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Questar (NYSE:STR)

Q2 2013 Earnings Call

August 01, 2013 9:30 am ET

Executives

Kevin W. Hadlock - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Ronald W. Jibson - Chairman, Chief Executive Officer, President, Chief Executive Officer of Questar Gas Company, Chief Executive Officer of Wexpro, President of Questar Gas Company and President of Wexpro

R. Allan Bradley - Executive Vice President, Chief Executive Officer Questar Pipeline and President of Questar Pipeline

Analysts

Timm A. Schneider - Citigroup Inc, Research Division

Danilo Juvane

Operator

Good morning, ladies and gentlemen. My name is Aaron, and I'll be your operator today. At this time, I would like to welcome everyone to the Questar Corporation's Second Quarter 2013 Earnings Release Conference Call. [Operator Instructions] I'd now like to turn the call over to Mr. Kevin Hadlock. Mr. Hadlock, you may begin your conference.

Kevin W. Hadlock

Thank you, Aaron. Good morning, everyone, and thank you for joining us for Questar's second quarter 2013 earnings conference call. I am Kevin Hadlock, Questar's Chief Financial Officer. With me today are Ron Jibson, Chairman, President and CEO of Questar Corporation; Jim Livsey, Executive Vice President and COO of Wexpro; Allan Bradley, President and CEO of Questar Pipeline; and Craig Wagstaff, Executive Vice President and COO of Questar Gas. During this call, we'll be referring to our second quarter 2013 earnings presentation that can be found on our website at www.questar.com.

Moving to Slide 2. Before we begin, let me remind you that we will be making forward-looking statements during our call today and actual results could differ from our estimates for a variety of reasons that we described in our SEC filings. Also, this call may reference non-GAAP financial measures. Our slides in the appendix of the presentation provide reconciliations to these measures.

Let's begin with a review of the second quarter on Slide 4. Yesterday, we reported second quarter 2013 net income of $39.4 million or $0.22 per diluted share, in line with last year's results. Adjusted EBITDA was strong in the second quarter, totaling $122.7 million, an increase of about 1% compared to last year's second quarter. Despite inflationary cost pressures, combined O&M and G&A expense was flat compared to second quarter of 2012. Capital investment for the first 6 months of 2013 was $192.9 million, an increase of 1% compared to the prior year.

Turning to Slide 5. All business units performed as expected in the second quarter. Consolidated net income was up slightly, with earnings per share equal to last year's second quarter. Corporate and other operations reported a net loss of $2.3 million in the second quarter of 2013 compared to a net loss of $400,000 in the second quarter of 2012. This increase was driven by higher estimated state income tax and higher mark-to-market valuations on deferred compensation.

Moving to Slide 6. Questar Gas, our retail gas distribution utility, showed a $1 million increase in gross margin during the second quarter to $56.7 million. Adjusted EBITDA was higher by $1.4 million. Questar Gas recognize a seasonal net loss of $1.2 million, which improved by $1.1 million compared to the same period last year. This improvement was due to higher recovery of the infrastructure replacement investment and customer growth. Questar Gas' capital investment in the second quarter was $42.4 million, an increase of $1.3 million compared to the second quarter of 2012.

Turning to Slide 7. Wexpro, our cost-of-service natural gas development company, grew adjusted EBITDA to $63 million, up $3.4 million or about 6% compared to the same period last year. Net income was up $2.6 million to $28.4 million, an increase of 10% over the second quarter of 2012. These results were driven largely by a higher 12-month average investment base, which increased $47.1 million, and higher oil and natural gas liquids revenues. Wexpro invested capital of $45.8 million in the second quarter, up $15.2 million compared to last year's second quarter.

Moving to Slide 8. Revenue at Questar Pipeline, our interstate natural gas pipeline and storage business, was down $3.7 million in the second quarter, primarily due to lower revenues from natural gas liquids. Questar Pipeline earned net income of $14.5 million, down $1.6 million versus the second quarter of 2012. Capital investment in the second quarter was $18.2 million, which was $5 million higher than the prior year.

Moving to Slide 9. With regard to costs, Questar's consolidated operating and maintenance costs in the second quarter were down $2.1 million compared to the same period last year, due largely to lower Questar Gas demand side management cost and lower Questar Pipeline outside maintenance.

General and administrative expenses were up $2.1 million, primarily due to higher employee-related costs. Production and other taxes were $2.1 million higher, driven by higher gas prices and volumes at Wexpro and higher Questar Gas property taxes.

