South Bow Corp (SOBO) 2025 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the South Bow third-quarter 2025 conference call and webcast. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your first speaker today, Martha Wilmot, Director of Investor Relations. Please go ahead.

Thank you, Marvin, and welcome, everyone, to South Bow's third-quarter 2025 earnings call. With me today are Bevin Wirzba, President and Chief Executive Officer; Van Dafoe, Senior Vice President and Chief Financial Officer; and Richard Prior, Senior Vice President and Chief Operating Officer.

Before I turn it over to Bevin, I'd like to remind listeners that today's remarks will include forward-looking information and statements, which are subject to the risks and uncertainties addressed in our public disclosure documents, available under South Bow's SEDAR+ profile and in South Bow's filings with the SEC.

Today's discussion will also include non-GAAP financial measures and ratios, which may not be comparable to measures presented by other entities.

With that, I'll turn it over to Bevin.

Thanks, Martha, and good morning, everyone. We appreciate you joining us today. South Bow's third-quarter financial results once again demonstrated the resilience of our business with our stable earnings profile, allowing us to meaningfully deliver on our capital allocation priorities in our first year as an independent company.

We have paid a sustainable dividend to our shareholders, funded our first growth project at Blackrod and strengthened our financial position. We are also nearing the exit of all transition services with TC Energy, which we expect to finalize by the end of 2025, almost a full year ahead of schedule. We have become more efficient in the process and are realizing cost savings that drive a more competitive tool for our customers and a stronger bottom line for our shareholders.

The team has successfully managed several priorities while establishing South Bow as a stand-alone entity. And I'm pleased, maybe even a little relieved, if I'm honest, to say that we are now fully focused on our future strategic priorities of growing our business and enhancing our overall competitiveness while ensuring safe operations, financial strength and capital discipline.

Regarding our growth initiatives, I visited our Blackrod site last week, and I am incredibly proud of the team's success in executing this important project, set to be delivered on schedule, within budget and with an exceptional safety record. I am confident that we will continue to demonstrate this type of project execution excellence as we mature our growth portfolio with organic and inorganic opportunities.

By adding more revenue lines through growth, we will become more competitive across our existing systems. As we look to the future and the role of South Bow will play in serving our customers, we are encouraged by the dialogue taking place in Canada and the United States about advancing energy solutions. These conversations not only underscore the strength of the supply basin and the demand centers we serve, but also highlight the resilience of our customers' businesses.

South Bow's assets are strategically positioned to serve their needs and we are focused on being the first choice for our customers. As we evaluate opportunities to leverage our pre-invested corridors, it will be important to establish appropriate risk and return frameworks, and carefully consider our investment requirements, which include minimizing shareholder capital exposure, adhering to our capital allocation priorities and seeking permitting durability.

On safe operations and asset integrity, we have made significant progress in our remedial actions following the Milepost 171 incident. The work our team is completing increases our confidence in the integrity of our system. As we work towards returning Keystone to baseline operations and closing out the requirements of PHMSA's corrective action order. Richard will provide further details on this shortly.

Finally, we have laid out a clear set of priorities for our team as we focus our attention on our second year. These priorities include maintaining safe operations, maturing and executing on our growth portfolio, continuing to enhance our competitiveness and the ongoing demonstration of discipline in our capital allocation and shareholder returns.

I will now ask Van and Richard to touch on the financial and operational expectations that come with these priorities. Richard?

Thanks, Bevin, and good morning. I first want to speak to the progress we've made on our remedial actions at Milepost 171, while we await PHMSA's publication of the root cause analysis. The findings from the third-party metallurgical lab report determined that the pipe and welds conform to industry standards for design, materials and mechanical properties, and our own records confirm the pipeline was operating within its design pressure at the time of the incident.

Through the remedial work we've completed to date, we do not see evidence of a systemic issue, and we're confident we will address the system's long-term safety through actions we've already taken or through planned enhancements to our integrity programs. To that end, since April, we've completed six in-line inspection runs that place a focus on the long-seam pipe integrity.

Preliminary inspection results show no notable concerns, reinforcing our confidence in the integrity and reliability of our system. We have also completed 37 integrity digs with no injurious issues to report. Our investigative work will be ongoing through the end of this year and into 2026.

