Atlantic Power Corporation
Q2 2018 Earnings Call Transcript

Published: 3 Aug 2018

[Operator:]

Good day and welcome to the Atlantic Power Corporation Second Quarter 2018 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ron Bialobrzeski, Director of Finance. Please go ahead.

[Ron Bialobrzeski:]

Welcome, and thank you for joining us this morning. Our results for the three and six months ended June 30, 2018 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 one year. Financial figures that we will be presenting are stated in US 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'll turn the call over to Jim Moore, President and CEO of Atlantic Power.

[Jim Moore:]

Good morning. Thank you for joining us today. With me this morning are Terry Ronan, our CFO; Dan Rorabaugh, our Senior Vice President of Asset Management; Joe Cofelice, our EVP, Commercial Development; and several other members of the Atlantic Power management team. As is our usual practice, we posted the prepared remarks for this presentation to our website last evening. This morning I’ll briefly summarize second quarter results and recent developments, which are covered in detail in our press release and presentation, and then revisit a couple of areas I addressed in my letter to shareholders three months ago. Then we will take your questions. As noted on page 4 of the presentation, second quarter results were modestly better than we had anticipated, which you may recall occurred in Q1 as well. Although results for the first half reflected a significant decline from PPA expirations and the non-recurrence of the 2018 OEFC settlement, as we had expected, they are on track with full year 2018 guidance. During the second quarter, we continued to use our strong operating cash flow to repay debt. We remain on track to repay a total of $100 million of debt this year. Although our leverage ratio increased this quarter because of the lower EBITDA, we expect it to begin declining again in 2019 as we continue to repay significant amounts of debt. We have taken a balanced approach to capital allocation. From April through the end of July, we used $4.6 million of our discretionary cash to repurchase and cancel common and preferred shares. We will continue to do so when they are trading at attractive implied returns, as they are now. I would note that over the past three years, we have repurchased and cancelled a total of $29.5 million in common shares at an average price of $2.31 and $8 million of preferred shares (US dollar equivalent). During this period, insiders have purchased another $4.9 million in common shares at an average price of $2.30. Last week we closed our first external investment in several years, the acquisition of our partners’ interest in the Koma Kulshan hydro facility for a total of $13.2 million, approximately 11 times estimated pro forma cash distributions. Koma is our longest-dated PPA, with close to a 19-year remaining life. At June 30, 2018 we had strong liquidity of $203 million, including approximately $42 million in discretionary cash, which we intend to continue using for share repurchases and additional growth investments, when they are accretive [rectified later by the company] to intrinsic value per share. In the area of operations, we completed the turbine overhaul at Manchief during the quarter and finished the work necessary for restart at Tunis, which we now expect to occur in October. We also took steps to reduce operations and maintenance cost at Williams Lake to mitigate the financial impact of the short-term contract extension. On the commercial front, we remain engaged with the Navy at two of our San Diego sites, but the probability of reaching an agreement on site control remains low. Turning to page 5, I’d like to discuss briefly how we think about the financial impact to PPA explorations over the next several years. As I noted in my letter to shareholders earlier this year, if power prices remain at current levels or decline further, the price we receive for power post PPA would be materially below current contract levels. Some of our projects would not be re-contracted and we would consider mothballing or decommissioning them. The market is very focused apparently on the EBITDA impact of these explorations. So are we, but there are mitigating elements when one considers the overall financial impact on Atlantic Power

[Operator:]

[Operator Instructions] Our first question will come from Nelson Ng of RBC Capital Markets. Please go ahead.

[Nelson Ng:]

I had a quick question on Williams Lake. Can you just give a bit more color in terms of, I guess, first the approvals required for that short-term extension and what would happen if the approvals are not received?

[Joe Cofelice:]

Sure. Good morning Nelson, this is Joe. The short-term contract is currently subject to a written hearing process with the BC Utility Commission. All parties are in the process of submitting their final arguments and that occurs in phases, but will occur over the period, August 7 through August 21, and then we’d expect the Commission to act at some point after that. As far as the longer-term prospects for the project, we believe that biomass will be considered as part of the IRP process and we still believe that is, we need to wait for that before we can have a more definitive view on the prospects. Having said that, it will be interesting to see that in the event the Commission were to turn down the short-term contract, the reasons for turning it down would be important facts for us too, so we certainly take those in to consideration regarding next steps also. But really we think the IRP process will drive what the long-term process will be for the assets.

