Fortis Inc.
Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. This is the conference call operator. Welcome to the Fortis Third Quarter 2015 Conference Call and Webcast. During the call, all participants will be in a listen-only mode. There will be a question-and-answer session following the presentation. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Janet Craig, Vice President, Investor Relations of Fortis Inc. Please go ahead, Ms. Craig.

[Janet Craig:]

Thank you, Jonathan, and good morning, everyone and welcome the Fortis’ third quarter 2015 results webcast and conference call. I am joined by Barry Perry, President and CEO; and Karl Smith, CFO, as well as other members of the senior management team. Before I begin today’s call, I want to remind you that the discussion will include forward-looking information which is subject to the forward-looking statements contained in the supporting slideshow. All non-GAAP financial measures referenced in our prepared remarks are reconciled to the related US GAAP financial measures in the MD&A. Also, unless otherwise specified, all financial information referenced is in Canadian dollars. I will now turn the call over to Barry.

[Barry Perry:]

Thank you, and good morning. I know it’s a very busy day for everyone and we appreciate you being on the call. We continue to have a very good year at Fortis and this quarter was no exception. We completed our exit from the properties business to tighten our focus on core utilities. We reached a settlement on the Belize expropriation matter and put this lingering issue behind us. We have managed a busy regulatory calendar and we continue to maintain operational excellence at all of our facilities and provide safe and cost-effective service to our customers. Total shareholder return is very important to us and we reinforced our commitment in Q3 by increasing our quarterly dividend for the second time this year. It is now CAD0.375 per common shares per quarter, up over 10% from Q1 and over 17% from last year. We also introduced dividend guidance. Our target of 6% annual dividend growth through 2020 really underscores the conference we have in our business. This confidence comes from our strategy for growth including continued investment in our existing franchises, pursuit of additional opportunities within our service territories as well as our ability to manage large capital projects like the Waneta Expansion. Our performance in 2015 underscores the strength of our strategy. In the quarter, UNS continued to be significant contributor to our earnings power and it is an excellent example of our ability to acquire and integrate regulated utilities. This combined with the benefits of a diversified asset base and the strength of our other utilities contributed to our earnings growth. Karl will walk you through this in a bit more detail. Looking out over the next five years we see lots of opportunity to invest in our business which I will speak to in a minute. 2015 will be the biggest CapEx spend in our history at a forecasted level of CAD2.2 billion. As is typical for our industry, the period from 2019 to 2020 shows a gradual decline in capital expenditure. We expect these numbers to climb as we get more visibility on the status of projects and new opportunities. The most important takeaway from our CAD9 billion capital program is the rate base growth it supports. We see our rate base growth climbing at a CAGR of 4.5% per year over the next five years with the growth being distributed among our businesses. In fact, by 2020 we are projecting our rate base to exceed CAD20 billion. For those of you who attended our Investor Day, we spoke a lot about good opportunities both gas and electric in the US and in Canada. One of the areas of significant interest to us is LNG infrastructure in British Columbia. Fortis BC is well positioned. We operate two of the five existing LNG facilities in Canada and we believe we are uniquely positioned to take advantage of the LNG infrastructure build-out in a BC. Currently we have three projects that we have talked about; the pipeline expansion to Woodfibre LNG, Tilbury 1A and Tilbury 1B. Woodfibre’s LNG project continues to progress. Recently Woodfibre LNG reached two important milestones for this project. Squamish First Nation approval of an environmental certificate and the passage of Environmental Assessment Office review. The project is still pending certain approvals including federal environmental assessment. We expect the final decision by Woodfibre LNG in 2016. The planning of our CAD600 million pipeline expansion to support Woodfibre LNG is also progressing. It is still subject to various approvals including environmental and of course is conditional of upon the LNG export facility proceeding. At our 35-acre to Tilbury site, which is known for LNG export, the Tilbury 1A project is progressing well. This CAD440 million project will be included in our regulated rate base. Tilbury 1B, a further Tilbury expansion is conditional on having long-term energy supply contracts for 70% of additional liquefaction capacity and has been designed to supply Hawaiian Electric with the LNG. We continue to have discussions with ECO about the viability and scope of this product. LNG remains a strong opportunity for us and there has been an increased activity in terms of the discussion around development of LNG in British Columbia. You will notice though that we do not have specific numbers associated with the LNG rate base growth assumptions as we have had in the past. This is a reflection of less visibility around project scope and timing. To sum things up before turning the call over to Karl, I would describe our overall tone as one of confidence and this confidence allowed us to initial dividend guidance for the first time in September. We have a clear line of sight of executing on our capital plan and we continue to pursue investment opportunities in our franchise areas. As always, we continue to focus on growing the business profitability. Now, let me turn things over to Karl.

