Tortoise Energy Infrastructure Corporation
Q2 2016 Earnings Call Transcript

Published: 28 Jul 2016

[Operator:]

Greetings and welcome to 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. I would now like to turn the conference over to your host, Ms. Pam Kearney, Director of Investor Relations. Thank you, you may begin.

[Pam Kearney:]

Thank you and good afternoon and welcome to our call. As a reminder, some of the statements made during the course of this call are not purely historical and may be forward-looking statements regarding our intentions, projections and strategies for the future. These statements are subject to various risks and uncertainties and actual outcomes and results may differ materially from our forward-looking statements. We do not update our forward-looking statements. 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 Adams, Managing Director and CEO of our Closed-End Fund.

[Brad Adams:]

Thanks, Pam, and good afternoon. And thank you all for joining the call today. Joining me is Brent Behrens, Tortoise’s Director of Financial Operations, Rob Thummel and Mat Sallee, both Managing Directors and Tortoise Portfolio Managers. We’ll being by going through prepared remarks, we'll then address some recent questions we have been receiving and then open it up to your questions. The second quarter was continuation of a positive momentum that began in February. During the second quarter we saw oil prices increased due to a sustain decline in North American production and strong demand. This support our thesis that US production is driving oil prices more than the influence of OPEC. Recently crude oil prices have retreated from year-to-date highs in early June, and was briefly over %50 per barrel as the supply demand rebalancing continues. On the geopolitical front, we mentioned the OPEC meeting in Doha in the last call and since then there was a meeting Vienna as well. As expected, the meetings were non-events, no agreements reached to freeze production. More of an issue were the Canadian wild fires in May that contributed to well over half of the supply outages that month. Additionally, Nigeria faces continued militant attacks on their pipelines and export facilities bringing their production to the lowest monthly average since late 1980s according to the EIA. Another newsworthy item to round up at the end of the second quarter was Brexit, the broad markets generally took a temporary hit with concerns that this could be a tipping point for other member nations of the EU to stage an exit. For now at least the market seems to be shaking off the Brexit news. In our view, crude oil spreads could widen and the softening of demand in Europe could occur, but we do not expect supply and demand to be affected and we do not think it materially affect MLPs. During the second quarter we saw a bit decoupling of MLPs from the price of oil, while they still move together directionally, they were no longer moving in lock step and the level of correlations started to move back towards historical levels. The 10 [ph] year’s treasuries around 1.6%, investment grade mid stream energy infrastructure companies offer an attractive current yield with a choice MLP index yielding 7.3% as of last Friday. The energy sector, as represented by the S&P Energy Select Sector Index was up 15% for the second quarter ending June 30, and the energy was the best performing sector in the S&P 500 for the same period and remained at that level through last Friday's close. Rob and Matt will provide more detail, but we're encouraged by improved performance across the energy value chain, particularly in the upstream segment. There were some important company specific news which Matt cover in more detail later. All American Pipeline, L.P., announced its simplification transaction and the market also gained some clarity on the ETE Williams deal, which is been laying on the mid stream space. Now I'll turn the call over to Brent for an update on our Closed-End Funds performance year-to-date through last Friday, July, 22, our use of leverage and views on distributions.

[Brent Behrens:]

