Just Energy Group Inc.
Q4 2013 Earnings Call Transcript

Published: 16 May 2013

[Operator:]

Hello, and welcome to the webcast titled Q4 Year End Call. We have just a few announcements before we begin. [Operator Instructions] I will now turn the call over to Ms. Rebecca MacDonald, Executive Chair. Please go ahead.

[Rebecca MacDonald:]

Good afternoon. I'd like to welcome you all to our fourth quarter and year-end conference. I have with me, this afternoon, Ken Hartwick, our CEO; and Beth Summers, our CFO. Ken and I will make a short presentation and then we will open the call to questions. Before we get going, let me preface the call by telling you that our earnings release and, potentially, our answers to your questions will contain forward-looking financial information. This information may eventually prove to be inaccurate, so please read the disclaimer regarding such information at the bottom of our press releases. I'm pleased to report our results for the year end March 31, 2013. It was a year focused on expansion of the business and customer growth, which allows us to build on the future value of Just Energy. Our long-term expectations for the business are deeply rooted in what we believe will be key growth drivers for our business. Let me take a few moments to highlight few of these areas and how our efforts during 2013 position our business for long-term value creation. While we work diligently to implement our long-term growth strategy, our business experienced some challenges. The company has taken proactive steps to deal with these issues, and because of our investment in growth, stands poised to see a major resurgence in profitability in fiscal 2014 and onward. Fiscal 2013 saw a continuation of the high customer growth cycle the company has been in for the last 3 years. This was seen in another record year for customer additions through our sales channels. Our Energy Marketing business added 1,335,000 new customers, up 24% from the previous record of 1,091,000 customers added in the fiscal 2012. Both sides of Energy Marketing contributed to this record. Increased sales through non-traditional channels and geographic expansion resulted in 631,000 customer additions by the Consumer division, up 47% from fiscal 2012 and by far the most in company history. The strong Commercial division broker channel also benefited from expansion into new territories, adding 724,000 new customer equivalents, up 9% from fiscal 2012. After all attrition and renewals, net customer additions were 352,000, up 11% from a year earlier. As Just Energy grows, there is a need to replace a greater number of customers annually. Fortunately, our expansions, both geographically and by channels, have allowed us to meet this challenge. I am particularly happy that our high-margin Consumer division saw net customer growth for the first time in 2 years. As our existing high price commodity contracts enter their final year, we have seen improvements in both attrition and renewals. Fiscal 2013 customer attrition rates improved to an annual rate of 10 -- 12% from 13% in fiscal 2012, and 15% in fiscal 2011. This improvement has come as our base of existing customer contracts have prices in line with current market levels, reducing the motivation to terminate the contract early. Customer renewal rates improved to 69% from 64% in fiscal 2012, and 65% in fiscal 2011. Similarly, the last very high priced Canadian customers now coming up for renewal. Once all renewals are, from contract, at market prices, we believe the rates will stabilize around the 70% historical average. The improvements seen in renewal and attrition rates will have a major effect on our long-term profitability. Strong customer growth was also seen at our NHS water heater/HVAC unit, driven by organic and small acquisitions. NHS built its installed base from 165,000 to 235,000 over the year, growth of 42%. NHS has recently moved into Québec and Texas and is seeing positive early results, particularly with our new smart thermostat product. Overall, our customer base has reached 4,457,000, up 10% year-over-year. Just Energy operates in a high growth industry, retailing a deregulated commodity. We are the second-largest residential retailer in North America, and we are the seventh-largest and fastest-growing player in the commercial market. We believe we are well placed to profitably capitalize in our growth. I will have Ken go through the detailed highlights of the quarter and the year end. We will then answer your questions.

[Kenneth M. Hartwick:]

