Atlantic Power Corporation
Q2 2019 Earnings Call Transcript

Published: 2 Aug 2019

[Operator:]

Good morning and welcome to the Atlantic Power Corporation Second Quarter 2019 Results and Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that the event is being recorded. I would now like to turn the conference over to Mr. Ron Bialobrzeski, Director of Finance. Please go ahead.

[Ron Bialobrzeski:]

Welcome and thank you for joining us this morning. Our results for the 3 and 6 months ended June 30, 2019 were issued by press release yesterday afternoon and are available on our website, www.atlanticpower.com and on EDGAR and SEDAR. Management’s prepared remarks and the accompanying presentation for today’s call and webcast can be found in the conference call section of our website. A replay of today’s webcast will be available on our website for a period of 1 year. Financial figures that we will be presenting are stated in U.S. dollars and are approximate unless otherwise noted.Please be advised that this conference call and presentation will contain forward-looking statements. As discussed in the company’s Safe Harbor statement on Page 2 of today's presentation, these statements are not guarantees of future performance and involve certain risks and uncertainties that are more fully described in our various securities filings. Actual results may differ materially from such forward-looking statements. In addition, the financial results in yesterday’s press release and today’s presentation include both GAAP and non-GAAP measures, including Project Adjusted EBITDA. For reconciliations of this measure to the most directly comparable GAAP financial measure to the extent that they are available without unreasonable effort, please refer to the press release, the appendix of today’s presentation or our quarterly report on Form 10-Q, all of which are available on our website.Now, I will turn the call over to Jim Moore, President and CEO of Atlantic Power.

[Jim Moore:]

Thank you, Ron. Welcome everyone. Good morning. With me this morning are Terry Ronan, our CFO; Dan Rorabaugh, our Senior Vice President of Operations; Joe Cofelice, our EVP, Commercial Development; and several other members of the Atlantic Power management team. The results for the second quarter are provided in the press release, the presentation and the prepared remarks which were posted on the website last evening. Please review those materials. I will cover the highlights. Following my remarks, we will take your questions.Page 4 of the presentation summarizes the key accomplishments of the second quarter as follows. First, we had strong financial results that exceeded our expectations mostly due to higher water flows at Curtis Palmer. Second, we continued to strengthen our balance sheet by repaying nearly $37 million dollars of debt, including our remaining 2019 convertible debenture bullet maturities. This improved our leverage ratio to 3.8x. Third, we made significant progress on our growth initiatives. We announced an agreement to acquire minority interest in two contracted biomass plants for $20 million. And earlier this week, we completed the acquisition of two others for $13 million. Fourth, we executed an agreement for the sale of our Manchief plant for $45 million following the expiration of its PPA in May 2022. This agreement preserves our cash flow from the project for the next 3 years, reduces debt and eliminates re-contracting uncertainty.Market fundamentals in the power sector do remain weak.Demand growth is low. Capacity additions continue to outpace retirements and public policy and tax subsidies continue to support additions of intermittent wind and solar. These additions drive up grid costs, impact demand and devalue more reliable power sources. All of this has made for a challenging environment in which to re-contract our gas plants. That said, we are seeing initial concerns in a few markets that are becoming heavily reliant on intermittent power, that there may be insufficient dependable resources available at peak times. Meanwhile, if the phase-out of tax subsidies for wind and solar projects occurs as scheduled, that should be beneficial to our re-contracting efforts over time.In terms of growth, as we’ve discussed in the past, the returns on the highly popular wind and solar investments have been competed to levels that are generally unattractive for us. They are also mostly tax-driven investments while we currently have a low tax appetite. Our investment search process is focused on out-of-favor and unglamorous assets, what we think of as "cigar butts." As we disclosed in June, the acquisitions we’ve announced of four operating biomass plants and an additional ownership interest in the Koma Kulshan hydro facility are expected to contribute $8 to $10 million of Project Adjusted EBITDA annually, on average, through 2027, and at lower levels thereafter. This represents an attractive potential return on our total investment of approximately $46 million.Measured against our expected 2019 Projected Adjusted EBITDA of $175 million to $190 million, the addition of $8 to $10 million is modest. However, as existing PPAs expire, particularly in 2022 and beyond, the addition is more meaningful. We have increased and extended our expected PPA-generated revenues and cash flow as a result of these acquisitions.Following the completion of the acquisition of Allendale and Dorchester earlier this week, we have an estimated liquidity of approximately $190 million. Meanwhile, our market capitalization is approximately $260 million based on recent share prices. Our deleveraging continues to be supported by cash flow from existing assets that remain under PPAs. Our liquidity can be used to further reduce debt, repurchase shares, or make acquisitions. Our capital allocation decisions are driven by our assessment of the most rational use of capital measured on an intrinsic value per share basis.We are encouraged by the deal flow we are reviewing, but we will be disciplined about comparing the returns on external investments to those available from investing in our own securities.We will now take your questions