Depreciation in the second quarter of 2013 was up $2 million compared to the same period last year due to higher capital investment. Consolidated interest expense was slightly lower due to the replacement of Questar Gas' debt at lower interest rates than in the second quarter of 2012.

Turning to Slide 10. The company continues to generate strong cash flow. For the first 6 months of 2013, operating cash flow before working capital changes totaled about $275 million, an increase of about 1% compared to the first 6 months of 2012. At the end of the quarter, Questar had net available liquidity of $544 million in unused commercial paper capacity. Subsequent to the quarter end, Questar Gas priced a total of $150 million of 30-year and 35-year private placement notes. These notes will be issued on a delayed draw basis in December this year. The coupon rate for both tranches of debt averages 4.8%.

With that, let me turn the time over to Ron to discuss operations and Questar's outlook.

Ronald W. Jibson

Well, thanks, Kevin, for that summary and good morning, everyone. Each of Questar's business units performed on pace with last year's second quarter and in line with our 2013 earnings guidance. I am very proud of the accomplishments of our employees and what they have achieved so far this year and their clear focus on controlling costs and delivering results.

Let's review some of these accomplishments, beginning on Slide 12. First, Questar Gas continues to perform very well and is executing in line with our forecast. The infrastructure replacement program, which is currently focused on replacing the high-pressure reconditioned pipe in our distribution system, increased gross margin by $1.1 million in the second quarter. We are also seeing acceleration in customer growth, which is currently running about 1.5% compared to 1.2% at the same time last year.

On July 1, Questar Gas filed a general rate case in Utah, requesting a modest revenue increase in continuation of the current 10.35% return on equity. The focus of this case is to review the infrastructure-cost-tracking mechanism. We expect the proceeding to take up to 240 days to complete, which means that any increase in revenue would primarily affect results after 2013.

Following the approval of the Wexpro II Agreement, we announced earlier this week that Wexpro has entered into a definitive agreement to acquire additional interest in natural gas-producing properties for about $106 million. I'll talk more about this announcement later in the presentation.

From an operational perspective, Wexpro continues to grow its investment base. Wexpro's ending investment base increased by $29.2 million or 6% over the past 12 months. Wexpro produced 15.6 Bcfe in the second quarter of 2013, an increase of about 3% compared to the second quarter last year.

Questar Pipeline announced the strategic direction for Southern Trails. I will detail the approach later in the presentation. Operationally, Questar Pipeline is performing in line with expectations and is effectively controlling costs. Combined O&M and G&A costs were down 9% compared to the second quarter of 2012. In addition, construction activities commenced on the Lake Side 2 power generation and Uinta Basin expansion projects. These 2 projects are important for Questar Pipeline's customers and to meet our strategic objectives.

Turning to Slide 13. As I mentioned in my opening remarks, we are very pleased to have announced that Wexpro has a definitive agreement to acquire additional assets at an attractive price. Wexpro is increasing its working interest in existing Wexpro-operated wells in the Trail unit of Southwestern Wyoming's Vermillion Basin. Essentially, this is a bolt-on acquisition to the company's current Trail assets, which are governed by the 1981 Wexpro Agreement for the benefit of Questar's Utah and Wyoming utility customers. We are excited to have this acquisition to our portfolio. It's in the heart of our operations and adds value to one of our premier assets.

Under the terms of the original Wexpro Agreement, Wexpro produces gas for our utility Questar Gas from certain properties at cost of service. The recently approved Wexpro II Agreement perpetuates that model. Wexpro II stipulates that all Wexpro acquisitions within the footprint of the 1981 agreement must be offered to public service commissions of Utah and Wyoming for inclusion as cost-of-service properties benefiting Questar's utility customers.

Wexpro already owns a 46% working interest in the properties being acquired. This acquisition will increase that interest to 88%. It will also add an estimated 118 billion cubic feet equivalent of net proved reserves, about 45% of which are currently proved-developed. Wexpro estimates that proved plus probable and possible reserves attributable to the properties to be 195 billion cubic feet equivalent.

In addition to the 78 producing wells, Wexpro has identified 172 additional well locations for future development on a combination of 20- and 40-acre spacing. The development target is Mesaverde sands that Wexpro has developed for several years. Wexpro estimates average gross reserves attributable to each future Mesaverde well to be 2 billion to 3 billion cubic feet equivalent, with well costs between $1.7 million and $2.1 million. Trail's repeatable low-risk development locations are ideal for Wexpro's business model. Finding cost in this field over the last 2 years have been below $1 per Mcfe.

