the conference call and the accompanying slides will be archived following the call on that same website. 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 require for financial statements and simply states that we cannot guarantee forward-looking financial results, that this is our best estimate to-date. I would also like to remind you that there's a regulation G reconciliation for gross margin in the appendix, along with projected capital expenditures. I will now turn the call over to Pete Delaney for his opening comments. Pete?

Thank you, Todd. Good morning, everyone, and thank you again for joining us this morning. Earlier we reported second quarter 2014 earnings of $0.50 per share compared to $0.46 per share in 2013. As in the last quarter, the primary driver for increased consolidated earnings was higher profitability from our LP ownership interest in the Enable midstream MLP. Enable reported solid earnings earlier this week and announced increasing it's quarterly distribution by almost 3%.

We're very bullish about the associated value creation from Enable's growth prospects and the IPO, in particular, our ownership of 60% of the IDR rights. Providing the majority of our annual earnings, the utility continues to perform in line with expectations. Although the weather has been cooler than normal this quarter, we have a lot of third quarter left. Our 2014 consolidated earnings guidance of $1.94 to $2.06 per average share remains unchanged at this time.

As the utility increased, margins were driven by our growing FERC transmission investments. We're projecting approximately $44 million of increased margin in 2014 from these investments. New customer growth in our service territory has added $3 million to margin in the quarter. As expected and discussed in our last call, the US supreme court elected not to hear the appeal of the lower court's decision followed by the Oklahoma attorney general and OG&E regarding the EPAs federal implementation plan on regional haze.

As a result, and as I mentioned on the last call, we would be ready to proceed quickly, and we are implementing our compliance plan. In short, the plan provides for dry scrubbers to be installed at the two Sooner units, a conversion of two coal units at Muskogee to natural gas, and replacement of a 60 year old mustang gas plant with 400-megawatts of CTs. Development of our compliance plan (inaudible) first, we want to determine the lowest risk base cost options for our customers. Second, we had to be able to meet a 55 month regional haze compliance timeline and April 2006 timeline for utilities MATS.

Third, we wanted the best position of the generation portfolio for the future, including the day two SPP marketplace. And finally, maintain an increase of our optionality to respond to future uncertainty such as pending CO2 rules. We believe we have accomplished this in our plan, and Sean will discuss the plan in greater detail later on the call. We now have 53 months left in our compliance deadline to meet the emissions limits. In June, as the first step in our regulatory process, we filed a draft of our integrated resource plan with the Oklahoma Corporation Commission, and just completed a 60 day comment period.

Monday we submitted our final IRP and (inaudible) our recovery plan was filed with the commission yesterday. We've been working with the commission staff and others to hopefully get a decision from the Oklahoma Corporation Commission in February of 2015. We'll also file for recovery with the Arkansas Commission in the third quarter of this year. We've asked the commission to allow for recovery under a rider of our $1.1 billion of expenditures, CWIP would help further alleviate potential rate shock to our customers.

The last thing we want do is give our customers a double digit rate increase at one time. The capital investment and coal conversion plan is purposely back ended to defer as long as possible the impact on customers. We plan on running those coal plants well into 2018. We believe the plan keeps the increase in rates to an affordable annual increase over the planned timeline.

Our large transmission investments are winding down and Enable's providing significant cash flow. So, from a cash flow prospective, we're well-positioned to finance the plan without accessing the equity markets. We're following our compliance plan, House Bill 1910 that was passed years ago, providing for presumption of prudence on our part. On regards to recovery expenditures to comply with Federal, or state environmental regulations.

Statute provides for a rate case to be filed within two years of the decision on the environmental plan. Accordingly, we're contemplating a filing based on the 2014 test year to comply with that provision, as well as to pick up the June 2015 expiration of a wholesale power contract, and return that capacity into the retail rate base at a cost of around $240 per KW, which was a very good deal for our customers.

As noted on our last call, the now Vice Chair of the Oklahoma Commision Patrice Douglas announced her decision to step down and is in a run-off for the US Congress seat. Commissioner Bob Anthony has stepped in as Chair in her place and Ms. Douglas will remain at the commission until January 2015. Former Oklahoma House Speaker Todd Hyatt won the primary on June 24, and without a Democratic opponent, he is scheduled to replace Douglas at the commission. Our experience with the commissioner elect is a quick study, a hard worker, and we do not anticipate any delays in the case because of his election.