[Operator:]

We will now begin the question and answer session.[Operator Instructions] And the first question comes from Sean Steuart from TD Securities. Please go ahead.

[Sean Steuart:]

Thanks. Good morning. A few questions. I was wondering if you could give us some context on deal flow. Are the best opportunities you’re seeing limited still to biomass? Or are there other technologies that – I guess fit your preference for out-of-favor, cigar butt-type investment?

[Jim Moore:]

Yes. So, biomass, I would say, is the main focus of what we’re looking at now because they’re unglamorous. They’re not popular. A lot of them have had difficult start-ups and difficult operating lives. Our internal expertise on biomass allows us to kind of roll that out as we try to integrate new plants. So, we’re becoming quite a large biomass operator. With the acquisitions, we’re going from four to eight. I think in the past we’ve said, "Look it," when we were asked this question over the last four or five years, "we’re paying off debt. But we’re going to be very focused on intrinsic value per share. We’re going to be very disciplined." So, it took us five years before we ended up making some acquisitions. And then, when we did, we moved with some speed and scale. So, I think that’s the way we’re always going to approach this. So, today, in terms of the deal flow, we are looking at biomass plants. We also picked up half of a hydro plant. It’s all about price-to-value for us.And a sector may be unpopular and then something happens. Back in 2015, we sold off I think it was five wind plants for what I estimated (my own look at it) around 14 times what would be normalized as cash available for distribution. And within six months, with the yieldco's coming apart, I thought we might be able to buy those at attractive prices. You might be able to buy wind at 15%.And so, we’re going to be very disciplined as evidenced by the fact that over five years we paid down a billion dollars of debt, we cut 60% of our overhead, and we didn’t do any external acquisitions for five years while we were buying in shares and buying in prefs. But when we saw opportunity at what we thought were attractive returns, we jumped on it. It’s getting interesting now. I mean power and commodities, the difficulty with them is they’re commodity-priced, and they’re capital intensive, and they’re volatile. But for a value investor, that creates an interesting opportunity set for us. So, we come in everyday, and Mr. Market tells us what return we can expect if we buy in our own shares or buy in prefs, what the cash return on that will be. And then, from time to time, we’ll see something in the external markets. And we didn’t go out and buy five plants in the last year because we had cash burning a hole in our pocket. We bought five plants because we thought the economics for the various plants we bought were compelling. So, we’re continuing to do that. And we are seeing some interesting deal flow, some interesting disruption in the market. There’s nothing imminent other than the other next two biomass plants that are going to close very soon. But that’s the game plan we’ll stay on the next few years.

[Sean Steuart:]

That’s great detail. Thanks. One other question with respect to the Williams Lake fuel supply review, can you give us a bit more detail on your options given the declining annual allowable cut for timber in BC and what looks to be a really rapidly growing list of saw-mill closures in the province? How does that inform your thinking around potential PPA there?