We expect to close the transaction by the end of August. Upon closing, we estimate the asset yield -- the access could yield estimated incremental production of about 2.6 billion cubic feet equivalent net to Questar in the remaining 4 months of 2013 and be immediately accretive to earnings.

Moving to Slide 14. Questar Pipeline completed the second phase of the strategic review of its Southern Trails Pipeline assets, resulting in new development options for the eastern and western segments of the pipeline. Questar Pipeline has entered into an agreement with an affiliate of Spectra Energy Corporation to evaluate the potential conversion of the western portion of the Southern Trails Pipeline to crude oil service. If market conditions and economics enable the project to move forward, it could be in service by late 2015. Additionally, on Southern Trails' eastern end, Questar Pipeline is in confidential discussions with undisclosed parties, one of whom has signed a letter of intent to purchase or contract for the full capacity of Southern Trails' eastern segment beginning in 2016.

Turning to Slide 15. Last year, we formed Questar Fueling to meet the needs of an expanding market for compressed natural gas for transportation. We have begun to see success in our efforts. Last quarter, Questar Fueling announced that it had signed an agreement to build, own and operate a CNG fueling facility in Houston, Texas that will serve up to 200 natural gas-powered gas tracks operated by Swift Transportation and Central Freight Lines.

This project is on track to be completed by the end of August. When completed, this location will be the largest CNG fueling facility in the United States to date. This facility is projected to dispense about 5 million gallon equivalents of natural gas per year. The facility will also offer public fueling to other CNG-powered vehicles.

In addition to the Houston facility, Questar Fueling has signed 2 new contracts to build similar fueling facilities for Frito-Lay in Kansas and Connecticut to fuel its CNG-powered delivery fleet. These 2 projects are also progressing on schedule and are expected to be operational later this year.

Questar Fueling is currently in discussions with many large national fleet operators regarding approximately 3 dozen potential anchor tenant sites. While not expected to make meaningful earnings or cash flow contributions in the early years, we are excited about Questar Fueling's long term growth potential as the use of natural gas per transportation expands.

Moving to Slide 16. Questar's return on equity continues to be industry-leading. For the 12 months ended June 30, 2013, we delivered a consolidated return on equity of 19.5%. This superior return is supported by Wexpro, which provided an ROE of 20.6%. On a financial basis, Questar Gas delivered an ROE of 10.5% and Questar Pipeline's return on equity was 10.3%.

Moving to Slide 17. With half the year complete, we remain confident in our EPS guidance range of $1.12 to $1.20 per diluted share. We plan to continue to invest for long-term growth and expect to maintain a competitive growth rate with industry-leading returns. Wexpro continues to demonstrate an ability to grow its investment base, production and earnings with its existing properties. And the announced acquisition of new properties demonstrates the ability to execute on the long-term strategic plan.

At Questar Gas, strong customer growth and the infrastructure replacement program should support long term earnings and rate base growth. Questar Pipeline continues to identify new long-term growth opportunities. Our commitment to customers and shareholders is to continue delivering superior service, while profitably investing in and growing our businesses. These growth opportunities should help us maintain a compound annual growth rate averaging 4% to 6% over the planning horizon.

With last quarter's dividend increase, we are nearer our target dividend payout ratio of about 60%. We expect dividends will grow in line with earnings over the coming years. Following the completion of our $100 million share repurchase program in 2012, we have authorization to repurchase up to 1 million shares per year. The focus of this ongoing program is to offset dilution from shares issued in company incentive plans.

Concluding on Slide 18. I want to emphasize and reemphasize Questar's unique strengths. Our integrated operations span the entire natural gas value chain from well head to burner tip. Our constructive regulatory relationships produce appropriate risk-adjusted returns. Questar has an attractive organic growth outlook, and we're excited about the new opportunities for Wexpro II, Questar Pipeline and Questar Fueling. Finally, our conservative balance sheet supports our earnings growth and long-term strategic plan.

And with that, we'd be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Tim Schneider from ISI Group.

Timm A. Schneider - Citigroup Inc, Research Division

Couple of questions on Southern Trails. On the first one, the oil conversion, on the western portion, can you just kind of frame what you think the CapEx is going to be in that and where the -- what the -- is their rail terminal involved, just a bit more color on the project there?

Ronald W. Jibson

Sure, I appreciate the question, Timm, and will ask Allan Bradley if he'll address that.