[Karl Smith:]

Thanks, Barry, and good morning everyone. As Barry mentioned, our financial results were strong in quarter three. Our adjusted earnings for the quarter more than doubled compared to last year and our earnings per common share grew by two-thirds. Cash flow from operations was CAD358 million in the quarter and CAD1.3 billion year-to-date. Our unused credit facilities today are approximately CAD2.4 billion, providing us with ample liquidity. Our regulated utilities raised almost CAD400 million in debt in the third quarter and we are on track with the CAD2.2 billion capital plan for the year. Digging into our adjusted earnings in a bit more detail then, as you can see from the waterfall chart, UNS was the biggest contributor to improved adjusted earnings per share. Last year our third quarter reflected just six weeks of UNS results due to the timing of the close of the acquisition. As a reminder, the earnings at UNS are highly seasonal with their third quarter typically being the strongest. We also saw strong contributions from other regulated utilities, the growth was tempered by timing differences at Fortis BC that are expected to reverse in the fourth quarter. Foreign exchange, excluding what has already been captured in the UNS, also had a favorable impact. Our strong financial metrics including increasing earnings and cash flow support our financial capacity and strong credit rating. With the light debt maturity profile, unused credit facilities and the strong balance sheet, we are focused on positioning ourselves to have ample capacity to fund growth through investments or acquisitions. It has been another busy period on the regulatory front. In August, the US Environmental Protection Agency finalized its Clean Power Plant. This sets targets for the reduction of carbon dioxide emissions from power generation. Individual states must submit their reduction plans by 2018. The plan is focused on reducing emissions from coal-fired generation and as a result will impact UNS. We do believe we have a path towards compliance. Reforming the energy business proceedings are ongoing in New York State. These are generic proceedings aimed at reviewing the role of distribution utilities and align their investments and earnings with state policy goals. The programs included in Central Hudson’s proposal in support of these proceedings are currently under review by regulators. In October, FortisBC Energy, the benchmark utility in British Columbia, filed an application to review 2016 ROE and common equity component of the capital structure. Generic cost of capital proceedings have also commenced in Alberta to set the allowed ROE and capital structure for 2016 and 2017. In October, Newfoundland Power filed a general rate application to set new customer rates to be effective July 1 2016 and Maritime Electric filed a general rate application to set new customer rates to be effective March 1, 2016. In both cases, cost of capital will be reviewed. Yesterday, Tucson Electric Power filed a general rate application requesting new retail rates to be effective January 1, 2017 based on June 30, 2015 historical test year. Since its last rate order in 2013, which was based on a 2011 historical test year, the utilities rate basis increased by $600 million and its common equity business has increased from 43.5% to 50.0%. Taking a look at the chart on screen right now, you can see elements of the application. We are seeking a return on equity of 10.35% on 50% equity fitness within original cost rate base of $2.1 billion. This is obviously an important application that will allow Tucson Electric Power to earn this allowed return in 2017. And now I will turn the call back over to Barry.

[Barry Perry:]

In closing, 2015 has positioned us well for sustained growth. Our business is in good shape as low risk and diversified. All the utilities are running well. Our five-year $9 billion capital expenditure plan positions us to have a rate base of over $20 billion by 2020. We have the financial strength and flexibility to maintain predictable dividend growth and to take advantage of opportunities in the market for additional infrastructure investment. We also have a proven track record for integrating acquisitions as evidenced by our two recent US acquisitions. We feel very well positioned to deliver good returns to our shareholder over the long term. That concludes my prepared remarks and now I'll turn things back to Janet.