In parallel, we are advancing important work with our in-line inspection technology providers to address and resolve tool limitations and apply the latest and advanced technologies across our system to increase our ability to prevent future incidents. This work is being incorporated into our remedial work plan, which we will submit to PHMSA for approval. I anticipate that the Keystone pressure restrictions will eventually be lifted in a phased manner.

We're proactively sharing with PHMSA the results of all investigative work being performed with the goal to safely return Keystone to baseline operations in 2026 ahead of when market differentials are expected to widen and demand for uncapacity -- uncommitted capacity increases. Switching gears to the Blackrod project.

In October, we achieved overall project mechanical completion and placed the 25-kilometer natural gas lateral into service. These are both significant milestones, and I want to extend a sincere thank you to the team for the tremendous effort in safely executing this project. Facility commissioning work is underway, and we remain on schedule and within budget to place the project into service early in 2026.

Lastly, in October, all parties withdrew from the legal proceedings related to the variable toll disputes filed with the Canadian and US courts and regulators. These proceedings had been active for nearly six years. And with the matter behind us, the team has now focused -- has turned its focus to new business opportunities to jointly create value for our customers at South Bow.

And a reminder that as part of the separation agreement with TC Energy, South Bow was indemnified for this matter in addition to other matters that existed prior to the spin up to a liability cap of USD22 million.

I will now pass it over to Van to discuss South Bow's financial performance and outlook.

Thanks, Richard. I'll start with our strong third-quarter performance, which included delivering normalized EBITDA of $250 million. As expected, the marketing losses that we crystallized early in the year were largely offset by normalized EBITDA associated with higher maintenance capital expenditures in the period. Distributable cash flow of $236 million benefited from a current tax recovery of $71 million resulting from changes in US tax legislation and successful optimization efforts from our tax team.

To reflect these tax wins, we are revising our outlook for distributable cash flow to approximately $700 million for 2025 and our effective tax rate to range between 20% and 21%. We are reaffirming normalized EBITDA guidance for 2025 of $1.01 billion.

Turning to 2026. Our outlook is supported by our highly contracted cash flows and the structural demand for our services. We are forecasting normalized EBITDA of $1.03 billion within a range of 2%. The key drivers of the increase from 2025 include; for marketing, we're expecting normalized EBITDA will be approximately $25 million higher, reflecting the recovery from losses recorded in 2025.

For intra-Alberta and other, we expect normalized EBITDA will be approximately $10 million higher, reflecting Blackrod cash flows ramping up in the second half of 2026. And for Keystone, we expect normalized EBITDA to be approximately $15 million lower primarily due to reduced planned maintenance capital expenditures following an active integrity program in 2025.

Distributable cash flow is forecast to be approximately $655 million within a range of 2%. As we consider the potential outcomes for the year, I'll note that normalized EBITDA and distributable cash flow will be influenced by pressure restrictions and price differentials. To exceed our baseline expectations, pressure restrictions will need to be lifted early in the year and price differentials would need to widen.

On the other hand, the low end of our guidance range reflects a scenario in which pressure restrictions have remained in place throughout the year and pricing differentials have tightened beyond current levels. Our capital program next year includes approximately $25 million of maintenance capital, reflecting a less active plan and approximately $10 million of growth capital to complete the Blackrod Connection project.

We plan to update our outlook for growth capital once we have sanctioned our next development project. Lastly, our Board of Directors has approved a quarterly dividend of $0.50 per share payable on January 15 to shareholders of record on December 31. The dividend remains an important component of our total return proposition.

With that, I'll hand it back to Bevin for closing remarks.

Thanks, Van. After another solid quarter of financial and operational results and through the hard work and effort of the team in establishing South Bow, we have strongly positioned our business for longer-term growth and success.

Our priorities for South Bow's second year are clear. We will maintain safe operations and continue progressing towards returning Keystone to baseline operations, mature and execute our growth portfolio of organic and inorganic opportunities, continue to optimize our workflows and increase our competitiveness and maintain discipline with our capital allocation and shareholder returns.

We look forward to sharing more on this next week at our first ever Investor Day.

With that, I'll now ask the operator to open the line for questions.

(Operator Instructions) Sam Burwell, Jefferies.

So we got these latest list of major projects, I believe, yesterday in the proposed crude pipeline that Alberta (inaudible) was not on that, but I understand that you're providing some engineering and permitting support. So I'm just curious for an update on that.

