TC Pipelines, LP (TCP) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.24.13 | About: TC PipeLines, (TCP)

TC Pipelines, LP (NYSE:TCP)

Q2 2013 Earnings Call

July 24, 2013 11:00 AM ET

Executives

Rhonda Amundson – IR

Steven Becker – President

Stuart Kampel – Vice President and General Manager

Sandra Ryan-Robinson - Controller and Principal Financial Officer

Analysts

Ted Durbin – Goldman Sachs

Operator

Good day, ladies and gentlemen. Welcome to the TC PipeLines LP 2013 Second Quarter Results. I would now like to turn the meeting over to Ms. Rhonda Amundson. Please go ahead.

Rhonda Amundson

Thank you, operator and good morning everyone. I would like to welcome you to TC PipeLines second quarter 2013 conference call. I’m joined today by our President, Steve Becker; Principal Financial Officer, Sandra Ryan-Robinson; and Vice President and General Manager, Stuart Kampel. Please note that a slide presentation will accompany their remarks and is available on our website at tcpipelineslp.com where it can be found in the Investor Center section, under the heading Events & Presentations.

Steve will begin today with a review of TC PipeLines second quarter highlights Stuart will then provide an update on the partnership assets including a brief summary of our recent acquisition. Sandra will follow with a more detailed review of our financial results for the first quarter and Steve will return and wrap up our remarks with a brief discussion of our sponsors’ activity and close with some key takeaways. Following the prepared remarks, I will ask the conference operator to coordinate your questions.

Before we begin, I would like to remind you that certain statements made during this conference call will be forward-looking regarding future events and our future financial performance. All forward-looking statements are based on our beliefs, as well as assumptions made by and information currently available to us. These statements reflect our current views with respect to future events and are subject to various risks, uncertainties and assumptions as discussed in detail in our 2011 10-K as well as our subsequent filings with the Securities and Exchange Commission. If one or more of these risks or uncertainties materialize or if the underlying assumptions prove incorrect, actual results may differ materially from those described in the forward-looking statements.

Please also note that we use the non-GAAP financial measure partnership cash flows during our presentation to provide a measure of the cash generated during the period to evaluate our cash distribution capability. This is provided as a supplement to GAAP financial results and we provide a reconciliation to the most closely related GAAP measure in our SEC filings.

With that, I’ll now turn the call over to Steve.

Steven Becker

Thanks Rhonda. Good morning everyone and thanks for joining us today. As outlined this morning in our news release and shown on slide number four TC PipeLines had a busy and exciting second quarter. We acquired an additional 45% interest in each of GTN and Bison pipelines, the effective closing day for acquisition was July 1st 2013. To assist and financing acquisition, we came to the market in May and issued 8.855 million common units for net proceeds of 373 million. In addition, we raised 500 million through a bank term loan facility with our existing banking syndicate which closed coincidentally with the closing of our acquisition.

In the second quarter, the partnership generated cash flows of 42 million and net income of 23 million. During the quarter, we paid out 43 million in cash distributions to our unit holders. And most significant the partnership today announced its second cash distribution in the amount of $0.81 per common unit, an increase of $0.03 over our first quarter distribution.

I’ll now turn the call over to Stuart to discuss some of our key developments including our recent acquisition.

Stuart Kampel

Thanks, Steve and good morning everyone. Moving over to slide five of the presentation, here we have outlined our investment portfolio which includes partial and full interest in six natural gas pipelines. The percentage ownerships shown on the slide now include the recent acquisition of an incremental 45% ownership interest in each of GTN and Bison pipelines.

On slide six, at over $1 million our recent acquisition is the largest in the partnership history. GTN and Bison’s contracts lengthened the overall contracted life of the Partnership’s portfolio. Both the pipeline have long term contracts extending beyond the end of the decade which provide predictable and sustainable cash flows and earnings to the partnership. Both assets also strengthen the market and gas supply diversity for the partnership and bring future potential organic growth opportunities, including connections to power generation facilities and emerging gas supplies. In terms of the impact of this transaction and Partnership’s portfolio there are several key changes I would like to point out. From an accounting perspective, the increase in our ownership interest to 70% of each asset will result in a consolidation of both GTN and Bison on our balance sheet. Previously, these assets were shown as equity investments. This will be reflected in our third quarter results.

