OGE Energy Corp.
Q2 2014 Earnings Call Transcript

Published: 7 Aug 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Q2 2014 OGE Energy Earnings Conference Call. My name is Mark and I'm your operator for today. At this time, all participants are in listen-only mode, and we will conduct a question-and-answer session later in the conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes. I would now like to hand the call over to Todd Tidwell, Director of Investor Relations. Please proceed.

[Todd Tidwell:]

Thank you, Mark, and good morning, everyone, and welcome to OGE Energy Corp.'s second quarter 2014 earnings call. I'm Todd Tidwell, Director of Investor Relations and with me today I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp.; and Sean Trauschke, President of OG&E and CFO of OGE Energy Corp. In terms of the call today, we will first hear from Pete, followed by an explanation from Sean of second quarter results. And finally, as always, we will answer your questions. I would like to remind you that this conference is being webcast and you may follow along on our website at oge.com. In addition, the conference call and the accompanying slides will be archived following the call on that same website. Before we begin the presentation, I would like to direct your attention to the Safe Harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to-date. I would also like to remind you that there is a Regulation G reconciliation for gross margin in the Appendix, along with projected capital expenditures. I will now turn the call over to Pete Delaney for his opening comments. Pete?

[Pete Delaney:]

Thank you, Todd. Good morning everyone and thank you again for joining us this morning. Earlier we reported second quarter 2014 earnings of $0.50 per share, compared to $0.46 per share in 2013. As in the last quarter the primary driver for increased consolidated earnings was higher profitability from our LP ownership interest, and the Enable Midstream MLP. And they have reported solid earnings earlier this week and announced increasing its quarterly distribution by almost 3%. We were very bullish about the value, associated value creation from Enable's growth prospects and the IPO, in particular, our ownership of 60% of the IDR rights. Providing the majority of our annual earnings, the utility continues to perform in line with expectation. Although the weather has been cooler than normal, this quarter we have a lot of third quarter left, our 2014 consolidated earnings guidance of $1.94 to $2.06 per average share remains unchanged at this time. As the utility increased, margins were driven our growing FERC transmission investment. We are projecting approximately $44 million of increased margin in 2014 from these investments, and new customer growth in our service territory has added $3 million to margin in the quarter. As expected and discussed on our last call, the U.S. Supreme Court elected to not to hear the appeal of the lower court's decision filed by the Oklahoma Attorney General and OG&E regarding the EPA's Federal Implementation Plan on regional haze. As a result, and as I mentioned on last call, we would be ready to proceed quickly and we are implementing our compliance plan. In short, the plan provides for dry scrubbers to be installed at the two Sooner units, a conversion of two coal units of Muskogee to natural gas, and replacement of a 60-year-old Mustang gas plant with 400 megawatts of CT. Development of our compliance plan has four basic parameters. First, we want to determine the lowest risk base cost option for our customers. Second, we have to be able to meet a 55-month regional haze compliance timeline and April 2006 timeline for utility MATS. Third, we wanted to best position the generation portfolio for the future, including the day 2 SPP marketplace. And finally, maintain an increase or optionality to respond to future uncertainty such as pending CO2 rules. We believe, we have accomplished this in our plan, and Sean will discuss the plan in greater detail later on the call. We now have 53-months left on our compliance deadline to meet the emissions limits. In June, is the first step in our regulatory process, we filed a draft of our Integrated Resource Plan with the Oklahoma Corporation Commission and just completed a 60-day comment period. Monday, we submitted our final IRP and our Environmental Recovery Plan was filed with the Commission yesterday. We've been working with the commission staff and others to hope we get a decision from the Oklahoma Corporation Commission in February of 2015. We also filed for recovery with the Arkansas Commissions in the third quarter of this year. We have asked the commission to allow for recovery under a rider of our 1.1 billion of expenditures. CWIP would help further levitate potential rate shock to customers. The last thing we