As always, when pertinent information regarding the case become available, we'll share it with you. Our service territory economic outlook remains strong compared to the second quarter of 2013. We've added over 9,000 customers to the system, and weather normalized sales continued to go at 1.5%. I read earlier this morning that in July, the state tax revenues was the highest July in the state's history, so things are going to do well here. Unemployment remains low, and Oklahoma City continues its strong growth and per capita income increases.

In Fort Smith, we'll see continued economic rebound, adding of new customers and expanding facilities in that region. Implementing the environmental compliance plan, including the mustang modernization is important, but we are continuing to execute on other initiatives that are perhaps more strategic.

We're delighted to once again win the JD Power number one ranking for residential customer satisfaction among large utilities in the Southern region. We're continuing to leverage our smart grid investment in new products and service offerings, as well as applications for more effective operations and improved customer experience. We're also preparing to pursue additional transmission opportunities outside of our footprint under FERC order 1000. In fact, we propose a number of projects and the Southwest Power Pool is schedule to grant awards after the first of the year.

The Enable IPO is an important part of our establishing an equity funding vehicle for growth capital of that business, for providing a source of cash flow through the distributions for our environmental compliance plan at the utilities, for funding dividend growth to support our balance sheet, and to improve as a separate equity vehicle, improves visibility and devaluation of that business. Enable announced a 2.6% increase in the quarterly distribution rate, and provide a glided path for the GP distributions to start in the last quarter of 2015.

From our standpoint, OGEs valuation, stock valuation, does not reflect our 60% claim on these potential or future cash flows. With our protected cash flows, we fortunately do in the expect to need to have to issue equity at these prices. We do expect to be able to fund our environmental compliance through cash flow and debt, even as our cash taxes increase over the next few years. As we've stated in the past, we're committed to growing earnings and dividends at OGE Energy as an important part of total shareholder return equation.

We're well aware our (inaudible) is lower than the average despite the increases in dividend growth rate in recent years. This funding strategy should provide higher earnings in the long run and should not preclude management from once again recommending, as we have in the last four years, of an increase in the dividend growth rate when the board reviews dividend policy in December. With that, I would like to turn the call over to Sean who will review our financial results for the second quarter in greater detail. Sean?

Thank you, Pete, and, good morning. For the second quarter we reported net income of $101 million, or $0.50 per share as compared to net income of $92 million, or $0.46 per share in 2013. Year-to-date, consolidated earnings per share were $0.75 in 2014 compared to $0.58 last year. The contribution by business unit on a comparative basis is listed on the slide.

At OG&E, net income for the quarter was $77 million, or $0.38 per share, as compared to net income of $79 million, or $0.40 per share in 2013. Second quarter gross margin at the utility increased approximately $14 million, or 4%, which I'll discuss on the next slide. O&M was $8 million higher for the quarter, compared to the second quarter of 2013. The increase was driven by a reduction in capitalized labor as compared to last year.

As you remember in the second quarter of last year, the utility was performing storm restoration work related to the severe weather that affected our service territory in May. Deterioration and amortization increased $3 million compared to the second quarter of 2013, primarily due to additional assets being placed into service. Finally, the increase in interest expense of $4.5 million was primarily due to the $250 million of long-term debt issued in May of this year.

Turning to the second quarter gross margin. Utility margins were up for the second quarter despite the impact of weather compared to 2013. There were two primary drivers for the increase in gross margin. First was an increase of wholesale transmission revenues contributing $13 million, and second, growth from new customers increased gross margin by $3 million. We added over 9,000 new customers to the system compared to the second quarter of 2013, and on a weather normalized basis, oil field sales continued to grow and were up nearly 5% for the quarter.

Partially offsetting these increases was mild weather as compared to 2013. Looking closer at weather, there is a saying that not all cooling degree days are created equal. This quarter was the perfect example. Cooling degree days were above normal and above the same period last year. However, those days were mostly in April and May and did not translate into increased margins because of the difference in rate blocks between the summer and shoulder months.

The mild weather decreased gross margins by $8 million compared to normal, and $2 million compared to last year. In looking at the full year impact from weather, recall we had a benefit in the first quarter from weather, so the weather impact year-to-date on gross margin was $6 million higher than 2013, and $10 million higher than normal.

Turning to our interest in Enable. For the second quarter of 2014, natural gas midstream operations contributed after tax equity income to OGE Energy Corp of $24 million, or $0.12 per share compared to $15 million, or $0.07 per share in 2013. I apologize for the busy slide with the move to equity method of accounting, it makes these comparisons difficult. But since we closed in the second quarter of 2013, this will be the last quarter that we have to show both accounting methods.