And, as part of the transaction, the partnership will receive its second quarter distribution each of GTN and Bison based on its 70% ownership in each pipeline. This will result in increased partnership cash flows in the third quarter such that our distribution coverage is expected to be approximately 1.1 times. The addition of more of these assets before they diversify our revenues and cash flows which will in turn reduce the relative impact of Great Lakes on our cash flows. Further by adding more of these two pipelines with highly contracted revenue, we have increased the overall contracted revenue percentage of our portfolio to approximately 91%. And finally, the significant side of the transaction together with the positive impact of the partnership and the receptiveness to our debt and equity offerings truly demonstrates the attractiveness of the partnership as a financing vehicle to TransCanada.

Moving to slide seven we’ll discuss the financing of the acquisition in more detail. A total of $921 million in cash was required to close the acquisition on July 1st. This included the original purchase price of $1,050 million less than $146 million of existing debt at GTN. In addition, there was a working capital adjustment of $17 million that included cash on hand at each of GTN and Bison. To fund this sizeable transaction, the partnership issued 8.855 million new common units for net proceeds of $373 million.

The offering was very successful concluded the full exercise of the option granted to the underwriters to purchase additional units. The General Partner also contributed 8 million to maintain its 2 percentage risk in the partnership. 500 million in term debt was obtained in the bank market from the Partnership’s existing syndicate of lenders. And finally an additional 40 million was sourced from combination of a drawn to the partnership revolving credit facility as well as cash on hand. The acquisition is expected to be immediately accretive to cash flow and earnings.

Turning to slide eight, I’ll provide a brief discussion and update on our assets. As we’ve outlined on previous quarterly calls, Great Lakes continues to operate as a regional, storage focused pipelines supported primarily with short term short-haul contracts for gas within both Westward and Eastward. Results through the next quarter will depend primarily on natural price spreads and how those spreads impact the amount for natural gas storage in Michigan and Ontario. In July, TransCanada’s mainline gas pipeline began operating according to the recent Canadian regulatory decision with specified long term contracted rates and market based short term rates. As market participants react to this new environment, Great Lakes continue to be impacted with no significant change in the capacities sold. Ultimately, a new equilibrium of (inaudible) and uncertainty should be reduced. Longer term changes in the pipeline industry are expected to occur which could impact aggregate pipeline capacity and ultimately the value of transportation.

As we have mentioned on previous calls, Great Lakes current rate case settlement expires on November 1st 2013 and is required to file this new rate on or before that date. Great Lakes continues to evaluate its options that could possible see changes to tariff rates to better reflect the book value available in the market. With respect to our other assets, Northern Border continues to show strong performance. Market spreads between Alberta and Chicago have been strong and the pipeline had had recent success with higher sales on the Chicago segment. In addition, the higher market spreads have led to successful renewals expiring capacity or capacity that was recently up for renewal was resold for terms of greater refunds for years. As a result, Northern Border’s long haul capacity is now substantially contracted through March of 2015. Our other four assets GTN, Bison, North Baja and Tuscarora performed as expected and contributed consistent results again in the second quarter.

That concludes my prepared remarks. I will now turn the call over to Sandra who will review our second quarter financial results in more detail.

Sandra Ryan-Robinson

Thanks, Stuart and good day everyone. My remarks follow the presentation materials starting on slide nine. Partnership cash flows were 42 million in the second quarter of 2013. The 10 million decrease is from the same quarter in 2012 was primarily due to lower cash distributions from Great Lakes and Northern Border. The Partnership paid cash distributions of 43 million in the second quarter, a slight increase compared to the same period in 2012 due to an increase in the quarterly distribution of $0.01 per common unit paid beginning in the third quarter of 2012. The Partnership’s overall net income was 23 million or $0.40 per common unit in the second quarter. I will discuss this in more detail on the next slide. As a result of our public unit offering in May the number of common units outstanding has increased to 62.3 million with an average of 57.4 million units outstanding during the second quarter.

Turning now to slide 10, the Partnership’s net income decreased by 10 million to 23 million in the second quarter. The $10 million decrease was due primarily to lower equity earnings from Great Lakes and increased Partnership expenses. Also Northern Border’s results reflect the rate case that was effect of January 1 2013. Equity earnings at Great Lakes were nil during the second quarter but the year-over-year decrease largely due to its capacity being sold at lower rates and volumes than in the comparable quarter of 2012. Partnership expenses which are made up of June 8 and financial charges increased by $2 million in the second quarter of 2013, due to expenses incurred in relation to the acquisition of the additional interests of GTN and Bison.

