TransAlta Corp (TAC) 2010 Q3 法說會逐字稿

Good morning, welcome to the third quarter results conference call. I would like to introduce Jess Nieurkerk, the Director of Investor Relations. Please go ahead.

Thank you, and good morning, everyone. Welcome to TransAlta third quarter 2010 conference call. With me are Steve Snyder, President and CEO. Brett Gellner, Cheif Financial Officer, Dawn Farrel, Cheif Operating Officer, Ken Stickland, Cheif Legal Officer, and Frank Hawkins, Vice President and Treasurer. The third quarter results were released earlier this morning and I hope you have had a chance to review them.

Additional operating information will be posted on our website after this call. All information provided during this conference call is subject to the forward-looking statement qualifications which is detailed in today's news release and incorporated in full for purposes of today's call. The amounts referenced in this review are in Canadian currency, unless otherwise stated.

In addition, the non-GAAP terminology used in this call, including comparable earnings, operating income, funds from operations and gross margin is reconciled starting on page 29 of the MBNA. Per share figures for the third quarter 2010 are based on an average of 220 million shares outstanding compared to 198 million shares in the third quarter of 2009. Also, please note, financial information has been rounded to the nearest whole number. On this morning's call, Steve Snyder will provide an overview of the operating results for the quarter. Brett Gellner will provide information on our cash flow, the OM&A, capital spending, and balance sheet items. And before going to question and answers, Steve will provide the outlook for the balance of 2010. Steve?

Good morning, everyone. Market conditions continue to be very difficult for the power industry with pricing at the lowest levels in almost a decade. We have seen though some modest demand recovery during the year , especially in Alberta. That is a more positive sign. As for prices, the average for the quarter in Alberta was only CAD36 per megawatt hour. That compares to CAD49 a year ago, and CAD79 in 2008.

In the Pacific northwest, prices were only CAD33 per megawatt hour. These price levels reduced the earnings potential of both the merchant capacity and our energy trading unit. As a result, our net and comparable earnings were CAD0.17 per share versus CAD0.34 last year. The results are disappointing from a financial perspective. But underneath the difficult market conditions, our operations continue to perform strongly.

Third quarter availability for the fleet was 91%, up from 83.9%last year. But option in the quarter was also stronger, an increase by more than 1,100 gigawatt hours. All of our fuel sources performed well, and contributed across the board to this noticeable improvement. Costs were also well controlled. As a result, generation gross margins were up slightly from last year, despite this low pricing environment. We saw solid contributions from the Canadian hydro acquisition and from the Sundance and Centralia thermal units. There was some offsetting impacts due to the decommission of our Wab four facility, water levels in the Alberta hydro system that are below historical levels and lower production from many from our gas fire facilities related to price.

Our energy trading business is experiencing a particularly tough period. Actions were taken in quarter two to adjust our strategies to the pricing environment in the very low level of volatility. These actions are starting to pay off. But we believe it will be 2011 before we see a full recovery to our historical margin ranges. In the meantime, our trading business is generating a positive margin, contributing to our overall fleet optimization plans and providing critical market intelligence for our development and contracting activities. In summary, the strong operational performance being delivered by our plants combined with ongoing excellent cost control are helping to mitigate the tough economic conditions we are facing.

We also provide a platform for solid earnings improvement as market conditions recover. Before turning the call over to Brett, there are two notable events in the quarter that I will comment on briefly. First, the Alberta balancing pool has confirmed the mechanical failure experienced on our Sundance 3 unit in the second quarter meets the requirements of a high impact, low probability event under its power purchase arrangement. This determination does not finalize the full review process under the PPA. But we believe it definitely strengthens our position with regards to financial protection from this event. Also, we announced this morning our plans to implement a 15 megawatt efficiency upgrade for Sundance 3. This will increase the unit's capacity to 368 mega watts and will be completed in conjunction with its scheduled major maintenance outreach in 2012. At only CAD1,800 per kilowatts this is expected to be a suburb investment, it also reflects our confidence that Sundance 3 will be a high performing unit once the repair work related to the recent mechanical failure is completed. I will now turn the call over to Brett for the financial presentation.