However, the results for the second quarter at Enable are solid and reflect the accretive effect of enabled transactions, as well as the higher gross margins in the business. Year-to-date, Enable Midstream has made distributions of approximately $77 million to OGE, and contributed equity earnings of $0.27.

As Pete mentioned earlier, OG&E filed it's environmental recovery plan yesterday with the Oklahoma Corporation Commission. First and foremost, we will be in compliance with the EPA regional haze and MATS Rules. At a high level, the plan includes adding scrubbers to Sooner units one and two, converting the Muskogee coal units four and five to natural gas, and replacing the mustang units with quick start combustion turbines. The plan maintains fuel diversity, ensures SPP capacity requirements are met, and provides the lowest reasonable cost to our customers.

The total cost for the construction is projected to be just over a billion dollars and as you can see on the slide, the investment ramps up and peaks in 2018, just prior to the January 2019 regional haze compliance deadline. Some of this can be attributed to the long lead items and production timeframe, but the other part of the driver is the schedules that we intend to run the Muskogee coal units as long as possible for the benefit of our customers.

As can you see from the previous slide, these expenditures have a significant impact to rate base. This projection does not include any additional growth in FERC regulated rate base from additional SPP transmission projects. But we wanted to convey the relative size of this environmental plan to the Company. The environmental compliance plan will increase customer rates and it's our job as a team to control the costs and help offset of some of these rate increases. Before I discuss guidance, I want to go over some of the key milestones of the regulatory timeline.

As Pete mentioned earlier, we filed for recovery of our environmental compliance plan yesterday with the Oklahoma commission. We've asked for a ruling in February of 2015. We have until January of 2019 to comply with regional haze and until April of 2016 for MATS. It is important to note, that Oklahoma House Bill 1910 requires OG&E to file a general rate case within 24 months within receiving the order for recovery. We will most likely file this case sometime in 2015.

The process is a little different in Arkansas, as we're required to request a declaratory order proving our environmental plan. We'll follow that with a rider application under act 310 to recover the expenditures. We expect to have the rider in place in the first half of 2015. In addition, Arkansas rules require mustang to be in service, and for OG&E to file a general rate case for recovery, which we plan to do in 2018.

Moving on to our long-term growth rate. In 2010, we established a key financial objective, to grow earnings between 5% and 7% annually, and I'm pleased to announce at the mid-point of 2014 guidance that equates to nearly 8% compound annual growth rate. Because it's been a number of years since we've refreshed the growth rate and the base year, and given the large environmental capital program, we will refresh that on our 2015 earnings guidance call at year-end, on the year end call.

Before answering your questions, I want to discuss our 2014 earnings guidance. It remains unchanged at $1.94 to $2.06 per share. Through six months, the utility is on plan and as you know, the vast majority of our earnings occur in the third quarter. Turning to the midstream business.

Things are going well at Enable, but I do want to clarify one point about our Enable guidance. Although the guidance range is the same, we're now including the delusion from the IPO in this guidance. This was approximately $0.02. Recall, we originally excluded the guidance because at the time of issuing guidance, the amount and timing of the IPO was unknown.

This concludes our remarks and now we'll open it up for questions.

(Operator Instructions). Your first question comes from Matt Tucker of KeyBanc Capital Markets. Please proceed.

Good morning, gentlemen, thank you for taking my question.

Good morning.

At first I wanted to ask about the utility O&M. I believe you mentioned there was some elevated costs tied to weather. I was hoping you could maybe give us a little more detail on those types of costs and give us a sense of what the underlying O&M growth looks like.

Sure, Matt, this is Sean. We've been doing a really good be job of maintaining our O&M growth and trying to manage that to kind of a rate of inflation, no more than the rate of inflation, so from an O&M standpoint we're on plan. We see no issues this year. What occurred in 2013 is, recall, we had some pretty severe tornados come through the service territory in May and so as a result in 2013, a lot of our time was restoring the system and that was capitalized. So what was typically would have been O&M expense was capitalized in 2013, and we were fortunate, we did not have storms this year. All that being said from an O&M standpoint and operating expenses, we're right on plan.

Okay, great. Sorry? That was helpful, thank you. The rest of my questions are going to be on the environmental compliance plan. I guess first, it looked to me at first glance like what you filed yesterday was pretty similar to the plan you had recommended in your IRP filing a couple of months ago. Are there any major differences I might have been missing?

No, not in our plan, no. I thought it was consistent. We went through a process there where interested parties, we reviewed it with them, really tried to gain alignment, so we made some minor tweaks and adjustments, but the fundamental core plan is the same.

So are there any aspects of the plan that you think could be more controversial than others, or you may get push back from either your regulators or the EPA?

