Tortoise Energy Infrastructure Corporation
Q3 2015 Earnings Call Transcript

Published: 28 Oct 2015

[Operator:]

Greetings and welcome to the Tortoise Capital Advisor’s Quarterly Closed-End Fund Conference Call. At this time, all participants are in a listen only mode. A question-and-answer session will follow the formal presentation [Operator Instructions] As a remainder, this conference is being recorded. It is now my pleasure to introduce your host Pam Kearney. Please go ahead.

[Pamela Kearney:]

Good afternoon and welcome to our third quarter closed-end fund conference call. I am Pam Kearney, Director of Investor and Public Relations here at Tortoise Capital. Joining me on today's call is Brad Adams, Managing Director of Tortoise Capital Advisors and CEO of our closed-end fund. Also speaking today with me Rob Thummel and Mat Sallee, both Managing Directors and Tortoise portfolio Managers. As a remainder, some of the statements made during the course of this presentation are not purely historical and maybe Forward-Looking Statements regarding our intention, projections and strategies for the future. These statements are subject to various risks and uncertainties and actual outcomes and results may different materially from our forward-looking statements. Past performance is no guarantee of future results. We do not update our forward-looking statements and this presentation is provided for information only and shall not constitute an offer to sell or a solicitation of an offer to buy any securities. And with that I’ll turn the call over to Brad.

[Bradley Adams:]

Thanks, Pam. Well it goes without saying but I’ll say it anyway, the third quarter was certainly one to forget as it relates to volatility in the energy sector. A number of developments challenge the global markets including global oversupply, growing concerns about China and the Fed’s on-again, off-again decision to hike interest rates. There also was the announcement on an agreement with Iran aimed at reducing its nuclear capability in return for lifting sanctions that have limited the country’s ability to export oil. The energy sector particularly the Midstream segment faced extreme pressure as the quarter drew to a close, somewhat like in 2008 with an important distinction in our view. Capital markets are not nearly disrupted as compared to the financial crisis of 2008 when capital markets were closed for MLPs and energy demand was very weak. In our view, MLPs are still able to access capital to fund growth projects and demand has remained strong, aided by low commodity price environment. Matt will talk more about this and alternative means to accessing capital later in the call. In challenging markets like these it's important to remember that Tortoise maintains a long-term perspective that looks across various investment cycles with the goal of delivering sustainable distributions and attractive total returns. We place the high value on quality and carefully evaluate risk and potential reward. So as we look ahead, we see opportunity. The third quarter particularly the latter part of September was a difficult one for investors in the energy closed-end fund market. In our view, price pressure resulted from lower crude prices, continued uncertainty on the impact of those lower prices and overall negative energy sentiment. Also technical pressures including short selling and force were drivers of the negative performance. Our closed-end funds were not spared finishing down directionally similar to the MLP sectors measured by the Tortoise MLP Index, that’s ticker TMLP which was down 23.5% for the third quarter. Use of leverage in closed-end funds magnifies performance whether positive or negative and that became a key area of focus for us as the quarter wound down. Our historically conservative nature in which we manage our funds supported our efforts during this period. Managing our use of leverage became a central focus late in the third quarter due to technical selling pressures from opened-end funds, exchange-traded product redemptions, short selling and closed-end fund leveraging. True to our commitment to manage leverage and take steps when prudent to maintain adequate cushion in excess of asset coverage requirements, we reduced leverage in modest amount in TYG and a very marginal amount in NTG. Asset coverage ratios have been met and we will continue to monitor these ratios and report them weekly on our website. Many ask us scenario such as this impact our ability to sustain distributions. Two of the key metrics that we look at when revealing distributions to stockholders. Our distributable cash flow DCF and distribution coverage. In this scenario DCF is impacted by the amount of leverage employ, but it's also impacted by other factors including increased distribution growth of the entire portfolio, substantial decreases and asset based expenses primarily management fees and leverage costs. The netting of changes in income and expenses may result in no material impact to DCF or even an increase in DCF. As for distribution coverage the scenario is just like this, difficult market that support the importance of maintaining distributable cash flow in excess of distributions. Looking ahead to Q4, we do not currently expect a material change in DCF for our funds from Q3. The fund board as it does consistently will consider DCF in a number of other factors determining the funds distribution to stockholders. Next distribution announcement is slated for the early part of November. Lower valuations have increase fund distribution rates with TYG at 8.8%, NTG 9.5%, TTP 8.8%, TPZ 8% and NDP at 12% based on their market prices as of October 23. Now for an overview of fund performance. As a reminder, we view our funds from an energy value chain strategic perspective. Our funds hold investments in strategic assets with strong balance sheets that provide sustainable cash flows through economic cycles. In the upstream space, NDP’s portfolio was portfolio was anchored in the oil and gas producers that in our view are located in the best locations in the best oil and gas fields within North America. The fund also utilizes a covered call strategy. NDP had a year-to-date market based total return of minus 17.5%, on NAV based total return of minus 19.6% calendar year-to-date through last Friday. Within the midstream space TYG, NTG and TTP emphasize high quality companies for strategic assets providing a visible growing cash flows and strong balance sheets and distribution coverage. Through last Friday, TYG had year to date market based total return of minus 29.2% and NAV based total return of minus 30.9%. NTG had a year-to-date market based total return of minus 32.8%, NAV based total return of minus26.27% against to last Friday. TTP has anchored and diversified pipeline equities along with some independent energy companies and utilizes the covered cost strategy. It had year-to-date market based total return of minus 30.1% and NAV based total return of minus 28.5% to last Friday. And lastly, TPZ a downstream strategy which invest primarily in fixed income and dividend paying equity securities of power and energy infrastructure companies at a year-to-date market based total return of minus 14.8% and NAV based total return of minus 16.6% through last Friday. Also, we announced on October 1, a modifications to TPZ's investment policy reducing the minimum amount it invest in fixed income securities on a minimum of 60% between minimum of 51%of its total assets. This change is intended to provide more flexibility to navigate a variety of market environments. The fund will continue to invest in fixed income and dividend paying equity securities of power and energy infrastructure companies that we believe provide stable and defensive of characteristics to economic cycles. While we expect continued volatility in the near-term in the broad energy market, which are closed-end funds invest. Our long-term views really have not changed. We view energy investments especially in midstream energy as very attractive especially at current MLP yields. With that, I'll turn the call over to Rob Thummel to give our perspective on the upstream segment of the energy value chain.

