CH Energy Group Inc. Q2 2009 Earnings Call Transcript

CH Energy Group Inc. (CHG)

Q2 2009 Earnings Call

July 30, 2009 2.00 pm ET

Executives

Steven Lant - Chairman, President & Chief Executive Officer

Chris Capone - Executive Vice President & Chief Financial Officer

Kim Wright - Vice President of Accounting & Controller

Stacey Renner - Treasurer

Analysts

James Heckler - Levin Capital

Maurice May - Power Insights

Dan Fidell - Brean Murray

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the CH Energy Group conference call. Now at this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions)

Your hosting speaker Steven Lant, please go ahead, sir.

Steven Lant

Good afternoon and welcome to our conference call. Joining me on today’s call are Chris Capone, Executive Vice President and Chief Financial Officer, Kim Wright, Vice President of Accounting and Controller and Stacey Renner, our Treasurer.

After my introductory remarks Kim Wright will cover our quarterly results in detail by business unit and Chris Capone will discuss our business environment and our outlook going forward. At the conclusion of Chris’s remarks we’ll take your questions.

Before we begin, I’d ask Stacey Renner to review our cautionary statements. Stacey.

Stacey Renner

Thanks, Steve. I’d first like to remind listeners that the presentation slides for this conference call and our supplemental second quarter financial information are available in the Investor Relations section of our website at www.chenergygroup.com. I refer you now to the paragraph on forward-looking statements at the bottom of this morning’s press release. If you’re following along with the presentation slides please reference page three.

During this conference call presentation and in the question-and-answer session to follow, CH Energy Group participants may discuss management’s intentions, beliefs, expectations, and projections or make other statements that are not historical in nature.

Please note these forward-looking statements are subject to assumptions, risks and uncertainties that could cause actual results to differ materially from the forward-looking statements.

These risks are discussed in more detail in our filing on Form 10-K for the year ended December 31, 2008 under the section labeled risk factors, and as updated on subsequent 10-Q filings. Those filings are available in the Investor Relations section of our website at the link for SEC filings.

I’ll now return the call to Steve Lant.

Steven Lant

Thanks, Stacey. Our earnings per share for the second quarter of 2009 were a loss of $0.09 versus a gain of $0.11 in the second quarter of 2008, an unfavorable variation of $0.20. For the first six months of 2009 our earnings per share were $1.37 versus $1.33 for the first six months of 2008, a favorable variation of $0.04.

The most important factor driving our lower results for the second quarter of 2009 was a weaker result at Central Hudson, our utility business unit, which was down $0.19. As we’ve explained in prior calls the three year rate plan that we’ve been operating under did not provide Central Hudson adequate revenue.

The second quarter of 2009 was the final quarter of that three year period, when the revenue gap had expanded to its maximum. I’m very pleased to report that on June 22 the New York Public Service Commission issued an order granting Central Hudson a rate increase of $39.6 million electric and $13.8 million for natural gas.

The rates set reflect a 47% common equity ratio up from 45% in the prior rate plan, and an allowed return on equity of 10%, up from 9.6% in the prior rate plan. The new rates also reflect higher rate base and contain revenue decoupling mechanisms whose primary purpose is to eliminate a disincentive for Central Hudson to promote energy efficiency.

Which it also serve to eliminate the risk of the type of revenue shortfall which plagued us under the prior rate plan. The new rates will be very helpful in bringing Central Hudson’s earning up to appropriate levels beginning with the third quarter of 2009.

However, we will be challenged to earn the allowed rate of return on common equity of 10% for three major reasons: The first reason is that the PSC did not fully recognize two legitimate costs of service, Directors and Officers liability insurance, and variable pay for management employees.

The second reason is that the PSC Austere Imputation of $3 million combined with the productivity adjustment of about 1.5% results in a combined productivity adjust of about 4.5% of non-fuel operations and maintenance expenses, which we will need to achieve if we are to earn the authorized return on common equity.

This is very challenging for a company that has been operating as leanly as we have been. The third reason is that regulatory lag is working against us relative to our uncollectible accounts, which have increased dramatically over the past few months as the unemployment rate has risen and which are likely to the peak well above the amount included in the new rates.