[Janet Craig:]

Thanks, Barry, and Jonathan, we are ready to open up the line for Q&A.

[Operator:]

[Operator Instructions] Our first question comes from the line of Linda Ezergailis with TD Securities. Please proceed with your question.

[Linda Ezergailis:]

Thank you, congratulations for a great quarter. So with respect to Alberta. I just want to make sure I understand what's going on. Obviously a great quarter in Q3, it doesn't appear to be timing related, but maybe you can just confirm that the revenue seasonality and the expenses for the full-year 2015 will be similar to 2014, which would imply strong Q4 as well?

[Barry Perry:]

So let me just jump in Linda, its’ Barry, definitely FortisAlberta is having a good year really getting good results now through the PBR process. I’ll let Phonse jump in here. Phonse Delaney, our President of FortisAlberta to comment on sort of comparison of quarter over quarter, Phonse can you offer anything there?

[Phonse Delaney:]

Barry, I could offer the fact that we're doing well on their PBR, as well as I don't have the exact number with me now, but it would be in the document. A portion of our year-to-date earnings would include a true-up of capital track revenue from 2014 and 2013. That was recognized in the first quarter and that should have answered the question, but there was a one-time true-up of revenue due to the Capital Tracker decision in Q1 that would have had a positive effect on our year-to-date earnings.

[Barry Perry:]

But no effect on Q3 though?

[Phonse Delaney:]

No.

[Barry Perry:]

Hopefully that helps Linda.

[Linda Ezergailis:]

Yes that’s very helpful, thank you. Just on slightly different front. For your Arizona rate application, the slide was very helpful to understand what exactly a summary of what exactly you’re applying for. Can you help us translate that into what the earnings reset or bump might be if you get what you ask for.

[Barry Perry:]

Linda, it's hard to obviously, as you go through these rate cases there are a lots of puts and takes through the process, so it's hard to predict what the outcome is. But I think going to let Dave Hutchens jump in here, but a simple measure is the rate base growth really when you look at CAD600 million of rate base, you look at 50% equity fitness, CAD300 million of equity to fund that rate base and you make an assumption on what you’re going to get on top of the capital, you can quickly identify that this is a fairly material change in earnings for TEP coming out of this rate case that we’re expecting. I will point out that the equity is in the business and we funded that equity in fact, that's arguably a little bit of a drag on our earnings right now because it's equity without rates at this point in time. But that's how it works with these historical test yours. David can you add anything on that?

[David Hutchens:]

Barry, thanks. I wouldn't add too much other than $110 - $10 million that we have filed for. If we did get all of that, it would just be a straightforward $110 pre-tax - $110 million pre-tax US dollar impact, all else being equal. Obviously there is puts and takes by the time you get out into the 2017 timeframe with some of the additional D&A and other expenses that will offset some of that. But I’m just from a clear perspective of the delta due to this rate case, it would be I think a straightforward as that.

[Linda Ezergailis:]

That’s helpful, and just some historical contest would there be any sort of precedence or arguments put forward by various interveners that might kind of try to rebut or diminish that number. Or is it pretty, I mean it seems pretty straightforward, but I'm just wondering if there is any other context within the state from various other interveners that might suggest otherwise?

[Barry Perry:]

David, do you want to take that one?

[David Hutchens:]

Yeah, I’ll take that. Yeah Linda, there will be plenty of interveners coming with a lot of different opinion on many different topics in this case, not the least of which is things around rate design changes that we’re looking to make as well as the standard things that focus get in there and argue about. So we won't get 100% of what we request and there will be some discussion around some of those key categories.

[Operator:]

Our next question comes from Paul Lechem with CIBC. Please proceed with your question.

[Paul Lechem:]

Just starting on the LNG, Barry thanks for the update there. Could you just discuss your Tilbury 1 be a little bit more in the off take agreement with Hawaiian Electric. My understanding is that that deal goes for decision before the Hawaiian PUC in the middle of next year, the NextEra takeout. Is that kind of the next data point we should look for or could there actually be a deal on your off take on the LNG prior to that merger being completed?

