South Jersey Industries, Inc.
Q4 2016 Earnings Call Transcript

Published: 24 Feb 2017

[Operator:]

Good day, ladies and gentlemen. And welcome to the Q4 2016 South Jersey Industries Earnings Conference Call. My name is Joy and I will be the operator for today. At this time, all participants are in listen only mode. [Operator Instructions] I would now like to turn the conference over to your host for today Marissa Travaline. Please proceed.

[Marissa Travaline:]

Thank you, Joy. Good morning, everyone and thank you for joining us to review SJI' fourth quarter and full year results year 2016. Joining me this morning to present on the call are Mike Renna, our President and CEO; Steve Clark, our CFO. We also have several additional members of our senior management team here today to help address questions following our prepared remarks. Our release and the slides intended to accompany the call were issued after the close of the market yesterday and are available on our website at www.sjindustries.com. The release and its associated 10-Q provide an in-depth review of earnings on both the GAAP and non-GAAP basis, using our non-GAAP measure of economic earnings. Reconciliations of economic earnings to the comparable GAAP measures appear in both documents. Let me note that throughout today's call we'll be making references to future expectations, plans and opportunities for SJI. Actual results may differ materially from those indicated by these statements as a result of various important factors, including those discussed in the Company's forms 10-K, 10-Q filed with the SEC. That said, I'll turn the call over to our CEO, Mike Renna to discuss fourth quarter performance and future initiatives in the context of our strategic plan.

[Mike Renna:]

Thanks Marissa. Good morning, everyone. Our 2020 plan is built on four principles. Earning growth, earnings quality, and strong balance sheet and reducing risk. And our 2016 performance represents successful year one of that strategy. We've delivered 4% earnings growth in 2016 despite the actions we took to reduce the contributions to earnings from investment tax credits by $29.2 million, a reduction of more than 75%. We achieved the high end of our economic earnings per share guidance while also conducting a highly successful equity offering during 2016. We utilize this offering to shore up our balance sheet, helping reset our equity to cap ratio more closely to our targets. And ensuring we can respond with agility to the opportunities for growth that lie ahead of us. As a result of the investments made to strengthen our utility, we filed the base rate case with the BPU on January 27. The filing which requires an increase to base rates of approximately $75 million is based on investments expected to total more than $500 million to our last base rate case. Additionally, low natural gas cost and the benefit we've been able to provide customers through BGSS bill credit have produced customer bills at levels below those seen 15 years ago. Looking ahead, we expect to invest an additional $1.4 billion through 2020 on infrastructure. With more than 90% of that focused on regulated and utility investments. Included in that projection is $300 million under our accelerated infrastructure replacement program which will allow us to replace all remaining bare steel and cast iron main in our system over the next five years. Additionally, with the most recent extension and expansion of this program, we've separated the regulatory recovery of the investments associated with this program from any base rate case filing. We are also evaluating an extension to our Storm Hardening and Reliability Program or SHARP. Through the first phase of that program we are upgrading our service along the barrier islands from low pressure to high pressure. An extension of this program could look to reinforce across our territory and in turn better protecting our communities against severe weather or other threats to service reliability. Another project essential to the region is to propose South Jersey Gas Pipeline to serve B L England. As many of you know the battle to bring this pipeline to construction began over three years ago when we first sought approval to go to supply line that would allow B L England to convert from coal to clean burning natural gas. Just as importantly, this line will provide critical redundancy to more than 142,000 residence in Cape May and Atlantic County, many of whom live in the Pinelands. We expected opposition to the project, passionate and vocal opposition. That is okay. What is disappointing however is the lack of misinformation used to simply disrupt and stall the approval process? Despite the rhetoric of our opposition, we remain a South Jersey company with deep roots in the local community and even deeper commitment to this region. With that in mind, we remain very optimistic that the Pinelands commission will vote to approve this critically important project. And we look forward to moving this project forward. Moving over to our midstream business, we continue working with our PennEast partners to bring this vital interstate pipeline to our region. We all recognize what a long -term supply of low cost, locally sourced shale gas can do to drive economic development for New Jersey. And we are proud to be a part of project that prioritizes the needs of the residence of our state in a responsible and environmentally sensitive way. To this end in January, FERC announced an extension of its comment review period moving the targeted release of the final environmental impact study to April 2017. This extension shifts the anticipated final approval of the project to July 2017. And presently allows us to maintain the targeted start update in a latter part of 2018. Within South Jersey Resources Group, our contracted assets in particular those related to our fuel supply management portfolio remain another key driver of our forward growth strategy. In 2016, we more than doubled the prior year's contributions from fuel management and with the total of 10 contracts executed our commodity marketing business is well positioned to realize its target of contributing roughly 20% to economic earnings in 2020. We are looking forward to 2017 being the first full year with five of those contracts in service and expect our six contracts to commence when Panda Stonewall merchant generating plant in Virginia assumes commercial operations later this year. Performance within South Jersey Energy Services clearly reflects strategy behind our 2020 vision. As we continue to shift away from renewable investment while improving and optimizing asset performance. This planned strategic reduction in renewable investment resulted in significantly lower ITC for 2016 as previously mentioned. This important to note while this reduction did negatively impact fourth quarter results as compared to prior year, the impacts were mitigated in large part by significant improvements in the contribution from our energy production assets. With 2017 well underway, we expect to continue building on the progress we've made. For the first time since 2009, there will be no ITC in our earnings as we continue reshaping our earnings profile to better reflect a long-term strategy. With customer additions continuing at a strong pace, the base rate case currently under review, B L England and PennEast projects progressing. Several additional fuel management contracts under negotiations, and additional midstream investments currently being weighed, we are making significant progress toward our 2020 goal of $150 million economic earnings. Additionally, strength of our balance sheet has us well positioned to continue growing while also continuing to provide a meaningful dividend to investors. Along with the rest of our management team, I remain fully confident of plan we've laid out in our progress in support of that plan. With that I'll turn the call over to Steve to detail result for the quarter and full year.