Thanks, Bred. I’ll review our funds across the energy value chain, where in our view the fundamentals have continued to improve quarter-over-quarter. All performance information is as of June 30th, 2016. Beginning with upstream. As a reminder, NDP invested in oil and gas producers that in our view are located in the best locations, in the best oil and gas fields within North America. This fund also utilizes a covered call strategy. For the second calendar quarter, NDP’s market based total return was 34.6% and its NAV based total return was 24.2%. NDP's year-to-date March based total returns was 42.0% and NAV based total return was 30.1%. Within the midstream space, TYG, NTG, and TTP focus on high quality companies with strategic assets providing visible growing cash flows and strong balance sheets and distribution coverage. TYG’s second calendar quarter market based total return was 27.8% and its NAV based total return was 17.9%. TYG'S year-to-date market based total return was 15.9% and its NAV based total return was 10.4%. NTG's second calendar quarter market based total return was 15.5% and its NAV based total return was 16.8%. NTG's year-to-date market based total return was 11.5% and its NAV based total return was 12.7%. TTP invest in diversified pipeline equities along with some independent energy companies and utilizes the covered call strategy. For the second calendar quarter, TTP's market based total return was 29.1% and its NAV based total return was 31.5%. TTP's year-to-date market based total return was 35% and its NAV based total return was 37%. Finally, TPZ is downstream strategies which invest primarily in power and energy infrastructure fixed income with the reminder in equities. TPZ's second calendar quarter market based total return was 14.6% and its NAV based total return was 20.4%. TPZ's year-to-date market based total return was 21.8% and its NAV based total return was 22.2%. Fund returns have continued show incremental improvement this month, improving between 4.2% and 5.7% on a market value basis and between 0.4% and 2.7% on a NAV basis through last Friday, July, 22. Now let's move on to fund leverage, consistent with our historical approach we remain prudent in our use of leverage to maintain adequate cushion in excess of asset coverage requirements. And improving market sentiment toward the energy sector certainly had a positive impact as well. As a reminder, we report updated leverage amounts and ratios on our website each week. Now, moving onto distributions for the second fiscal quarter. We maintained NDP’s quarter-over-quarter distribution of $43.75 due in part to the covered call premiums we’ve continue to earn. Our goal with our MLP focus closed-end funds, TYG and NTG is to establish and maintain what we believe to be adequate distribution coverage, supporting our emphasis on long-term distribution sustainability. Our focus on high quality companies that has continue to generate solid cash flows allowed us to again maintain quarter-over-quarter distributions of $0.655 for TYG and $42.25 for NTG. TTP also maintained its quarterly distribution of $40.75 which reflects our historical baseline distribution supported by DCF. TPZ’s second quarter monthly distributions of $0.125 also reflect its historical baseline distribution supported by DCF. TPZ eliminate the capital gain component of the monthly distributions during the second quarter because we had anticipated the same level of capital gains following market declines over the past year. This resulted in a reduction of the monthly distribution rate of 9.1% as compared to first quarter. Our distribution coverage key for our board in determining MLP funds distribution. As a reminder, distribution coverage’s DCF divided by distributions paid to stockholders. Several factors are included in the DCF to consider, including growth from distributions from portfolio investments, leverage costs and changes in asset value based expenses, including management fees and administration expenses. Looking ahead, we’re closely monitoring earnings and outcomes for our portfolio companies. Based on announced results from our portfolio companies thus far, we currently intend to recommend our board to maintain our current distribution rates for the third quarter distributions coming up next month. Fund distribution rates have lowered since last fiscal quarter end as prices have rebounded. As of July, 22, distribution rates whereas follow, TYG was at 8.1%, NTG at 8.7%, TTP at 8.4%, TPZ at 7.4% and NDP was at 11.3%, these rates compared towards the MPL index average of 7.3% also on July 22. With that, I’ll turn the call over to Rob Thummel to give our perspective on our upstream segment of the energy value chain.

[Rob Thummel:]