Moving now to our liquidity and capital resources on slide 11. As at June 30th the Partnership’s senior credit facility was undrawn due to the repayment of all outstanding amounts under our credit facility from the proceeds of equity offering in late May pending the closing of the acquisition in July. Immediately after the closing in July, the facility was redrawn to $360 million which is reflective of the previous balance together with an additional draw to complete the funding of the acquisition. The average interest rate on this facility was 1.45% for the quarter ended June 30th 2013. The Partnership will continue to maintain a prudent approach to managing its financial position. Our conservative capital structure at 45% debt and our investment grade credit ratings reflect our solid financial condition and provide us with financial flexibility for future growth.

That concludes my remarks on the second quarter financial results I’ll turn the call back to Steve.

Steven Becker

Thanks, Sandra. I’d like to first highlight the significant capital program which our General Partner, TransCanada is currently (inaudible) in. And then conclude my prepared remarks today by leaving everyone with some key takeaways shown on the final slide. TransCanada has assets of approximately $50 billion and is progressing through a large growth programs having commercially secured upwards of 26 billion in capital projects to be completed by the end of this decade. These projects include a number of significant oil pipeline projects such as the Gulf Coast Project, the Keystone XL project and some regional oil pipelines and terminals. They also include gas pipeline projects including three natural gas pipelines in Mexico, expansions to TransCanada’s Alberta NGTL system at two large LNG pipeline projects in the West Coast of British Columbia. There are also various power generation projects.

In addition, and as noted in our last quarterly conference call, TransCanada is considering the Energy East project. This is potential conversion of a portion of its Canadian mainline pipeline system from natural gas to oil and also includes construction of new segments of pipe to connect to oil supply and new segments of pipe to connect to market locations. This would significantly increase the size of TransCanada’s capital program. A capital program of this magnitude translates into the need for a significant funding program. One of TransCanada options is to drop down assets to attract partnership. The recent drop down is a testament to our continued ability to play a significant part in provision of capital to TransCanada.

Moving to slide 13, I would like to conclude our prepared remarks today with some key takeaways. First, our priority continues to be that of delivering long term value to our unit holders from a stable gas pipeline asset base. TC PipeLines has investments in a solid portfolio of key natural gas infrastructure assets which collect their cash flows through a long term ship or pay contracts to majority with utilities and major energy companies. Our recent acquisition strengthens our position in this regard. Given the changing market dynamics, Partnership’s second quarter results from five of our six pipelines portfolio were relatively consistent year-over-year reflecting our long term contract status.

Second TransCanada holds a significant 29% interest in our partnership including its General Partner interest. TransCanada is an industry leader in the developing North American energy infrastructure and is progressing through this large capital program with 26 billion of projects through the end of the decade which could provide an opportunity to grow our asset base. Our liquidity and financial flexibility position us a financial optional for TransCanada to assist and funding their future growth plans. With that I’ll now turn the call back over to Rhonda.

Rhonda Amundson

Thanks, Steve. I’d now like to open the call for questions. Operator, please go ahead.

Question-and-Answer Session

Operator

Thank you. The questions will now be taken from the telephone lines. [Operator Instructions]. The first question is from Ted Durbin with Goldman Sachs. Your line is now open. Please go ahead.

Ted Durbin – Goldman Sachs

Thanks. Good morning.

Steven Becker

Good morning, Ted.

Ted Durbin – Goldman Sachs

Just want to ask a couple on Great Lakes here. First in terms of the mainline and the changes to the mainline sounds like you’ve got the lower fixed holes but interrupt or rates are higher which sounds like people are going to be less to move on uninterruptable on the mainline. I’m just wondering if that will have any knock on effects on Great Lakes as we go forward here?