And then there were also some press reports, I mean, this is going back a little bit further about Keystone XL, a reboot of that being talked about in trade discussions between the US and Canada. So with respect to that, just curious about what sort of existing infrastructure you guys might be able to leverage to expand crude egress capacity over kind of the medium and longer term?

Yes. Thank you, Sam. It's Bevin here. I mean, first off, one of our key capital allocation priorities is to leverage our pre-invested corridors that we have both in Alberta, the pre-invested capital that we made for the former Keystone XL project and then pre-invested capital along our system in the United States. So we're always evaluating ways of leveraging that pre-spend for other solutions.

Directly to your question on the West Coast project. Yes, we are providing some advisory support. Many members of our team have a long history in developing significant capital projects. And so we're lending some of that expertise to the provinces initiative there, but it goes no further than that.

With respect to trade negotiations, to be honest, Sam, that's way above our pay grade. We're obviously watching and encouraged by the ongoing dialogue between Canada and the US, but I can't really speak any more detail to what's going on behind closed doors that we're not a part of. So thank you.

Yes, of course, totally respect that. And then the commentary around marketing and tight crude spreads that certainly makes sense and squares with commentary from some of your peers. Just curious if you have a view looking out a little bit further when you think that spreads can widen out, inventories in Alberta can normalize and then we might start to see some contribution from spot volumes once presumably the egress has been lifted?

Yes. Our views have remained very consistent on that front. We anticipated with our -- with the TMX pipeline coming on that, that would relieve some of the egress issues that we had over the last number of years. But we're very encouraged by the supply growth that has been occurring by our customers.

If you just listen to the last week of quarters from our customers here up in Canada, you'll have noted that they are all very encouraged by potential growth in their organizations. And so our outlook has us seeing conditions being a lot more favorable in effectively late '26, early '27, where we see that, that supply growth will exceed what currently exists for egress, making our systems likely to see more walk-up and spot needs.

Maurice Choy, RBC Capital Markets.

Can I just double-click on the tax optimization and the US legislation changes? Can you share a little bit more about what these were? And if these benefits reflect in the guidance for DCF for this and next year would actually translate to benefits also beyond 2026? Or do you envision returning back to, I guess, the prior cash tax run rate level?

Yes, Maurice, it's Van here. Thanks for the question. The tax wins that we got were a couple of things. One is the one big beautiful bill in the US that allows us to deduct additional interest. We have reached the cap on interest deduction. So that was extended. So that would be as long as that legislation stays, then we would continue to benefit from that.

The second piece was around tax optimization, and we identified some tax pools that we were able to accelerate. And so those tax pools were on our balance sheet, and they were there. We just accelerated them. So we'll get that benefit in 2025 and 2026. And then in 2027, we'll go back to more of a regular cadence. So it's really just a flip between current tax and our deferred tax.

Understood. And if I could finish with a question on the transition agreements. I think you previously mentioned that this transition will help improve your processes to be more efficient and realize cost savings for your customers through a more competitive toll, both of which I think you reconfirmed today in your prepared remarks.

But you also mentioned that this could benefit the bottom line for shareholders. So are you able to quantify what that is and whether this is within the 2% to 3% EBITDA CAGR objective?

Yes, Maurice, it's Bevin. So our objective of getting off of the TSAs as quick as possible in our first year is that it was -- you're not able to really optimize many of the processes within the company until you're legitimately on your new systems. And a simple example of that would be supply chain and procurement on how you issue and pay invoices. And we delivered Blackrod very successfully, but it came with a very kind of clunky procurement system that we needed to use.

So we're now as one -- just one example, being able to optimize that and the delivery. I did point out in my remarks is that we believe that we can accrete those savings and those optimizations through to our variable toll. But there are some of those cost savings that do then flow through as well down to EBITDA. We have not included any optimization efforts into our 2% to 3% outlook with respect to EBITDA going forward.

Those elements, we're still targeting to improve. We made good headway and at our year-end results. I hope to provide a good summary of what we found in our first year. But just for clarity, Maurice, we did not include that optimization into our EBITDA outlook guidance.

Jeremy Tonet, JPMorgan Securities.

This is Eli on for Jeremy. I wanted to circle back to the organic growth opportunity set. I know opening remarks mentioned the upcoming development project. Just hoping to get some more color on what types of projects you guys are looking at, which side of the border and maybe just whether Blackrod kind of represents the template for growth projects as you see it?