Over the past few weeks our management team has been assessing what we can do to earn a return close to the authorized level in a rate year, which began on July 1, 2009. While we think that achieving the 10% will be difficult, we’re dedicated to coming as close as we can and we’re cautiously optimistic that we can come close.

If we do so our earnings over the next 12 months at Central Hudson should be much higher than they’ve been over the past 12 months. We’re also preparing to file a rate case tomorrow to cover the period beyond the current rate year which ends on June 30, 2010. This rate increase will be fairly modest and is driven primarily by inflation, environmental compliance, taxes and rate base growth.

Before I turn the call over to Kim Wright I would also like to mention Griffith’s continued strong performance. While the second quarter is not a quarter in which we expect to make money at Griffith, because of the seasonal nature of the business, our loss was $0.03 cents per share lower than for the second quarter of 2008.

For the 12 months ended June 30, 2009 Griffith’s return on equity, after accounting for its inter-company debt, was 12.15% well above the utilities ROE and the highest level we’ve yet achieved. We take these results as evidence that our strategy to improve Griffith’s return is working.

I’d now like to turn the call over to Kim Wright.

Kim Wright

Thanks, Steve. Good afternoon everyone. As Steve mentioned I’ll be reviewing our results for the second quarter and will be covering pages five to eight of the power point presentation for those of you who are following along online.

Beginning with our consolidated results, you see on page five that we lost $0.09 in the second quarter of 2009, a $0.20 reduction from last year’s second quarter earning of $0.11. This decrease was expected given the sales shortfall in Central Hudson’s three year rate settlement that ended June 30, 2009.

Moving on to page six, Central Hudson’s earnings of $0.06 were $0.19 lower than the second quarter of 2008. The primary driver of our lower earnings was the sales shortfall I just mentioned. Looking at some of the details provided on the bottom half of the page, as we’ve discussed on prior calls, our earning are down because the sales forecast reflected in our rates was too high providing insufficient revenue to keep pace with our operating costs.

You can see that although our earnings were $0.03 higher than 2008, as a result of the rate increases, if you look below you can see that the normal cost of our business such as depreciation, tree trimming, taxes and interest charges, increased over 2008 at levels in excess of what we generated from the higher rates.

Another driver of the lower earnings were higher uncollectible expenses as more customers struggled to pay their bills. This increased our uncollectible accounts and reduced earnings by an additional $0.05 in the second quarter of 2009 relative to the same period last year; bringing the year-to-date total to $0.10 higher than the first half of 2008.

While our new rates do reflect an increased recovery for these costs, given the continued impacts of the weak economy, particularly the increase in unemployment rates, we expect that our expenses will continue to exceed the rate allowance. We continue to monitor these costs closely and have implemented a variety of measures to reduce the impact of these costs on our earnings.

Moving on to page seven, you see that Griffith’s results were $0.03 higher than the second quarter of 2008. The improved performance was primarily driven by lower operating expenses as we discussed last quarter. Given the level of conservation we began experiencing last year, we took a close look at our expenses to ensure they were inline with the lower sales volumes.

The result of this review reduced our cost and added $0.04 to our second quarter earnings relative to last year. You can see that in the second quarter higher margins were unable to offset the impact of our lower sales volumes, which lowered earning by $0.08. While still higher than the second quarter of 2008 margins were tighter in the second quarter of 2009 than in the first quarter due to rising oil prices.

Wrapping up on page eight with our other businesses and investments, earnings were $0.04 lower than 2008 due to an extended outage at our Lyonsdale facility and interest expense on the holding companies long term debt issuance. In terms of the Lyonsdale outage, as Chris Capone noted during last quarters call, we plan to extend our annual spring outage to make repairs to some equipment that has caused unplanned outages in the past.

The plant has been operating well since it came back from this outage in May. The holding companies interest expense was also expected as we issued $50 million of long term debt during the second quarter.

This debt is being serviced by interest income from inter-company loans to the non-utility operating companies, primarily Griffith. The holding companies 2008 results also reflected interest income from Griffith for its inter-company loan but without the offsetting interest expense for external debt.