want to do is give our customers a double-digit rate increase at one time. The capital investment and coal conversion plan is perfectly back-ended to defer as long as possible the impact on customers. We plan on running those coal plants well into 2018. We believe the plan keeps to increase in rates to an affordable annual increase over the planned timeline. Our large transmission investments are winding down and enables providing significant cash flow. So from a cash flow perspective we are well positioned to finance the plan without accessing the equity markets. We are filing our compliance plan or a House Bill 1910 that was passed years ago providing for presumption of prudent on our part, on regards to recovery expenditures to comply with federal or state environmental regulations. Statue provides for rate case to be filed within two years of the decision on the environmental plan. Accordingly, we are contemplating a filing based on the 2014 test year to comply with that provision, as well to pick up the June 2015 expiration of a wholesale power contract, and return that capacity into the retail rate base, at a cost of around $240 per kWh which was of course a very deal for our customers. As noted on our last call, the now Vice Chair of the Oklahoma Commission Patrice Douglas announced her decision to step down and is in a runoff for the U.S. Congress seat. Commissioner Bob Anthony has stepped in as chair in her place; and Douglas will remain as Commissioner until January of 2015. Former Oklahoma House Speaker Todd Hiett won the primary on June 24 and without a democratic opponent, he is scheduled to replace Douglas at the Commission. Our experience with the commissioner elect is a quick study, a hard worker, and we do not anticipate any delays in the case because of his election. As always when pertinent information regarding the case become available we will share it with you. Our service territory economic outlook remains strong compared to the second quarter of 2013 we've added over 9,000 customers to the system and weather normalized sales continue to grow at 1.5%. I read it earlier this morning that in July the state tax revenues was the highest in July in the States history. So things are well continue to be, do well here. Unemployment remains low and Oklahoma City continues the strong growth and per capita income increases. In Portsmouth we will see continued economic rebound, adding of new customers and expanding facilities in that region. Implementing the environmental compliance plan, including the Mustang modernization is important, but we are continue to execute on other initiatives that are perhaps more strategic. We are delighted to once again win the J.D. Power number one ranking for residential customer satisfaction among large utilities in the southern region. We are continuing to leverage our smart grid investment in new products and service offerings, as well as applications for more effective operation, and improved customer experience. We are also preparing to pursue additional transmission opportunities outside of our footprint under FERC order 1,000. In fact we proposed a number of projects and the Southwest Power Pool is scheduled to grant awards after the first of the year. The Enable IPO was an important part of our establishing an equity funding deals for growth capital of that business, for providing a source of cash flow through the distributions for environmental compliance plan and utility, for funding dividend growth to support our balance sheet, and to improve as a separate equity vehicle improve visibility and the valuation of that business. Enable announced a 2.6% increase in the quarterly distribution rate and provided a glide path for the GP distribution to start in the last quarter of 2015. From our standpoint OGE's valuation, stock valuation does not reflect our 60% claim on these potential future cash flows. With our projecting cash flows we fortunately do not expect to need to have issue equity at these prices. We do expect to be able to fund our environmental compliance through cash flow and debts, even as our cash taxes increase over the next few years. As we have stated in the past, we are committed to growing earnings and dividends at OGE Energy it is an important part of total shareholder return equation. We are well aware our payout ratio is lower than the average and despite the increases in dividend growth rate in recent years. The funding strategies provide higher earnings in the long run and should not preclude management from once again recommending, as we have in the last four years, of an increase in the dividend growth rate when the board reviews dividend policy in December. With that, I would like to turn the call over to Sean who will review our financial results for the second quarter in greater detail. Sean?

[Sean Trauschke:]