Steven Becker

Perhaps I can Do you have a second question as well may be if you could give us that one maybe we can

Ted Durbin – Goldman Sachs

Yeah and then the other one if you can just preview for us I know you’ve got to go on Great Lakes with the rate case on as well kind of how that all those dynamics are going to play into the funnel and you’ll be in which –

Steven Becker

Okay so I think I’ll answer the first question and Stuart can answer the second question on the rate case filing. So I think within the mainline tolls the National Energy Board set a toll mechanism where the company can charge a recourse rate on an annual basis of a contract to one year longer or it can charge market based rates and so that system was implemented as of July 1st and so those short term contracts are based at market based rates. So the impact for Great Lakes is then how do those market based rates fit with Great Lakes’ market based rates and with market based rates in storage in both in Michigan and Eastern Canada? And so there is a sort of a combined market delivery from Alberta gas to storage and then on to end users. And so the mainline structure has changed where previously it was a rate that was fixed and didn’t change it’s now a market based rate and that’s why everybody is reacting to that.

So within the pattern I think that the some of the storage facilities are challenged because of the forward longer term contracts in the general market and that’s impacting some of the flows. Those storage balances will change over time and impact flows both in the third and fourth quarter and that will affect the Great Lakes results. So that’s how the mainline by charging market based rates have an impact and it’s a new factor and everyone is adjusting to that factor. So it’s difficult for us to generalize and give you specifics looking forward because there is a lot of participants all reacting to the new realities of the market based system that the National Energy Board has decided on for the TransCanada mainline

Ted Durbin – Goldman Sachs

But I guess would you say that the Great Lakes market based rate are lower or higher than the mainline market based rates right now or are they just moving around too much that we don’t know?

Steven Becker

They both are moving around in tandem and they are moving around both in daily rates, monthly rates and one in two year rates. So they are all moving around differently and that’s why it’s been quite dynamic because it’s such a different change in the market that people have been used to. And so consequently, there is no real pattern that’s difficult to read from the first 20 or 23 days of trading in that market.

Ted Durbin – Goldman Sachs

Understood.

Steven Becker

So as a result within that I think that what we still feel in fundamental is that shippers have the alternative to go to a fixed rate on the Canadian system if they choose to contract for longer term of greater than one year. And that’s the alternative that the market based rate that’s their recourse and if they choose not to do that they can choose to market and within the shorter term rates and TransCanada is a market participant trying to balance all of those factors.

Ted Durbin – Goldman Sachs

Yeah, go ahead.

Stuart Kampel

If you’re good with that I’ll address your second question there about the Great Lakes rate case. As we’ve discussed previously Great Lakes is required to file a rate case by November the 1st Typically what we try to do on all of our pipelines is we’ve seen previously on GTN, Tuscarora and Northern Border is to try to reach a settlement with our customers prior to go into a full litigated rate case, usually sees a lot of time expense and complications avoiding the full litigated process. So Great Lakes continues to work with the shippers on trying to reach a settlement before that November the 1st date so stay tune on that as we go forward into the next quarter. One of the areas that they’re really reviewing is how to change the rates to better reflect whether value exists on the Great Lakes to capture more value or does occur either seasonally or in different market segments on the Great Lakes system. So for example, as we’ve discussed before Great Lakes is a receiving a lot of gas off the ANR Pipeline.

The TransCanada in the Eastern zone of the Great Lakes system over the last (inaudible) the market value is in the Eastern zone of Great Lakes system has actually been higher than the rates that Great Lakes has been able to charge. So there is money that’s been kind of surrendered to the market if you will in that area so but they’re looking for us to a mechanism to change how they can actually capture that value when it does exists either on the seasonal basis or on a change in the price within that market zone. So that’s where it sits right now. They’re making good progress with the shippers but until they actually find something with them we don’t know whether good or litigation or whether they’ll final settle I doubt but I prefer as obviously is to reach a settlement here as quickly as possible to get those new rates into effect.

Obviously the change that Steve was talking about here with respect to the mainline is a factor that’s kind of come into play on the Great Lakes rate settlement. So as Steve mentioned as we keep moving through that and as the market kind of adjust to the new reality and everything, we’ll start seeing more certainty and that should lead to better results and better line of sight here for the Great Lakes rate case.

Ted Durbin – Goldman Sachs

That’s very helpful. Thank you. If I can ask a second one just in terms of through the balance sheet and financing, it looks like you’re using more debt than equity for this transaction I’m just wondering the kind of the thought process there as you kind of felt you’re under-levered going in here And I realize can you have the debt to cap metrics how do you see yourself say debt to EBITDA or more of a cash flow metric as you exit the year? And then in terms of finances if I read this correctly looks like you’re using the variable rate sort of 500 million the LIBOR what’s the thought process behind using variable rate rather than fixed rate that you term out?

