Southwest Gas Holdings Inc (SWX) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Southwest Gas Holdings 2017 Midyear Earnings Conference Call. (Operator Instructions) And as a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Ken Kenny, Vice President of Finance and Treasurer. Sir, you may begin.

Thank you, Sandra. Welcome to the Southwest Gas Holdings, Inc. 2017 midyear conference call. As Sandra stated, my name is Ken Kenny, and I am the Vice President, Finance and Treasurer.

Our conference call is being broadcast live over the Internet. For those of you who would like to access the webcast, please visit our website at www.swgasholdings.com and click on the conference call link. We have slides on the Internet which can be accessed to follow our presentation. Today, we have Mr. John P. Hester, Southwest's President and Chief Executive Officer; Mr. Roy R. Centrella, Senior Vice President, Chief Financial Officer; Mr. Justin L. Brown, Vice President, Regulation and Public Affairs; and other members of senior management to provide a brief overview of the company's operations and earnings ended June 30, 2017 and an outlook for the remainder of 2017. Our general practice is not to provide earnings projections. Therefore, no attempt will be made to project earnings for 2017. Rather, the company will address those factors that may impact this coming year's earnings.

Further, our lawyers have asked me to remind you that some of the information that will be discussed contains forward-looking statements. These statements are based on management's assumptions, which may or may not come true, and you should refer to the language in the press release, Slide 3 of our presentation and also our SEC filings for a description of the factors that may cause actual results to differ from our forward-looking statements. All forward-looking statements are made as of today, and we assume no obligation to update any such statement.

With that said, I would like to turn the time over to John.

Thanks, Ken. Turning to Slide #4. First, I'd like to start with a review of some of the highlights we experienced in the second quarter. First, from a consolidated results perspective, we experienced second quarter earnings of $0.38 per basic share, a notable increase over the prior-year period. We also paid out a quarterly dividend of $0.495 per share or $1.98 annually. This dividend represents a 10% increase over the March 2017 dividend of $0.45 per share. For our natural gas segment, we saw a resolution of our Arizona rate case with new rates effective April 1. We added 32,000 customers for the 12 months ended June 30. We submitted a Nevada Gas Infrastructure Replacement application proposing $66 million of pipe replacement activity for 2018, and the California Public Utilities Commission approved an extension of our next California rate case until September 2019. As a result, we will continue to experience post test-year annual additional revenue increases of 2.75% through 2020. Finally, for our Centuri Construction services segment, we completed requalification of employees affected by a temporary work stoppage at one of our customers. Centuri revenue and contribution from net income increased in the second quarter compared to the prior-year period. We're also affirming our full year expectations.

Moving to Slide 5. On today's call, Roy Centrella will cover an overview of our consolidated earnings for the period ended June 30, along with segment detail for both utility and nonutility operations. Justin Brown will provide a summary of our various regulatory activities, and I will close with an overview of customer growth and regional economic conditions, capital expenditures and rate base growth and our expectations for 2017.

With that, I will now turn the call over to Roy.

Thank you, John. I'm going to jump right into things on Slide 6 with a look at consolidated operating results. For the 3 months ended June 2017, we earned $17.9 million or $0.38 per basic share, doubling the $8.9 million or $0.19 per share earned in the second quarter last year. During the 12-month periods, our earnings improved from $146 million or $3.08 per basic share to $155 million or $3.26 per share.

Next, we'll look at the relative contributions of each segment to the change in earnings starting on Slide 7. Natural gas operations saw its earnings increased by $7.2 million between quarterly periods, principally as a result of impacts from our Arizona general rate case order effective this April. Construction services experienced a $2.1 million earnings improvement, driven by revenue growth and lower depreciation expense.

The next slide breaks down the change in earnings between 12-month periods. Gas segment net income increased $12.6 million, while construction services experienced a net decrease of $2.9 million.

