Talen Energy Corp (TLN) 2015 Q2 法說會逐字稿

Good morning and welcome to the Talen Energy second quarter 2015 financial results conference call. All participants will be in listen-only mode.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Andrew Ludwig, Director of Investor Relations. Please go ahead, sir.

Thanks, Anice, and good morning, everyone. Thank you for joining the Talen Energy conference call to discuss second quarter results and general business outlook. Today's presentation is being webcast and we are providing slides of the presentation on our website at talenenergy.com. Referring to our Safe Harbor statement on slide 2, any statements made in this presentation about future operating results or other future events are forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from such forward-looking statements. I will turn the call over to Paul Farr, Talen Energy President and CEO. Paul?

Thanks, Andy. Good morning everyone and thank you joining us on Talen Energy's first quarterly conference call. With me on the call this morning are Jeremy McGuire, our CFO; and Joe Hopf, our Chief Commercial Officer and Head of our Non-nuclear Generation. Tim Rausch, our CNO, is at an industry conference and not able to join us today.

Let's turn to slide 4 and begin with some high-level comments on financial results and our adjusted EBITDA and free cash flow targets for 2015 and 2016. We are solidly on track to achieve the $1.01 billion midpoint of 2015 adjusted EBITDA guidance and the $340 million midpoint of adjusted free cash flow.

For 2016, we are reiterating the previously supplied adjusted EBITDA and free cash flow targets but making a small adjustment to both targets to reflect the previously announced sale of the renewables business. And Jeremy will go over those numbers in a few minutes. This accretive transaction should close by year end.

I'm going to leave the balance of our prepared comments on financial performance to Jeremy and will focus on our tactical and strategic priorities and how we believe that successful execution of those will have direct and material benefits to shareowners. We said on our launch call that our story comes down to execution and while we have a very full plate of activities underway, the team is energized to execute on all fronts to drive value for shareowners. We do not believe our current share price reflects the underlying value of our business and capital discipline will remain our top priority.

We will generate $650 million in adjusted free cash flow over 2015 and 2016, have non-core asset sales at various stages of execution, and have very attractive assets in advance sale processes to address FERC mitigation as part of the Riverstone acquisition. We also stand to benefit materially from the ongoing CP auction of PJM. We have a reasonable amount of material to review this morning but I'll circle back to these items at the end of my prepared remarks.

During the second quarter, we made significant progress on a number of key priorities. Siemens completed the final root cause assessment of the turbine blade cracking at Susquehanna and confirmed that the shortened blades restored the full strength of the turbine blades. We do not anticipate any further special turbine outages and plan to compete the short blade replacements on Unit 1 during next spring's planned refueling outlet and on Unit 2 in the spring refueling outage during 2017. Both units have had very strong runtimes over the past year and I'll comment more on that when we get to the operational overview.

Beyond the announced sale of the renewables business and the acquisition of the MACH Gen portfolio, we also made significant strides on the sale processes for the four FERC mitigation assets. We expect to be able to announce our preferred sales strategy and have sales contracts executed by the fourth quarter. From a timing perspective, our goal remains to have the bidders factor the CP auction results into their final valuations.

Moving now to page 5, the more we evaluate the opportunities for the MACH Gen portfolio, the more we really like this deal. Jeremy's tax team is working to maximize the usage of the NOLs and tax attributes in the shortest timeframe possible. And Joe's gas team is advancing the dialogue with Siemens on fleetwide LTSA economics as well as the cost estimates for a potential relocation of the facility. At 1,031 pounds per megawatt hour, the final Clean Power Plan 2030 target for Arizona is definitely supportive of highly efficient gas-fired generation assets such as Harquahala and we're also evaluating transmission upgrades that could prove beneficial to the plant's economics. As we said on the call last month, this deal accomplishes a great number of strategic priorities for us and at very compelling value for shareowners.