Good morning. I'm going to provide an update on our cash flow performance and outlook for the remainder of the year. Our OM&A expenses, the status of our capital expenditures and our liquidity. Despite lower earnings our cash flow continues to remain solid and exceeded last year both in the quarter and for the first nine months of the year. This improvement is despite the challenging market conditions, the low wind resources in the first quarter, and the sun 3 event in Q2. Our improved cash flow performance is primarily a result of our diversification and contracting strategy, strong operational performance, and lower OM&A expenses.

In terms of the numbers, funds from OPS were CAD184 million in Q3 CAD6 million higher than last year and CAD558 million for the first nine months, which is CAD95 million higher relative to 2009. Cash flow from OPS which adjusts for changes in working capital was CAD230 million in the quarter, an increase of CAD36 million relative to last year. For the first nine months, cash flow from OPS increased CAD168 million over last year, to reach CAD502 million this year. Given the difficult market conditions we face this quarter, and our disciplined approach to trading, we are reviving outlook for energy trading and now expect between CAD30 to CAD50 million in gross margins for the year.

In terms of our total cash flow for the year, we now expect to be at the low end of our guidance of CAD800 million to CAD900 million. Over the last nine months, we have been very focused on managing our costs and improving productivity. Our cost saving initiatives, combined with lower major maintenance for the year, has brought OM&A down CAD44 million for first nine months, despite adding significantly more generation to our fleet including the Can Hydro acquisition. We now expect OM&A for the entire year to be at least 5% lower than last year.

Now turning to capital we expect our gross CapEx for 2010 to increase by approximately CAD15 million for a total of CAD475 million to CAD535 million for the year. This is mainlydue to timing of spend on our Ardenville and Bonecreek projects. In Q3 we spent CAD113 million on our growth, and CAD383 million in the first nine months. A detailed break down of our gross spend can be found in our MD&A. Turning to our sustaining compact, we spent CAD59 million in the quarter and CAD202 million in the first nine months. For the full year we continued to track CAD275 million to CAD320 million.

Our overall major maintenance CapEx and operating costs are still expected to be in the range of CAD190 to CAD215 million for the year, of which we have spent CAD160 million through the quarter, or year to date. Finally, we continue to maintain ample liquidity. As of September 30, we had approximately CAD800 million of our CAD2.1 billion committed credit facility available to us, and we also continued to maintain strong credit metrics as shown in the supplemental information section of our quarterly report. With that I'll turn it back over to Steve.

Thank you, Brett. Over the last year, we have been committed to driving operational excellence by achieving strong availability, lowering our cost structure, and delivering our projects on time and on budget, and we have made strong progress on all three fronts. After nine months, our availability was 88.1% well ahead of the 84.4% we achieved at this time last year. As we look forward to the remainder of2010, we will continue to drive toward our target of 89% to 90% for our full year for the fleet.

Looking at our cost structure, coming in to 2010, we plan to hold OM&A costs flat to 2009 despite the addition of the Canadian hydro assets to our fleet. We did remain disciplined and continue to find ways to offset costs, and as Brett mentioned we expect OM&A to come in well below than 2009. With respect to our construction projects, that are progressing well and remain on track. The tough market conditions of course mean we must remain very disciplined with our growth strategy. With the addition of a Sun 3 upgrade we announced this morning, we now have seven projects ongoing that will provide an additional 427 mega watts of capacity to our fleet by 2012.

Our project management teams are doing a terrific job to deliver on all of our projects. The Summerview 2 windfarm was commissioned ahead of schedule and below budget. The Ardenville windfarm is on target to start up ahead of schedule with commissioning in the fourth quarter versus the original target of Q1 2011. Our (inaudible) will be on schedule with (Inaudible) targeted for a quarter four this year, both the hydro in Q1 2011, and Keephills 2 in Q2 22011.