Well, Matt, I think one thing that's important to note here is this is a mandate. This is not an election and we're required to comply, and we will comply. Then I think it's our job to figure out what's the best way to comply with this for the benefit of our customers and shareholders for the long term. I will tell you that there certainly will be a lot of opinions. The EPA have their views about certain fuel types. There is a view that you could have more gas, you could have more renewables. Matt, I can assure you that we've looked at all of those different permutations, risked those under different assumptions for gas and future regulations, and this is the right plan.

Okay. And then you mentioned some aspects of the plan with long lead items and it looks like the spending trajectory is really pretty back end loaded over the five year period. Are there any aspects of the plan where you're particularly concerned about getting the projects done by the deadline?

Well, I think the most significant projects are probably the scrubbers. And so, the sensitivity there is those are long lead time activities. And what we're trying to do, when we bring the coal units down to tie those scrubbers in, we want to make sure that we're doing that in the shoulder months, or the wintertime. You don't want do that in the summertime, so you want to make sure you maximize that benefit, too.

We've been doing a lot of engineering work prior to this on those scrubbers. We're working forward, or moving forward, and that's probably the longest lead time item we have is getting those scrubbers in service. As far as the conversion, as I said in my remarks, we're going to run those coal units through the summer of 2018, wait till the very, very end there, then convert them because we think there's a lot of value to our customers to continue to run those.

To answer your question, I think the scrubbers are probably the big gating item for us because those are long lead time items and we want to minimize the interruption to generation.

Really appreciate the color, guys. I'll give others a chance.

Okay, thanks, Matt.

The next question comes from the line of Brian Russo, of Ladenburg Thalmann. Go ahead, your line is open.

Good morning.

Good morning, Bryan.

Good morning.

I think you mentioned earlier that the board is going review the dividend in December. Sean, maybe you can just kind of talk a little bit more about what's kind of a reasonable dividend growth range that you might recommend to the board given all of the moving parts?

Well, Brian, I'll jump in on that, it's Pete. For several calls we have talked about that we're aware of payout ratios low on the average, and we've talked and been consistent about we had the litigation and wanted, we had hoped, that we could prevail and that would have had a significant impact on our CapEx requirements in the financials of the Company. We're waiting to see how that turns out. We know how that turns out and now we're moving ahead with our compliance plan.

That was one of the large triggers. The Enable IPO was a key item that we wanted to see how it worked out, which has gone well. We're moving those. We're checking those off, and we have been growing our growth rate as you know, the last several years, and our expectations and are continue to do that. When we look at our total shareholder return over the last few years and the attribution for that, it appears that relative to other utilities, about twice the amount of our at attributions can be towards the earnings growth rate as opposed to dividend yield compression. And that sets us up for where we are today, I think well, for our abilities because of our 8% compounded annual growth rate to continue to grow and recommend that increase to the board.

I think it's not really appropriate for us to tell you before we tell the board what we think the right increase is, but we as a management team are dedicated to continue to grow that dividend and increase that growth rate, which we think we should be, that we're well positioned to do.

Okay. Just to summarize. Potential dividend growth rate recommendation could mirror that of your historical earnings growth?

Well, we've been historically at 8% and last year was 8%, so we're pretty much already at our historical growth rate on our dividend increase. From there, what we would obviously be talking about is going up from that.

Okay. Could you just outline what's the appropriate effective tax rate on the distributable cash flows from Enable to OGE?

Sean?

Sure. Brian, today, as we have mentioned before, we are in an NOL position, so the effective tax rate coming out of the Enable is zero. We are not paying taxes on those. I want to make sure, I know this gets confusing sometimes, but remember, as an equity owner of Enable, those distributions that come out are included in our consolidated tax returns at OGE. Pete was talking about the dividend as we've discussed, as we become a federal taxpayer and our tax rate increases, that is a use of cash going forward. Okay?

Understood. When do you think you might start paying taxes, or have to pay taxes on the distributable cash flows?

We're not expecting to be a full taxpayer prior to 2016.

Okay, great. Then, can you possibly quantify the FERC SPP 1000 transmission project opportunities?

Unfortunately, Brian, we can't. That's a confidential process, but we submitted projects. I will tell you that we submitted projects in Oklahoma, we also proposed some projects in Texas and Kansas that we think would be good ideas. The SPP received a significant number of proposals, so it's going to take them a while to work through that process, and as soon as we receive a notice to construct, we will let you know.