Let's turn to slide 6 and our list of key priorities. While this isn't our entire list by any means, success in each of these can create meaningful benefits for shareowners. This week, we're completing the bidding for the 2018/2019 CP auction at PJM and the results will be announced prior to the 21st with the transition auction for 2016/2017 and 2017/2018 following close behind.

As I've previously mentioned, we expect to be in a position to announce our preferred path on FERC mitigation by Q4. We believe the market understands the attractiveness of these assets and we look forward to announcing our decision. The key regulatory filings from MACH Gen have all been made and we expect to close and debt finance that transaction by year end. We recently achieved change of control approval from the current lender, decreasing the amount of near-term financing requirement to $625 million. As Jeremy will cover in his financial review, we have identified $10 million to $20 million of additional synergies above our $155 million base number and the team continues to look for additional opportunities.

Since we have an upcoming slide on Brunner Dual-Fuel project, I'll defer comment on that and comparable Montour opportunity for a minute. We compared the relative level of spend at Keystone and Conemaugh against our Montour, Brunner and Brandon Shores facilities and we see meaningful capability to improve the operating and capital cost of those units. We'll be working with the ownership group on a plan to significantly improve the economics of those facilities.

Since I already covered the opportunities we're looking at to maximize the value at Harq, let's turn to slide 8 for a review of plant performance and safety. We've had phenomenal performance from our gas fleet and nuclear units in Q2 as well as year to date. With cash gas running on M3 well below $2 on average for the second quarter, our 11,500 heat rate Martins Creek plant has basically been running baseload and will for virtually the entire year. Our high level of hedges has protected the economics of the solid fuel plants in light of the low gas prices but the economic dispatch of the coal units have definitely been impacted.

The quarterly performance of the two units at Susquehanna for the last year is outlined on the bottom left of the side. And the performance of the units and Tim's operating team has been really fantastic. We can see from the data we get from the instrumented blades that the shortened blades are working and lowering vibration. Other than in outage at one of the Texas gas units in June shortly after the close of the transaction, the forced outage factors outlined in the upper right chart remain at very attractive levels, especially in the East where CP will reward this type of performance. The entire Eastern fleet is running below 3% for forced outage factors on a year to date basis, with the nuclear units incurring no forced outage impacts.

On the safety front, we're definitely not satisfied with our performance this year. Both Tim and Joe are highly engaged with all plant personnel to return us to much better levels of safety performance and we look forward to materially improved results on that front.

On slide 9, we've included a perspective on the markets and some supply and demand drivers. In our region of PJM, we continue to see very strong spark spreads for 2016 and 2017. With the welcomed return of heat in Texas, summer 2016 sparks are back to the $30 level they were at for much of this year, and as a number of our peers have already reported load growth in Texas even with extremely depressed oil and gas pricing has been resilient.

As ERCOT reported last week, the system reached all-time peak demand records on Wednesday and Thursday, with real-time prices rising to over $700 a megawatt hour at one of the peak hours on Wednesday. Another system peak record was set yesterday at just under 70,000 megawatts and records were set for weekend peaks this past weekend as well at over 66,500 megawatts. The prior all-time record for peak demand was set during the heat wave of 2011.

In the East, coal units and some nukes in PJM remained under significant pressure. We'll see what happens with the CP auctions but we see nine gigs of additional retirements possible should capacity not fill in the money that's gone missing from energy margins and lower [dark] spreads driven by low gas prices. The phenomenon that we've been dealing with in [MAC] will spread West as gas pipelines export the Marcellus surplus and the Utica begins producing at more meaningful levels.

On slide 10, we provide some color on capacity performance. We will remain consistent in not predicting where we think prices will clear or what our strategy is relative to bidding capacity. We're very comfortable with the level of reliability of our fuel diverse units and the availability of local gas to dispatch in distressed situations. We previously discussed our margin sensitivity to an uplift in capacity at $45 million for every $10 per megawatt day move in prices for the full fleet. To get the actual uplift, you simply multiply the expected or actual outcome times the percentage of our capacity that clears.