[Robert Thummel:]

Thanks, Brad. While, the entire energy market continues to be concerned about an oversupplied global oil market, the supply and demand fundamental supporting oil are moving in the right directions. Non-OPEC supply, specifically U.S. supply is declining and global demand for oil is rising. So why do oil prices keep rolling and the answer is that OPEC continues to produce above its stated production quota. And we believe that the current oil price environment is unsustainable as we move into 2016 and once again global demand exceeds supply the oil price should return to levels that incentivizes producers to invest capital. In the U.S., oil and gas producers are adopting a lower for longer mentality as they began to prepare 2016 capital budgets. And we're really starting to see a separation between the high quality and low quality producers. The distinguishing factors that separates the producers are number one the location of their acreage and number two their balance sheet. We estimate that there is approximately 1 million barrels a day of U.S. oil production that is produced by producers for total debt represents greater than 50% of total enterprise value. These producers are expected to cut capital expenditures and or restructuring 2016, which results in production declines from these producers. High-quality, lower levered producers in the Permian and Eagle Ford are lowering drilling costs and increasing volumes recovered per well allowing them to generate economic returns in the current price environment. Now keep in mind, the energy sector is not just about oil, the Marcellus Shale continues to dominate the U.S. natural gas landscape. The emergence of the Utica shale which sits just below the Marcellus Shale offers another source of growth from North east natural gas producers. A recent study by Wood Mackenzie highlighted the near-term potential of the Marcellus and Utica. The study estimated that the Marcellus and Utica would grow its market share from 27% of total U.S. natural gas supply today to 39% by the end of 2017. This means volumes from those areas grow by approximately 20% per year for the next two years. The point is, even in this low natural gas price environment Marcellus producers are earning strong rates of return and growing production volumes. Now from a performance perspective, the energy sector has struggled in fact, more than any sector in the S&P 500 this year. In Tortoise North American oil and gas producers’ index returned a negative 26% for the quarter underperforming the S&P 500 return of negative 6.4% by 19.6% due to concerns both the oversupply of oil as well as demand growth. E&P, MLPs were the worst performers as well as basins with geographical and geological disadvantages. Year-to-date, Permian and Eagle Ford producers have been notable outperformers partially due to proximity to the Gulf Coast. However, we believe the fundamentals are moving in the right direction as U.S. supply falls and global demand rises that should ultimately lead to higher oil prices. The U.S. oil rig count keep falling and is now down over 1,000 rigs or 60% lower than one year ago. A lower rig count ultimately means lower production. Led by the U.S. non-OPEC production should continue to fall as we move into 2016, according to the EIA. And non-OPEC countries outside of North America could experience reduced production including Brazil, China, Columbia, Norway, Russia and the UK. 2015 global demand keeps rising and is now forecasted to grow by 1.8 million barrels per day according to the IEA, though those estimates vary. Initial estimates for 2016 oil demand are around 1.4 million barrels a day. As a point of reference, for the past two decade global oil demand has growing by approximately 1 million barrels per day each year. So 2015 and 2016 oil demand are significantly higher than normal. OPEC is producing near capacity and over the next several years as oil demand continues to rise. U.S. Shale production will be very important in balancing the global supply demand equation. Moving on to natural gas and natural gas liquids. Natural gas inventories in mid October for the EIA stood at level of 18% higher than the same time last year and are on pace to injection season in October with near record high inventories. Unlike crude oil, we already have the ability to export natural gas liquids and we are currently doing so at an increasing cliff and despite the increase in exports, it will take time to rebalance the market and we believe in 2016 will remain challenged for natural gas liquids. Additionally given the reliance on exports, global economic held is important to absorb excess U.S. supply. Moving onto valuation, as is our practice, we focus on devaluation metrics for oil and gas producers. The first valuation metric is Enterprise Value to EBITDA. The sectors trading that above historical norms for 2015, but below for 2016. Again this third quarter we note that 2015 multiples reflect lower commodity prices and flat production levels in general. The other metric we like to use the value oil and gas producers is current price relative to net asset value. The net asset value reflects the value of the company’s current oil and gas reserves, plus potential future reserves. These calculations are always risk adjusted for potential future reserves. As additional wells are drilled, the risks associated with future reserves are reduced and the net asset values should increase. Oil and gas producers were trading at approximately 85% of net asset value at the end of the third quarter. We expect net asset values to improve as service costs continue to decline. As such, we see a compelling valuation gap and we expect mid-teen returns for oil and gas producers over the next several years. To summarize, the third quarter was extremely volatile from an oil price perspective with oil price volatility increasing nearly a 140% of the second quarter. After rising roughly 25% in the second quarter 2015, crude oil price has experienced a significant decline due to concerns over China oil demand reaching a seven-year low of $38.09 in late August. Since then, oil prices have modestly recovered trading within a range of $45 to $50 a barrel. OPEC is producing near capacity and over the next several quarters as oil demand continues to rise, we believe U.S. Shale production will be very important in balancing the global supply demand equation. In our view $45 barrel oil prices are too low to encourage investment in new production. A $90 oil price per barrel is produces too much shale, but oil in the 70s is just about right. Now I’ll turn it over to Matt for a discussion on the midstream and downstream sectors.

[Matthew Sallee:]