[Nelson Ng:]

And could you just touch on the current fuel supply situation? So you have short-term flexible fiber contracts.

[Jim Moore:]

I’m going to ask Dan to respond to that.

[Nelson Ng:]

Were they at much higher prices because they are short term, and if Williams Lake does receive a longer-term contract sometime next year, are there any issues in terms of obtaining fiber?

[Dan Rorabaugh:]

Hi Nelson, Dan Rorabaugh. A couple of things. They are higher than they had been, as you said, because they’re short-term contracts and because after the fires last year, the supply was cut down and some of the mills did go out of business. So we are paying a higher price for fuel right now than we had historically. But obviously if we get a long-term contract, then we’ll be able to get into long-term, more economic fiber supply. And that’s also tied to our ability to burn rail ties. Assuming we get this longer-term contract, then we’ll be able to burn rail ties and we’ll have a supply of that to last through the new contract.

[Nelson Ng:]

So you’d be looking to burn rail ties rather than pay up a bit more for the fiber which, like you said, has been reducing due to the fires and mill shutdowns?

[Dan Rorabaugh:]

Right, it’s not really “rather than.” I think the numbers - we can go up to 50% with the rail ties, but by doing that then you take away the pressure of having to buy the highest-priced wood coming in. So it does effectively lower the price you’re paying for the actual wood products.

[Joe Cofelice:]

Nelson, this is Joe. Just to add to that, just as a reminder - the air permit is also currently being appealed and the written hearings are ongoing, and submissions are due between August 10 and I think September 14. So that process is ongoing too and our ability to burn up to 50% rail ties is subject to our winning there.

[Nelson Ng:]

And then just in terms of capital allocation, you mentioned earlier that you bought the rest of Koma Kulshan. If you look at your existing portfolio where you own, I guess 50% interest, Frederickson and Orlando. Those ones are obviously gas-powered facilities with much shorter PPAs. Are those attractive opportunities or due to the short-term PPAs there they won’t look attractive or how do you look at? Like have you considered buying up larger interests in something in your existing portfolio?

[Terry Ronan:]

Hi Nelson, it’s Terry. So regarding those three projects, Orlando and Freddy anyway, I think we’ve said all along for any of these, ideally we’d love to be a 100% owner. But at the right price, we’re either a seller or a buyer and otherwise we remain a good partner and certainly the tenor of the PPA comes into play as far as the economics. So, nothing really to report on that other than at the right price we are either a buyer or a seller.

[Jim Moore:]

Yes, I mean your comment on the gas, let me just kind of go off on that for a second. So we bought a hydro - we particularly like hydro facilities in this market, because if there is continued high penetration of intermittent resources then hydro ought to do well, gas would not do as well. If there is an overestimation or over-optimism on what energy storage can achieve and on the economics of batteries, then hydro ought to do well. It’s difficult to put new hydros in. We have Curtis Palmer on the Hudson and as you know, there are actually movements to pull down dams in some places. So I think there is pretty good NIMBY against even hydro. So when we look at the asset classes, all of the different technologies, I think hydro has maybe got the best risk-reward profile. And then after that at biomass - it’s probably the least popular asset class in the power sector. It’s got high costs and post-PPA, you’ve got to worry about what they’ll be worth in the market. What we’re doing there is using our operating team. We’ve had really good results on Piedmont the last couple of years. We think we can get the normalized EBITDA up there the run rate to $9 million or $10 million, and that gives us a really good return on the $60 million we used to pay off the debt. Most of the biomass plants you look at, they had overruns early on in cost. So if you can jump in to them after they’ve already gone through that period and you’re not the person paying to build them, they’re kind of the cigar butts of the industry, you know the Ben Graham type deals. So we really like the Piedmont deal and then we’d love to do some more of those and use our operating expertise to kind of expand that business line. So we’re looking around at those. On the gas side, if I was in charge of the grid, we’d be majoring on gas plants as the best combination of environmental and economic attributes and reliability. Gas right now is not a favorite asset class, but we have plants that – we tried to keep San Diego going and we’ve mothballed some of the stuff in Ontario. We want to hang on to as much optionality on those types of plants as possible, because at some point I think public policy is usually myopic and you could have a real spike in value on peakers. And if that’s the case, we think there might be some good unrecognized value in the portfolio for our currently mothballed gas plants.