[Steve Clark:]

Thanks Mike. As Marissa noted earlier, both earnings release and slide deck we made available provide you with detail information regarding GAAP earnings and I would encourage you to review that information. For the purposes of this call as we normally do, we'll focus on discussion on our non-GAAP measure of economic earnings. As management believes that this measure provides valuable insight into the performance of our business. SJI's full year economic earnings totaled $102.8 million as compared with economic earnings of $99 million in 2015. Economic EPS for the year totaled $1.34 as compared with $1.44 per share for the prior year. For the fourth quarter of 2016, economic earnings were $33.2 million with economic EPS of $0.42 as compared with $43.2 million and $0.62 of economic earnings and economic EPS respectively for the fourth quarter of 2015. Quarterly and annual comparisons were heavily impacted by the planned strategic reduction in solar development that resulted in a smaller portion being derived from investment tax credits. On a full year basis, we reduced the contribution by ITC for $38.3 million in 2015, down to $9.1 million in 2016. For the quarter, ITC declined to $4.5 million in 2016 from $19.7 million for [Technical Difficulty] Now we'll take a closer look at the key items that help drive our year-over-year performance within our individual business lines. South Jersey Gas contributed earnings of $69 million for the year, exceeding prior year result of $66.6 million in 2015. For the fourth quarter, Utility contributed $22.9 million in 2016 as compared with $22.2 million for the same period in 2015. Earnings growth is largely attributable to the benefits from infrastructure improvements through our AIRP and SHARP as well from customer growth. We closed out 2016 investing $74.1 million in total between our Accelerated Infrastructure Replacement Program and our Storm Hardening and Reliability Program. These two programs produced a full year aggregate incremental net income contributions of $5.3 million compared to $2.3 million in 2015. We expect these programs to remain strong drivers of growth within our utility largely due to the approved extension of our AIRP in November which Mike noted in his comments. Customer additions strengthened in the last quarter of the year as we added 2,242 new customers further for the 12 months ended December 31, 2016; our customer base grew by 1.2% on a net basis bringing our total number of customers served to 377,625. This growth was derived largely through aggressive marketing of conversions in our service territory but was also complimented nicely by new construction. Our ability to continue adding customers help drive a 4.2% increase in utility margin during the 12 months ended December 31, 2016. Turning to our non utility business. They contributed total economic earnings of $34.2 million for 2016, as compared with $31.5 million in 2015. For the fourth quarter, our non utility businesses provided aggregate economic earnings of $10.6 million in 2016 as opposed to economic earnings of $20 million from same period in 2015. I'll address the significant drivers that impacted these results as I discuss our primary non utility businesses. First, our wholesale and retail commodity businesses housed within South Jersey Energy Group contributed $17.7 million in 2016, as compared with $16.8 million in 2015. For the quarter, this area contributed $7.3 million in 2016 versus economic earnings of $10.7 million in 2015. Economic earnings growth for the year at South Jersey Energy Group is largely driven by the increase in volumes delivered to support two new fuel management contracts, the facilities that came online mid year. With the addition of these facilities, 5 of the 10 currently contracted merchant generating facilities are operational. Economic earnings performance also reflected gas marketing being hampered by warm weather and very limited price volatility experienced in the fourth quarter of 2016. Optimizing our transportation assets in support of our wholesale and retail marketing contracts remains an important part of this business. We expect to see marketing performance benefit as additional, less favorable legacy producers contracts roll off in 2017 allowing us to better utilize transportation assets they are currently used to support those contracts. Our energy project businesses, South Jersey Energy Services contributed economic earnings of $16.5 million in 2016 as compared with $14.7 million in 2015. For the quarter, this business produced economic earnings of $3.3 million in 2016 versus $9.3 million in 2015. Once again this is the area of our business where you see that impact of higher investment tax credits from solar development that we experienced in 2015. However, we remain committed to driving high quality earnings growth from regulated and repeatable income sources. So the reductions you see are consistent with our strategic decision to substantially reduce investments in renewables for 2016. Despite the reduction in ITC, energy services still delivered strong results for 2016 driven largely by increased production, additional solar assets that came online in 2016 and strong SREC prices. Full year SREC production in 2016 totaled 225,000 across our assets in New Jersey, Massachusetts and Maryland markets as compared to 136,000 in 2015. You'll note in the appendix of our slide deck this production is highlighted against the total megawatt capacity online. And with that I'll now turn the call back to Mike.