[Joe Cofelice:]

Yes. Sean, this is Joe. Good morning. The – you hit the main issue for us in BC. It’s the main issue that all biomass plants are facing there. As you know, we’re in the middle of negotiations with BC Hydro. And the focus of those negotiations is how we can best mitigate that risk contractually. But the one thing that I will say about the contract is that we will not have fuel cost passthrough, so it’s important that we negotiate terms and conditions that provide us some way of dealing with the fuel supply situation there. But when you negotiate a contract, there are a number of factors that you try to take into consideration, including when you run, how often you must run. What are the penalties when you don't run? What periods of time do incur penalties? So, there’s a lot that we’re doing there.And then, on the supply side, as you know, we have received a permit to burn fuel tie – sorry, rail ties. And we’re factoring those into these negotiations. We haven’t made any definitive decisions on whether we’ll go forward with rail ties, but that’ll depend on the outcome of the negotiations under the PPA. But clearly, unlike a number of other biomass plants in the province, we do have rail ties that we can consume up to 35% of our requirement there. So, we’re working with – on the fuel supply side. We’re working on the contractual side. And at this point, we feel pretty good. We think our odds are good to get to the finish line with BC Hydro.

[Sean Steuart:]

Okay. That’s all I had. Thanks very much.

[Terry Ronan:]

Thanks, Sean.

[Operator:]

The next question comes from Rupert Merer from National Bank. Please go ahead.

[Rupert Merer:]

Good morning, everyone.

[Terry Ronan:]

Good morning, Rupert.

[Rupert Merer:]

You have some comments in your disclosures on re-contracting. If we look out a little further to Chambers, I think the contract there goes until March of 2024. But are you thinking at all about opportunities for repowering assets like this and some of your other assets, like conversion to gas, for example?

[Joe Cofelice:]

Yes. Rupert, this is Joe. Yes, sure. Chambers, as you said, the contract expires in March of 2024, and that’s a good way out. We have a partner in that project. We consider all options, and we’ll continue to consider all options. But it’s a little early for the re-contracting of that asset. Typically, there’s not a lot of interest from potential buyers in assets that will be available in April of 2024. So, we’ll consider all options, and we’ll have more to say closer to the PPA expiration date.

[Rupert Merer:]

Okay. And that really leads to my second question, which is a bit of a follow-up on Sean’s question. You’re looking at attractive cigar butts. And today we have coal and gas assets that are trading out of favor. Are you looking at any assets that are coal or gas in your potential deal flow these days?

[Joe Cofelice:]

Yes. Oh.

[Jim Moore:]

Yes. Sorry. We look at coal assets. We’d be happy to own them. On coal, I am okay owning the CO2 risk, what we are focused on is -- we consider ourselves environmentalists. We started I helped start up a wind company in 2001, I was on the board of a solar company, but I’m really focused on particulate emissions. And so, we want the coal plant to be good on the emissions front, well-scrubbed. We would worry about coal ash. If we can get solid environmental attributes on those issues and decent returns, we’d be willing to buy coal. It should be an interesting area because a lot of funds due to ESG just can’t own coal. So, we’ve been looking at it for five years. But we haven’t really found anything to pull the trigger on.The difficulty with gas is I think gas is probably the most important power source in North America today and going forward. It really supports the wind and solar. And it’s, to me, the place where the Venn diagram overlaps between environmental responsibility and economic responsibility. The problem is if you have a long-dated PPA, then in this current environment where the world is awash in capital, and people are competing returns down, and you’ve got I forget how many trillions of dollars in negative interest rate bonds in the world, people are willing to take returns on gas plants, on any contracted plants that are long term, including long-term biomass, wind, solar, gas, maybe not coal. And they’re willing to take returns that we just don’t think on an absolute basis are attractive returns.Now, the flipside of that is if you have merchant gas, you can buy them cheap. But with the current dynamics, we’re adding more supply than we’re taking off the grid. So retirements are less than supply additions. The PTCs and ITCs are beginning to be phased out, but they’re not phased out yet. So the fundamentals aren’t great. And the fundamentals going forward were based on a bet on public policy. And we’re not willing to bet a lot of capital on public policy being rational. So, and on top of that, as we expressed, the re-contracting situations on our gas plants, as they roll off, we’re creating more merchant plants. So, we have Ontario. We have a merchant exposure we could use. As the next set of PPAs roll off, it inherently creates organic merchant megawatt growth for us. So, we don’t have to go out and buy it. And even if it wasn’t the case we wouldn’t go out and buy because we just don’t like the set-up currently of the fundamental supply and demand and the direction of current public policy at the moment. Does that answer? Or is that too much, too little?