We'll now look at each segment, starting with natural gas operations on Slide 9. This waterfall chart provides a breakdown of the major components of the earnings increase. Operating margin increased $6.5 million as a result of customer growth and rate relief in Arizona and California. We added 32,000 net new customers over the last 12 months, a growth rate of 1.6%. Now partially offsetting the margin growth were O&M cost increases totaling $3.8 million or 3.8%. A portion of the increase pertains to compensation programs whose accounting expense is skewed toward the first half of the year for retirement-eligible employees. Depreciation and property tax expense declined $9.5 million between periods, primarily due to lower depreciation rates in Arizona.

Moving to Slide 10. We summarize the gas operations segment change between the 12-month periods. There are 3 principal causes of the improvement. Operating margin increased $25 million, primarily due to rate relief and customer growth. Depreciation and property taxes increased just $1.8 million, as lower depreciation expense in Arizona largely offset increases related to growth in gas planning service. And then other income increased $6.2 million, mainly due to strong investment returns related to company-owned life insurance, or COLI policies.

We'll now review Centuri first quarter operations starting at Slide 11. Revenue increased $8.2 million between quarterly periods, as pipe replacement work picked up momentum and weather conditions improved. Construction expenses and depreciation, on the other hand, increased a net $4.6 million between periods due to greater workload and extension of the lives of depreciable assets. Additionally, during the second quarter, Centuri was able to requalify all remaining work crews affected by the temporary work stoppage noted during our first quarter call. We incurred a small operating loss during the second quarter in this area, but would expect more normal operating profit levels over the remainder of the year.

Slide 12 rolls forward the contribution to net income for the 12-month periods. Construction revenues grew by $59 million or 6% due primarily to additional pipe replacement work across our service territories. However, construction expenses and depreciation increased a net $66 million between periods. Some of the factors, which influence disproportionate expense increase, were a mix of work, start-up costs associated with new customer contracts and logistics surrounding the timing and length of the temporary work stoppage. We're excited to be moving into our peak construction season, and look forward to a strong second half of the year for this segment of the business.

Let me now turn the time over to Justin Brown for a regulatory update.

Thanks, Roy. The focus of my comments today will be on 3 key areas: An overview of our rate relief plans in each of our 3 states, an update on the progress of our various infrastructure replacement programs and an update on 2 important expansion and reliability projects.

Turning to Slide 14. The Arizona Corporation Commission approved our proposed rate case settlement, and rates became effective April 1, one month earlier than was originally expected. Through the combination of a $16 million increase in revenue and a $45 million reduction in depreciation expense, we expect to see an overall increase to operating income of $61 million. We anticipate the incremental change to operating income to be split between 2017 and 2018, with approximately $45 million being realized in 2017 and $16 million in 2018. We've very pleased with the rate case outcome in terms of the impact to operating income, and it being the largest increase in the company's history. But we're equally pleased with the constructive working relationships we have with our stakeholders in Arizona and with the progress that we were able to make on getting important regulatory tools in place as part of this last rate case, namely the continuation of our fully decoupled rate design, the expansion of our existing customer yard line program, implementation of a vintage steel pipe replacement program and the implementation of our property tax tracker.

Turning to Nevada. We plan to file our next Nevada rate case in the first half of 2018, with new rates becoming effective 210 days after filing. Since we filed 3 rate applications as part of our Gas Infrastructure Replacement program, in order for us to continue the GIR program this year, we were obligated to either file a rate case to clear out the deferral balances and moving them to base rates or to file a petition requesting a waiver from that requirement. The commission approved our petition earlier this year that we filed requesting a waiver, thus allowing us to proceed with the GIR program for another year and setting the stage for our next Nevada rate case to be filed in 2018.

Turning to California. We're on a 5-year rate case cycle, which means we were scheduled to file our next rate case later this year since our last rate case was filed in 2012. However, following discussions with the Office of Ratepayer Advocates, we filed a petition at the end of last year requesting to extend the rate case cycle by 2 years. The petition requested the commission extend the rate cycle, leaving all other aspects of the decision intact, including our ability to make post test year attrition adjustments of 2.75% each year for 2 additional years. The commission approved the request in June. And with this decision, we are now targeting a September 2019 filing for our next rate case in California.