Thanks, Rebecca. Let me quickly cover fiscal 2013 and the quarter, and then I will focus on our future. The customer growth Rebecca has described resulted in fiscal '13 gross margin of $526 million, up 5% year-over-year, falling short of our published growth guidance of 10% to 12%. Our fourth quarter margins were $158 million, down 8% year-over-year. The shortfall was created by both challenges in our Commercial division and the trailing impact of the extreme warm winter in 2011 on our gas business. Fiscal '13 saw realized margins of $121 per customer annually; this was a reduction from the $138 per customer in fiscal 2012. In Commercial electricity, price competition in Texas and unforeseen increased capacity costs in the Northeast resulted in margin compression, both on realized margins and new per-customer margin, which fell from $82 in fiscal '12 to $74 in fiscal 2013. We believe that this situation has stabilized and that margins should remain in this range for fiscal '14. Natural gas realized margins were also down due to the fact that we must reconcile under-consumed gas from the warm winter of fiscal '12 during the first half of the current fiscal year -- fiscal '13. This reduced realized gas margins in the current year despite the fact that winter weather was normal during the period. With these reconciliations completed, fiscal 2014 will not see similar negative impact. The remainder of the company's fiscal 2013 results reflect the cost of our expansion into 10 new utility territories and the sale and marketing costs to bring in the record customer additions seen over the past year. Administrative expenses were $138 million, an increase of 22% over fiscal '12. This increase was higher than the 10% increase in customers due to 2 main factors

[Operator:]

[Operator Instructions] And our first question is from Nelson Ng with RBC Capital Markets.

[Nelson Ng:]

Just a quick question on the NHS business. The government recently -- I think they introduced a bill to kind of double the cooling-off period to 20 days, and to also kind of prevent installations of the water heaters during that period. Has that had an impact on the business yet? Or has it been implemented?

[Kenneth M. Hartwick:]

No. The bill is still in, I believe, its second reading. So it is -- and then it will go off to the committee process within the government process, so to speak. And we think there are opportunities to amend and change some of the provisions within it. We don't disagree with a longer cooling-off period, so if its 20 days, that's fine, whether it's 10 or 20 shouldn't matter. But we do have other items in there that we think that will be addressed in that process. So it has not impacted the business currently, and I think we'll need to see where the bill finally ends up before we could assess it.

[Nelson Ng:]

Okay. And then also on the water heater business, has there been any kind of one-off items in Q4? I was just looking at the numbers, and if my calculations are correct, I think revenues increased by about 50% from Q3. So I was just wondering whether -- like whether the rates have increased materially this year or whether it's like a one-time item somewhere.

[Beth Summers:]

Yes, Nelson, there would be 2 things. The one is in January, is when you would typically see the percentage increase on the contract that we have the ability under the contract to put in place. So for the quarter, you would've seen that percentage increase. You'd also see all the impact from these acquired water heater contracts.

[Nelson Ng:]

Okay. And it's just those 2 items?

[Beth Summers:]

Yes. Those would be the 2 items that would have the largest impact. Yes.

[Nelson Ng:]

Okay. And then just moving on to the NCIB, so you haven't made any purchases yet, and I was just wondering whether you intend to do so. Or under what circumstances would you look to buy back shares or convertible debt?

[Kenneth M. Hartwick:]

Yes. I think given the recentness of the dividend change, our first goal, as we said, we wanted -- we made the dividend change to ensure that we could fund growth and then look to reset parts of the balance sheet. So I think as we proceed along here, our view is the same, that the -- a couple of those long -- the converts that are out in the 17 and 18 range are of more interest to us, and we'll just balance off the cash needs for the growth relative to doing that, which we will do on a monthly basis. So the intention is still there. But again, it's a relatively short period of time since we made the dividend change.

[Rebecca MacDonald:]

I'll just add to it, Nelson, dividend change took place last month. So this is not something that's going to have an impact on what we do on a monthly basis. This is going to have impact on going forward, over the next 3 to 5 years.

[Nelson Ng:]

Got it. And just one last question. Like this past winter, I presume it was an average winter in terms of the temperature?

[Kenneth M. Hartwick:]

Yes.

[Nelson Ng:]

And I was just looking at the Canadian gas business versus the U.S. gas business, I think the margins in Canada went down, whereas the margins in the U.S. went up. I was just wondering -- what was the -- what were the reasons for the -- for that divergence?

[Kenneth M. Hartwick:]

I think you have to -- on the Canadian gas customer base, you actually have a decline in the customer base to begin with, and that would be probably the primary factor. And then, just in general around the gas market, it is the options we had in place and how we effectively account for those. But you have a decline in Canadian gas base.

[Operator:]

Our next question is from Kevin Chiang with CIBC.

[Kevin Chiang:]

I just have a question on your assumption that your renewal rates get back to 70% as you kind of roll through some of your higher-priced contracts. I know the 70% number comes from, I guess, the historical rate that it has typically been at, but when you look forward, with a stable gas price environment, or if we assume a stable gas price environment, is it realistic to assume that you'll get 7 out of 10 customers willing to pay a premium to fix those costs? If what they're reading in the newspaper is that gas prices are expected to remain relatively low for the foreseeable future. And I guess what type of earnings sensitivity or cash flow sensitivity do you have around that 70% number?