Now I’ll turn the call over to Chris Capone for a discussion of the outlook for our businesses and investments.

Chris Capone

Thank you, Kim. Good afternoon everyone. The second quarter of 2009 was a very critical quarter for CH Energy Group and especially Central Hudson, as Steve and Kim alluded to, and Central Hudson is by far our largest business unit in terms of assets and earnings, as well as a very successful quarter and more importantly a trailing 12 month period for Griffith, which is our second largest business.

Generally while the credit markets improved during the second quarter we do continue to focus on maintaining access to adequate liquidity and right now we have approximately $30 million in cash at the holding company in addition to a $150 million committed line of credit, and $125 million of committed credit at Central Hudson.

At this point I’d like to begin making comments on our primary business units. As Steve and Kim mentioned at Central Hudson we received a rate order at the end of June and the new delivery rates went into effect July 1. The rate order contains a number of important elements that should serve to improve the earnings and financial integrity of Central Hudson and also importantly reduce the risk of earnings substantially less than the authorized ROE.

Primarily that will be done via the revenue decoupling mechanism, which Steve eluded a few minutes ago. Some of the key elements of the rate plan, again as Steve mentioned, is the ROE now at 10% compared to the 9.6% in the just ended rate agreement. Now, in addition our ability to earn the authorized 10% while challenging is still much higher now than in the prior rate structure.

As Kim mentioned in her comments relative to the sales level that was built into the prior rate agreements and what was actually experienced, the revenue decoupling mechanism does address what was a significant revenue mismatch in that prior agreement. For the past few quarters we’ve been providing information on the impact of that mismatch, again, the mismatch between the level of sales used to set rates and actual sales.

In the first half of 2009 alone, again the first half of this calendar year, the mismatch was approximately $0.46 per share and that compares to approximately $0.55 per share for all of 2008. So, it was certainly an accelerating trend and that was really driven by the fact that the sales forecast assumed slightly higher but continuously higher sales per customer.

Regarding the common equity layer, rates now reflect a 47% common equity ratio. The prior agreement, as Steve mentioned, was predicated on a 45% equity layer and in fact right now we currently have a 48% equity layer which we believe is much more supportive of single A credit rating. As a capital intensive business we do feel single A credit rating is critical to being able to access capital on reasonable terms and in virtually all market conditions.

Regarding CapEx and rate base growth, our utility infrastructure continues to require significant investment even though growth has slowed during these difficult economic times. These investments lead to rate based growth and the equity component of this rate base growth drives our earnings at the utility.

The CapEx program we are projecting in the current rate year should provide us with the resources to maintain the integrity and reliability of our delivery restructure. Now based on an estimate for the 2010 rate base, the earnings power of the utility is approximately $2.50 per share, assuming we are in the full 10% authorized ROE.

As Steve alluded to before, there are some elements of this rate agreement that will make it difficult for us to achieve that full 10% level and those are things again that he alluded to on collectible expenses which Kim described in a little bit greater detail, Directors and Officers insurance and some other exposures.

As a reference point each 25 basis points of earned ROE equates to about $0.06 a share or about $1 million after tax. Now we are currently analyzing ways to offset these under recoveries in terms of certain elements of cost, but it’s too early to determine the level of success.

Some of the important elements that were contained in this agreement that were carryovers from prior agreement certainly continue to play a very critical role in allowing to us manage the risk of the business

Mainly one of the very important once is the full recovery of purchase power costs. The new rate order continues the PSC policy of providing full recovery for all costs associated with purchasing natural gas and electricity for our full-service customers. We do continue to utilize hedging practices to dampen price volatility for our customers.

This agreement also includes a continuation of the public service commission policy, a full recovery of pension and other post employee benefit costs. When we look at uncollectibles again, something that Kim alluded to in terms of what we will be able to collect going forward relative to what we believe our experience maybe.

Now, in our rate filing last year, we requested deferral treatment for any amounts that were different from those that we can actually collect via rates. The commission chose to allow recovery for uncollectible expense based on our latest known experience for the period ending March 31 of 2009.