Looking forward, we are basing our plans for 2011 on the forecast that market conditions will not materially improve over 2010. That means we will remain disciplined on cost, and focus on steady operational improvements and cash flow. For growth, it means that while we maintain a deep pipeline of Greenfield opportunities, growth initiatives will be more focused on asset acquisitions. Sustaining capital will be focused on delivering strong availability performance. That combination of good availability and a strong focus on cost means that when market conditions do improve, we believe we will be well prepared to capitalize on them. With that, I'd like to turn the call back to Jess for the Q&A period.

Thank you. So that we may rotate through callers, we'll take one question and one follow-up before moving down the queue. We'll answer questions from the investment community first and then open the call to media. We shall then respond to individual investors, so please identify yourself when asking a question. I remind you we do not provide guidance and that we shall answer your model-related questions off line after the call. Katherine, we'll now take questions, please.

Thank you. We will now take questions from the telephone lines. (Operator instruction s). our first question is from Juan Plessis from Canaccord Adams, please go ahead.

Thank you very much, I was wondering, you mentioned the solid contribution from the Canadian Hydro assets, can you quantify that in terms of what it contributed in the quarter?

This is Steve, no, we don't break that out. Let me just say though that we did exceed our targets for the synergies in terms of cost takeouts. The development portfolio has proved to be as strong as we thought, and those projects are all on schedule. And we continue to see great long-term value from those assets as we go forward.

Okay. Thank you. As a follow-up, I was wondering if you could talk a little bit about your forecast for demand growth in the Alberta market and how that may be impacted by the economic activity from the announcement structure of the oil sands project?

Well, for this year, to date, we have seen sort of 2.5% to 3% demand growth. At this point, our expectations are that level of demand growth will continue for the next several years. So we see the trend in Alberta trending upwards over the next two to three years in a positive way.

Okay. Thank you.

Thank you.

Our next question is from Matthew Akman from Maquarie, please go ahead.

I had a quick question for Brett and the follow-up for Steve. Bret, is there a cash flow guidance for this year at the low end of CAD800 million CAD900 million inclusive or conclusive of working capital changes?

That's, we do cash flow from OPS, Matthew, so that's inclusive.

So is there a positive or negative working capital change this year for the full year?

Yes, I mean, if you're looking at our year to date it's tracking in line with that.

Okay. So we don't expect a big move in the fourth quarter?

Again, this stuff moves around, Matthew, but for now, that's all you can look is the CAD800 to CAD900 and assumes that factors into our changing for working capital.

Thanks. Steve, maybe if you could just expand, you talked about positioning the Company for a rebound in power markets when that does happen. I'm just wondering how you're thinking about that with respect to Centralia because you negotiate the MOU, it's not totally clear how much merchant exposure you might or might not have there going forward there. Given that the power markets are kind of depressed and there's potential upside there, do you want to be able to capture that at Centralia or do you want a more kind of steady, fixed cash flow type of model as you think about the next three to five years?

Well, certainly longer term we would probably be in favor of the more steady cash flow positions to derisk the plant. That would be our goal. I do believe in the short term because there's going to be a lot of time here to work through this process with the state of Washington, clearly economics also play a role now in the state process. So we've got some work ahead of us between both of us that continue these discussions, which we're doing. There's a lot of extra factors here. Short term though, to answer your question, Matthew, we would probably see market conditions starting to slowly improve with time and so we wouldn't want to get too much into the low price levels right now. We might take n the short term a bit more open risk. But, medium term we do want to get a steady cash flow on that plant and basically contracting laddering strategy will stay in effect broadly and very short term we'll try to capture a bit of upside on the short term.

Thank you. Our next question is from Andrew Kuske of Credit Suisse, please go ahead.

Good morning. I guess my first question is for Steve. If you give us your views on relative asset valuations right now as you made some comments about acquisitions and some of the deals we have seen recently in the market. On a per megawatt hour basis, or per megawatt basis of capacity, the acquisitions have been very attractive, which really does highlight we are a trough market right now and everyone is guessing on when the rebound happens, but if you could give us some color on your thoughts on really the build versus buy.