Thanks Rob. Well that negative sentiment that Rob described flowed through to midstream companies as well. Pipelines represented by the Tortoise North American pipeline index were down about 19.4% for the quarter and the same amount year-to-date through last Friday, October 23. MLPs as represented by the TMLP Index were down 23.5% for the quarter and 24.4% year-to-date through last Friday as well. To add to what Brad touched on earlier, selling pressure grew tremendous in the third quarter for pipeline companies, this was particularly apparent during the last week of September. The index was off 17.3% just in the period of September 21 through the 29, so pretty rough period there. As we evaluate the fundamental though, we see fairly steady fundamentals. Broadly production of crude oil is modestly declining in the U.S. which should lead to a more balanced market in 2016 and improving crude prices, some tailwinds for midstream include new project announcements and continuing solid distribution growth. There are headwinds obviously with the supply and demand imbalance and various commodities and uncertainty around when that will be back in balance, but bottom line in our view, the main question is not if there will be a recovery but more when that recovery will take place. Now I'll step to the midstream fundamentals starting with our fine product pipelines. Demand is exceptionally strong as lower prices at pump have lead to an all-time high for vehicle miles traveled. Net imports of gasoline have doubled year-over-year as domestic refineries are struggling to keep up with rising demand, despite running at utilization levels that are the highest that they have been over the last five years. Moving on to crude pipelines, demands for crude has exceeded expectations, various reporting agencies continuously or continue to make monthly revisions higher on their expected demand for 2015 and 2016. As we talked about production in the U.S. is starting slow down and since really moving into declining and expect that to continue in the 2016. And while we think that will flow through to pipeline volumes related to that crude oil production decline our historical analysis, leads us to believe that the impact will be marginal and will not have a material negative impact to cash flow for pipeline companies. Regarding gas pipelines, given the strength in the Northeast, we continue to see a resurgence in the need for natural gas infrastructure. Low prices are incenting incremental demand, we expect that to continue over the remainder of the decade. At a recent conference, a large producer in the Northeast noted that the Utica could be a game changer for U.S. gas production, some of the dry gas wells that have been drilled there recently are the most prolific that we've seen in U.S. onshore history. We've also in the gas pipeline space evaluated the incremental takeaway capacity out of the area and layered on incremental production or basically oil production forecast and bottom line is with takeaway capacity, we assume that everything that's proposed gets built and our view is that will all be needed due to the competitiveness of the basin and the fact that you need excess capacity for gas to satisfy peak demand periods. Last thing is on NGL prices, Rob talked about it, they remain weak and that's headwind for gathering and processing companies, but like he said, we have the ability to export NGLs and continue to do so at an increasing rate. Nonetheless, we are fairly oversupplied there and think we are going to stay that way through 2016, so that will be a headwind for NGL prices. Shifting to growth, consistent with prior quarters, we like to look at project totals on a three year old rolling basis and that project backlog increased $6 billion from last quarter for [indiscernible] pipelines and MLPs. Investments fairly even we distributed across the different segments including crude oil and natural gas pipelines as well as gathering and processing. All told, we expect approximately $245 billion of internal growth and acquisition activity over the next few years. We believe these CapEx dollars will drive distribution growth over the next several years. On a weighted average basis, pipelines in MLPs produced just under 10% growth on a year-over-year basis. Looking forward, we haven't had a lot of companies report earnings so far for the third quarter but distribution announcements have been right in line with our expectations, in some cases actually little better. While growth for the next 12-months maybe a bit more challenged, we do continue to expect 6% to 8% dividend and distribution growth for the midstream sector. Moving to pipeline valuation, I would like to look at several different metrics here beginning with cash flow multiples for pipelines. They are really at or below historical averages looking at 2015 multiples and well below for 2016, in some cases of