While this approach provides less protection than a deferral mechanism this treatment is the most beneficial in this state, but again Steve and Kim alluded to, given the state of the economy and trend that appears to be unfolding, we feel these rates of recovery will prove insufficient. This is most likely the greatest impediment to our ability to earn the 10% authorized rate of return.

Depending upon the size of the under-recovery, we would have the right to request deferral treatment, though under-recovery would have to be significant to meet those thresholds. We are taking steps to address our accounts in arrears, but the biggest factor will likely be the unemployment rates and the period during which the economy begins to grow again.

Now, overall this rate order represents significant progress in our efforts to provide shareholders with an acceptable return, maintain financial integrity and meet the service and quality levels our customers expect. As I’ve stated in the past, our management team felt that the recent earnings from Central Hudson representing a trough and not a trend and we feel that this agreement will result in a rapid improvement over the course of the next year and set the stage for a trend towards higher future earnings.

Now I’d like to make some comments about Griffith. As Steve alluded to earlier in his comments, during the second calendar quarter Griffith does typically report a loss, though results did improve year-over-year by $0.03 per share. Griffith results were driven by a focus on managing cost and expanding margins to address the declining usage per customer.

As an industry, it appears margins have expanded in recognition of changing customer usage and to address increases in the cost of providing service. I feel the more important point regarding Griffith is the trailing 12 months earnings figure of $0.50 per share. Griffith earns ROE, again as Steve alluded to earlier was 12.15%.

This was an earned ROE well in excess of two times what Central Hudson earned in the final rate year of the three-year agreement. The returns were also obviously in excess of the 10% recently authorized ROE for Central Hudson. We believe that with these levels of earned returns that Griffith warrants the capital we have allocated to this business and we will continue to look for and finds ways to improve performance in the future.

We believe the operational performance of our field distribution business is commendable in what has been a very, very difficult economic environment for the industry overall and Griffith’s management has delivered positive earnings despite significant volatility of wholesale fuel prices in recent years. This is a time during which some of our largest competitors have struggled.

Recent results are a testament to their skills and efforts. We are continuing our strategic review of the fuel distribution business with the objective of gaining the most value out of CH Energy Group’s investment in Griffith over the long term and we will inform everybody of any additional developments as they unfold.

Regarding our other business and investment segment, this is the segment that houses our ethanol, biomass, wind-to-landfill gas investments and includes inter-company interest income. At Cornhusker, our ethanol investment, crush margins have improved in recent weeks as corn prices have declined more rapidly than ethanol prices, but the ethanol market does remain volatile.

The construction portion of the planned expansion, that I’ve alluded to in some of the prior calls, has been completed and debottlenecking is currently underway. This expansion should increase current annual capacity of approximately 40 million gallons by roughly 15 million gallons and reduce overall production costs per gallon.

At Lyonsdale, our upstate biomass plant, capacity factors have returned to levels that are more typical since coming out of the unplanned spring outage. At our winds investment, which is the CH-CWE, this is the wind investment worth assets in Atlantic City and Bear Creek, Pennsylvania, this group of assets continues to perform well.

We have announced in the past our Auburn landfill gas-to-electricity project where we expect final permits will be received shortly, at such point as we receive them we can then begin construction. Construction completion is projected towards the end of 2009 and very early 2010.

We continue to review a number of projects for consideration with risk and return profiles that are more in line with our requirements and which we feel are an appropriate use of our shareholders capital. We recognize that the renewable area is a very large market space and we are analyzing whether to narrow our focus to a few sectors where we believe we can more successful.

At this point Kevin, I’d like to turn it back to you and open it up for the question period.

Question-and-Answer Session

Operator

(Operator Instructions) We do have a question from James Heckler of Levin Capital. Please go ahead.

James Heckler - Levin Capital

Hi, good afternoon.

Steven Lant

Good afternoon, James.

James Heckler - Levin Capital

I know you went through this, but I was wondering, I didn’t catch all of it. Could you go through again what the lag might mean in terms of earnings at the utility? You said $2.50 per share for the utility under the latest rate agreement, if you earn the full ROE, and what was the sensitivity in the ROE?