Well, I think that I made in the comment just really not a great need for additional capacity in markets right now. So that will slow Greenfield down. The subs of available renewable, I think the renewable s are starting to get squeezed a bit as the government look at financial problems, so that will, a lot of renewable projects and heat and air type projects will slow down, that does to your point in a down market sort of see where the asset valuations go to the lower levels and so there's some opportunities that may bet here. That's where our focus is right now. I think there's still a challenge a bit if you're buying assets that also have a bit of a development stream attached to them, the development stream, the spreads are quite large depending on your view of the market. So that makes those type of acquisitions difficult. But if you asset only, that is contracted would be very attractive to us, and we'll continue to focus on that area. I do think that this capacity over the long run next ten years will be very profitable capacity as we go forward.

So then I'll ask a follow-up and either Steve or Brett could really answer this one, but when we look at the Canadian capital markets and the valuations of the Canadian power players versus those in the US, let alone the access to capital that you have got in Canada whether debt or equity, and then also just the currency, the CAD versus the US dollar, its seems you're in very good position right now to potentially you grow the Company in a pretty meaningful fashion if you chose to do so. So I guess the question really is, how much time do you think about looking at the US and acquisitions and the financeability of it in the current market?

Well, Matt, let me respond to that. First, I would agree with your assessment broadly. Our strategy is quite clear, we'd like to grow this company along the West Coast of North America. That means largely the US. We do think with our balance sheet and our track record and our mix of fuels that we have some excellent opportunities. I do think that given our balance sheet and our track record that our ability to finance transactions is quite good. You never know until you test it, but right now I think the signs are good, the valuations are good. So I think while we're going to be very opportunistic here, but our development teams are certainly focused on keeping their eyes open for any phone calls to come in that we could take advantage of. So we'll see what plays out over the next couple of years.

That's great. Thank you.

Thank you. Our next question come is from Robert Kwan from RBC Capital Markets. Please go ahead.

Good morning. Maybe building on that, on the acquisition side, so Steve, you touched on the geographies. With respect to what you might be looking, and I know you can never necessarily pick what comes up, but would you be focused more on plant by plant acquisitions or small clusters of plants or something more scale changing?

I would say the focus right now is asset acquisitions. But, we are certainly open to anything that could be more of a step change and I think from the earlier comments we think those opportunities may arise, so we have to be prepared for that. So the focus right now is clusters of assets or individual assets. But I don't, I would say certainly we would be open to something if we saw something that was unique that fit our strategy . But we'd certainly want to take a hard look at it.

Okay. Just my other question, Brett, this is probably for you. Just, an accounting question on IFRS, you had laid out that major inspection cost going forward would be capitalized versus expense. So, is the right way to think about it if you're starting to move towards five a year based on the coal side and I think you in the past you said CAD20 million of turn around and 40% of that in the past has been expensed is really kind of that the math that you're going to be enhancing earnings by about CAD40 million pretax a year?

I think you have to, there's a number of adjustments that come into play when we adopt IFRS. So there's no question that OpEx does move down into the CapEx. Having said that, we have to go back and adjust, and so out of the gate we don't see any significant changes. But over time we should see some pickup. How much that will be will really depend on our spend going forward. So I think the only way you can look at it right now is really does it change our cash flow, it just moves items around. For now, we don't see significant impact on our earnings. There will be pluses or minuses but no significant change.

But if you're reclassifying that, why would that not be a major change to your earnings?

Again, we have to go back and adjust our depreciation to reflect that that would have been n CapEx before, so our depreciation will move up. So that's an offsetting factor that you have to take into consideration.

Thank you. Our next question is from Pat Kenny from National Bank Financials. Please go ahead.

Thank you. I wanted to get a bit more color on your energy trading. You know, expecting to earn CAD30 million or CAD50 million this year, and versus your more normalised run rate was CAD50 million to CAD70 million. I'm wondering what your key market conditions, what sort of assumptions you are assuming that will be improving in 2011 versus 2010?