[Kenneth M. Hartwick:]

Yes. I guess, sort of -- I look at it maybe a little bit differently in that we're seeing the trend back to 70%, which we've seen now for the last number of quarters. And again, the consumer mindset and this is maybe more true of Canada but, to some degree, in the U.S. is similar to the mortgage analogies that we've used. Interest rates have been low for a long time, but people still go into 5-year mortgages, so why would they? It's still the same -- the premise is the same for the consumer. And I think when we have customers coming off of the equivalent of $8 or $9 gas down to $4 gas, they do question their decision. But what we've seen, and believe will continue, is that when they're coming off of the equivalent of $4 gas on to $4 gas, that we will get that decision made again for the renewal at the levels that we expect. And again, all the data is trending there, and also the other gauge on that one is what is happening with attrition rates, because attrition is just a customer that wouldn't have renewed when they get to the -- or some of them wouldn't have renewed when they get to the end of the contract. The fact the attrition rates are getting better, in line with the same principles, in Canada and the U.S., would tell us that, that is a very realistic assumption.

[Rebecca MacDonald:]

And just to add to it -- I'm sorry. And just to add to it, a few years ago, everybody was looking at declining gas prices and they were even talking about a $2 gas, where it's been settling now in -- around $4 range. It's safe to say that when a customer is looking at relatively stable pricing, that -- on that level, as Ken pointed out, exactly compared to a mortgage scenario, they are just saying, "I don't see them going down but there is a potential, down the road, that they will go up. And I like this price and I like the level that I can potentially lock it in."

[Kenneth M. Hartwick:]

The other thing to note is 70% of our business is electricity. So, again, you have to look on -- it's not just gas prices, it is also what happens to power prices and the volatility in those as well.

[Kevin Chiang:]

Okay. That's a fair point. And you're right, your attrition rates have trended to extremely low levels here. Actually, on that last point you made, on the electricity market, the U.S. electricity business seems to be where you're seeing a good clip of growth, can you -- are you able, I guess, differentiate for me what percentage of those new customer adds come from existing geographies that you currently service, versus new geographies that you happened to move into over the last couple of quarters? Like is this -- are these -- are a lot of these -- is this uptick in increasing market penetration within existing geographies? Or is this a reflection of your growing footprint, overall?

[Kenneth M. Hartwick:]

Well, I think it's our -- what I said in my commentary that we've entered a number of new utility jurisdictions in the past year, and our sales force, led by our door-to-door group, is very intentionally slow and methodical when we go into a new jurisdiction to make sure we're -- have the marketing right, have the sales process right. So a lot of the additions in fiscal '13 are coming from existing markets that we've been operating in, and we -- as we enter the other ones, we slowly build them. And that's why I mentioned that by year 2, they start to look better from a cash flow standpoint, and then year 3 are almost all positive. So -- and I think the reason we're bigger in electricity is those markets are just bigger in the U.S. and the product itself is more volatile, so it's easier than natural gas to get a good customer value proposition. So that's -- if we're going to put our next best sales organization in a market, it's going to be probably directed towards electricity market.

[Kevin Chiang:]

Okay. And can you remind me again what your market share is within the geographies you currently play in? And where you view the kind of that threshold is where the churn is more 1 for 1 and it's tougher to kind of get that incremental customer? If I remember it correctly, I thought you were around 5%, and you thought like 10% or 15% was where the market penetration gets more challenged?

[Kenneth M. Hartwick:]

Yes, you're exactly right. We'd be somewhere between 5% and 6% depending on, again, how long we've been in a particular state. And let's say, in virtually every market we operate in, we can easily see us doubling our customer footprint in that market over the upcoming years. So we think it's realistic to expect to get to 10%, in the U.S., specifically.

[Rebecca MacDonald:]

And that's obviously over time. And remember that most of those jurisdictions that we operate have a much higher population than we ever had in Canada. So that's why it's not surprising after all of these years that 70% of our revenue is coming from the States. It's the sheer number of potential customers that we've got there.