Steven Becker

If we could answer that is we were a little under-levered when we went into the transaction and we were sort of financing is a little bit more lumpy in terms of the absolute sizes of debt and equity that we could issue. So we sort of arrived at a factor for the transaction that sort of tried to reflect an overall target of sort of 60% debt 40% equity. We’ll not always be exactly at that number just as the results and flow as we continue on within the activities within the partnership. So that’s our overall sort of target where we’d like to be. In terms of floating rate debt we chose to finance the $500 million at floating rate and we have the capability and the option to swap some of that into a fixed rate for the five years. We haven’t entered any interest rate swaps at this particular time but that’s an option that we still will look at when market’s when we were considering doing this debt issue during June the market was a little bit choppy and that’s where we chose to go to the bank debt with floating rates at this particular time. And so that’s something that our financial people will manage for us going forward.

We generally have kind of a rough rule of thumb of fixed to floating but again that’s not specific at any one time it’s just within a range. And so currently the Partnership unit holders are getting the benefit of a fairly low interest rate that we’re sitting at right now. So we’ll be watching at and what you may see in the future is some interest rates swaps to change the mix of fixed to floating. But that will just depend on market conditions and we’ll report on that as we will in each of quarters what activity we’re doing in that area.

Ted Durbin – Goldman Sachs

Okay. That was all I had. Thank you very much.

Steven Becker

Thank you.

Operator

Thank you. The next question is from Matt Niblett with (inaudible). Your line is open. Please go ahead

Unidentified Analyst

So I have a few questions as well I will put them both out there and you can answer. The first is that is this recent increase in the distribution is this reflective of what you think is a sustainable annual pace going forward or is this sort of one time judgment? And then secondly is there an enhanced attitude that’s apparent around drop downs into the parent or into the partnership that we could see them on a more regular basis going forward?

Steven Becker

Well thanks Matt may be I’ll start off with these one. The $0.03 increase is reflective of the whole partnership portfolio. Generally our distribution pattern is not as deal specific it tends to reflect the aggregate of the whole portfolio so that the transaction was very large of being over $1 billion but it’s reflecting over $4 billion asset based that we have in terms of how we would do that and we do believe that it’s sustainable for a number of years going forward and that was part of our judgment in making that and judging the size that we felt we could make it this time.

Unidentified Analyst

But just to clarify sustainable at the current rate going forward or the pace of the increase is sustainable?

Steven Becker

What we tend to do is that the current rate of being able to pay $0.81 is sustainable and if you’re trying to say it’s increased a gain what that happens is it will depend on what our portfolio is a year from now.

Unidentified Analyst

Okay

Steven Becker

So depending on our (inaudible). In the past few we’ve tended to ride with a slightly higher coverage ratio and that gives us some ability to increase we’ve been able to increase our distribution every year since 1999. So that’s the way we manage distributions are at the discretion of the board and so that would be decision they would make likely sometime next year with all the market information and facts at that time. And then when you go on to your second question about the aspect what’s apparent is I think that what we’re really trying to indicate is that the in the past TransCanada had a number of different projects. And so if you were tracking us this time last year the primary one was Keystone XL. The southern end of Keystone XL with Gulf Coast project is being built from Cushing to Port Arthur so that capital is going on. But what’s more importantly has happened is TransCanada has landed number of other new projects including three projects in Mexico and other different oil projects. And so as a result of that their capital program is much larger than it was at this time last year and as well as they are working on this Energy East project and they’ve had an open season but they’ve not announced their results yet. So their aspect of will they do more drop downs, their need for capital is higher but you’ll have to wait and ask that question on the TransCanada call. And we (inaudible) we’re an option for them to drop down assets to but it’s their decision when and which assets would be dropped into the partnership. And so therefore I think you’d have to ask the magnitude in that aspect on the TransCanada call which is later this week.

Unidentified Analyst

Alright

Steven Becker

Thank you.

Operator

Thank you. [Operator Instructions]. There are no further questions registered on the telephone lines at this time I’d now like to turn the meeting back over to Ms. Amundson.

Rhonda Amundson

Thank you everyone for your participation today. We appreciate your interest in TC PipeLines and we look forward to speaking again with you soon. Bye for now.

Operator

Thank you. The conference call has now ended. Please disconnect your lines at this time. Thank you for your participation.

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