Turning to Slide 15. We continue to focus on maintaining infrastructure recovery mechanisms in each of our jurisdictions in order to timely recover capital expenditures associated with commission-approved projects that enhance safety, service and reliability for our customers. In Arizona, we have 2 such programs. First, since inception of the COYL program back in 2012, we have invested over $35 million, and have been authorized to collect just under $12 million in margin. Most recently, the Arizona Corporation Commission approved our request to update the COYL surcharge to collect margin of $1.8 million based upon 2016 capital expenditures of $12.1 million. All previous investment revenues were incorporated in the base rates as part of our last rate case. With the expansion of this program being approved, with our rate case decision, we expect continued growth in our replacement activity. As I mentioned previously, we were also granted approval on our most recent rate case to start a vintage steel pipe replacement program. We are currently underway with this program and are targeting $27 million of replacements in 2017. We are pleased that we're able to get a start on the replacements this year, albeit a partial year, and we look forward to ramping this program up in 2018.

Turning to Nevada in Slide 16. Since 2014, we received approval to replace over $115 million of COYL pipe replacement projects, and we've been authorized to collect over $9 million of margin through the GIR surcharge. We recently filed our 2017 advanced application proposing $66 million of replacement projects for 2018. We filed the application at the end of May, and we were able to reach a settlement agreement that was then submitted to the commission last month. The proposed settlement agreement approves the company's $66 million proposal, as filed, including the ability to start replacing COYLs in Southern Nevada and under certain situations. We anticipate a final commission decision on the proposed settlement agreement within the next 2 months.

Turning to Slide 17. In our expansion projects, in July, Paiute filed its formal certificate application with the Federal Energy Regulatory Commission for its $18 million expansion project in the Carson City and South Lake Tahoe areas. This proposed project consists of approximately 8.4 miles of additional transmission pipeline infrastructure. We currently anticipate the facilities to be in service by the end of 2018 following FERC approval, and the new rates for the project would go in place coincident with the in-service date of the facilities.

With respect to our Arizona LNG facility. Construction on the $80 million facility has begun, as we have started and completed some of the off-site work. To date, we have invested approximately $6 million in capital expenditures, primarily associated with the land that was chosen for the site. As part of our rate case settlement, the commission approved the proposed cost recovery methodology for the facility, which will allow us to defer the revenue requirement associated with all costs incurred before December 31, 2020 to be recovered in a future rate case.

And with that, I'll turn it back to John.

Thanks, Justin. Turning to Slide 18. As I mentioned at the outset of the call, we added 32,000 new customers in the most recent 12-month period across our 3 state service territory, a growth rate of just over 1.6%. We now serve just under 2 million customers.

On Slide 19, we provide some data on the regional economic climate. Year-over-year, we saw unemployment rates decline across the board as well as continued job growth for the vast majority of our service territory.

Moving to Slide 20, we show how we expect our capital expenditures to trend over the coming 3-year period. We expect to invest up to $1.8 billion over the next 3 years to serve growth and increase the safety and reliability of our natural gas delivery systems. Also noteworthy is the growing amount of our capital expenditures that are covered under favorable regulatory cost recovery mechanisms, as detailed earlier by Justin.

Turning to Slide 21, we illustrate how our investment and growth, safety and reliability for our customers translates into rate base. While our rate base totaled approximately $2.9 billion last year, our planned capital expenditures should cause that value to grow to upwards of $3.8 billion at the end of 2019, a compounded annual growth rate of 9%.

Closing our prepared comments with Slide 22, we are affirming our 2017 overall expectations in this call. For our natural gas operations, we are updating our expected year-end operating income increase to 11% to 13%, while also projecting that interest expense will increase by $2 million over 2016 levels. Similarly, all expectations for our construction services business remain as we have previously stated. With that, I'll return the call to Ken.