[Barry Perry:]

Yeah, it's interesting. Clearly, the NextEra purchase of HECO is being reviewed in Hawaii now by the Hawaiian Public Service Commission. And just recently, I think the discussion of LNG got included with that review, so it’s all wrapped up to a certain extent together from our perspective, Paul and so I think you had to watch both the NextEra acquisition of HECO, that file I think is going to contain a lot of information as we go forward a year as to whether our project with HECO continues to progress. You know, we are optimistic. There is a significant benefit for Hawaii to do this transaction, and we’re not talking small dollars here. There is some substantial savings in Hawaii for this deal. But it’s for Hawaii to decide obviously and the Governor has made certain statements about his view of this and those are the things that HECO and NextEra are working through in Hawaii and we are hopeful that they will be successful in convincing the regulator and the governor that this is the right thing do for Hawaii. So we are supporting wherever we can those efforts.

[Paul Lechem:]

So in the meantime, are you advancing any discussions with any other parties on the offtake [ph] here?

[Barry Perry:]

We continue to have a number of discussions on LNG, generally I would say given our position in British Columbia with our pipelines there and our expertise in British Columbia. So with regard to Tilbury 1B, our real focus is getting this transaction or opportunity done with HECO and NextEra frankly.

[Paul Lechem:]

Okay, fair enough. Thanks. And now just on the lease, now that an agreement is being reached there, can you discuss a little bit about the state of the operations there? Is that an area that you will be putting incremental capital into or you’re going to take a very cautious step there?

[Barry Perry:]

I think, we will be cautious, we have still our regulated - sorry, our non-regulated hydroelectric generation there, which generally generates say, CAD20 million, CAD25 million a year in earnings for the company. We do get certain assurances from the government in our discussions to settle the Belize electricity expropriation matter around sort of no interference in that business, so we are happy with that. But overtime, I can see us possibly participating in a very small way in further investments on the renewable side in Belize for example, applying our expertise, helping the utility there to progress. But it’s early and it’s government-owned business now, which - the majority owned by the government. We own one-third. We have a member on - all levels of that Board for us and a couple of other people. So we’ll see how it goes, but I could see down the road, maybe doing some small further investments there.

[Paul Lechem:]

Thanks, Barry.

[Operator:]

Our next question comes from Robert Kwan with RBC Capital Markets. Please proceed with your question.

[Robert Kwan:]

Good morning. If I can come back to the TEP rate case, we talked about the whole cost of capital side of things and as referenced earlier, you’ve got other proposals on the table. I think you like to change, including rate designs, so thinking about where your priorities are particularly with it being a good region for distributed generation. You’ve requested an ROE that’s higher as well, but fair value rate of returns higher, so how are you looking at kind of the asks in terms of your priorities of what’s most important to you?

[Barry Perry:]

Robert, clearly put forward your best position in these rate cases, there are a number of things that we want to achieve, but I wouldn’t rank anything at this point in time. David and the team are going to, I’m sure, be working with the various participants in this rate case to try to come up with a reasonable outcome. So clearly cost of capital is very important. Making headway on cost allocation is also very important. But I would say we believe we put together a very comprehensive proposal. This historical test year is somewhat new to us in terms of now refreshing things after 2011, it’s been a long time. So a lot has happened in the business. We spent a $1.03 billion in CapEx since that time. So the business has changed materially since the last time rates have set - were set. So really optimistic that we’ll make headway out a lot of the things that we’ve put forward in that case. David, anything that you can add to that?

[David Hutchens:]

No, Barry, they are all number one priorities for us going into the process.

[Robert Kwan:]

I guess just as part of that too, one of the things you have been successful with in other jurisdictions are finding things that maybe don’t necessarily have a big impact to your bottom line, but have been ways to creatively manage the rate increase to customers, which is obviously important. Are there some things here that as you have gotten into the business that you think you can do to help keep the rate increase manageable yet, earn the fair return and then recover the new costs and on rate base?

