USD Partners LP
Q2 2018 Earnings Call Transcript

Published: 7 Aug 2018

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to USD Partners LP Second Quarter 2018 Results Conference Call. At this time, all participants have been placed in a listen-only mode. The floor will be opened for your questions following the prepared remarks. [Operator Instructions] It is now my pleasure to turn the floor over to Jennifer Waller, Financial Reporting Manager for opening remarks. Please go ahead.

[Jennifer Waller:]

Good morning and thank you for joining us. Welcome to our second quarter 2018 earnings call. With me today are Dan Borgen, our Chief Executive Officer; Adam Altsuler, our Chief Financial Officer; Brad Sanders, our Chief Commercial Officer; Josh Ruple, our Chief Operating Officer, as well as several other members of our senior management team. Yesterday evening, we issued a press release announcing results for the three and six months ended June 30, 2018. If you would like a copy of the press release, you can find one on our website at usdpartners.com. Before we proceed, please note that the safe harbor disclosure statement regarding forward-looking statements in last night's press release applies to the statements of management on this call. Also, please note that information presented on today's call speaks only as of today, August 7, 2018. Any time-sensitive information provided may no longer be accurate at the time of any webcast replay or reading of the transcript. Finally, today's call will include discussion of non-GAAP financial measures. Please see last night's press release for reconciliations to the most comparable GAAP financial measures. And with that, I will turn the call over to Dan Borgen.

[Dan Borgen:]

Thank you, Jennifer, and good morning everybody and thanks again for joining the call today. I’ve got a little bit of allergy here, so bare with me as we work through this agenda. We’re proud to announce another successful quarter at the partnership. As we have previously reported Western Canadian macro continues to provide tailwinds for our business and specifically for terminalling assets. As oil sands production out of Western Canada continues to grow, demand for a strategically located network continues to exceed supply. As all of our existing capacity of Hardisty is contracted through 2019 and 2020 respectively. As a result, we’ve seen customer activity and demand at our Hardisty origination terminal increased substantially over the last several months. During the quarter, we announced the execution of a multi-year renewal and extension of approximately 25% of the capacity at our Hardisty rail terminal with one of our existing investment grade customers. In addition, the execution of a five-year take-or-pay terminalling services agreement with a high quality refiner by our parent USD Group. This new agreement could support the construction of additional capacity at the Hardisty terminal pursuant to USD Group’s existing development rights and could be viable dropdown candidate in the future. Given the increased market demand, we are actively negotiating with current and new potential customers to extend the terms of our existing take-or-pay agreements as well as evaluating a potential expansion at Hardisty from two to three units range per day. This will be supported by long-term take-or-pay contracts and we have taken the steps to assure this increased capacity will be brought on by year-end. Adam is going to start this off with an update of the partnership’s latest operating and financial results, our distribution coverage and our liquidity position then we will jump back into the recent market and commercial developments. With that Adam take it from here.

[Adam Altsuler:]

Thanks, Dan and thank you for joining us on the call this morning. Yesterday afternoon we issued our second quarter 2018 earnings release, which included the details of our operating and financial results for the quarter and we plan to issue our second quarter 10-Q with additional details after the close of market today. For the second quarter, we reported net income of $6.7 million, net cash provided by operating activities of $11.5 million, adjusted EBITDA of $15 million and distributable cash flow of $12.2 million. The partnership ended the quarter with approximately $204 million of available liquidity and distribution coverage of approximately 1.3x. The partnership results during the second quarter of 2018 relative to the same quarter in 2017, we’re primarily influenced by additional revenues and costs related to the commencement of operations at our Stroud terminal in October 2017 and the conclusion of customer agreements at our San Antonio and Casper facilities in May and August of 2017 respectively. In addition as a result of a substantial increase in the customer activity at our Hardisty terminal, the partnership incurred additional operating cost during the second quarter of this year. Net cash provided by operating activities increased by 21% relative to the second quarter of 2017, primarily due to the timing of receipts and payments on accounts receivable, accounts payable and deferred revenue balances. Adjusted EBITDA decreased by 3% and distributable cash flow increased by 2% relative to the second quarter of 2017. Net income for the quarter decreased by 22% as compared to the second quarter of 2017, primarily as a result of a decrease in the Partnership’s estimated benefit from income taxes of approximately $1.4 million. The partnership paid approximately $270,000 in net cash taxes in the second quarter and estimate its total net cash taxes paid for the full year 2018 to be in the range of $750,000 to $1 million. Effective January 1st of this year, the partnership adopted ASC 606 with regard to its accounting for revenue arising from contracted customers. And we adopted this accounting standard by applying the full retrospective approach resulting in the restatement of prior period financials to comply with the new standard. As of June 30th, the partnership had net leverage of 3.4x LTM adjusted EBITDA including pro forma adjustments for the Stroud acquisition and total available liquidity of $204 million, including $9 million of unrestricted cash and cash equivalents and undrawn borrowing capacity of $195 million on its $400 million senior secured credit facility subject to continue compliance with financial covenants. The partnership is in compliance with its financial covenants and has no maturities under a senior secured credit facility until October 2019. On July 27th, we declared a quarterly cash distribution of $0.355 per unit, or $1.42 per unit on an annualized basis, which represents growth of 0.7% relative to the first quarter of 2018 and 4.4% relative to the second quarter of 2017. The distribution is payable on August 14 to unitholders of record at the close of business today. And with that I'll turn the call back over to Dan.