Chris Capone

James, this is Chris Capone. What I was alluding to was for each 25 basis points of ROE. So, if we under-ran for arguments sake by 25 basis points, that’s worth so to speak approximately $0.06 per share.

James Heckler - Levin Capital

Okay.

Chris Capone

And that equates to about $1 million after tax.

James Heckler - Levin Capital

Got it. Thank you.

Chris Capone

You’re welcome.

James Heckler - Levin Capital

I had a couple other things to ask about. One, you have a significant amount of cash on the balance sheet and was wondering, what is the intended use of that cash going forward?

Chris Capone

James, generally when we raise that capital, if you’ll remember back at the time during which we were raising that debt and that is the proceeds of the debt issuance that Kim alluded to the $50 million that was raised at the holding company level. That was to introduce actual leverage into a portfolio that up until that time had been fully funded with just equity.

We felt based on the opportunities that we saw going forward and the ability to raise capital during what was then a very difficult period and not really having much visibility on when that difficulty might abate, that it was still prudent to go out and raise that external capital and that will be the basis for everything from general corporate purposes to additional investments in our existing businesses as well as new assets.

James Heckler - Levin Capital

Okay. So it’s sort of pre-funding future investment in the utility and elsewhere?

Chris Capone

Correct.

James Heckler - Levin Capital

Because you had an opportunity, understand, thank you, and then given your current valuation, did you evaluate the various costs of capital of among debt, equity, etcetera, because it looks as though where your stock price is now that it might almost be at parity, the cost of equity and your cost of debt?

Chris Capone

I’m not quite sure James, how you’re measuring the cost there. I mean I guess we view the cost of equity as higher than the cost of debt, but clearly if we did need to access the equity markets to fund our growth, we would certainly welcome the opportunity to do that at a share price that’s well above book value as it currently is. That would certainly be more attractive than doing so if our price were lower.

James Heckler - Levin Capital

That’s all I had. Thank you.

Chris Capone

Thank you, James.

Operator

And at this time we have no further questions in queue.

Steven Lant

Okay, but why don’t we keep the line open for another minute or two just in case someone has stepped away and wants to ask a question.

Operator

Right now we do have a question from the line of Maurice May, Power Insights. Please go ahead.

Steven Lant

Hello, Maury.

Maurice May - Power Insights

I’ve got a couple of questions for you. First of all, the attrition at Central Hudson off the 10% authorized ROE. Steve, I think in the first quarter conference call you made a comment that if the disallowances from the recommended order stood that the attrition would be 50 to 75 basis points off the 10%, and I was just wondering whether you could update that comment.

Steven Lant

Well, a lot has changed since then, some of the things that we’re looking at have gotten worse and some better. I guess at this point there’s enough uncertainty that we don’t want to really give a tight range around that other than to, I guess couch it in the terms I did earlier that we’re cautiously optimistic that we can come close to that 10%.

We don’t want to leave the impression that we think we can exceed it, but nor do we think that we’re going to under-run it by a large margin, but there’s just, at this point the degree of uncertainty is such that we’re not comfortable giving a very tight range.

Maurice May - Power Insights

Okay, but you sound a little more optimistic today than you did on the first quarter conference call.

Steven Lant

Perhaps a little bit.

Maurice May - Power Insights

Okay, because 75 basis points not very close, is it?

Steven Lant

No, that’s not too close.

Maurice May - Power Insights

Okay. Good and then my second question has to do with the profitability of Griffith. You mentioned a 12.1% ROE and I assume that’s on the trailing 12 months, is it not?

Steven Lant

That’s correct.

Maurice May - Power Insights

What equity are you assuming there?

Chris Capone

If you can just bear with us one moment Maury; Kim is just going to find that page in our presentation.

Steven Lant

We can give that number to you.

Kim Wright

Maury, that’s approximately $73 million.

Maurice May - Power Insights

About $73 million. Okay, great. That’s it, thank you, folks.

Chris Capone

Thank you, Maury.

Steven Lant

Thank you, Maury.