[Mike Renna:]

Thanks Steve. At this time, we'll be happy to answer any questions you may have.

[Operator:]

[Operator Instructions] The first question comes from the line of Tate Sullivan with Sidoti. Please proceed.

[Tate Sullivan:]

Yes. Thank you very much. The comment in the press release, if I can start where you say I mean at least $150 million in 2020. Is the key variable in there your customer growth assumption you use? Or how did you -- why did you comment -- say at least in the press release?

[Mike Renna:]

Because our initial forecast was we believed and we've communicated was built on very realistic achievable set of assumptions and we be continue to try develop our business development pipeline and new things falling between now and 2020 it could be incrementally beneficial to the bottom line.

[Tate Sullivan:]

Yes. I think I can paint a case that you get there even without PennEast, depending on my customer growth assumptions. But I think you mentioned too you're evaluating other midstream opportunities. What does that -- does that refer to potentially expanding PennEast or is that other opportunities?

[Mike Renna:]

I think if there is always the potential to expand the capacity of PennEast. We sized the pipe to allow for larger volumes. We certainly -- we have not gone out with any kind of open season to try to market that incremental volume that would probably be a phase two or latter type of initiatives somewhere down the road. But, no, I mean I think that we are -- we see a lot of opportunities for midstream like investments in the region and if we can find one that is complimentary to our wholesale group as well as to our utility, it would be something we would be very interested in doing.

[Tate Sullivan:]

Okay, thanks. And last one from me is on the fuel management prospects too. And what's the lead time from when the plant will actually turn on? And can you market this business to existing natural gas power plants that don't use a third-party currently?

[Mike Renna:]

Certainly. I mean it is trended towards new projects. We had one; we've been serving now for Greg how long

[Greg Nuzzo:]

2001 I think.

[Mike Renna:]

2001 right. So over 15 years. So other gas fired generating facilities that are looking for a fuel management certainly that will be something that we could do. Lead time from kind of initial scoping to electricity being generated is about three years.

[Tate Sullivan:]

In terms of when you'd sign the contract to when it would start, is that correct?

[Greg Nuzzo:]

Yes. The one, this is Greg Nuzzo. So once we are discussing and negotiating now, the plants are studying things years before or when they contact us, it's usually three year lead time. So we are talking to a few right now that would be in service commercially late 2019 early 2020.

[Operator:]

The next question comes from the line of Spencer Joyce with Hilliard Lyons. Please proceed.

[Spencer Joyce:]

Thanks. Steve, good morning. How are you? First off, congrats on a really nice first year of execution on that 2020 plan, Mike. I'm pretty excited about the momentum we have heading into 2017. Just a couple questions from me. Steve, I apologize if I missed it, did you say that 2017 or 2018 would be the first year with no ITC?

[Steve Clark:]

2017

[Spencer Joyce:]

Okay, perfect. And as we wind down the new build on the solar side, is there any overhead you are able to shed there? Could we even see some increased profitability from that slice of the business, even outside of the rally in SREC prices that we've seen?

[Mike Renna:]

It's Mike. I think that what we'll continue to look to do is -- we've had some very talented people that have helped us grow that business whether it was through the business development, sale side of it to the actual operations to all the analysis that went around it and we think that there is a great opportunity for those folks as we continue to wind down the growth side of that business to provide value in other areas of our company. So not necessarily a direct reduction in overheads but it will allow us to not after go out and hire new bodies strengthen other areas of the company.