[Dan Borgen:]

Thank you, Adam. We'll shift now and I'll ask Brad to start with an update on the meaningful market events that have occurred in Western Canada crude oil market since last quarter. Brad?

[Brad Sanders:]

Thank you, Dan. So as you mentioned earlier, the macro environment in Canada remains challenge, supply continues to grow and takeaway challenge, not only from a export pipeline standpoint, but from a railroad availability and we can talk more about that in a second. But this has led to historical apportionment levels for export pipelines out of Canada, which has led to historical inventory levels in Canada, which ultimately impacts the price of WCS, Western Canadian Select, relative to all the competing crude alternatives both domestically and internationally. During the second quarter, we saw that spread, the WCS to WTI spread as widest $22. Currently that spread is trading at $32. So you can see that it is trading beyond the cost of rail. So what we like to state it’s wider than rail parity as people are competing for solutions for stranded barrels in Canada. This has led predictably to higher utilization of Hardisty and higher activity at Casper. We are currently training to 100% utilization at Hardisty in the third quarter and at Casper with not only has utilization gone up, but our spot activity with customers has been very active in second and third quarter and we’re in contractual discussions with those customers to commercialize those on extended terms. Finally, our Stroud asset at Cushing has – is fully commercialized and is 100% utilized as the midcon markets are a critical outlet for the Canadian heavy barrel.

[Dan Borgen:]

Thank you, Brad. One of the questions that we get from time to time and so as you well know our format, we tend to ask ourselves the questions and ask questions that that we think like Brad said, the investor community should be asking. But giving these strong macro dynamics that are out there, how much term and what rate we expect to achieve through this cycle. I'll ask Brad to jump in and answer that as well.

[Brad Sanders:]

Yeah, so we've talked about this in the past and we would be consistent with our messaging here is that we will – what we do is we look at the underlying macro fundamentals and we continue to see growing production. In Canada takeaway will remain challenge from a pipeline standpoint and over time we expect it to get better from a rail standpoint, but when you look at the current spot price of $32 on the differential on WCS, the WTI, the indicators in the future are equally beyond what we call rail parity. In other words, the spreads are wider than the cost to move by rail. Currently, those spreads are somewhere between $23 and $25 through 2023. So it’s a lead indicator one the need for rail takeaway over the next three to five years and two given the level of spreads our ability to negotiate competitive rates.

[Dan Borgen:]

Yeah, I think that’s right, Brad. I think as you can see that’s further evidence by the contracts that we are getting in the multiple years, five year, new contracts that meet that macro demand cycle that Brad just described. So thanks, Brad, I appreciate you’re going through that. Let me shift and talk about the railroads a minute and how they’re reacting to this. There’s been obviously news in the market if you’re following that around a railcar, compression of time to transition into a newer car. There has always been a plan to transition to the latest and greatest cars out there, which we at USD totally support. We always want the safest, most efficient car type to be able to handle any kind of hazardous goods. The BSNF, the Burlington Northern Santa Fe owned by Berkshire Hathaway has announced that they'd like to see a compression of that time of transitioning to those cars and they are the only railroad that are doing that the other Western Road, Union Pacific, Canadian Pacific as well as Canadian National and the Eastern Roads including the central roads of Kansas City Southern, Norfolk Southern and the CSX have not done that they're – they're in line with the industry standard and the industry timeline of transitioning over the multiple years to those cars. So our – how does it impact us? Our existing customers, who already have term agreements with us and railroads are not impacted by that transition which is a good thing for us and perhaps makes us a unique. However, it could be challenging for some new customers, who don’t have railcars, so we have been actively pursuing that, working with both the roads as well as the railcar manufacturers to provide adequate railcar coverage for that coming on at the end of this year and first part of next year. So we feel comfortable with that. We look forward to continuing working with the railroads to make sure that again that the product is handled in the safest manner in the safest cars that we can. So with that let me transition again and I'll ask Brad to comment about our Texas Deepwater asset on the Houston Ship Channel as well as our exciting developments in Mexico. Brad?