full standard deviation below the long-term average. From a yield standpoint, MLPs based on the TMLP Index stood at 8.2% as of last Friday's close that compared to 5.8% at year-end 2014 and 5.9% for the three-year median. We believe MLPs remain very attractive relative to long-term in the historical splits for fixed income, as an example, recent spreads to tenure treasury represent the widest that we’ve seen since the middle of 2009. Moving to our outlook, growth combined with current yields results in our total return expectation for pipeline companies in the mid-teens and that really assumes no additional compression of the yield more back to norms. We remain stead fast in our belief that pipelines remain an attractive long-term investment. While uncertainties facing the energy sector, with these uncertainties capital markets were a little less active for MLPs and pipeline companies during the quarter, they raced about $4 billion each in debt and equity bringing a total raised year-to-date to about $60 billion. There were no midstream IPOs during the quarter, there was one downstream IPO, TerraForm Global they raised about $675 million. In this challenging environment, there are other ways to access capital between besides the standard overnight equity issuance, just to name a couple. We’re seeing increased sponsor support for MLPs, MLP still have the ability to issue equity through the at the market programs, something we know a fair bit about is private investments in public equities or pipe deals we’ve seen more activity there recently, expect that to continue and then obviously private equity has a lot of dollars and the sidelines looking to make investments. That said, on the equity side for debt markets they remain fairly wide open. We’ve seen both investment grade and high yield issuers coming to market fairly recently and really at pretty decent rates. So in total, capital market have tightened a fair bit on the equity side with lower stock prices, but remain fairly open on the debt side. We continue to anticipate that growth projects will be funded in the standard 50/50 debt equity mix over the long-term. So to sum it up on the capital markets, we believe the concerns about pipeline company’s ability to excess capital are fairly over stated. Now just a few comments on the downstream sector starting with refiners. They are benefitting from the 4% increase in demand compared to year-ago levels for U.S. refine products such as gasoline and diesel. In addition, refining margins have been very strong due to low crude prices and then discount in U.S. prices relative to global prices. The petrochemical sector continues to generate strong free cash flow yields around 15% due to low input cost for natural gas and natural gas liquids, balanced against very strong demand for their products that they produce. Lastly renewable energy has been negatively impacted recently by concerns regarding their access to in cost of capital, but long-term the outlook there remains pretty strong for wind and solar, we think there will be a lot of growth. Shifting to regulatory matters of note, in August President Obama and the EPA finalized the Clean Power Plan regulating carbon emissions from existing power plants. This will target carbon emission reductions of 32% by 2030 from 2005 levels. Also in August, the Commerce Department announced it would improve a limited number of applications to export U.S. domestic light oil to Mexico under a what is called a Swap Agreement in which basically we will send light oil to Mexico in exchange for the same volume of heavy crude coming from Mexico. Post quarter end the House of Representatives voted in favor of legislations seeking to legalize crude oil exports. That move was largely symbolic, but it does represent progress towards changes in that policy. So to summarize, I think we’ve covered it, but clearly it was a rough quarter for energy investors. We believe our holding within our funds are well position though to result or as a result really of our high quality focus or focus on high quality companies. While energy fundamentals are mixed, we believe technicals were the main driver of third quarter sharp downturn for pipeline company specifically, where fundamentals remain relatively intact. Importantly capital market access remains open for midstream companies, particularly on the debt side and as I mentioned there are multiple options to access equity markets to help fund growth projects. With that basically we believe distribution growth will hit 6% to 8% over the next 12-months and given current evaluations on what the market is pricing and we think it's pretty compelling opportunity for long-term investors. We would caution though that the next several months are likely to be volatile, but we think patient investors stand to be rewarded. So with that go royals and we will open up the call and take questions.