[Barry Perry:]

Robert, again, we are always focused on operating cost in our business, that’s part of Fortis’ approach to doing business and we are always aware of when you are going in front of our regulators that we have to show a good track record on controlling operating costs, and David and his team have done that since the last time rates were set. They have also made some really strategic investments in purchasing Gila River generating plant for a very, very low price. It’s bringing significant benefits to customers. So all of these things are helping mitigate the impact on rates. When you look at the rate increase that’s probably is coming out of it, it’s not - it’s in the inflation area kind of level for the period of time that we have been - that we - since we last set rates. So I think that itself suggests that the team there has done a very reasonable job in running the business. Again, David, anything else?

[David Hutchens:]

The only thing I would add Barry is that, we do always look for some fuel assets, and as natural gas stays cheap, as it stays cheap during this process, there can be some additional offsets to customer bill increases from our purchase power and fuel adjustment cost pass-through. So that’s always nice to have at the time that you put in the rates into effect.

[Robert Kwan:]

Okay, got it. If I could just ask one more question. Turning to Alberta and the generic cost of capital, maybe I am reading too much into the wording, but you have got some wording around that, which will impact FortisAlberta. Is that because you have some early reads as to where this is going given it actually only impacts a relatively small component of the capital tracker at this point?

[Karl Smith:]

Robert, it’s Karl. We’re not trying to predict the outcome of that at all, so that wouldn’t suggest that you’re reading too much, but the way we express that was that any change to the cost of capital will have an impact on FortisAlberta. I think it’s too early yet to suggest what that outcome might be and we’re obviously very keen and very involved in that whole process. What I will say is that it’s a very cohesive approach to cost of capital in Alberta and that the other utilities that operate there, we are all doing this together. So we’ll just have to wait and see what comes out of that, Robert.

[Robert Kwan:]

Okay, that’s great. Thanks very much.

[Barry Perry:]

Thanks, Robert.

[Operator:]

Our next question comes from Matthew Akman with Scotiabank. Please proceed with your question.

[Matthew Akman:]

Good morning. On the LNG comments - hi, Barry - the Woodfibre facility talking more about Tilbury, looks like there is some decent progress on permitting and local stakeholder relations there recently. But are you getting more pessimistic on the timing of that due to something commercial on the other side?

[Barry Perry:]

Well, the timing has slipped, right, as you can tell that the final investment decision now of the proponent that’s building the actual export terminal is not until 2016. So this is not unusual, Matthew, as you know a lot of the projects, the larger ones especially, have been pushed back. So it’s sort of almost to be expected. But I would say the last quarter in terms of the progress made there has been substantial with Squamish First Nations support for the project and with the BC province environment approval for the proponent to move forward. Those are significant milestones and does give us confidence that this project continues to move forward nicely at this point in time.

[Matthew Akman:]

Okay, thank you. Regarding Belize, I guess first of all, was hydrology there normal in the quarter or how would you describe hydrology?

[Barry Perry:]

It was a little better than normal for the quarter, but frankly the fourth quarter here is looking really below normal. So they’ve had very little rain for a while. They are not getting any benefits of El Nino. So this will, overall, this year will likely be a slightly lower year for that operation. We've had a bunch of good years, but this year, the water levels overall will be for the year are definitely going to be below average.

[Matthew Akman:]

And finally, maybe this is for Karl on Belize’s electric, now that you’ve settled there, there wasn't any mention of whether there were any earnings booked for the, I'm talking about the wires and poles company now?

[Karl Smith:]

There was nothing booked in the third quarter, Matthew. We will start booking earnings in the fourth quarter and because of our minority position there, we’re going to be a couple of months lagging when we book our earnings. So expect to see earnings for the first time in quarter four.

[Matthew Akman:]

Okay, thank you guys. Those were my questions.

[Barry Perry:]

Thank you, Matthew.

[Operator:]

Our next question comes from Ben Pham with BMO. Please proceed with your question.

[Ben Pham:]

Okay, good morning. I had a question about UNS and the earnings in the quarter, 97 million. I was wondering if there is any meaningful seasonality in that earnings number. It seems it’s a bit higher than the last few years and I’m just wondering if there was any sort of one-time items in there.

[Barry Perry:]

David, do you want to just jump in there and provide an answer to that?

[David Hutchens:]

Yes. As far as seasonality, there was probably just a couple of million dollars of net income due to other than normal summer down here, it wasn’t that significant, the other things that year-over-year that were a little bit different was higher transmission in wholesale revenues. So nothing really remarkable.