[Rupert Merer:]

No, that’s perfect. I’ll leave it there. Thank you very much.

[Terry Ronan:]

Thanks, Rupert.

[Operator:]

The next question comes from Nelson Ng from RBC Capital Markets. Please go ahead, sir.

[Nelson Ng:]

Great. Thanks. Just a quick clarification on the last one, you mentioned that you’re looking at coal and gas, but you don’t really want more exposure to the merchant market. So you’re mainly looking at contracted opportunities on the gas, coal, biomass side and not on the merchant side, right?

[Jim Moore:]

Correct. Correct.

[Nelson Ng:]

Okay. Perfect. And then, my next question is on Oxnard. The PPA expires next year. I think you mentioned in the prepared remarks to that there could be a solicitation by Southern California Edison. Could you just tell us how far along that proposal or that idea is and the timing?

[Joe Cofelice:]

Sure. In June, the CPUC issued an order seeking comments to various proposals they were making. And nothing officially has been announced by SCE. But based on our conversations with them and with the CAISO, we would expect to see one to two solicitations over the next 12 months.

[Nelson Ng:]

Okay. And then, I believe your facility I just wanted to check are there any land right issues at the facility? I know your San Diego facility were located in a Navy yard. But is this one located next to a farm?

[Joe Cofelice:]

Yes, it is. But what’s important here is that we control the land. It’s our land. And so, we can we have a lot more options there and a lot more flexibility. It’s a totally different issue than we had in San Diego.

[Nelson Ng:]

Okay, got it. And then, just moving on to that biomass asset you purchased from EDF and AltaGas, are they base load assets with high utilization?

[Dan Rorabaugh:]

Yes. They are baseloaded at effectively 100% utilization.

[Nelson Ng:]

Okay. And then, in terms of potential cost savings, could you just touch on the magnitude on the potential opex savings with the EDF assets?

[Dan Rorabaugh:]

Sure. We just closed this deal. We did look at some potential optimization projects at the plants. In particular, we’re looking at their fuel handling system. We think there are ways to both reduce the cost of fuel handling and reduce the cost of the fuel there. So, we’re -- and there are a couple of other projects we have in mind. So, we’re looking at modeling those, developing those through our budgeting process coming later this year. But we think there are some proportional to the cash coming from the projects, some reasonably good, high-return projects we can do at both of those South Carolina plants.

[Nelson Ng:]

And in terms of reducing fuel costs, is it more about having the flexibility to use lower quality, cheaper fuel, or cheaper wood biomass?

[Dan Rorabaugh:]

Yes.

[Nelson Ng:]

Okay.

[Dan Rorabaugh:]

Yes, we think right now there we could bring in equipment to do a better job of processing the fuel they get. And when we do that, we can also get a lower quality fuel and process that just as easily and thereby just naturally reduce our fuel costs.

[Nelson Ng:]

Okay. And then, just on the AltaGas asset. Is it fair to say that there’s pretty limited opportunities for savings given that it’s a minority interest as operated by CMS?

[Dan Rorabaugh:]

That is fair. That’s kind of how we look at it. CMS is a very good operator. Having said that, we don’t own the project yet, haven’t had a chance to get in. We’re going to work with them. And they're well-operated plants already. But we will, of course, look for opportunities with our partner once we close on that deal.

[Nelson Ng:]

Okay, great. That’s all for me.

[Terry Ronan:]

Thanks, Nelson.

[Operator:]

This concludes our question and answer session. I would like to turn the conference back over to Mr. Jim Moore for any closing remarks.

[Jim Moore:]

We appreciate your ownership and interest in the company. And we look forward to updating you on our progress as it unfolds. Thanks for joining us today. And we’ll talk to you next quarter.

[Terry Ronan:]

Thank you.

[Operator:]

This concludes our conference. Thank you for attending today’s presentation. You may now disconnect. And enjoy the rest of your day.