[Kevin Chiang:]

Okay. Point noted. And then maybe lastly for me, just on your leverage targets, your debt-to-EBITDA target, maybe you can just walk me through, in greater clarity, how you think about getting there and the levers you need to pull to get to your targeted leverage ratio. And the reason why I ask that is, you have a naturally increasing debt level through your self-financing mechanism at NHS, and it seems to me as though, while I agree that your dividend cut was prudent and does save you some cash flow, it seems like a big chunk of that goes to offset that growing NHS debt, at least when I look at the trajectory over the past 3 years. So how do you get the debt lower then? Is it -- do we need to see better earnings, better renewal rates? Is the dividend cut sufficient within your modeling? I'm just trying to get a sense of how you view the path to your leverage target.

[Kenneth M. Hartwick:]

Sure. I think there's 3 parts to it. First of all, to answer your question, we do think the dividend cut is sufficient, so to remove that from the equation. But the first part, obviously, is just earnings. As we head towards the embedded margin book that we have built on existing customers, which will contribute towards the $220 million of EBITDA in the fiscal '14, the guidance that we've given. And in the guidance we've said that moving towards that payout ratio of 60% to 65% over the upcoming number of years, by its nature, generates cash flow that we can use to remove some of the leverage on the company, including some of the converts that we have, which is a form of debt. So that's step 1. On NHS, it is self-liquidating so it's -- acts very much like a mortgage, and as that base of customers has grown, and those customers pay back the debt that has been incurred on them. On a relative basis, the number of new NHS customers we're adding relative to the base should allow that number to stabilize as well. And again, it's very much back, but the first -- your first point was right. It is the earnings performance of that embedded margin that will allow us to move towards the debt levels that we think is appropriate.

[Rebecca MacDonald:]

And I have to tell you, we cannot emphasize strong enough, because of speculation that's out there on the Street, how confident we are when we look into our dividend cut and making sure that, that was sufficient for us to satisfy all our needs and lower the leverage over the next 4, 5 years. So if anybody out there is talking about Just Energy doing another dividend cut, they are very, very wrong. And we want that on the record.

[Kevin Chiang:]

And, I guess, is that how you got to the fiscal 2016 time frame? Because I would imagine, if I remember correctly, a lot of your NHS contracts have a roughly 5-year length before the -- as you mentioned, they're self-liquidating. So is it in that 2016 time period that we should start seeing that roll forward?

[Kenneth M. Hartwick:]

Yes. And we've been in the business on the -- some of the contracts, I think, we're entering our fifth year of the NHS business or about to. So like I say some of those contracts, to the extent that they exist, are going to start being free of the cash flow. And -- but the 2016, that was -- by us giving the guidance we did, that was around the cash flow from the dividend change and just the pure earnings of the company.

[Operator:]

[Operator Instructions] Our next question is from Damir Gunja with TD Securities.

[Damir Gunja:]

I just wanted to get a little clarity on the Northeast Commercial electricity business, and just to understand the gross margin compression there. You were citing increased capacity costs, what exactly did that involve?

[Kenneth M. Hartwick:]

Yes. In the number of the markets that we operate in, the cost or price to the -- to a commercial customer is comprised of an energy element and then a capacity piece. And what we saw in the Northeast was typically capacity, especially for some of the more constrained areas, might be in the 10% to 15% range of the total cost to the customer or total price to the customer. And with a number of the constraints that we saw in the last year was -- or in that period of time, was that, that changed closer to 25% to 30% of the total, because of constraints in the system itself. And that's something -- so from our standpoint, it obviously impacts the margin of the customer. Capacity you cannot -- it hedges differently than energy. And what we've really done from a going-forward basis, until we see the volatility maybe reduce again, is really allow some of that to be passed through to the customer, which virtually all of our competitors now are now doing because of the same dynamic that we saw that they saw, or at least capping what portion of capacity we'll fix. So again, it's like I say, each of our competitors have seen exactly the same thing and are approaching the customer arrangement the same way I've just described.

[Damir Gunja:]

So sounds like it will be less of an issue going forward?

[Kenneth M. Hartwick:]

Yes.

[Damir Gunja:]

Okay. And I guess, obviously, your guidance for EBITDA, a lot of that has to do with operating leverage heading into the new year here. How are you thinking about margins on a year-over-year basis? I guess, customers lost versus customers gained? Are we going to see that gap narrow a little bit?

[Kenneth M. Hartwick:]

Yes. I think for -- I think you're going to see the gap between the 2 be very, very small. So it's what we add will be within a few dollars of what we lose.