Thanks, Brent. Starting with performance, the Tortoise North American oil and gas producers’ index for the TNAOP between 16% to 23% for the second quarter, outperforming the S&P 500 Index by nearly 14%. TNAOP’s total return performance was 24.1% year-to-date through last Friday with oil and gas, natural gas producers really befitting from higher commodity prices. And we've seen a nice recovery in oil prices through June 30 with crude oil rising 31% for the year and 84% since hitting a bottom on February 11. So why such a strong recovery in oil prices? The biggest reason is decline in US oil production and according to the IA, US oil production is over 1 million barrels per day lower today, than one year ago as of July 15, 2016. In our view, the fundamental that of continue to support an improvement in oil prices in 2016 and beyond. Crude oil supplies is falling by even more then expected and estimates for global oil demand are being increased. The only thing that appears to be holding back crude oil prices at the present time is excess inventories. In the second half of 2016 we expect to see declines in global inventories that will help reduce oil prices. It is likely that oil prices are expected to remain range bound in the mid 40s to mid 50s per barrel for the remainder of the year. What is been a pleasant surprise in the current low oil price environment, is how US oil and gas producers have found new ways to stay economically competitive. Technology is continued to increase the volume of oil. The US producers is expect to recover from each well drilled. This combined with lower drilling cost have been making several US basins such as the Permian Basin economically competitive with oil basins from around the world, including some OPEC countries. Now a change that few are talking about right now is how the US is expected to be a critical supplier of crude oil to the rest of the world, as global oil demand increases over the long-term. Despite the recent increase in oil prices, current prices are still too low. And as a result, we expect North American capital expenditures to fall again this year, which marks the first time since 1986 and 1987 that E&P CapEx is fallen two years in a row. We believe it will take $60 oil price to stop the decline in US production and longer term we believe US oil production will need to grow to supply global demand. OPEC remains relevant today, but in our opinion become less relevant in the future because there is simply not a lot more that the curtail can do. OPEC is producing near its capacity limits, as some of few supply disruptions in Nigeria and Libyan and Venezuela is temporary. But we see these disruptions is permanent, increasing the likelihood of an upward oil price spike in the future. Now oil and gas producers have continued to raise capital in the second quarter, but at a much lower level than the previous quarter. With improving oil prices and active capital markets, some investors have raised concerns that we will see a repeat of 2015 when oil prices collapse in the second half of the year. We do not believe that the second half of 2016 will be a repeat of 2015 for three reasons. First, US oil production volumes are declining, this was not the case in 2015. Second, oil prices are still too low to support additional investments. The futures curve for oil price is approximately 20% lower than last year and is at prices that are not economic for most producers. And last leverage it, most oil and gas producers remained high and needs to come down. So we expect oil and gas producers who will the extra – the extra cash flow from higher commodity prices to reduce leverage. Shifting our attention to the natural gas sector, natural gas prices are finally increasing with the majority of that increase having occurred in June. Prices rose by almost 50% during the quarter. The price increase occurred due to more demand going into the summer months. Natural gas demand is running exceptionally strong, thanks to the hot summer we've experienced so far and oil prices, as prices this low are attractive to electric utilities making natural gas an economic choice over coal. While demand trends continue to be positive, supply is flat due to low prices. Natural gas production growth is expected to rise only slightly in 2016. However, we expect to see production pick back up in 2017 as prices arise and increases in liquefied natural gas or LNG exports lead to expected production growth increases. Natural gas inventory levels are 20% higher than last year at this time and more than 20% higher than the previous five year average according to the EIA. We expect inventory level to continue to increase through October at which point levels could be at record high. How much of the over supply the US works through after October will largely be dependent on winter weather. We expect continued increases in demand to lead the positive prices in 2017. So in summary, the oil and gas producer sector had a strong second quarter outperforming the S&P 500 Index by almost 14% as of June 30, 2016. Crude oil prices are expected to remained range bound in the mid 40s to mid 50s per barrel for the remainder of the year. However, global represents potential for an unexpected price spike as seven of the 13 OPEC producers produce less oil than a year ago. We think current oil prices are still too low. So US oil production should continue to fall through 2017 allowing global inventories to fall. The Permian Basin, the premier US Basin will likely lead the increase in US production in the years to come gaining market share in all price environments. Natural gas prices are rebounding, thanks in large part to the extraordinary warm start to the summer. But with the energy sector in the midst of a recovery, we believe that the US energy sector is an attractive place for investor to increase their allocations. So on that note, I'll turn it over to Matt Sallee, for discussion on the mid-stream and down-stream sectors.