[Brad Sanders:]

Thank you, Dan. So Houston Ship Channel asset, we've been working in the last two years primarily on improving our connectivity options there and that made tremendous strides in improvements in that regard and I'll talk through a couple of examples here that that we think are pretty exciting. One is given our current rail capability at that facility and given the Canadian macro that we've talked through in terms of rail playing an increasing critical role from a takeaway standpoint. The way that we think the world works and it's pretty simple and logical is rail barrels out of Canada will seek the mid-continent market through our Stroud asset. They will seek direct refiners through the East Coast and West Coast, but ultimately barrels have to move to the Gulf Coast. So as rail activity increases, Texas Deep Water is uniquely positioned to take advantage of that and we’re in discussions with a number of potential customers in that regard and excited about the likely outcome. Additionally, our crude connectivity improvements will – are providing – will provide access to light crude solutions that C team export options given the growing light suite imbalance between supply and demand. So going forward we feel good about our ability to access barrels from Cushing, access barrels from Permian, access barrels from South Texas. So we’re excited about that and feel like we'll be able to make real progress now on a go forward basis. Finally, the macro story in the U.S. is just not a cruel story. It's also a light products story and it's also a – what I'll call NGL story. So we've actually made significant progress and connectivity upgrades on both of those. We’re in active discussions with potential partners in both light products and NGLs and look forward to announcing some progress in that in the future. On Mexico, I’m going to ask Josh Ruple to give us an update there since we are on early days and just commissioning our assets at this time.

[Josh Ruple:]

Thanks, Brad. Relative to Mexico, as we've spoke before on the call, there is a market opportunity to materializing to provide Mexico with refined products from the U.S. USD is well positioned both at origin and destination to provide opportunities, one of those specifically is the Texas Deepwater Asset as an origin. In destination, we have a strategy that centers around what we call the central corridor as well as the Western corridor, predominantly focused on rail movements into Mexico. We've been actively developing translating facilities at destination and as Brad mentioned we have one currently open and operational in [indiscernible] at the Bravo facility, we call that our QEG asset. We're very close to opening another trans loading asset near Chihuahua location called [indiscernible] that facility will be open and operational in a couple of weeks and then we have additional development strategies that are again along the central and western corridors of Mexico that are aimed at providing transloading capabilities for inbound refined products predominantly diesel and gasoline to service those markets. We’ve been actively engaged in the permitting process and the predevelopment process land procurement all of the above for really the last year and are starting to see really good progress commercially as well as technically from a development perspective with permits coming in and our physical ability to turn those assets on. So soon we’ll have two operational assets in Mexico and we hope to have two additional assets go live early part of next year and then continue to work on our network strategy to basically develop a destination network working with the railroads to service markets in Mexico that are best served by rail.

[Dan Borgen:]

Thank you, Josh. Obviously, the political election in Mexico some questions maybe as that affected your Mexico strategy in any way, it is not President-elect over door has been understanding and supportive of the type of business that we are doing in Mexico. We are working alongside. The Panamax, the sovereign owned national oil company in Mexico and look forward to continuing to work with them to provide good logistics alternatives that create better netbacks for them as well as providing customer access by our U.S. base and global customers, investment quality customers, dollar-based customer contracts, multi-year agreements into those markets. So we feel good about our strategy there and continue to be confirmed by the execution of agreements into that market. So with that let me change and talk about our transition into our next expansion, which is our diluent recovery unit, or DRU we call it, which produces a trademark, USD trademark barrel called DRUBIT. And in this type of environment that we're seeing today with constrained takeaway capacity both on pipe and on rail and growing multi-year oil sands production, our discussions with existing and new customers regarding the DRU have gained significant momentum. And we're very pleased with that. A reminder, our first train set of DRU will take 100,000 barrels of blended product of approximately, I will use round terms, 70

[Operator:]

[Operator Instructions] Your first question comes from the line of Derek Walker with Bank of America.