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. We ask you please limit yourself to one question and one follow-up question [Operator Instructions] Our first question today is coming from [Timothy Kifole] (Ph) a Private Investor. Please proceed with your question.

[Unidentified Analyst:]

Yes, thank you. So I want to complement you on your presentation especially your detailed quarterly reports, they are really just superb, full information.

[Bradley Adams:]

We appreciate that very much. We've put a lot of work into those.

[Unidentified Analyst:]

It is really detailed and it's really spectacular compared to everybody else. My question is - then I have one follow-up. Distribution growths are coming down and by everyone's estimate, are the growth rate in distribution is coming down, based on what you know now, so you can just give me an estimated growth rate for distributions for NTG and TYG for either your 2016 and 2017, I know it’s just some thoughts on that?

[Matthew Sallee:]

Speaking to the portfolio, I mentioned the 6% to 8% that's for the index level. The funds have more vague growth orientation in the investment strategy, so we would expect them to do a little north of that. I'll let Brad answer as far as the actual dividend that we are paying out and we have provided guidance there for the year. I guess one other comment though, is just I mentioned that we are getting into the distribution announcements for the third quarter, actually most of them are out at this point. And this is just a simple average calculation, but for the securities and the closed-end funds, we are running north of - or depending on the fund, once a little north of, once a little south of about 4% on a sequential basis. So, we're pretty encouraged by that because the decisions that management teams are making with very real time decisions and taking into account their one, three and five year outlook for their business, they are still comfortable growing their distribution at a healthy cliff. So we are pretty encouraged by that.

[Bradley Adams:]

Timothy from the fund perspective Matt talked about kind of the top line growth in distributions that are coming into the fund, but our board looks at a lot of different items when they look to declare a distribution. I mean there is obviously the change in expenses, asset based expenses, leverage costs, taxes, I mean they look at a lot of components before they set any kind of distribution numbers.

[Unidentified Analyst:]

I understand completely. That was a 4% sequential increase quarter over quarter?

[Matthew Sallee:]

No, keep in mind that's a simple average not a weighted average because not all the companies have reported but just…

[Unidentified Analyst:]

That's a quarterly number not a yearly number?

[Matthew Sallee:]

That is third quarter compared to second quarter.

[Unidentified Analyst:]

Thank you. Then my follow-up question. My follow-up question is the cost of capital, some of the a MLPs their distribution rates are 10% and that really cuts down on the spread between capital projects and I just want to know how much you think that really are.

[Matthew Sallee:]

We actually run a sensitivity on that and just to move over the last couple of weeks, assuming pressures where to stay here, we would anticipate that it would shave about 1% off of growth rates just due to the yields widening out and assuming no change on the returns on projects. So yes, it matters and like I said, we runs sensitivities on it and just to give you a sense that it's been a pretty sharp downturn over the last couple of weeks, but that would in our view equates to about 100 basis points difference in growth rates all else equal.

[Operator:]

Thank you. We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments.

[Pamela Kearney:]

Okay, well thank you for joining us for today's call and we appreciate your interest in our funds. If you have any further questions, you can contact me Pam Kearney and Investor Relations both toll free at 866-362-8331 or at [e-mail]. And also, please turn in to our weekly podcast which will provide you timely updates on what is going on in the energy sector and we just issued a Tortoise Talk market commentary piece this afternoon. We would like to get that to you if you are interested and it’s on our website. We look forward to our next call, which will summarize 2015 later in January. Thanks again and have a great afternoon.

[Operator:]

Thank you and that concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.