[Nelson Ng:]

So just one last question, in your prepared remarks you talked about shifting resources to support biomass and energy storage initiatives. Are these more like development projects and what type of energy storage are you referring to? And then also you were just talking about biomass, and you kind of implied you’re looking at operating assets rather than development. So could you just touch on biomass, whether it’s development or operating and what type of energy storage initiatives are you looking at?

[Jim Moore:]

Let me do that second part and then Joe will do the first part. Yes, with biomass we’re really not looking at development. The history of biomass has been cost overruns, poor operating results. I’ve been in the power business for 30 years; every IPP company I’ve gone to the worst project in the portfolio has been a biomass, particularly if you get into some of the funky fuels. But once you line them out and you get through the operating period, the shake-out period, if you can buy them at the right price, they tend to be pretty solid performers, and we wouldn’t put a lot of value post PPA. So I guess the shorter answer is, biomass is the unloved asset class right now and it’s – people really aren’t that interested in buying them. So that’s a perfect market for a small cap value investor like us or a deep value investor. But we are more focused on operating facilities. There’s not a lot of them, but we’re looking and we’re talking and if we could do a Piedmont-like deal we’d do it again. And then the first part of your question, I’ll throw over to Joe.

[Joe Cofelice:]

As far as the battery opportunities, they’re greenfield development battery opportunities, but then as I said in my prepared remarks, we’re doing it on an opportunistic basis, and we’re focusing on our existing sites, where we may have interconnection value, land value that will provide us a competitive advantage, because as you know in these utility RFPs, battery RFPs you’re getting 10 times or more megawatts bid than they’re requiring. And so without some type of a competitive advantage our chances of winning are not very good. So that’s the rationale for focusing on the existing sites to see if we can create something better advantaged and, yes, greenfield development not acquisitions.

[Operator:]

Our next question will come from Sean Steuart of TD Securities. Please go ahead.

[Sean Steuart:]

Just one question, you guys have been pretty comprehensive in covering everything else. There was reference to consultants being brought in to benchmark the thermal assets. Can you go in to a little bit more detail of the expected outcomes of that process, what the motivation was to start with that?

[Dan Rorabaugh:]

Sure, this is Dan Rorabaugh. Motivation is part of our long term looking at cost savings. We started with fuel efficiency, we did a lot of optimization projects around that, and we’ve been taking a hard look at all of our assets and what our O&M costs are. And we got to the point where we had all the internal data we could get, so we brought in an external consultant who has a large database of projects to compare us to. We expect to get those results in the next couple of months here and use that to drive the next phase of cost savings, which is where they identify where we are overspending, where we are underspending. We’ll take that data and use that to inform ourselves and cut more costs going forward.

[Jim Moore:]

Let me jump in there too and add a little long-winded addendum to that, which is Bruce Greenwald, who is the legendary value guru at Columbia University, who I think retired this summer, has come and spoken to us before and worked with us. And if you read his book Competition Demystified, if you are in a no barriers to entry business, then it’s all about managing efficiency and we think we are in a no barriers to entry business, it’s capital-intensive, it’s commodity-priced. So we’re all about cost and efficiency first and foremost, and extracting as much cash flow as you can out of the legacy assets. And then not using that money to fulfill some management agenda, or focus on the size of the empire, but to really focus on intrinsic value per share. So on the operating side, we’re trying to be as efficient as possible. But we always tell our plant people, safety first, we don’t cut corners. We want bad news in nanoseconds, if we trip over any environmental issues, we want to get those on the table and disclose them right away. And then we don’t want to short-change on maintenance that’s going to cause us longer-term cost issues. A lot of financial buyers of these types of assets, when you pick them up from them, there’s a lot of low-hanging fruit. We spent tens of millions of dollars on our plants a few years ago and had high returns, 20% cash returns, because the plants had been short-changed. So when we operate these, we think like we’re going to own the plants forever and we don’t want to short-change maintenance that’s going to create longer-term costs. On the other hand we want to be smart about it. I know, Dan, at one of the plants we used a cheaper lube oil fuel because the life of the lube oil fuel we had been using was longer than the remaining life of the plant. So we’re telling our people that we want to be efficient and productive, but we don’t want to short-change safety or environment or create long-term cost. So every day we are out there continuously trying to improve. We think there is room to keep improving the cost side of it. On the G&A side, we came down by 60% or so and we flat-lined the last couple of years. As I had told the market earlier, we probably run with a few extra million of G&A overhead than was necessary just to help look at external things and to be available to buy assets and do things when the market throws up some opportunities. But there we’re still being frugal. In 2015 when we moved from downtown Boston out to Dedham, we cut our rent from $1 million to $0.5 million. In about a month we’re going to move from the second floor of our building we’re in in Dedham to the first floor and we’re going to cut our rent about in half again. So we’re continuously grinding away on costs because in this business, really, cost is the most important thing.