Operator

Your next question is from the line of Dan Fidell, Brean Murray. Please go ahead.

Dan Fidell - Brean Murray

Good afternoon, guys.

Steven Lant

Hi, Dan, how are you?

Dan Fidell - Brean Murray

Just a quick question you’d mentioned I think on your last call about the possibility of shifting some of your asset mix. Just assuming that potentially down the road, interested in maybe going into some other areas in a little bit deeper or possibly into the smart grid technologies or renewables or a little deeper in the transmission infrastructure.

Can you maybe talk about that a little bit what your current feeling is in going a little bit more aggressively into those kinds of projects and how it might tie into your current feeling for Griffith? Thanks.

Steven Lant

Sure, I’ll try. All of these are things that are on our radar screen clearly. However, I would say that none of them are likely to result in very large investments over the next year or so.

Relative to the smart grid, we are expecting to proceed with a pretty significant pilot program over the next year that will really help inform our judgment, as to whether a wholesale roll-out is an economic and appropriate thing to do. So, the timeframe of that would be probably a couple of years before we would make significant investments if they are warranted.

Relative to transmission, while we think the opportunities are strong there as well, the timeline is even longer in that. We’re in the process of doing studies which indicate the reinforcements that we believe are necessary.

Those studies will be completed by the end of this year, but then that would then lead to an application and licensing phase that takes quite a while to get regulatory approval before any significant investments would be made. So, again the timeline on that opportunity is several years rather than over the next couple.

Relative to renewables, we are looking at renewable investments really across the spectrum. Although, as Chris indicated, we’re doing some internal study work just to see whether it would be better if we were to concentrate and focus on a subset of that area based on the characteristics of those investments that we see.

Dan Fidell - Brean Murray

Great and one last question. Just in terms of Griffith. Can you put any kind of a timeline on it for us in terms of when you think you’ll sort of conclude your strategic review of that asset?

Steven Lant

Hard to say, Dan. We’ve already done a number of things to respond to the changing environment. I know in prior calls, we’ve mentioned to you that we’ve done quite a bit of restructuring of our cost structure, initially taking about $4 million on an annual basis out of the cost structure, but we haven’t concluded that effort.

There’s still more potential, we believe to find some savings. Additionally, we are taking a hard look at our marketing programs to assess whether under the current economic and market conditions, the offerings that we’re making are the most appropriate to meet our customers needs.

So, there are a number of ongoing things and I’m not sure we’ll ever be done with the process of improving the business, but at this point there are no other major things that we could point to that we are prepared to share with you, but of course as things evolve and if we reach any decisions that are significant to the prospects of Griffith, we’ll certainly share them with you.

Dan Fidell - Brean Murray

Great and maybe just a final question, you mentioned that you’re going to be filing or expect to file very shortly here for a follow-on case. One of the things you mentioned as being a significant issue is regulatory lag especially associated with uncollectibles. Is that the potential in your filing to also seek along with what you had mentioned earlier in the call, a bad debt tracking mechanism? Is that something that’s open to you?

Steven Lant

Well, that is mechanism that is interesting. There has been though, a different approach that has been used in New York. We have seen it used and we would I think welcome it in our case, and that is deferral treatment off of a good forward-looking forecast, and that maybe, it results in the same effect on an earnings basis that perhaps introduces a little bit of mismatch of cash recoveries.

The tracker is even better from that standpoint, but depending on the magnitude of the variations, we would expect, I think we could evaluate those two alternatives.

Dan Fidell - Brean Murray

Thanks very much for your comments. Best of luck as you go forward into this next case.

Steven Lant

Thanks Dan.

Operator

Thank you. (Operator Instructions) and we have no further questions in queue at this time.

Steven Lant

Well, if there are no further questions. We thank you very much for your attention and your time this afternoon and as always Stacey Renner and Chris Capone are available to answer your questions should any arise after this call has ended. So, thank you again and we look forward to speaking to you next quarter.

Operator

Thank you. Ladies and gentlemen, that does conclude your conference. We do thank you for joining, while using AT&T Executive Teleconference. You may now disconnect. Have a good day.

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