This is going to be an interesting auction. We know there are significant number of units in PJM that are currently operating at flat to negative cash flows on an open basis and they will need to make commitments for 2018/2019 before they know what the opportunity is for incremental cash flows in the transition auctions. Those types of units do not have the fleet reliability stats that we do and they need money to derisk operating performance. Given the current economic realities facing those units and the penalties for non-performance as well as the risk in betting what gas and power prices are going to be in 2018 and 2019, this is a pretty big bet. That said, we'll all see what the numbers are in a week and a half.

Let's now turn to the Brunner Island coal-fire project on slide 11. We're providing some key financial metrics and project milestones for this project that, once completed, will let us burn coal and gas in any combination at Brunner. The lower future gas and power prices are, the greater the economics of the project and vice versa. In our base case, we see $20 million to $35 million of incremental gross margin from the project and expect to have the capability in place by late 2016. We see a similar opportunity for the Montour facility but we need Sunbury lateral off the PennEast pipeline to make further progress before we commit the comparable $100 million to that project. We'll keep you updated as things progress on both projects.

Before I turn the call over to Jeremy, I'll give you an update on our hedge levels and pricing on slide 12. We're very well hedged for the remainder of 2015 and right on target for hedge levels in 2016, given we're more than halfway through this year. By later this year, I fully expect we'll be at or near our 75% target for 2016. The 75% is simply a target; however, and we'll be flexible in our approach depending upon what happens with market prices. As was the case with Riverstone acquisition, we do not and cannot know what the Mach Gen owners will do regarding hedging from the time that we announce the deal through the close of that transaction. But based upon what we saw during our due diligence, they were not that active so those assets could definitely come in under our target levels when the transaction closes later this year. With that, I'll now turn the call over to Jeremy for our financial review.

Thanks Paul. Slides 14 provides an overview of our second quarter financial performance. Second quarter adjusted EBITDA was up $45 million versus a year ago, driven primarily by improved margins. These margins were up 14% from strong Susquehanna output, robust spark spreads for our gas fleet, and the consolidation of RJS as of June 1. Spark spreads were so strong that production from our Martins Creek facility increased 500% compared to second quarter of last year. These improvements to margins were partially offset by lower capacity prices. We also experienced an $11 million reduction in corporate O&M costs, which were partially offset by the consolidation of plant level O&M from RJS.

Let's turn to slide 15. As Paul already mentioned, we are reaffirming our 2015 adjusted EBITDA and adjusted free cash flow guidance given our strong financial performance to date. Three weeks ago, we announced the acquisition of MACH Gen and at that time, we updated our 2016 adjusted EBITDA and adjusted free cash flow midpoint estimates to $1 billion and $320 million, respectively. After our investor call and webcast, there were some questions as to why we didn't update our 2016 base numbers as part of the transaction update. The answer is there is not a material difference between the two values. You can see the reiteration of the MACH Gen update in the fourth column.

In the last column, we have further adjusted our 2016 adjusted EBITDA and adjusted free cash flow midpoint estimates as well as our projected end-of-year 2015 net debt balance to reflect the previously announced sale of our small renewable energy business. In 2016, the renewables business was expected to contribute $15 million of adjusted EBITDA and $10 million of adjusted free cash flow. The sale price for renewables was $116 million which represents more than $1,700 a kilowatt. We expect this transaction to close by the end of 2015. No further adjustments to our 2016 estimates have been made. We will, however, continue to update the 2016 estimate as asset sales are announced.

Turning to slide 16, I want to spend just a minute or two on our list of positive financial performance drivers for 2017 and beyond. Talen Energy's future performance is not solely about the forward curves. Some of the drivers on this list are structural, such as the expiration of the Sapphire HRCOs and Longview PPA. Others like reducing Harquahala drag and ultimately realizing value for the station, the Brunner Island project and improving synergies over the base target are among our top execution priorities, as Paul already discussed. Just in this list, we have identified $6 to $10 of value per share that we believe is within our grasp and importantly, we have not included any value for CP, our ongoing asset sale processes or value for any fill-in-the-blank hypothetical acquisitions.