Thanks, John. That concludes our prepared presentation. For those who have accessed our slides, we have also provided an appendix with slides, which includes other pertinent information about Southwest Gas Holdings, Inc. and its subsidiaries and can be reviewed at your convenience. Our operator, Sandra, will now explain the process for asking questions.

(Operator Instructions) And our first question comes from the line of Barry Klein with Macquarie.

You've provided rate base guidance through 2019, so I was hoping you could provide a little more color on how you think about how we should think about earnings in 2019. So that is, should we look at the 9% rate base growth as the main driver? And also, should we anticipate that your regulated ROE will improve from the 7.7% achieved in 2016?

Barry, this is Roy. I think when you look at the rate base growth, that will ultimately translate into rate relief and earnings growth. As you can imagine, there's not a certainty to the timing as to when that'll happen. Now we've laid out that we have a Nevada rate case in 2018, so we'll pick up some of that growth there, and then Arizona we agreed to stay out until '19. So I think what you would see is a trend that should, over time, equate to 9%, but it's hard for us to put the timing out there.

I guess, the question is, you earned 9.7 -- I'm sorry, 7.7% in 2016 according to your year-end slides. Is there a reason to think that, that achieved ROE would decline? Or I would think with all the rate relief that it would increase. Like why would that achieved ROE not increase, I guess, over time with all this rate action?

Yes. No, good question. If you -- in our appendix, we have Slide 38. And we're seeing now, as the Arizona -- results of the Arizona rate case start flowing through our earnings, even today, an uptick to 8.1% over the most recent 12 months for a return on equity, and that only has one quarter of the results there. So I think you're spot on that we would expect to see that earnings or the return grow more closely to our authorized, particularly with the infrastructure tracker mechanisms. Now between the infrastructure tracker and/or the growth component of our CapEx, about half of our CapEx is directly generating either a new margin or a deferred cost. And so while it's -- we still might be challenged to reach the overall authorized return in the short period of time. In the longer run, that's certainly our goal, is to shrink that gap between authorized and earned rates of return. And these kind of mechanisms have a direct impact on that.

Okay, that's very helpful. And then regarding the construction business. I know there's been a lot of activity and some sort of one-time type of activity with the contractor recertifications. I'm just wondering, is there a way to sort of split out what the impact for the half of the year was as a result of this versus what it would have been had you been in sort of the normal type of operations?

We do provide in our Q, and it might have been the earnings release, what the impact of that particular contract was. I believe I got a couple of guys sat next to me. It was $3.7 million operating loss for the first 6 months of the year on the temporary work stoppage. As mentioned, we're now -- requalified all of our workers. And so we should see sort of normal profit levels from that particular contract going forward.

Okay. So the $3.7 million, so that's just the pretax number, and that's the difference between sort of getting rid of all the costs associated with recertifying, and then also adding in the additional margins that you would have seen had they actually been doing work? Is that how should I think about it?

It's not adding in the additional margins, but their workload would have been greater. I think we...

Right, that's what I'm saying. So how much of that -- how much more would it have been if like they had their normal workload also rather than having to pause the work, I guess?

Yes. Year-over-year, revenues in that area were down about $26 million.

$26 million? And what about margin? What would be -- could there be costs associated with it, right? Or should I just think of it as an incremental $26 million, I guess, times that -- it's like that 5% margin I should think about that you've talked about?

Yes, exactly.

Okay. $26 million times 5%? Okay.

And our next question comes from the line of Chris Sighinolfi with Jefferies.

Just want to follow -- I guess, I was curious. You've mentioned in quarters past a potential appetite maybe to do something jointly on underground storage in the West. And I was just wondering I didn't see any language on that. And I know you have a lot on your plate, but I was just curious where that type of initiative stands at the moment.