Okay, understood. And then just want to understand House Bill 1910 and the whole regulatory process that you guys have begun with the compliance filing. You're requesting the tracker, but according to House Bill 1910, you would be required to file a rate case two years following approval of a tracker? Is that accurate?

Within two years. Within two years.

Okay. Potentially you get the tracker around the regional haze spend, then you'll just true up rates with the 2014 test year?

Correct, that's our current thinking right now.

Lastly, Pete, there seems to be a disconnect in the marketplace with OGEs stock and Enable's performance since the IPO, and it seems like some of the parts proposition just isn't being realized. I'm wondering, strategically, have you ever considered a one oak structure where you could split the GP and the LP for spin off OG&E utility to add transparency and kind of match-up the different sets of investors that are looking for different fundamental drivers?

You know, Brian, as you can see the sectors, and you know and everybody on the phone as well or better than I, have gone through some changes here, probably driven by perception around interest rates and as it relates to Enable IPO, that has done well, and the units have done well, which we're obviously excited about, Looking at some of the parts, and one of the things we're very much aware of, until just a couple of days ago, there was not a lot of clarity around the distribution growth rate at Enable, which of course did not provide a lot of clarity heretofore about when we would be in the splits for our IDR ownership.

Our belief is that visibility has to be provided in the market for us to be able to start to get some value for our IDRs. And as you stated, and I stated in my comments and agree with, although the analysts are starting to put a value out there in terms of what the GP IDRs are worth to us on a per share basis, we have not seen that in our opinion, based on maybe if I look more like a longer term sustainable multiples for the utility that's not in our stock price. But, however, that guidance has only been out there for a couple of days.

We're going to continue to work and get that story out there, and we're very thoughtful. We take long-term approaches to building value. We're committed to that, all of the transactions we've done. When we felt that Enogex and we were, for whatever reasons not getting value in that stock, we went ahead with the ArcLight partnership, then the Center Point transaction and the IPO. So, I hope our actions demonstrate that we are committed to closing valuation if there's some to be some structural, if you want to call it structural, issues get in the way of what we think would be fair value to our shareholders. I would say I don't think instead of reacting to movements in the markets, which happen at the time when markets and investors shift their money around, as you well know.

We're confident that the value will be realized longer term, and we're committed to making that happen, and we don't think that, and we think that One Oak is a different situation than we have here.

Okay. Just a follow-up on the tax rate with the DCF. What tax rate should we assume in 2016?

I'm just forecasting out there, Brian, but maybe 38% would be good number.

Okay, great. Thanks for the updated rate base and CapEx slides. Thanks a lot.

Thanks, Brian.

The next question comes from the line of Sarah Akers, of Wells Fargo. Please proceed.

Hey, good morning.

Hey, good morning, Sara.

Hey, Sara.

A follow-up to Brian's question on the rate case timing, It looks like you would have the option of deferring that filing until well into 2016, so can you talk about what's driving your current thought process in filing next year and what factors might impact that decision on timing?

Sure, Sara, this is Sean. Pete mentioned in his comments we have a generation contract that expires, terminates in June of 2015, And so, what Pete was talking about is we're going to, as part of the rate case would roll that back into accrue that low cost of generation back into the benefit of our customers, we've recovered that. We also have the last line of the transmission on investment program that we're involved in, comes into service later this year, so we picked that up, too.

Okay. So the test year would be trued up through mid 2015 to pick up that contract, is that how that would work?

Year-end 2014 test year with a 6-month look-forward.

Got it, thank you. And then a question on the rider request in Oklahoma. Are you hearing a lot of pushback based on your initial conversations with the staff, and then separately, is there precedent in the state for including CWIP in rates?

It's allowed for in the legislation. Not necessarily. CWIP has been granted in the state many years ago, but it's not a common occurrence. As far as the staff is concerned, we've been meeting with the staff, the commission, and interested parties since late January of this year for the simple purpose of we have to move forward. We have to be in compliance and we wanted to make sure that everybody had a fair amount of time to get their arms around this, so we're in constant communication with the staff and commission and everybody's aware of the timeline and the need to be in compliance here.

Great. Last one is just a clarification on the rate base slide. I assume those numbers include CWIP on environmental spend, correct?

No, no, they don't.

They don't. Okay, got it. Thanks a lot.

Okay. Thanks, Sara.

We have no further questions, so I'd like to hand the call back to Pete Delaney for closing remarks.

Thank you, Operator. Just like to thank you all for being on the call this morning for your continued interest in OG&E, and, of course, I'd like to also thank our members for their hard work, for their focus on safety, and their commitment to moving this Company forward. Thank you, again, and have a great day.

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Enjoy the rest of your day.