R. Allan Bradley

First, let me just say it's nice to have the strategic review behind us. Since we've been working on it, obviously, markets have moved quite a bit. Also, I'd like to say, now Questar Pipeline is very pleased to be partnering with Spectra Energy on our Southern Trails' western segment crude oil pipeline project. I feel our project interests are aligned, so are our development schedules going forward. But let me just emphasize the real important point, Timm. Because the project is now being managed as a joint venture, it's not exclusively being driven by Questar Pipeline. I'm just simply not going to be able to give you any more details on our joint development plans and quite frankly, what we've already released. Going forward, the joint venture is going to keep investors apprised of major project development milestones as they're being met. Obviously, communication is going to be developed, coordinated and jointly released by both Spectra and Questar. So I really don't want to respond in the definitive detail that you've suggested, but let me just answer your last question. Yes, we will need a rail terminal and that is part of the development plan related to that western zone. And obviously, we want to keep our selection of that site confidential as well. So I apologize for not being able to give you any more color, but I hope you understand sort of the new relationship we have relative to this project.

Timm A. Schneider - Citigroup Inc, Research Division

Yes, absolutely. And then shifting to the eastern portion of this project, so kind of reading through the release, I just want to make sure I got this right, this is for -- this is a natural gas, so the party is essentially signing up for a natural gas service in the east, right?

R. Allan Bradley

That's correct.

Timm A. Schneider - Citigroup Inc, Research Division

And that's 80 million cubic feet a day, right?

R. Allan Bradley

That's correct. Probably, it's going to [ph] play. I mean, their load is, again, confidential. But as we indicated, this line is in a unique corridor, difficult to replace. Clearly, it's one-of-a-kind and this party recognizes that.

Timm A. Schneider - Citigroup Inc, Research Division

Got it. And then if I -- just a quick question. If I look at the volumes, obviously, there hasn't been a lot of gas moving to Southern Trails. Can you kind of -- I guess, if you could do these -- yes, go ahead.

R. Allan Bradley

The pipeline has actually done remarkably well. We continue to run that close to the 80,000 deck terms a day. What's happened, of course, is the basis differential for natural gas, San Juan versus the Cal border, over the last 4 or 5 years, has really come in. So what you've seen with the renegotiated contract last fall for about 40,000 deck terms a day is we took a much lower price and that pipeline now is just below break even. So it delivers sort of a small loss with the current contract environment.

Timm A. Schneider - Citigroup Inc, Research Division

Got it. And then just to understand, this new party that would potentially spend up for all these contracts, all these contracts would be reset at new rates?

R. Allan Bradley

That's correct.

Timm A. Schneider - Citigroup Inc, Research Division

Got it. And then do you have the rate base on Southern Trails? If not, we can follow up offline. That's fine too.

R. Allan Bradley

What's interesting is those are mostly negotiated contracts, Timm. But that may be one thing we're looking at is going to more recourse rates in this negotiation.

Timm A. Schneider - Citigroup Inc, Research Division

Okay, got it. And then any color on what would drive a purchase versus just kind of sign up for capacity, or is that out of your hands?

R. Allan Bradley

No. I'm going to leave the -- that's really out of my hands. The party was interested in both options and we'll see where it goes.

Operator

[Operator Instructions] Your next question comes from the line of Carl Kirst from BMO.

Danilo Juvane

This is Danilo Juvane for Carl. To follow-up on Timm's questions. Though you can't speak to the western portion sort of project offset, can you at least say directionally if you're going -- if you expect to be up or down from the sort of $400 million estimate that you sort of threw out there before?

R. Allan Bradley

Yes. I'm just not going to comment on it. I'm sorry.

Danilo Juvane

No, that's fair. And I guess, moving on to guidance, with the Wexpro II acquisition possibly being accretive this year, any reason why it sort of maintained the guidance range? Just let me get a sense for why that...

Ronald W. Jibson

Yes, I'll ask Kevin if he'll address that.

Kevin W. Hadlock

Yes, when we set our guidance range at the beginning of the year to incorporate variability and uncertainties and certainly, some opportunities to grow. As we looked at the acquisition within Wexpro and other activities, that certainly is contemplated within the guidance range that we have, realizing that we will likely just have a portion of the year in our earnings stream this year.

Ronald W. Jibson

We'll look at that as we go through. Again, once we get this closed and move forward, then third quarter, we'll update guidance and also try to project what that could mean in the future years.