Thank you, Pete and good morning. For the second quarter we reported net income of $101 million or $0.56 per share, as compared to net income of $92 million or $0.46 per share in 2013. Year-to-date consolidated earnings per share was $0.75 in 2014, compared to $0.58 last year. The contribution by business unit on a comparative basis this is listed on the slide. At OG&E, net income for the quarter was $77 million or $0.38 per share, as compared to net income of $79 million or $0.40 per share in 2013. Second quarter gross margin at the utility increased approximately $14 million or 4% which I will discuss on the next slide. O&M was $8 million higher for the quarter compared to the second quarter of 2013. The increase was driven by a reduction in capitalized labor as compared to last year. As you remember in the second quarter of last year the utility was performing strong restoration work related to the severe weather that affected our service territory in May. Depreciation and amortization increased $3 million compared to the second quarter of 2013, primarily due to additional assets being placed in the service. And finally, the increase in interest expense of $4.5 million was primarily due to the $250 million of long-term debt issued in May of this year. Turning to the second quarter gross margin, utility margins were up for the second quarter despite the impact of weather compared to 2013. There were two primary drivers for the increase in gross margin. First, was an increase of wholesale transmission revenues contributing $13 million; and second, growth from new customers increased gross margin by $3 million. We added over 9,000 new customers to the system compared to the second quarter of 2013. And on a weather normalized basis, oil field sales continue to grow and were up nearly 5% for the quarter; partially offsetting these increases was mild weather as compared to 2013. Looking closer at weather, there is a saying that not all cooling degree days are treated equal. This quarter was the perfect example. Cooling degree days were above normal in about the same period last year. However, those days were mostly in April/May and did not translate into increased margins because of the difference in rate blocks between summer and shorter months. The mild weather decreased gross margin by $8 million compared to normal and $2 million compared to last year. And looking at the full year impact from weather, recall we had a benefit in the first quarter from weather. So the weather impact year-to-date on gross margin was $6 million higher than 2013, and $10 million higher than normal. Turning to our interest in Enable. For the second quarter of 2014 natural gas midstream operations contributed after-tax equity income to OGE Energy Corp. of $24 million or $0.12 per share, compared to $15 million or $0.07 per share in 2013. You know, I apologize for the busy slide with the move to the equity method of accounting and make these comparisons difficult. But since we closed in the second quarter of 2013, this will be the last quarter we have to show both accounting methods. However, the results for the second quarter at Enable are solid and reflect the accretive effect of Enable transaction, as well as the higher gross margins in the business. Year-to-date Enable Midstream has made distributions of approximately $77 million to OGE and contributed equity earnings of $0.27. As Pete mentioned earlier, OG&E filed its environmental plan yesterday with the Oklahoma Corporation Commission. First and foremost, we will be in compliance with the EPA regional haze and MATS Rule. At a high level, the plan includes adding scrubbers to Sooner Units 1 and 2 converting the Muskogee Coal Units 4 and 5 to natural gas and replacing the Mustang Units with quick star combustion turbines. The plan maintenances fuel diversity ensures SPP capacity requirements are met and provides the lowest reasonable cost to our customers. The total cost for the construction is projected to be just over $1 billion. And as you can see on the slide the investment ramps up and peaks in 2018 just prior to the January 2019 regional haze compliance deadline. Some of this can be attributed to the long lead items and production timeframe but the other part of the driver is the schedules that we intent to run the Muskogee coal units as long as possible for the benefit of our customer. As you can see from the previous slide, these expenditures have significant impact to rate base. This projection does not include any additional growth in FERC regulated rate base from additional SPP transmission projects. But we wanted to convey the relative size of this environmental plan to the company. Environmental compliance plan will increase customer rates and it's our job as a team to control the cost and help offset some of these rate increases. Before I discuss guidance, I want to go over some of the key milestones of the regulatory timeline. As Pete mentioned earlier, we filed for recovery of our environmental compliance plan yesterday with the Oklahoma Commission. We've asked for a ruling in February of 2015. We have until January of 2019 to comply with regional haze and until April of 2016 for MATS. It is important to note that Oklahoma House Bill 1910 requires OG&E to file a general rate case within 24 months of receiving the order for recovery. We will most likely file this case sometime in 2015. The process is a little different in Arkansas, as we are required to request a declaratory order proving our environmental plan. We will follow that with a rider application under Act 310 to recover the expenditures. We expect to have the rider in place in the first half of 2015. In addition, Arkansas rules require Mustang to be in service and for OG&E to file a general rate case for recovery, which we plan to do in 2018. Moving on to our long-term growth rate. In 2010, we established a key financial objective to grow earnings between 5% and 7% annually. And I'm pleased to announce that the midpoint of 2014 guidance that equates to nearly 8% compounding of growth rate. Because it's been a number of years since we refresh the growth rate, and the base year, and given the large environmental capital program, we will refresh that on our 2015 earnings guidance call at year-end -- on the year-end call. Before answering your questions, I want to discuss our 2014 earnings guidance. It remains unchanged at $1.94 to $2.06 per share. Through six months the utility is on plan and as you know, the vast majority of our earnings occur in the third quarter. Turning to the Midstream business. Things are going well at Enable. But I do want to clarify one point about our Enable guidance. Although, the guidance range is the same, we are now including the dilution from the IPO in this guidance. This was approximately $0.02. Recall, we originally excluded that guidance because of the time of issuing guidance, the amount and timing of the IPO is unknown. This concludes our remarks. And now we'll open it up for questions.