Before I turn it back to Paul for some closing remarks, let's turn to slide 17, which will be familiar to many of you. As we've said before capital allocation is where the rubber meets the road, turning financial results into shareholder returns. We continue to think of our capital priorities in the context of leverage ratios. 3 to 5 times remains our comfort zone but as we have indicated in the past, these are not hard limits. The MACH Gen acquisition, on its face, will push us towards the upper end of the lane, leading some to wonder if we have reached our limit. The answer is no for several reasons.

First, our divestiture processes are proceeding well and again, we expect to signed definitive agreements by the fourth quarter. Subsequently, we would expect to close in three to six months after signing those agreements. Second, as part of MACH Gen, we are requiring significant and usable tax attributes that will reduce Talen Energy's cash tax bill in a very tangible way. This value does not show up in EBITDA but it is very real and improves the cash flow profile of the Company. EBITDA is a useful guide for leverage but at the end of the day, it's cash flow that pays the bills.

Third, the addition of MACH Gen, while accretive in its own right, will add a degree of margin resilience over a wide range of natural gas prices. As we have discussed in the past, depending on how the composition of our generation fleet changes over time, it may be prudent to revisit our leverage lane. Fourth, any subsequent acquisition will bring EBITDA with it that can support some increase in total debt without stressing leverage ratios.

And lastly, we are on track to produce more than $600 million of adjusted free cash flow over 2015 and 2016, with approximately $100 million earmarked for the Brunner Island project. With that, I'll hand it back to Paul.

Thanks Jeremy. We have been a public company for a little over two months and I want to thank the entire Talen team for all the hard work and perseverance that has taken us to get to this point. We have accomplished a lot and we're proud of that but we clearly understand how much work remains to deliver the full value potential of this Company.

I mentioned earlier that we had a pretty full plate and it's all focused on driving shareowner value and no matter what the specific opportunity is, I'm extremely confident in the execution capability of this team. As I said earlier on upfront, I wanted to come back and summarize the key messages that we want to leave you with today, as we know this was quite a bit of material but we tried to fill in a lot of the blanks that were left out there during the roadshow, during the MACH Gen call, we hope you found this useful.

The first point I'd like to make is that we're reiterating guidance for 2015 to 2016 and we outlined a number of things additionally to consider as very positive value drivers post-2016, including upwardly revised synergies. Second, we have excellent unit reliability and fuel diversity in PJM and stand ready to capture the upside opportunity from PJM CP auction construct at higher levels than the peer group. And third, we're executing on non-core asset sales and FERC mitigation sales that will restore our leverage to targeted levels.

We'll absolutely stay disciplined in our deployment of capital and I fully expect this team will continue to find ways to unlock value for shareowners beyond the items that we've discussed this morning. With that, operator by way of review, we're ready to take questions.

Thank you.

(Operator Instructions)

Greg Gordon, Evercore ISI.

Thank you. Good morning. A few questions, guys. First, Jeremy, just be clear on the guidance, I mean, we looked at the forward curves from June and the forward curves today. It doesn't look like they're materially different so effectively, the guidance is -- would be approximately a current mark? Is that -- I just want to make sure I understood your statement on that factor.

Yes. We still think that 2016, the original 2016 numbers are good numbers on a margin basis.

Okay. Great. Second, on the tax attributes, you indicated, as a base case assumption, that your tax rate would come down from 30% to 20%; thus, improving your EBITDA to free cash conversion ratio once Montour closes. Any chance that you can -- that, that number could be improved upon further and also, have you gotten tax attributes that will allow you to shield the capital, potential capital gain on the sale of the assets under FERC mitigation?

So the first piece of the question is that the tax team is working hard to try to find ways that we can accelerate some of the utilization of the tax attributes that are being acquired that could drive that rate lower and lower on a sustainable basis. So it could be the effective cash tax rate could, in fact, end up being lower than 20% and quite a bit lower. But that requires a lot more tax analysis that is a top priority of the team.