What we will be seeing in 2011 versus 2010, we hope slightly more market volatile which is helpful to the business. We would hope to see a second-half general rise in prices which will helpful the business. And I think our teams have also done a good job this year to adjust their strategies and their training strategies to less volatility than they have seen, and while it will improve it will still be less than we have seen in the past. But unless that trading business takes a good sort of six to nine months to flow through your book and get in the new mode, so I think we'll see that as we start 2011 to change for us in a positive direction. So I think those are the three things that we'd start to see improving the business as we go through 2011.

Okay. Thanks. Just also wondering in a follow-up here if there's any update to your hedging positions versus your most recent presentation is the August presentation.

Yes, Pat, I think we'll updating most things at our Investor Day, right away.

Thank you.

I don't think you see dramatic change, but we'll give you a full update at Investor Day i n a few weeks.

Thank you. Our next question is from Petro Panarites from CIBC World Markets. Please go ahead.

Thank you. The first question, just a follow up on the marketing question previously, is there anything in your current book that might enable you to give us a bit more granularity on timing of a recovery?

You mean timing of an economic recovery?

No. A timing of a recovery in margins, is there any positions that you have now that might suggest all else being equal that there might be a recovery in the second or third quarter of next year?

I would say not. Okay.

Second question, I guess for Steve. We've got the prospect of growing carbon regulation. Also the desire on the part of the market for clarity and certainty. Just thinking longer term, do you see the possibility of the Alberta market changing at some point from its current energy-only structure? What do you think might happen longer term?

I don't, I can't see that far ahead, like anyone else. Right now, I don't see that happening . I think the government has made it quite clear that they like the market the way it is. The open market. They feel it's served Albertens well overall in the last ten years, and our goal forward plans are based on the fact that the market will remain an open market. And currently the way it is, and our only challenge will be as our current PPA's come up we'll transition those to new types of contracts with our new customers and we feel quite confident we can do that and capture alot of upside value with our plants during that process. Quite frankly, we are looking forward to it. But I don't see a lot of market conditions to change.

Okay. Thank you.

Thank you. Our next question is from Michael McGowan from BMO Capital Markets. Please go ahead.

Hi, good morning. I'm just wondering if you can provide an update potentially on the time line with respect to your discussions with the government of Washington State.

Well, Michael, it's Steve here. Those discussions are ongoing. They have been complicated a bit by the tough economic conditions in the US right now, and Washington State is not immune from that. That's made it a bit more challenging for the government in terms of allocating resources and time to work through this process. But, they're dedicated to it. The meetings have continued to go forward and we're still optimistic that as we go through 2011 we'll find some methodology that's acceptable to both the state and our customers and ourselves that will make it work. So we'll keep plugging away at it. But we're optimistic for 2011.

Has there been a drop dead date that's been established that if no contract is reached by that point on negotiations will break off?

No, not at all. This is pretty complex. It's far-reaching. And important for both ourselves and the state. And important for reliability of the system in Washington State.

Remember our Centrellia plant is the keybase load plant in the state. So this is a very delicate sort of process and I think all sides want to do it right. And we have all agreed we have time, we'll take the time we need. At this point, we haven't set any dead lines. I guess at some point in the future it will come to a conclusion, but right now we don't want that pressure point on this, this is too critical for both sides to do that at this point.

Just a follow-up maybe on the energy trading business. You're now looking for a CAD30 million to CAD50 million of gross margin for 2010. You have done CAD17 million so far, so have you positioned the portfolio that you're taking more risk or open positions for the fourth quarter.

We don't do that. That's one thing we have never done in the past or won't do. We do not take a risk Chase the number. You know, the prime purpose of our trading business is to trade around our own asset, to get market intelligence so we can contract properly and price those contracts properly. And the propriety trading, we need to do that to accomplish all those functions. But we do not chase risk higher in order to improve the margins. We keep the risk profile the same and then we live with that variation within the range we have. We'll maintain that risk strategy as we go forward.

Okay. Great. Thank you.

Thank you. Our next question is from Sam Kanes with Scotia Capital, please go ahead.

Steve, with respect to strategy with your assets, Australlia, you've been quiet on, I was wondering if you had a hypothetical cluster opportunity to Australlia, would you look at it or conversely if you had a cluster opportunity on the west side of North America, would you monetise Australlia?