[Ben Pham:]

Okay. And there is commentary about Q2, Q3 being 75% of the annual earnings and now that we've seen both the numbers for those two quarters, is that a good gauge to think about the earnings upside for UNS for this year on an annual basis?

[Barry Perry:]

I didn't understand your question, Ben. That sort of, I guess, ratio that we provided just to give a sense of how much of the earnings of UNS are concentrated in Q2 and Q3, but that should remain consistent going forward, those kind of allocations. So I don't know if that answers your question.

[Ben Pham:]

I guess I'm just trying to, if you look at Q2, you did 52 million and then this quarter, you did 95, 97, and then when you add that up and you divide it out, you get about CAD200 million of earnings for the year?

[Barry Perry:]

We are definitely not going to get the 200 million of earnings. So that math is not right. David, the fourth quarter is generally - what percentage of annual earnings?

[David Hutchens:]

I don't know the percentage.

[Karl Smith:]

Sorry, Dave. It’s Karl. Ben, if you think about second and third quarters combined, it's between 75% to 80%. So the first and last quarter will be between 20% and 25% typically in any given year, combined.

[Ben Pham:]

Okay, well, those are my questions. Thanks everybody.

[Operator:]

[Operator Instructions] Our next question comes from Andrew Kuske with Credit Suisse. Please proceed with your question.

[Andrew Kuske:]

Thank you. Good morning. Given the fact you've got distribution utilities in [indiscernible] and also Alberta and clearly a lot of the generation dynamics in both of those areas are changing and maybe very pronounced in Alberta when we look out the next 5, 10 years, as the utility owner there on the distribution side, how do you think about the future changes, how it affects your businesses and how engaged have you been with the governments in both those regions?

[Barry Perry:]

Andrew, I think it presents some opportunities for us. In Alberta, we are primarily a wires business, distribution only. If you're thinking about some of the changes that could come along coal plants, around more renewable generation, I think you will find Fortis going forward, it’s going to play a greater role in the province of Alberta in terms of these investments areas and we are always trying to do some consolidation in rural electric associations, but I think we will be looking at things like renewable power, we’ll look at transmission if we can compete with some of the other players there. So I think it’s longer term, I think it presents more opportunities for the company. In PEI, the small jurisdiction clearly generates 12 million a year in net income for the company. It’s a good business. We are continuing to work with the government on philosophy there, the government tends to want to own assets in that jurisdiction and we obviously are not, that's not our business model. So we continue to work with the province to really do a good job and earn our sort of repeat there to make sure the province understands what we bring to the table and I’m optimistic that over time, we’ll find further investment opportunities in that jurisdiction as well.

[Andrew Kuske:]

Okay. That's great. And then just on Alberta, maybe for a bit more clarity on potential renewable investments, how would you think about renewable investments in that jurisdiction. Is it more just connecting up other people's equipment with some transmission, maybe within your service territories or is it actually owning the actual renewable generation, and under what construct would it be really rate base driven?

[Barry Perry:]

Clearly, it's probably both, our business is primarily wires there. So that is where we would like to be. But I said in Investor Day and many times over the last year that we are also interested in building our renewables portfolio. Ideally, that is with contracted arrangements, I'm not that interested in merchants just bidding in on a daily basis. That's not the model we’re pursuing and so hopefully, we'll find some of these opportunities. It’s very competitive out there clearly, but with our advantages on cost of capital and our footprint in these jurisdictions, we do believe overtime, we will find opportunities, whether it be say solar in Arizona or wind in Alberta or hydro in Alberta, these are things we will pursue and hopefully we will achieve some of them over our business planning period.

[Andrew Kuske:]

Okay. That’s great. Thank you.

[Barry Perry:]

Thank you, Andrew.

[Operator:]

Thank you. And as there are no further questions, I would like to turn the call back to Mr. Perry for any closing remarks.

[Barry Perry:]

Well, thank you very much. Again, we are having very strong year at the company and we thank you for your support and have a great day. Thank you.

[Operator:]

Thank you for participating. Ladies and gentlemen, this concludes today's conference. You may disconnect.