Operator

Your next question comes from the line of Lewis Shamie [ph] from Zimmer [ph] Partners.

Unknown Analyst

Thanks for a little bit of clarity on where things went with that strategic process on Southern Trails. Just had a couple of questions on this, specifically on the western side of that system. I guess, first off would be, why you guys chose to work with Spectra on this? They're primarily natural gas focused guys that are obviously very good at that. But what did they really bring to the table that you're bringing them into this project?

Ronald W. Jibson

Let me just say, we're very pleased to be able to work with Spectra, a great company and very good history and their culture there, and I'll let Allan kind of elaborate as we went through the strategic review.

R. Allan Bradley

Well, quite frankly, they are in the oil pipeline transportation business through their Platte Express projects. So they have, I think, very good resources. So from the standpoint of sort of matching up with our interests, they bring operating capability to bring producer contacts in Canada that we don't have and elsewhere with refiners. So I don't view them exclusively as natural gas, like I view myself, after their recent transaction and expansion into this business. And I think, as sort of the new kid on the block, I won't speak for them. Obviously, they want to grow that business and this is an opportunity that hopefully will help them do that. So as we looked at the sort of the slate of options that were available, we felt that Spectra brought that same enthusiasm for the Southern California markets that we did, and when I say markets, I'm talking about crude oil. And I think our cultures are aligned as well, so -- which was a comforting factor to it, so that's about all I can say. Again, it's a good relationship. It's a company we've known for many years, back during the expansion era of the Rockies. They had an interest in participating up here and we came close, but maybe this one will be our winner.

Unknown Analyst

Okay, that makes sense. And I'm not sure, maybe you addressed this a little bit and I missed it, but what's the timeframe for talking to customers, maybe coming out with a defined open season? How are you planning to sequence the development there?

R. Allan Bradley

Well, really, the only thing that we've said that it -- is if markets react over the next 6, 9 months, we could be in service as early as late 2015. And you can imagine, now that we're through the strategic review, there's a lot of energy around developing and marketing this project, and that's where our focus will be during this initial period.

Unknown Analyst

I got it. So at this point, you guys, along with Spectra, go out, talk to potential interested parties, gauge the interest and then kind of formalize the project in -- over the next 6 to 9 months?

R. Allan Bradley

Correct.

Operator

[Operator Instructions] Your next question comes from Timm Schneider from ISI Group.

Timm A. Schneider - Citigroup Inc, Research Division

Just one real quick follow-up. Now that the strategic review is over, maybe you can shed some light on what the breaking point was? I guess, was it just because the spread had come in and producers weren't willing to sign up for a long-term contract, and you guys obviously made it clear that's what you were kind of looking for? Or was there anything else that led to the full conversion not going ahead?

Ronald W. Jibson

Yes. I think, Timm, in general, certainly, we saw the spread change radically, fairly quickly. But at the same time, in the same view going forward, it can change just as quickly. So I think that's the nature of the beast, you might say. We'll continue to watch that. But the nice thing is, it still remains that Southern Trails is the only pipeline that really runs through that area that goes right into Long Beach. And we also believe the eastern segment has great value, either gas or potentially future other things. So we're going to watch that very closely. Certainly, the timing of those differentials had some impact. Allan, any color you want to give on that?

R. Allan Bradley

No, I think it hits the nail on the head.

Timm A. Schneider - Citigroup Inc, Research Division

Then on the western portion, since you do have a joint venture partner that, I guess, kind of de-risks that project, would you guys be willing to do this without kind of the long-term commitments that you were looking for on the initial Southern Trails conversion?

R. Allan Bradley

I can't answer that, Timm.

Ronald W. Jibson

It's still part of the review, yes.

Operator

[Operator Instructions] We're showing no further questions on the phone.

Ronald W. Jibson

Okay. Again, just want to say thanks to everyone this morning for taking the time. As always, we really appreciate your interest in Questar. Our intent is to create the value that you've come to expect from us and we look forward to continuing to do that in the future. We're very excited about our core businesses and the ability for them to execute on our strategic plans.

And in addition to that, having these additional growth opportunities with what we're seeing with Wexpro II, we couldn't be more pleased with the fact that we've been able to get the Wexpro II Agreement in place. And then to be able to have this kind of an acquisition come in line for us, just puts it right on spot with where we were hoping to be.

So we look forward to getting out and visiting with you soon. And also, as always, if you have any questions, please give us a call, and thanks again.

Operator

This concludes today's conference call. You may now disconnect.

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