[Matt Sallee:]

Thanks, Rob. The second quarter felt better than the last several quarters for sure. In the second quarter pipeline corporations as represented by the Tortoise North American Pipeline Index returns 16% and 29% year-to-date through last Friday. It was also a strong quarter for MLPs as represented by the Tortoise MLP Index, with the highest single quarterly return in history at 22.6% and an 18% year-to-date return through last Friday, outperforming the S&P 500 year-to-date through July 22, 2016. So the correlation between crude oil and MLPs moderated. It’s well above historical levels. The TMLP Index had an approximate correlation of 0.7 to WTI in the first half of 2016 versus the historical average of 0.4. Capital markets were one of the key concerns for investors in the back half of 2015 and well into '16. Recent activity however has started to lay fear and lot companies to get back to a more traditional financing the 50% equity and 50% debt. The market is not fully opened yet, but with continued improvement it bodes well for the sector and its ability to finance capital projects and acquisitions. Specifically in the second quarter MLP and other pipeline companies raised close to $14 billion, approximately $5 billion in equity and $9 billion in debt. High yield pipeline that was issued for the first time in several quarters and total debt issuance almost exceeded the total for the last three quarters combined. Preferred's continue to be an alternative means of financing in the mid stream space totaling $1.5 billion. There were no high peers in the energy sector during the second quarter. Merger and acquisition activity among MLP and pipeline companies was lower compared to the first quarter with announced transactions totaling just under $4 billion for the quarter. Moving to the fundamentals and drivers. Exports remained robust in the US at all time highs and exporting natural gas to Mexico, as well exporting LNG, ethane and crude oil globally. Multiple CapEx projects are in the works and we anticipate exports will be one of the key ingredients to the US energy story for the next decade plus. Infrastructure overbuild continues to be a concern for investors. One of the key concepts of mid streams – of mid stream is that basins constantly alternate between over-built and under-built from a capacity perspective. As companies build out pipelines that frequently build for the prospect of growth not to satisfy just current volumes. This inherently make sense as it’s inefficient to have cost in building taking place. But it does pose a risk that if production expectations aren’t met the period of being over-built may be longer than anticipated. Some basins will likely be over-built given the drop in commodity prices, but the ship grew temporary. CapEx is generally spent in ways based on which commodity is in favor and whether or not it’s more producer or consumer driven. After a wave of supply push crude oil projects, we're now in a wave of natural gas and NGL demand pull projects. Speaking of projects, internal growth activities have been focused on gathering and processing NGL exports and natural gas transmission projects in the Marcellus Utica regions. These projects are connected on – these projects are concentrated on demand pull projects in the largest areas where infrastructure build-outs needed. In the Gulf Cost area infrastructure is needed to support export capabilities. All to all, we anticipate approximately $185 billion of both internal and acquisition activity for MLP and other pipelines during the three year period from 2016 through '18. This activity should result in distribution and dividend growth and reiterating comments from last quarters, while MLP growth for the next 12 months may be a bit more challenged, we continue to expect 5% to 7% distribution growth in 2016. I would note we expect a median growth rate to tick down, while the weighted average growth remains in the 5% to 7% range x-cuts. Highlighting the high quality mid stream companies remained the best position to grow. There is some concern around possible distribution cuts. We've been monitoring several companies, including Williams’s companies’ ticker WMD, Energy Transfer equity, ticker ETI and Plains All American, PAA. The potential for distribution cuts is largely occurring due to pressure from the rating agencies. Plains recently announced plans to simplify its corporate structure by exchanging with its general partner LP units for the elimination of the incentive distributions rights, at the same time it reduced its distribution 21%. While we never like to see a distribution, but we fully anticipated this could occur and we felt the cut was essentially priced into the stock. On the news PAA traded up approximately 10% confirming this thesis. With regards to WMD and ETE, the mid stream space saw some resolution at the end of the quarter with ETE terminating the proposed merger. The best news from all of this is that, both companies are taking steps forward in returning to what they do best, operating strategic infrastructure assets. We expect the Williams companies will also likely cut their dividend to support WPZ in the near future and have similar thoughts regarding how it would trade. Moving to valuation, the yield for the TMLP Index was 7.3% as of last Friday's close. This compares to the three, five and 10 year medians of 6%, 6.1% and 6.5% respectively. For pipeline corporations the TNF yield was 4.8% as of last Friday. We expect current yield plus the distribution growth to generate low, mid teen’s total return, but it’s important to point out that our ongoing assumption is the market applies the same exit yield as we look forward. We think a range of total return scenario is appropriate to understand. Given the strong second quarter you'll notice our total return outlook for the next 12 months is come down for each scenario. In our low case scenario we assume a retrace in the exit yield to 8% and also assume growth of 1.5% or about one quarter of our current estimate. This generates flat to slightly positive total return over the next 12 months. Our medium case scenario assumes growth of 5% to 7% but allows the exit yield to revert to 7% as opposed to the current 7.3%. This yield compression generates a total return of approximately 20%. Our high case scenario assumes the same growth rate 5% to 7% but with an exit yield of 6% essentially inline with both the 3 and 5 year medians. In this scenario total return comes in just under 40%. As I've stated many times its difficult predict the exit yield, but this provides what we think are reasonable scenarios to examine potential return over the next 12 to 24 months. We still believe the probability of further compression is higher than a move out over the longer term. The last topic we'll cover is the down stream sector starting with refiners. While refine product demand remains at record levels, refining margins have declined due to narrow or crude oil differentials and growing inventories. Higher rinse [ph] prices, which is the cost to blend gasoline and ethanol was also an additional headwind. Even with these headwinds refiners continue to generate healthy profits compared to historical levels. In the petrochemical sector, though the price of ethane has increased following higher demand from new facilities, demand for the end product also increased essentially neutralizing the margin impact. The US still provides the lowest priced ethane in the world thus making US competitive globally. Lastly, power and utility companies including LDCs do not participate in as much of the recent rebound compared to other energy sectors since they are defensive by nature. Renewable energy was negatively impacted by regulatory uncertainty in corporate restructuring following a high leverage and limited access to capital. We continue to maintain a strong long-term growth outlook for wind and solar. That concludes our thoughts on the energy value chain. So in summary, fundamentals in the various commodities continue to show signs of improvement. MLP and pipeline companies continue to improve. Our MLP correlations to crude oil have come down, they are still above historical levels. Capital market access is steadily opened, exports remain a key focus and valuations remain attractive across the energy value chain. So with that, we would be happy to answer any questions.