[Damir Gunja:]

Okay. So marginal improvement there?

[Kenneth M. Hartwick:]

Yes.

[Damir Gunja:]

Okay. And the potential for strategic alliances, how should we be thinking about that? I guess on the one hand, thinking about that, I mean, potentially a big driver? Or is it more of a slow, gradual build as you develop a relationship and sort of add customers?

[Kenneth M. Hartwick:]

Yes. I think it's on any type of partnership or alliance that we do, it will be slow and gradual. I think that's on both parties of any partnership. It's going to be how do you make sure that you have the right customer propositions working, but it's something that I think we're actively working on and -- but like I say, we think it has big returns but starts very slowly. And which is why we'll focus on the 2 or 3 that we are interested in.

[Rebecca MacDonald:]

And you know, Damir, the whole premise is looking forward to the next 5 years of how we will be positioning the company and including our bundling services with the different strategic alliances. So as Ken said, it's going to be slow but over time it's going to grow, because everybody is looking or figuring out how to maximize their customer base value.

[Damir Gunja:]

Okay. Maybe a final one for me, you mentioned you're only entering one territory for the coming year. I guess that's maybe partially a conscious decision to try and sort of rightsize the cash flows? Could we see an acceleration again in 2015 as you start to expand a little further?

[Kenneth M. Hartwick:]

Actually, it's not -- we're -- the reason for entering one is that we're in, now, virtually everywhere. So really, I think before you'll see us enter 2 or 3 more states, for instance, deregulation process has to further advance itself in those states. We have states like Arizona that is just beginning to examine the full deregulation of the state, but that's a 2-year process. So from the time they start what they're doing to the time they actually open for competition is 2 years out. So it's as much a function of we spent a little bit of 2012 and '13 building into everywhere we needed to be. And now it's the case of we'll wait for other states to open, but we have no market share constraints so it doesn't really affect the business, but it does make it more profitable because we're not spending to open 10 new markets.

[Operator:]

Our next question is from Stephen Sax [ph].

[Unknown Shareholder:]

First of all, I'm glad that you reconfirmed the dividend. And to get that on the record. I'm an investor in the company. And the other question I have is regarding the Carbon Offset Program. I know the company made some releases on that, but I didn't hear anything about that. How is that growing? And I'd like to know the answer on that.

[Kenneth M. Hartwick:]

Sure. Our green program, in general, whether it's the renewable energy credits or Carbon Offset Program, continues to be a major part of our particularly residential part -- or Consumer part of our business. So I think we are up to approximately 90 renewed -- green projects that we've contracted with or are buying the renewable energy credits and/or the carbon offsets from. So -- and, I think, from a customer standpoint, we're sort of consistently in the high 20s, low 30s with respect to customers who choose some element of green. So yes -- no, maybe we didn't talk a lot about it in the scripting, but it is -- remains a very big part of what we like to do as a business.

[Operator:]

Our next question is from Robin Gullason with RBC.

[Robin Gullason:]

I'm just wondering if you can comment on your revolving credit facility that expires later this year?

[Beth Summers:]

Yes. It is -- as you're saying, on December 31, it would expire. We plan on having it renewed well before the end of the year.

[Robin Gullason:]

Okay. Do you think the terms will be in line with previously? Or...

[Beth Summers:]

That would be something that we're currently in the process of negotiating.

[Operator:]

[Operator Instructions] The next question is from John McIlveen with Jacob Securities.

[John McIlveen:]

Yes. I believe there's a potential earnout on to the prior Fulcrum shareholders? Will that payment -- I think that was $20 million, will that payment be made in Q1?

[Kenneth M. Hartwick:]

The -- you're referring to the Fulcrum acquisition from 1.5 years ago? So we are just in the process, actually, of submitting the information to go through the earnout mechanics right now, which actually started as of yesterday. So that's something that we will be able to comment on more fully as we go into our Q1. But the process on that has just started with the various audits and other things that need to be done.

[Operator:]

[Operator Instructions]

[Rebecca MacDonald:]

Well, if there are no other questions, we would like to thank you for your support, and if there are any further questions, feel free to call our CEO, Ken, and our CFO, or myself, any time. And we look forward talking to you in the middle of August, when we will be reporting our first quarter. And just a reminder to all of you, at the end of June, we will be having our AGM. Thank you very much again for attending this call.

[Operator:]

Thank you, ladies and gentlemen. That concludes this webcast.