[Operator:]

(Operator Instructions). Please standby for your first question, which comes from Matt Tucker of KeyBanc Capital Markets. Please proceed.

[Matt Tucker:]

First, I just wanted to ask about the utility O&M. I believe you mentioned that there were some elevated costs tied to weather. Just hopping you could may be give us a little more detail on those types of costs and give us a sense of kind of what the underlying O&M growth looks like?

[Sean Trauschke:]

Sure Matt, this is Sean. So we've been doing a really good job of maintaining our O&M growth and trying to manage that kind of a rate of inflation now more than a rate of inflation. So from an O&M standpoint we're on plan see no issues this year. What occurred in 2013 is recall we had some pretty severe tornadoes come through this service territory in May. And so as a result in 2013 a lot of our time was restoring the system and now it's capitalized. So what was typically would have been O&M expense was capitalized in 2013. We were fortunate we did not have storms this year. All that being said, from an O&M standpoint and operating expenses were right on plan.

[Matt Tucker:]

Okay, great. And then I have a few --

[Sean Trauschke:]

Did that help?

[Matt Tucker:]

Sorry.

[Sean Trauschke:]

Did that --?

[Matt Tucker:]

Oh, yes, that was helpful. Thank you. The rest of my questions are going to be on the environmental compliance plan. First, it looks to me at first glance like what you filed yesterday was pretty similar to the plans you had recommended in the IRP filing a couple of months ago, are there any major differences that I might have been missing?

[Sean Trauschke:]

No, not in our plan, no. I think that it was consistent. We went through a process there where interested parties, we reviewed it with them really trying to gain alignment. And so we made some minor tweaks and adjustments but the fundamental core plan is the same.

[Matt Tucker:]

So are there any aspects of the plan that you think could be more controversial than others or you may get more push back from either your regulators or the EPA?

[Sean Trauschke:]

Well, Matt I think one thing that's important to note here is this is a mandate. This is not an election and we're required to comply and we will comply. And so -- and then I think it's our job to figure out what's the best way to comply with this for the benefit of our customers and sales for the long-term. I will tell you that there certainly will be a lot of opinion, the EPA have their views about certain field types. There is a view that you could have more gas. You could have more renewables. Matt, I can assure you that we've looked at all those different permutations, risk those under different assumptions for gas and future regulations and this is the right plan.

[Matt Tucker:]

Okay. And then you mentioned some aspects of the plan where there are long lead items and it looks like the spending trajectory is really pretty back-end loaded over the five-year period. Are there any aspects of the plan where you are particularly concerned about getting the projects done by the deadline?

[Sean Trauschke:]

Well I think the most significant projects are probably the scrubbers. And so the sensitivity there is those are long lead time activities. And what we're trying to do when we bring the co-units down to tie those scrubbers in, we want to make sure that we're doing that in the shoulder months or the winter time, you don't want to do that in the summer time. So you want to make sure you maximize that benefit too. But we've been doing a lot of engineering work prior to this on those scrubbers. We're working forward, moving forward, and that's probably the longest lead time item we have is getting those scrubbers and service. As far as the conversion as I said in my remarks we are going to run those co-units through the summer of 2018 wait till the very end there and then convert them. So we think there is a lot of value to our customers to continue to run those. So I would -- to answer your question, I think the scrubbers are probably the big gating item for us because those are long lead time items and we want to minimize the interruption to generation.

[Operator:]

The next question comes from the line of Brian Russo of Ladenburg Thalmann. Go ahead your line is open.

[Brian Russo:]

I think you mentioned earlier that the board is going to review the dividend in December. Sean may be you can just kind of talk a little bit more about what's kind of a reasonable dividend growth range that you might recommend to the board given all the moving parts?