Yeah, we declared many years ago that Australia was non core and on the other side, they're among our best performing assets on any measure per megawatt dollars per unit, whatever you want. From a business perspective that trumps strategy any day. So we'll maintain it. But clearly, if we could repatriate that capital into our core market some time, at equal or better earns we'd look for that opportunity. We haven't matched those two things yet, I don't know if we can match them in the short term. Medium term I think we'll be able to. In the meantime, we'll just enjoy the cash flow and earnings from them and pass them on to shareholders here.

Thanks, Steve.

Thank you. Our next question is from Linda Ezergailis from TD Newcrest. Please go ahead.

Thank you. With the transition to IFRS, I'm wondering if you'll be revisiting your, or the board might be revisiting the dividend policy and changing from a earnings based payout ratio approach to a cash flow based approach?

It's Steve here. Linda, you know as well as I do, that's clearly a board decision to call how they look at the dividend, but we do look at the dividend both ways. Certainly the primary way to look at it is our cash flow. In this industry, cash flow is the key. As we always, that's what I said in the comments, we focused strongly on cash flow and as you have seen from the numbers here, very strong cash flow relative to the dividend. Anything do with the dividend relative to the pay our rate or the futures is up to the board. They review that constantly. All I can say is that we, again, our dividend was declared and shows the confidence that we have in the ability to pay it now and going forward.

So would it be fair to say that even if we don't see a change in the payout ratio policy being 60% to 70% of comparable earnings, that as well as long as you're able to pay the dividend that would be the focus, the cash flow?

The 50% to 70% payout ratio is sort a target over a number of years, and we had said it's consistent any one year we could be above or below that based on market conditions at the time. So we would tend to look at the dividend on a multi year basis. And we tend to look at the payout ratio on a multi year basis. My sense is quite clearly the market conditions while tough today, they always improve, they will improve. We're well positioned for that opportunity. And when that happens earnings will rise, payout ratio comes in line and we go forward again. But in the medium term, cash flow is the key to managing the Company.

Okay. And while looking at cash flow metrics maybe you can give us an update as to your debt metrics and what sort of credit rating you want to stay at.

Yes. Linda, it's Brett. There's no change. We're continuing to target and maintain that investment grade. Our credit metrics are in the MD&A and the financial statements so point you to that. There's no change in our financial policies and strategies in that regard.

Thank you. Once again, for the investment community, (Operator Instructions). our next question is from Juan Plessis from Canaccord, please go ahead.

Thank you. I want to get back to the strategy on acquisitions, can you tell us what your hurdle rates are for potential acquisitions and how much leverage do you think is available on your balance sheet to pursue acquisitions?

It's Steve here. Just responding to the second part of your question, first, I just refer back to the comments made by Brett. We will remain disciplined around our investment grade credit rating and will not do anything relative to leveraging the balance sheet that would put that in jeopardy, so that's simple, we have been that way and will be that way. And so that's where, I forget the first part of the question.

Hurdle rates.

We are not changing any of our hurdle rates. I think we have been saying that we would be looking at sort of a 10% internal rate return after tax, but there are always risk adjusted. We certainly see with the cost of capital dropping for some companies and some players that's shifting. But basically we look at that hurdle rate. We adjust up and down based on the risk factors.

Okay. That was a 10% unlevered IRR?

Yes.

Okay. And as a follow-up, you mentioned that you were making some change to the energy trading side, that would get you back to previous levels in 2011. What specifically were the changes?

Well, I don't want to comment on the strategies. That's how they get their edge, but I think that the, we saw some difficulties in our western markets and taking a hard look at what caused those. I think they have plans in place to correct that. The rest of the operation is doing well and just really impacted by broader market conditions. So I can't be specific obviously because that would be competitive information, but we believe the changes made will help improve that operation in 2011 and we're looking forward to that.

Okay. Thank you.

Thank you. We will now take questions from the media. (Operator instructions). We have no questions from the media. I would like to turn the meeting over to Mr. Nieukerk.

Great. That concludesTransAlta's third quarter 2010 conference call. I'm available for any follow-up questions. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.