[Operator:]

[Operator Instructions] Our next question will come from Rupert Merer of National Bank. Please go ahead.

[Rupert Merer:]

So you mentioned that you’re being very disciplined on price in looking at external investments and you gave us that reference of 10% to 11% cash return opportunity cost on repurchasing pref shares. So looking at that Koma Kulshan, that acquisition, how do you look at the returns on that investment, is that above that threshold or is that a little more of a strategic investment?

[Jim Moore:]

So Koma came to us as a ROFR (right of first refusal) with our partner. They had been approached, they had a price and so we really didn’t negotiate the price. It was either take it or leave it and so you’re right in our external investments we’re looking at more like 12% to 15% or higher unlevered returns. To get those returns in this market you really have to look at assets that are broken or need turnarounds. Koma is not broken, it’s a hydro plant, it’s got a really long-term PPA. We were picking up the operations and a 100% ownership. So that’s about as a low-risk investment as we can make other than buying back shares or preferred arguably. So we did push to the low end of what we would take and so therefore I would say it wasn’t a bargain-priced acquisition. We thought we paid a fair price for a really attractive, low-risk asset that helped firm up the back-end of our EBITDA and it’s a project we know very well since we own half of it. But that would be about as low as we’d go, and then what the exact return on that is, it’s 11 times current cash flow and then you’ve got to figure out what do you think you’re going to make on the back-end after the PPA, is there some terminal value. So that profile, we would go as low as we’re going to go on returns. Anything we do externally on an asset we don’t own that wasn’t as lower risk, we would expect higher returns.

[Rupert Merer:]

And I suppose you could probably recycle that at a better price if you decided to in the future?

[Jim Moore:]

Yes, that’s a great point too. Without going into too much detail we’re highly confident that we could flip the asset for more than what we paid for it.

[Rupert Merer:]

And then just one high-level question, you’ve had a couple of solid quarters and you mentioned you’ve been performing better than expected. What were the main drivers of that performance and do you expect those to continue for the rest of the year?

[Terry Ronan:]

Hi Rupert, it’s Terry. We did perform a little better than expected in the first half and really, there were several drivers of that. Our Morris plant had higher steam and ancillary services revenues; at Mamquam, we had some higher water flows, which we don’t expect that to continue, it usually reverts to the mean; and at Kenilworth, we had some higher merchant energy and steam sales. What we’ve said I think in our presentation was that we expect to give most or all that back in the second half. Some of our maintenance expenses got pushed in to the second half from the first half. We also talked about the Tunis contract, which we originally expected to start around July 1, has been delayed due to reasons that Dan has discussed. And we also expect to see the impact of the higher fuel costs at Williams Lake in the second half of the year. Those were the main factors, but beyond that, if you look at the fleet as a whole, there is probably 10 or so of the other plants where there’s anywhere from $0.5 million to $0.75 million just maintenance timing expenses. Though we’re ahead by about $12 million as of the first half on our Project Adjusted EBITDA, we haven’t changed our guidance from that range of $170 million to $185 million for this year, because we think we’ll be giving some of this back in the second half, but overall other than the timing and some of the normal pluses and minuses on water flows and what not, we feel that we’re right on plan to hit that target for the year.

[Operator:]

Ladies and gentlemen, this will conclude our question-and-answer session. At this time, I would like to turn the conference back over to Mr. Jim Moore for any closing remarks.

[Jim Moore:]

Thank you. We appreciate your ownership and interest in the company, and we look forward to updating you on our progress as it unfolds. As always, we remain focused on protecting and building intrinsic value per share in your company as best we can with a long-term ownership orientation. Thank you for your interest and participation. We look forward to updating you on our progress on the third quarter conference call.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.