Thank you, Eli. I think we're obviously going to have that as a subject area for our Investor Day next week. But consistent to what we've said previously, we've been listening to our customers and trying to understand what kind of services they're looking for, for their businesses to be competitive. We were able to provide a great solution for IPC on Blackrod.

And we're in a number of conversations, both in Canada and in the United States. And so we've seen probably the -- when we launched this business and made the announcement that the spin was occurring in mid-2023, I would say, since that time, the environment actually has become a little bit more constructive in both Canada and the United States.

And so we've been maturing those growth opportunities. And that's one of our key priorities for 2026 is to mature and execute on the next organic and inorganic opportunities.

Looking forward to the Investor Day. And then just for the second question, I think you guys had a helpful slide showing 2026 guidance drivers. But just hoping to get some more context on how the kind of Milepost 171 remediation plan fits into potentially reducing that DRA and providing some upside next year.

What does that process look like? And when might we expect a little bit of color there and maybe framing how that fits into the guide?

So, Ely, I'll start and then pass it over to Richard on the plans for this year. When you looked -- when we provided the guidance around the range, I just want to remind everyone that 90% of our EBITDA comes in every year through our contracted period. So we have a great solid base to start from. And we've been working very diligently around getting our system capacity back up.

But at a very high level, what has allowed us to deliver all our contracts and deliver our base business is our system operating performance, our SOF has really hit it out of the park. And our teams have done a great job allowing our systems to be available for the volumes that we're moving today.

But I'll pass it to Richard to just talk about our mitigation plans and the work that's left to do here as part of the Milepost 171.

Sure, yes. And I touched on in my comments, some of the work that we've completed to date. So we're implementing a comprehensive remediation program that's system-wide. We've completed, so far, six in-line inspection runs and 37 integrity digs. We'll continue that work through this year and into next year.

And then what we'll end up doing is filing all of this work as it's ongoing, but we'll file a remedial work plan with PHMSA and eventually work with the regulator around lifting the pressure restrictions. Our goal is for that to happen sometime in 2026, it's hard to point to a precise timing for it.

But as we work through the year, I think we'll start to see pressure restrictions removed in increments, and that will allow us more access to uncommitted volumes, which we think will ramp up through the year.

And Eli, it's Van here. I think that even if pressure restrictions are lifted, with those tighter differentials, you won't see a ton of EBITDA from those spot volumes. So that's just another thing to point out.

Praneeth Satish, Wells Fargo.

So recognizing you're going to talk about your projects more at the Analyst Day. But as it stands today, do you think a placeholder assumption for CapEx in 2026 would be kind of in that $165 million range that you're spending in '25? Or do you think at this point based on the nature of the discussions that you're having in the pipeline that, that spend won't really hit in '26, and therefore, CapEx is likely to go down significantly in '26, even if you announce new projects. Just trying to get a better sense of what to assume for CapEx and what to assume for free cash flow next year?

Thank you, Praneeth. So in our capital table, we only put capital that we have sanctioned. And so you'll note that we don't have anything sanctioned at present, but we're working towards maturing those projects forward. With what Van commented on in our tax optimization, we've created a bit more capacity with respect to free cash flow and just to be able to put towards capital.

I would say that right now, we've consistently said that we need to invest roughly on average $100 million plus or minus every year in order to deliver our 2% to 3% EBITDA growth CAGR. And I would use that as probably a good proxy over the next few years. If we do find something that's larger or more material, then we would love to finance that on a different basis.

But I think for your modeling efforts, remaining kind of consistent to what we originally guided right out of the gate would be the best approach.

Got it. That's helpful. And maybe following up on one of those modeling assumptions. So I'm just trying to square the moving pieces here with the variable toll settlements and what the future P&L impact could look like at this point. I guess the way I read it is you've got maybe $33 million of remaining payments that SOBO would make over the next six years.

But then you'd receive $19 million over the next two years and all of this, I think, is excluded from EBITDA. I just want to kind of double check that?

Yes, it's Van here. All that would be normalized out of our EBITDA. So that wouldn't be included. If you're talking about GAAP and cash, then yes, yes, you're correct.

I'm showing no further questions at this time. I'd now like to turn it back to Bevin for closing remarks.

Well, thank you all for joining us today. We appreciate your continued interest in South Bow and look forward to connecting with you next week at our Investor Day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.