[Spencer Joyce:]

Okay. That makes sense. So we may see some decrease cost but it maybe an evolving story as you redeploy some people. That makes a lot of sense. The fuel management contract seems to be a really exciting business and could be a growth driver for a pretty long time if I understand correctly. Am I correct in assuming that you should be able to add one, two, three new contracts a year almost on a kind of perpetual type basis? It's not like we pick the low hanging fruit and are just going to have this steady business. Is that correct?

[Greg Nuzzo:]

Correct. Yes, this is Greg, Spencer. Yes, I think that I mean we are excited too I mean its -- our Q is rich in terms of the business development. Again, there is a lot of new plants being proposed and in our footprint in PJM that's where the bulk of them are. So I am just trying to -- we are its realistic and to add maybe one to two supply deals and that's kind of what our goals have been each year. And based on what we are seeing in Q I think that's pretty realistic.

[Spencer Joyce:]

Okay. And then final just kind of a housekeeping question. I know you all are pretty quick to get the Q filed, is it possible we'll see the K today or will that be sometime next week?

[Steve Clark:]

We expect that Monday, Spencer.

[Operator:]

The next question comes from the line of Chris Ellinghaus with Williams Capital. Please proceed.

[Chris Ellinghaus:]

Good morning, everyone. Mike, I am not sure I caught this. Did you say you are currently negotiating two new fuel contracts?

[Mike Renna:]

No, I don't know that I did but I think I was talking about -- we have -- we've got a pretty rich Q. As we mentioned we've now got 10 under contract. Our original 2020 plan had eight as the assumption so we're already in excess of what we built into our original plan. And we continue to see a lot of opportunity out there. I think what is fair to say is that we are pretty far along in conversations with two of them. The two new potential customers.

[Chris Ellinghaus:]

Okay. And how far regionally are you looking? Are you generally sticking to PJM because it's a rich market? Or how are you thinking about you know how far you want to range in terms of new contracts?

[Mike Renna:]

I think its two things. One is that it is a rich market. There is a lot of development going on in within PJM. And then I think that the other piece of it is where our assets are. And most of our wholesale assets that would -- we would utilize to serve these facilities; again they also reside within PJM. So it's probably I would say that's a fair assumption to say that’s our target market.

[Chris Ellinghaus:]

Is there any thought of expanding assets to back future contracts as you have the opportunity to maybe expand regionally?

[Greg Nuzzo:]

Yes. It's Greg. I mean one thing we are taking a look at it. A lot of these merchant plants are newer ones are getting their own assets. And so it's really a complimenting our existing location and our relationship so the few that we are looking at now they are subscribing to their own assets and we are managing them and compliments are existing. So there is an opportunity to grow outside of that just because we built such a big portfolio in PJM in our relationships. And great thing is we are just managing someone's assets to really deliver gas to them and make a set fee.

[Chris Ellinghaus:]

Okay. Steve, I'm looking at slide 12, the Energenic line. Can you give us a little color on what's included in that $1.7 million?

[Steve Clark:]

So $1.7 million that was when we -- that really reference when we kind of separated out the partnership and we dole out the different projects. So that was really all that was the ramification of that split up.

[Chris Ellinghaus:]

Okay, so just in totality the impact of the Energenic transaction?

[Steve Clark:]

Yes. On our income statement, that's correct.

[Chris Ellinghaus:]

Okay. Can you talk a little bit about tax reform and maybe regulatory reform things like Dodd-Frank? Do you see benefits from those two possible policy shifts?

[Steve Clark:]

No, it's -- there is so much conversation about what all the possibilities are, particularly when you are talking about tax reform. The general view I think at this point not knowing exactly how the detail fall out is, so we are probably neutral for the regulated utility. You would think that whatever plus and minus happened would be sorted out in the regulatory process to kind of get us back to equilibrium where we are right now. Probably see a little bit of benefit in the midstream side and in our non reg businesses it would probably a benefit for those businesses particularly given how we had them structured now where we are currently not extending with a lot of additional capital investment and we are just using those businesses as cash flow engines to drive our investment in some of our regulated businesses. Now, tying that into Dodd-Frank and access to capital and things like that, the question there becomes really how that relates to the potential deductibility of interest issue that pops up in the whole tax reforms. So there are so many inter related moving parts here that it's hard to make a call but in general I think I would anticipate that it's -- I wouldn't expected it to be a net negative. So neutral to even slightly positive should be what we are looking at.

[Chris Ellinghaus:]

Okay. Can you talk about your expectations for SREC pricing and what your year-end hedge position is?

[Steve Clark:]

Year end, Greg you want to jump in.