Greg, some of the attributes are limited under NOL utilization roles and some of the attributes are unlimited in the nature related to that acquisition. We've also got significant tax basis in Montana such that as we resolve our ownership there over time, that also provides an unlimited utilization of the basis so that also can act as a shield against any potential tax, current tax kit that will come from the sale of assets at a gain in mitigation.

Okay. Great. And then my final question is tremendous focus on capital allocation amongst all the quarter, the IPPs, all of them, there's four of you, but when you look at the leverage lane that you're in, you think about the fact that you basically just told us you're going to generate a third of the market cap of the Company in cash between now and the end of 2016. When do you look at a stock price and say, listen, that what I would argue is around 6 times EBITDA; that's a better use of our cash flow than another acquisition and when's the soonest you might come around to that conclusion if the stock were to start acting better?

Let me -- okay, I recognize where you're coming at and let me start by saying that we are absolutely not interested clearly in issuing stock at these evaluation levels to do acquisitions. That -- I want to make that clear even though that wasn't necessarily the direct point of your question. We are going to generate roughly a third of the market cap through the cash, ongoing cash flow. We're also going to generate some very significant proceeds from non-core asset sales and FERC mitigation sales as both Jeremy and I mentioned so that takes that number even more, as we said, more than effectively restores when you combine those to our leverage to the kind of target levels of the midpoint of that range. I guess, I don't see -- we have found, I believe the capability to deploy capital in a very disciplined way at levels below what we don't see as acceptable less of EBITDA multiple in our share price, like we did for Harquahala. We talked about the margin and therefore EBITDA opportunities coming off things like the Brunner Island project. To the extent that whenever we look at projects, we always consider the share price. We also consider our ongoing EBITDA profile, the profile of assets that we, from time to time, can look at in the market. We look at the risk profile and determine whether or not things are helpful to the shape of EBITDA in various power and gas scenarios. I'm not trying to dodge your question but I think we will ultimately, as the others have done, look at and could commence a buyback program but in the very short term, I don't see that because I think we can find ways to, one, just restore the leverage to our more targeted level. But, two, see if we can find opportunities that would improve upon it. As we said on a very first Talen call, if we cannot find those opportunities, that call on June 1, that we would return capital to share owners via stock buybacks.

Okay. Thanks guys. Have a good morning.

Thanks Greg.

Julian Dumoulin-Smith, UBS.

Hello, good morning.

Good morning, Julian.

So perhaps just to follow-up on Greg's question there; it wasn't originally my intent but just to clarify what's the timeline that you think about executing on a share buyback? Is the thought process if you don't engage in M&A right now, once you get the proceeds from any kind of divestment or mandatory divestment, that's the point in time in which you would evaluate deploying capital to buy back shares?

I think the way that we would think about that is we've got lots of data points. That's why we tried to put a time horizon on several of the key priorities when I went through those early, in the early part of the presentation. We're going to know on CP here in the relatively short term. That's going to inform bidders on valuation relative to the asset sales that are FERC mitigation related. We've announced one non-core sale and are looking at some other things. I think we need to see what the current we need to execute on and close on the financing for the MACH Gen acquisition by year end. We've got a number of moving parts in the short term. So I think we're going to wait to see what the market informs us to relative valuation, how successful the FERC mitigation and non-core asset sales are going to be; what CP does. All of that, we believe, will reset the base line in terms of valuation for the stock. So if we are sitting on cash or below levels of net debt, if we've got robust CP results, depending upon how those very positive value drivers get reflected in the share price or not, would determine how we think about that relative to other opportunities to deploy capital.

Got it. Excellent. And then secondly, on Montana, I'd just be curious, any opportunity to monetize that asset? Just curious on any views around the monetization of Puget and also any thoughts on coal ash, as it relates to that potential?