Chris, that's a good question. It still is something that we are very interested in. We had been in talks with a number of other parties in Arizona, working on a potential project. It doesn't look at the moment like that particular project is going to go forward. But I think the fundamentals of our company as well as a number of other utility operators in Arizona still are very interested in that. So I think it's a matter of getting the right project with the right customer support. We certainly would be one of those customers. And if we can get that together, that's something we would really like to move forward with. And we still are in informal discussions with some of the other interested parties in Arizona. So that idea has not gone away.

Okay. And John, I guess, now that it's in flight on the LNG storage regionally, can you just remind us? I seem to remember, although at the moment I can't look back and find it. When you were conceiving that project, can you just remind us if there's expansion opportunities on it longer term? And then I seem to remember there was maybe a bifurcation of storage versus liquefaction. Some of that would be helpful just as we understand maybe the eventual scope of what you guys are doing with that or could do with that.

Yes, Chris, and your memory is correct. When we were initially involved in conversations with the commission, we looked at this project as potentially going 2 different ways. One could be a project, which is ultimately the form in which we undertook it, where we would truck LNG into the tank, and then we would vaporize it during peak conditions or some upstream supply disruptions. And we also, at the outset, talked to the commission about potentially putting liquefaction facilities on that storage property. And the conclusion of those discussions was to proceed with the project without the liquefaction facilities, get that up and running, see how it's used in normal operations, and then reserve that additional opportunity for liquefaction facilities to something that could be considered down the road.

Okay. And I guess, with the construction underway now, I think Justin had said completion by the end of '19, that is there any sort of commissioning process on something like this? Or should we expect it to be sort of in-service beginning of 2020?

I think that you would expect it to be in service by the beginning of 2020.

Okay. Okay, great. And I guess, switching gears. I just had one question. Obviously, I appreciate all the developments on the Centuri front and getting things back in order on the work stoppage. I was just curious, with regard to the capital plans there, I guess, I have 2 questions, John. You had mentioned, I think, on a prior call, maybe 1 or 2 quarters ago, about opportunities to do things other than gas pipe. I think you had started a multi-year water pipe initiative. So you've given us pretty good CapEx profile for the natural gas operations. I was wondering if there's any sort of step-change expectation we should be factoring in on Centuri, given some of those new initiatives. I think it's been running around $60 million, $70 million of CapEx. And then a related question is just, as it pertains to Centuri debt needs, I think, right now, you have a term loan facility and a revolving credit facility. I'm just wondering, at what point does it get large enough that you start thinking of replacing debt there?

Chris, it's Roy. We don't see any material change to the CapEx needs. They're running, like you say, $60 million to $70 million this year. They generate sufficient cash to cover their CapEx on a normal run-rate basis. Where they do perhaps, if they're looking to do an acquisition, then you might see us need to use -- expand their facilities. But right now, they generate enough cash to cover their CapEx.

Okay. And Roy, the gain on asset sale, as you guys mentioned, and I know we've it seen previously, I mean, that's just, I guess, typical course of business, where you're upgrading the equipment, selling the older stuff, maybe modestly changing what it is you have in terms of capabilities. Is that -- I'm less familiar with it. So I just wanted to understand what -- okay.

Oh, yes. Yes. I would say there's sort of a $50 million to $60 million run rate on replacement of equipment, where you have the typically older equipment for 6 to 7 years. And so you have sort of almost a natural $50 million to $60 million increment that goes with that. And then any -- as they build up new customers, new lines of business, then that's where that extra $10 million to $20 million comes from.

And our next question comes from the line of Tim Winter with Gabelli & Co.

I was wondering if you could talk a little bit about just the outlook, the market for pipe replacement, let's say, over the 3 years, what you're seeing in terms of competition and contracts. And do you expect Centuri to grow faster than the utility over the next few years?