[Pete Delaney:]

Well, Brian, I will jump in on that. It's Pete. And we've -- yes, on several calls we have talked about that we're aware, our payout ratio is low on the average and we've talked inconsistent about. We have the litigation and wanted to -- we would hope that we could prevail and that would have added significant impact on our CapEx requirements and financials of the company. We wait to see how that turns out. We know how that turns out. Now we're moving ahead of our compliance plan. That was one of the large triggers the Enable IPO was the key item that we wanted to see how it worked out, which has gone well. And so we're moving those, we're checking those off and we have been growing our growth rate, as you know, the last several years and then our expectations are continue to do that. When we looked at our total shareholder return over the last few years and the attribution for that, it appears that relative to all the utilities about twice the amount of our attribution can be towards earnings growth rate. And I suppose the dividend yield compression and what that sets up for where we are today, I think, well for our ability because of our 8% compound annual growth rate to grow or continue to grow, and recommend that increase to the board. I think it's really not appropriate for us to tell you before we tell the board, what we think the right increase is. But we as a management team are dedicated to continue to grow that dividend and increase that growth rate which we think we should be that we're well positioned to do.

[Brian Russo:]

Okay. So just to summarize potential dividend growth recommendation could mirror that of your historical earnings growth?

[Pete Delaney:]

Well, we've been our historical growth 8% -- in the last year was 8%. So we are pretty much already at our historical growth rate on our dividend increase. So from there we are obviously what we're talking about we would be going up from there.

[Brian Russo:]

Okay. Got you. Thank you. Could you just outline what's the appropriate effective tax rate on the distributable cash flows from Enable to OGE?

[Pete Delaney:]

Sean?

[Sean Trauschke:]

Sure, Brian. So today as we've mentioned before we are in a NOL position. So the effective tax rate coming out of the distribution -- coming out of Enable is zero. We are not paying taxes on those. And I want to make sure, I know this gets confusing sometimes but remember as an owner of Enable -- an equity owner of Enable those distributions that come out are included in our consolidated tax returns at OGE. And so Pete was talking about the dividend, as we've discussed, as we become a federal tax payer and our tax rate increases that is the use of cash going forward. Okay.

[Brian Russo:]

Understood. When do you think you might start paying taxes or have to pay taxes on the distributable cash flows?

[Sean Trauschke:]

We are not expecting to be a full tax payer prior to 2016.

[Brian Russo:]

Okay. Great. And then can you possibly quantify the FERC SPP 1000 transmission project opportunities?

[Pete Delaney:]

Unfortunately Brian, we can't that's confidential process and but we submit the projects, we will tell you that we submit the projects in Oklahoma. We also propose some projects in Texas and Kansas and we think it would be good idea. The SPP received significant number of proposals. So it's going to take them a while to work through their process. And as soon as we receive a notice to construct we will let you know.

[Brian Russo:]

Okay, understood. And then I just want to understand House Bill 1910 and the whole regulatory process that you guys have begun with the compliance filing. You're requesting a tracker but according to House Bill 1910 you would be required to file a rate case two years following approval of a tracker is that accurate?

[Pete Delaney:]

Within two years. Within two years.

[Brian Russo:]

Okay. So potentially you get the tracker around the regional haze spend and then you will just true up rates with the 2014 test year?

[Sean Trauschke:]

Right.

[Pete Delaney:]

Yes, that's our current thinking right now.

[Brian Russo:]

Okay, great. And then lastly, Pete, there seems to be somewhat of a disconnect in the marketplace with OGE stock and Enable's performance since the IPO. And it seems like some of the parts proposition just isn't being realized. And I'm just wondering strategically have you ever considered kind of a OneOk structure where you can split the GP and the LP for spinoff OG&E utility to add transparency and kind of matchup different sets of investors that are looking for different fundamental drivers?