[Derek Walker:]

Good morning, guys.

[Dan Borgen:]

Hey, good morning, Derek. How are you?

[Brad Sanders:]

Hey, Derek.

[Derek Walker:]

Doing well, doing well.

[Dan Borgen:]

Good.

[Derek Walker:]

Just a couple of questions for me. Regarding the Hardisty expansion, where are you with that. It seems like you went through the permitting process and you’re ready to go there, but has that been contracted yet and I guess our question to that would be do you have a sense on – how you’re thinking about dropping that into the MLP?

[Dan Borgen:]

Sure, great question, Derek. So we have begun construction at the parent. And as I said earlier, we will have that operational, I will ask Josh to speak to that, but we will have that operation before year-end. We feel extremely bullish about where we are in our contract negotiations with current and existing customers as well as future customers, new customers, that are needing additional capacity as we said and adding a third train when there is a third train, unit train, which is call it 100 car plus unit train is a drop in the bucket compared to the macro demand that’s there that exceeds 10 trains. So we feel very, very good about that. Josh, do you want to speak to construction timeline?

[Josh Ruple:]

Sure, Derek, as we've talked in the past, Hardisty was originally designed to accommodate an expansion. So the physical expansion while it is extremely competitive from a CapEx perspective. It also is quite an easy project to deploy. Whereas Dan mentioned already down the path with the construction activities all long lead procurement has been completed and we plan to have the asset commissioned in early December and fully operational a little later that month.

[Dan Borgen:]

Thank you, Josh. I think in addition, Derek, let me try to answer the – a dropdown timeline, obviously as we've always done we will derisk the asset from a commercial standpoint have it – have it termed up. And at that point then we can look at the optionality drop it into the partnership. And obviously be discussing that with our conflicts committee as well and looking for that timeline. But bringing it on at the end of the year and then I think previously we had said a potential end of the year drop or first quarter of next year as a potential drop assuming the market supports it. Does that help you out there, Derek?

[Derek Walker:]

It does. It does. Thank you.

[Dan Borgen:]

You bet.

[Derek Walker:]

Just – I appreciate the color on the DRU commentary. Do you have a sense on the project cost? And I think before – in prior continent discussions you have mentioned sort of three to four DRUs in various locations. You mentioned Edmonton, perhaps Hardisty and Casper. Is that still sort of the market size that you're seeing for the DRUs?

[Dan Borgen:]

Yes, that's right. And we have never disclosed our capital cost, Derek, and so we don't with the DRU, but it’s a reasonable. This is not maybe you've seen other costs out there in terms of more major refining type DRUs that people have looked at. This is not that that type of assets. This is a much more efficient – capital efficient asset. It is a twenty eight month build time and – but we would look at those same locations, those continue to be the drivers for where an asset like those could be utilized and create efficiencies in the market. So, yes, you're right about the – about our Hardisty, Edmonton, Casper and maybe a couple more.

[Derek Walker:]

Okay, thanks guys. That's it for me.

[Dan Borgen:]

You bet. Thanks, Derek.

[Operator:]

[Operator Instructions] Your next question comes from the line of Mike Gyure with Janney.

[Mike Gyure:]

Hey, good morning, guys. Can you maybe…

[Dan Borgen:]

Hey, Mike. Good morning.

[Brad Sanders:]

Good morning.

[Josh Ruple:]

Hey, Mike.

[Mike Gyure:]

Can you maybe talk a little bit I guess what you're seeing as far as competitors and alter – alternative rail solutions that you think may coming out of Canada? I guess specifically have seen some stuff about Edmonton recently. Could you talk about that a little bit?

[Dan Borgen:]

Sure, sure, I think, Brad, do you want to talk about that and then I will follow up.

[Brad Sanders:]

Okay, yeah, sure. Listen we – there are two major hubs where oil is produced and gathered into. Edmonton is one and Hardisty is the other. And there Edmonton has a unit train capable solution that can handle up to – and we think in the best of world’s three unit trains a day and that is primarily controlled by a multinational, who not only produces heavy Canadian, but also refines heavy Canadian. So it's really more of a single customer solution type of rail takeaway solution. So that's three. And then the only other really unit train type solution that has significant crude gathered or behind that location to support a unit train solution and grow this Hardisty. And that’s us and we're currently two and we've talked through on this phone call, the likelihood and potential for three. Dan mentioned just generally when he was speaking that let's say that’s a total of six. We can count up to between 12 and 15 required on a go forward basis. That’s simply cannot be supported by the railroad. So there is the industrial logic of where the oil is and where who's providing those solutions then there is the industrial logic of what the railroads can and cannot do. So it's part of the story of supply. It’s much greater than takeaway capacity even from a railroad standpoint, not just from a pipeline standpoint.