Tim, I think that we continue to be pretty bullish on the pipe replacement market for Centuri. I think that when you look at Southwest Gas and some of the things that we talk about on the utility side, those are the types of dynamics that you're seeing playing out across the country. And as you're familiar, Tim, with our system, we've got a relatively new system. But there are a lot of utilities out there again, as you know, that have a lot of cast iron pipe, other types of older vintages of pipe that are in need of replacement. And we see that market continuing to be strong. In terms of the relative growth rates of the businesses, we are going to want to grow the utility business to a pretty good growth rate. And I think that while it wouldn't be surprising to see the construction services business grow at a little bit faster growth rate, as we've talked about before, Tim, we're also going to be mindful of that business mix that we have between the regulated and nonregulated operations because we certainly don't want to lose our core identity as a natural gas distribution company.

So on Slide 24, you have -- I guess, the current pie is 19% of the consolidated business of Centuri. Is there -- what's the parameter you're kind of looking at? And what would be the thought process? So should Centuri grow at a faster rate than the utility over the next several years?

Tim, I think that you could see that continue to edge upward. I think one of the thresholds that we kind of keep in the back of our mind is a rating agency sensitivity if we get up to a 30% construction services business mix. So if we reach that, when we reach that is ultimately going to be a question, as you mentioned, at the outset on what those relative growth rates of the 2 businesses are going to be. But if we see we approach that, then we'll look at exploring some of the other things that we've talked about in the past to make sure that we're able to continue marginally in that business mix.

(Operator Instructions) Our next question comes from the line of Paul Ridzon with KeyBanc.

When in the quarter did the issues with the work stoppages resolve themselves or get resolved?

That was pretty well concluded by early May.

And as we look forward in Arizona, I know you've got a moratorium. Do you think can stay out of the regulatory arena beyond that moratorium? Or are the trackers going to keep you whole? Or are there other spending that's not tracked that's going to force your hand to refile?

Well, I think, Paul, that generally speaking, we'll continue to take a look at that as we go through the process. I think that while we certainly have had a pretty good step-up in trueing up our costs, and we've got an expansion of these cost tracking mechanisms, et cetera, there are going to be normal traditional increased costs of service that we experience over time that are not going to be captured by those mechanisms. So I would expect that as we talked about in an earlier question with Barry, you probably would expect to see those earned rates of return increase compared to the past. But that doesn't mean that we're not going to continue to want to go in periodically with the commission after that moratorium ends, to freshen our rates again. Now you might expect, and time will tell, that as we move forward, those adjustments to rates might be smaller because of the mechanisms that we have in place. And ultimately, that's something that you should see as you look at the earned rates of return perspectively.

So should we think about the earned ROEs kind of rising for the next 3 quarters, plateauing, and then kind of start to work themselves down to a point where eventually you'll have to refile? Is that kind of the trajectory you see?

Well, I think if you are isolating individual jurisdictions, that's probably true. But I mean, bear in mind that we'll have -- in 2019, we'll have the Nevada rate case. So the overall earned returns of the company may not trend downward just because one jurisdiction is, if that makes sense. So we probably could see them trend up, like you were talking about, and then perhaps stay there or even improve a little bit more following your next rate case.

Yes. A couple of the other things you might want to keep in mind, Paul, that Justin mentioned earlier, the fact that we continue to have that post test year adjustments in California, that's the future test year jurisdiction. We've got that Paiute expansion on the horizon. So again, as Roy said, if you were limiting yourself solely to the State of Arizona, and we don't break out those numbers, you might see a little bit of that fact. But that doesn't necessarily mean that, that time frame is going to apply to the entire regulated operations because of a lot of the other things that we have going on in the mix.

Understood. So across the portfolio, you have other mitigants to kind of sustain the ROE.

And I'm showing no further questions at this time. So this does conclude today's Q&A session. I would now like to turn the call back over to Mr. Ken Kenny for any closing remarks.

Thank you, Sandra. This concludes our conference call, and we appreciate your participation and interest in Southwest Gas Holdings, Inc. I hope everyone has a great day. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.