[Greg Nuzzo:]

Yes. I mean we are in good shape for the next couple of years. I think we are -- we've hedged in the mid-upper 90% of our position for 2017, great thing is with the rebound in the market last year we took advantage of that opportunity and actually locked in some of our hedges for 2017 and 2018, and captured some good value there. So we like what we saw and took advantage over the next two years. Again I think we are in the upper 90% area for both years.

[Operator:]

The next question comes from the line of Stephen Percoco with Lark Research. Please proceed.

[Stephen Percoco:]

Hi, thanks. Could you review for us the general terms of the fuel management contracts? How are you compensated? What exposure, if any, do you have to fluctuations in the price of natural gas? And are the contract terms similar from contract to contract, or do they vary?

[Greg Nuzzo:]

They are pretty similar. I mean depending-- half of our deals have, we are the counterparty subscribe to capacity. But effectively we are not taking any commodity risk; every counterparty calls on gas basically in at market gas price. So each day the gas price is set. We are basically transporting it to them and making a fee to move that gas to their facility. Any differential in usage is not our risk as well. So we are just making a set fee basically nominating and moving gas to the facility. Again, no commodity risk in these deals.

[Operator:]

[Operator Instructions] We have a follow up question from the line of Tate Sullivan. Please proceed.

[Tate Sullivan:]

Hi. Thanks for taking my follow-up question. Can you go back to -- I'm referring to slide number 12, where you break out -- and it's a very useful bridge by the way two for the SJ Energy Services. I think you -- can you break out the components of that $3.3 million economic earnings in the quarter? Because I think you mentioned that you had $4.5 million in ITC in the quarter, but I'm also interested in the renewable contribution, given if that could be very stable based on your hedging in the next couple of years too.

[Steve Clark:]

Hi, I am little confused as I look at slide 12. It kind of does break it out.

[Tate Sullivan:]

Well, I think that's the bridge. Is that the change year-over-year or is that the actual dollar amount within the $3.3 million? [Multiple Speakers]

[Steve Clark:]

Oh I see. It is the change. You know what, I'd just say how about if I just have Marissa follow- up with you with the individual piece there?

[Tate Sullivan:]

Okay. Thank you. And if I may on another one. On more big picture in your service area too in terms of customer growth being 1.2% in the fourth quarter. What are you assuming going forward, if you can talk in that context? Or I mean are there more large residential developments underway in your service territory? Are there more multifamily across the river from Wilmington or Philadelphia? Or just how should I go about handicapping your customer growth for the next three or four years?

[Mike Renna:]

Well, that 1.2% is for the full year not for the quarter but I would expect that you'll continue to see growth somewhere in the 1.2% to 1.5% range largely driven by conversions. I think it will be very similar to what it has been for the past four, five years. New construction continues to be steady and certainly not as a passive was pre recession. And I don't really think anything in South Jersey is pointing to some kind of aggressive kind of growth and new construction. But as far as geographically most of the new construction and most of the growth is coming in the western part of our service territory. And I think that's largely the result of Philadelphia's economy being a little bit stronger right now than Atlantic City quite frankly. The thing is having is important though is that I wouldn't get completed fixated on the actual customer growth number as much as the margin growth as well because what we are seeing right now is strong growth in our commercial market which is allowing us to have significantly higher growth rates in terms of margin. I believe, Marissa, what is the margin growth upper year-over-year?

[Steve Clark:]

4.2%

[Mike Renna:]

4.2% margin growth which again is I think a very strong indication of success of our target marketing efforts as well.

[Tate Sullivan:]

Well, that's -- what is the commercial growth due to business -- general resident business growth in your region, or is it large factories?

[Mike Renna:]

No, well, it's not quite large factories yet but when we get PennEast to put in and we just upbringing cheap Marcellus gas into South Jersey, we expect to see some new factories crop up. Now it's primarily commercial. There are a lot of healthcare facilities that have come up over the last few years in New Jersey. The hospitality industry outside of Atlantic City continues to grow. And you are seeing a lot of conversion in the commercial industry as well.

[Operator:]

There are currently no further questions in queue. I'll now like to turn the call back over to Mike Renna.

[Mike Renna:]

Do this every time, I shut my slide deck down and forget my little wrap up. So before we wrap up as always please feel free to contact Marissa Travaline, our Director of Investor Relations or Ann Anthony our Treasurer if any follows up question arise. Marissa can be reached at 609-561-9000, extension 4227 or via email at [e-mail]. Ann could be reached at extension 4143 or by email [e-mail]. Again thank you for joining us today. And for your continued interest and investment in SJI.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.