[Pam Kearney:]

Wait a minute, Matt, if you don’t mind could we ask just a few that we heard recently from investor?

[Matt Sallee:]

You bet.

[Pam Kearney:]

Okay. I'll start with you Matt. Can you provide us more information on the ETE, WMD deal and a transaction on where do we go from here with that?

[Matt Sallee:]

Sure. Both companies are really focused at this point on moving forward on a standalone with their standalone business plan. The key goals for them are taking care of the 2016 funding and getting off negative outlook, so WPZ, has a negative outlook at both S&P and Moody's, ETP has a negative outlook just at Moody's. So along with that we mentioned that we expect a cut at WMD potentially ETE and both of those would be focused on supporting their underlying limited partners. As it relates to WMD just a couple other things to note, they are suing ETE. They are not suing to close the deal, but rather suing to prove that – or for ruling the good faith was not exercised to getting tax opinion, so basically they are looking for a penalty there, and not to close the merger transaction. One other thing to keep in mind on WMD is they have an annual meeting scheduled for November. There is a basically dissenting se of board members who have dropped off the board since the close or since the termination of the merger agreement. So we would not be surprise to see a proxy fight related or to come about at the time of that November meeting.

[Pam Kearney:]

Okay. Great, thanks. A question for you, what is a good estimate for long-term CapEx spending in the energy sector?