[Pete Delaney:]

Brian as you can see the sector, as you know and everyone on the phone as well as better than I, have gone through. Again some changes here probably driven by perception around interest rates and as it relates to Enable IPO and that it's done well that the units have done well, which we're obviously excited about and looking at some of the parts and one of the things that we're very much aware that until just couple of days ago there was not a lot of clarity around the distribution growth rate at Enable. And which of course did not provide a lot of clarity heretofore about when we would be in the splits and for our general -- for our IDR ownership. And our belief is that that visibility has to be provided to the market for us to be able to start to get some value for IDRs. And as you stated, and I think that I stated in my comments and agree with, it's although the analysts are starting to put a value out there in terms of what the GP IDRs have worked to us on a per share basis, we have not seen that, in our opinion, based on what may be if I look more like a longer-term sustainable multiples for utility or that's actually not in our stock price. But however that guidance has only been out there for a couple of days. We're going to continue to work and get that story out there and we don't make, as you know, we're very thoughtful, we take long-term approaches to building value where we're committed to that all of the transactions we've done. When we felt that Enogex and we were for whatever reasons not getting buying that stock, we went ahead with ArcLight partnership and then the CenterPoint transaction in the IPO. So I hope that our actions demonstrated we are committed to closing valuation if there seems to be some structural, if you want to call structural issues getting the way of what we would think the fair value for our shareholders. That I would say I don't think, we instead of reacting to of course movements in the markets, which happened at the time when markets and investor shift and money around as you well know. So we're confident that the value will be realized longer-term and we're committed to making that happen and we don't think that we think that OneOk is a really different situation than we have here.

[Brian Russo:]

Okay. Just a follow-up on the tax rate for the DCF. What tax rate should we assume in 2016?

[Sean Trauschke:]

I'm just forecasting out there Brian, but may be 38% be a good number.

[Brian Russo:]

Okay. Great and thanks for the updated rate base in CapEx, guys. Thanks a lot.

[Operator:]

The next question comes from the line of Sarah Akers of Wells Fargo. Please proceed.

[Sarah Akers:]

Just a follow-up to Brian's question on the rate case timing. It looks like you have the option of deferring that filing until well into 2016. So can you just talk about what's driving your current thought process in filing next year and what factors might impact that decision on timing?

[Sean Trauschke:]

Sure. So Sarah, this is Sean. So Pete mentioned in his comments, we have a wholesale transmission contract that expires in -- wholesale, not transmission. Generation contraction that expires terminates in June of 2015. And so what Pete was talking about is we're going to as part of the rate case would roll that back in to a crew that low cost of generation back into benefit of our customers. We recover that. We also have the last line of the transmission. An investment program we're involved in comes into service later this year. So we pick that up too.

[Sarah Akers:]

Okay. So the test year would be trued up through mid-2015 to pickup that contract, is that how that would work?

[Sean Trauschke:]

Yes. There is --

[Pete Delaney:]

Right.

[Sean Trauschke:]

Yes, it's. Year-end 2014 test year was kind of six month look forward.

[Sarah Akers:]

Got it. Thank you. And then a question on the rider request in Oklahoma. Are you hearing a lot of pushback based on your initial conversations with the staff? And then, separately is there a President in the state for including CWIP in rates?

[Sean Trauschke:]

It's allowed for in the legislation. There's not necessarily, CWIP has been granted in the state many years ago, but it's not a common occurrence. As far as the staff is concerned, we've been meeting with the staff, the commission, and interested parties since late January of this year for the simple purpose service. We have to move forward. We have to be in compliance and we didn't want -- and we want to make sure that everybody had a fair amount of time to get their arms around this. And so we're in constant communication with the staff and the commission and everybody is aware of the timeline and the need to be in compliance here.

[Sarah Akers:]

Great. And then last one is just a clarification on the rate base slide. I assume those numbers include CWIP on environmental spend, correct?

[Sean Trauschke:]

No. No, they don't.

[Sarah Akers:]

They don't.

[Sean Trauschke:]

No.

[Operator:]

We have no further questions. So I would like to hand the call back to Pete Delaney for closing remarks.

[Pete Delaney:]

Thank you, Operator. And just like to thank you all for being on the call this morning, for your continued interest in OG&E. And of course, I would like to also thank our members for their hard work, for their focus on safety, and their commitment to moving this company forward. Thank you again. And have a great day.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect. Enjoy the rest of your day.