The coal ash expectations for CCR so that the bottom ash, fly ash and the scrubber byproduct is actually lower as we've evaluated those rules than we originally thought. We had $50 million of consolidated CapEx in our plan and as we will see in our second-quarter Q, we increased our ARO by only $33 million. So there will be less capital being deployed across the fleet. Montana is one of the facilities with the pond there that will need to be mitigated and remediated. That would ultimately be reflected in the economics of a sale, of some related action with respect to Units 1 and 2 or all four units. We will keep working on that. It's a distressed situation that could improve our EBITDA profile; Generate, as I indicated earlier, a very significant amount of cash as a result of tax basis that incumbent in that asset out there. So we'll keep at it.

Great. Just lastly, just real quickly on taxes. Just obviously, looking at the results year to date, but how do you think about potential for improvement there and cost-cutting, et cetera?

Not -- because the facilities are operated by a relatively small amount of personnel and we're actively weaning ourselves off of the Topaz or Riverstone asset support activities, I don't think that there's a huge -- the quite the level of synergy that we're looking at in other areas. So I wouldn't look at those as significant now. When you look at where the market pricing has been and day ahead, some hours of real-time, this last couple of weeks with, it's going to a little cooler here balance of the week but still well over 90 degrees. It doesn't take much to generate the upside but we had intimated it was available in a few hours of performance As we outlined on the call on the 1st. We like the assets a lot. We're finally getting some heat, as I indicated, that's popped 16 summer sparks again, which will let us do some hedging as we see fit. But we'll keep at the value creation there.

Great. Thank you.

You're welcome, Julian.

(Operator Instructions)

Abe Azar, Deutsche Bank.

Good morning and thank you for the additional disclosures particularly on the 2017 drivers. Is there any significance to your reaffirmation of a range for 2015 but the midpoint for 2016? Should we read into that at all or --?

I will let Jeremy answer that question, Abe.

So the 2016, we don't actually have a range out there. When we launched Talen on June 1, we decided to go with point estimates since we were way out in front of the other IPPs in terms of giving a look at 2016. We will seek to convert that into a formal range and any update to midpoint as necessary in the Q4 earnings call at the beginning of next year.

Okay. And then just so I understand, the first half disclosures, for -- we have $1.1 billion at midpoint and you're saying you did $484 million equivalent for the first half, so that leaves $526 million for the balance of the year. Is that the right way to think about it?

That's correct.

And then shifting gears a little bit, what, if anything, have you taken away from the stock market volatility and the energy complex? Does that bias you towards being on the lower end of the leverage lane?

Well, coming from the legacy company is more volatile than what we had. That's for certain. I don't think that it biases us. I think the way that Jeremy and he did a really good job, I think, profiling or talking about this, on the launch call on the 1st is that the balance sheet -- beyond the $1.85 billion of liquidity plus our right-way facilities that we used to support the hedged book. We look at the balance sheet as almost a first line of defense against commodity volatility, which is why we might be a little more conservative maybe than some of the peers, as it relates to looking at it. So where the MACH Gen acquisition, because of the debt that came with the assets plus the amount of capacity that we had given the cash flow we generate and the asset sale proceeds that were -- that are expected, we took it up to the upper end of the range, will more than restore this to the acceptable levels for us, as we go through the next, as Jeremy indicated, the next quarter to announce contracted asset sales. And then it's a three to six month timeframe for those to show up. That's the way that we do look at the balance sheet. We look at hedging the balance sheet and the cash flow generation profile, the assets, all as one integrated picture.

All right. Thank you.

Sure.

At this time, there are no additional questions. I would like to turn the conference back over to Paul Farr for his closing remarks.

Okay. Thank you all for joining us on the call this morning. Hopefully, we have provided a number of different items from a value opportunity perspective. The management team is highly engaged across virtually every waterfront in this Company to deliver that value. We've got CP coming here in another 10 days or so, 11 days or so; that's going to inform quite a bit. We're well advanced on a number of different asset sale processes, improving our synergy expectations and we'll continue at working on these, and as I indicated, a number of other fronts to keep driving value for share owners. We look forward to talking to you guys as we approach the fall conference season. Thanks much for joining us.

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.