[Rob Thummel:]

Sure. Very good question. So there is a couple of ways to look at that. I am going give you a perspective on sub-sectors because what's happened in the oil and gas producer sector two years ago when it was at $100, North American capital spending was $200 billion, today that was in the 30s and 40s, North American capital spending is half of that, its barely a $100 billion. So on a normalized basis, the sector itself probably we need to spend somewhere around a $130 billion to $150 billion a year in North America specifically to keep production flat, to continue to grow. And so that’s what we'll see going forward now that we really ended this commodity price cycle and moved past low oil prices. On the mid stream side, there is not as much volatility in the capital expenditure sector. And generally speaking there was been some studies done, that basically show that you need at least to spend $20 billion a year, really between now and 2035 to support the continued need for energy infrastructure.

[Pam Kearney:]

Okay. Thank you. Brad, one for you and its really a two part question, what are your thoughts on leverage levels in the funds, and in light of the changes in leverage in current distribution announcement, can you provide some insight regarding distributions going forward?

[Brad Adams:]

Sure. First with leverage, the absolute amount of leverage outstanding is relatively unchanged from Q1, while leverage as a percent of total assets has decreased rather significantly, as a result of increasing asset value. So based on where we are today, I wouldn’t expect further reductions in leverage. Regarding distributions, these funds have a lot of moving parts that impact DCF, a there are number factors support considers in establishing distribution rights. Brent mentioned you know we intend to recommend to the board the whole distribution is flat for third quarter, but obviously keep in mind that the distribution terminations at the end of the day are board decision.

[Pam Kearney:]

All right. Well, thank you. And with that operator, we ask if you'd open the line and do we have any questions from listeners.

[Operator:]

[Operator Instructions] Our first question comes from the line of Kristi Peterson with [indiscernible] Please go ahead.

[Unidentified Analyst:]

Hi. Thanks so much for doing the call. I was wondering if you might be able to quantify the exposure to the demand end of the pipelines in TYG versus the production or supply end?

[Matt Sallee:]

Sure. This is Matt. You know, most of our companies are fairly diversified at large asset footprints. That being said, I think if you look at the various sectors that we're investing in, specifically refine products and natural gas transmission tend to be more demand full, whereas crude oil and gathering processing would be a little more supply push. So looking at refine products and natural gas transmission, combining those two you're just shy of about 60% of the portfolio, whereas the other two would make up the balance or you know a little more to 40% of the portfolio. So it’s probably about, roughly speaking 60-40 mix between little more emphasis on the demand pull or supply push. And we've flavored it little more that way really since the cycle started back in mid 2014. And I think it would be reasonable to expect that as prices improve, you know, maybe a move a little more back towards the supply push, not so much today, but as we get further clarity around improvement commodity prices.

[Unidentified Analyst:]

Thanks.

[Operator:]

[Operator Instructions] Our next question comes from the line of Bill Barrel, Private Investor. Please state your question.

[Bill Barrel:]

NTG in the second quarter, I believe had about 94% of distribution coverage, how do you reconcile that with maintaining the distribution going forward?

[Brad Adams:]

This is Brad, I'll be glad to address that. As I mentioned in my remarks, there are a number of components that impact TCF, you got to think about distribution growth, changes in portfolio composition, leverage levels cost, asset based fees and as a result you know, DCF can move around quite a bit from quarter-to-quarter. Looking back, I know NTG is had coverage above 100% at times. It’s had coverage below 100% at times with no change distributions during those time period. So if we really manage the funds with the long-term perspective, with the goal of covering distributions with DCF over that longer term and that’s how we look at the firms DCF and distribution payouts.

[Bill Barrel:]

Thank you.

[Operator:]

I am showing no further questions at this time. So I will turn it back to management for any closing remarks.

[Pam Kearney:]

We have no further remarks, but we thank you for joining us today and we look forward to talking with you again. In the meantime, we invite you to check out Tortoise QuickTake podcast. It’s a series where members of our portfolio team share their views on timely energy events. For more information on that, there is Tortoise's website at www.tortoiseadvisors.com. And while you’re there, be sure to check out the latest edition of our Tortoise Talk that will be available by the end of this week. Thank you and have a great afternoon.

[Operator:]

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.