[Dan Borgen:]

Okay, thanks, Brad. I think in addition to that, during these markets, Mike, what we’ve seen historically is milk trucks, hay wagon, just about anything that can transport crude in these kind of oversupply markets will happen. The challenge for that however is that the railroad – as Brad said, the railroads will have a hard time supporting that. They want to – they want to support this type of business in highly efficient locations that create efficiency throughout the railroad network and work well and round in corridors and some of those locations are out of – out of location or out of network if you will and the efficiencies are just not there to do it and be able to move in unit trains. So again Hardisty is well located, connected – connected to obviously the Hardisty hub and that’s why it has been so much in demand and continues to be in demand. Does that answers that question for you, Mike?

[Mike Gyure:]

Yeah, that's really helpful, Dan. And then maybe if you could touch on just a little bit your Stroud assets. I guess it sounds like 100% utilized there. What kind of potential do you have to expand there? I think you do have some extra acres there, but if you could talk about that a little bit that would be great.

[Dan Borgen:]

Sure, Mike. It – we are proud that it is a 100% utilized and I'll ask Josh to comment. We do have some additional property there. We are looking at some expansion alternatives. Josh, can you speak to that a little bit more for Mike?

[Josh Ruple:]

Absolutely, Mike. As we've talked in the past, Stroud indeed has the ability to expand. We actually consume about half of the 75 acre footprint at Stroud. We're actively in the process of reviewing the expansion potential for inbound unloading opportunities into Cushing. Ultimately to support that exercise, we've got to increase our pipeline. Push capability into Stroud and solve some very minor rail network issues to support increased capability there. It's very doable. It's actually quite cost effective and we're working on plans as we speak.

[Mike Gyure:]

Great, thanks. Thanks guys.

[Dan Borgen:]

Good.

[Mike Gyure:]

Thanks. That’s all I had.

[Dan Borgen:]

Okay, thank you, Mike.

[Operator:]

And at this time, there are no further questions. I would like to turn the floor back over to Mr. Dan Borgen.

[Dan Borgen:]

All right, thank you. Just in quick summary. Obviously the market that we've talked about for a while is here. It’s been here for few months now. The railroad is reacting to the strong growth in the market. They are being disciplined in the way they are approaching the market, which we support. We think that we will have the – because of this discipline from the railroads as well as the multi-year term agreements from customers both producers and refiners that we will have the most efficient cost effective dependable ratable system to deliver product out of Canada through both our network and others. We are extremely bullish as Brad had mentioned earlier about the macro demand on our assets and these are just facts that you can independently verify, not something that we're trying to sell to the market. These are just plain facts. The facts are that the production is going to grow over a million barrels, new production coming out of Canada. There's just not enough takeaway to support that even with the announced line three Enbridge expansion of roughly 300,000 barrels a day is again a small important, but small part of that takeaway system and there will continue to be heavy demand for rail for the next several years as the market – as Brad had alluded to as the market curves have strongly suggested out there with 32 spreads to mid 20 spreads on a per barrel of comparable WCS to alternative barrels in the network. Also a lot of our customers – we not only move north to south, but we move both west and east and there aren’t pipeline to support that business. And so those customers are basically not pipeline above. And so those we seek as longer-term customers as well and have been able to see that in our commercial discussions. We've got a lot of exciting things going on obviously around the expansion in Mexico, expansion at Texas Deepwater. We are frustrated a bit with the MLP market and just the overall condition of that, but we remain strong in terms of our base business. And you know we'll continue to grow that and do good business every day. There are just certain things we can't control in the public space, but we’ll – our commitment is we will strongly work to develop a sound business model that's not overleveraged that is based and backed by multi-year committed revenues by investment grade high quality customers both through our existing assets, our new assets included in the Mexico and Texas Deepwater. So with that obviously I can't leave this call without saying how much we appreciate you all on the call, the questions, the support, the digging in of our business to know and understand it and it's something that we don't take quietly and we appreciate it very much. So with that, I’ll close the call and again say thank you very much and have a great rest of the week.

[Operator:]

This concludes today’s call. You may now disconnect.