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Executives

Alan R. Hodnik – Chairman, President and Chief Executive Officer

Mark A. Schober – Senior Vice President, Chief Financial Officer

Analysts

Paul T. Ridzon – KeyBanc Capital Markets

Brian Russo – Ladenburg Thalmann

ALLETE Inc (ALE) Q2 2013 Earnings Conference Call August 2, 2013 10:00 AM ET

Operator

Good day and welcome to ALLETE Second Quarter 2013 Financial Results Call. Today’s call is being recorded. Certain statements contained in this conference that are not descriptions of historical fact are forward-looking statements such as terms defined in the Private Securities Litigation Reform Act of 1995. Because such statements can include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that can cause results to differ materially from those expressed or implied by such forward-looking statements include but are not limited to those discussed in the filings made by the company with the Securities and Exchange Commission.

Many of the factors that will determine the company’s future results are beyond the ability of management to control or predict. Listeners should not place undue reliance on forward-looking statements, which reflect management’s view, only as of the date hereof. The company undertakes no obligation to revise or update any forward-looking statements or to make any other forward-looking statements whether as a result of new information, future events or otherwise.

For opening remarks and introductions, I would now like to turn the conference over to ALLETE’s President and Chief Executive Officer, Alan R. Hodnik. Please go ahead.

Alan R. Hodnik

Good morning, everyone. As you have already seen this morning has been a busy one for us and that we issued two press releases, as well as an 8-K and our Form 10-Q. The first press release and the 10-K disclosed our financial results for the second quarter and Mark Schober, ALLETE’s Chief Financial Officer, will walk you through the details in a few moments.

Through the first half of 2013, we have earned $1.18 per share compared to $1.05 per share last year. Our year-to-date results are where we anticipated they would be and we’re on track to achieve our earnings guidance range of between $2.58 and $2.78 for the full year. The 8-K announces just received demand nominations for Minnesota Power’s larger industrial taconite and paper customers for the final four months of 2013. Based on the nominations, these customers are expected to operate at full demand levels for September to December, just as they have all year.

Our second press release issued this morning is the announcement of the Minnesota Power’s plan to build approximately 200 megawatts of new wind generation in North Dakota. Upon receiving North Dakota’s site permit approval, we expect to begin construction of this new wind project, which we are calling Bison 4, in the fourth of the this year and yet to be online by the end of 2014.

This $345 million expansion is part of our Energy Forward vision, a strategy designed to achieve a balanced energy mix including one-third renewable, one-third coal, and one-third natural gas. We anticipate Bison 4 qualifying for the extended production tax credit or PTC and to be completed and placed into service by the end of 2014. Upon commissioning of Bison 4, we anticipate that our combined wind, biomass, and hydro energy will account for over 24% of Minnesota Power’s electric generation.

The Bison 4 expansion will allow Minnesota Power to virtually close out the 25 by 2025 State of Minnesota renewable mandate. Beyond this nearly closing out the 25 by 2025 renewable initiative early, Minnesota Power will have done so, while at the same time reducing costs per kilowatt hour to its customers.

In the 10-Q, you’ll find that our five-year capital expenditure table that includes the updated forecast of this project, which has been increased and accelerated from our original plans. Bison 4 is rider eligible and is subject to the normal regulatory approvals in both North Dakota and with the Minnesota Public Utility Commission. We are especially pleased to have announced the Bison 4 project this morning, and likewise to be further advancing our Energy Forward vision and doing so while ensuring reliability, protecting affordability, and living our core environmental stewardship values. I’m very satisfied with ALLETE’s financial performance and strategic execution through the first half of this year.

At this time, I’ll turn the call over to Mark and then I’ll have some additional remarks before we take your questions. Mark?

Mark A. Schober

Thanks, Al, and good morning, everyone. I would like to remind you that we filed our 10-Q this morning, and I encourage you to refer to it for more details. For the second quarter, ALLETE earned $0.35 per share and net income of $14 million and operating revenue of $235.6 million, compared to $0.39 per share, on net income of $14.4 million and operating revenue of $216.4 million in 2012.

First, I will highlight a few points from ALLETE’s regulated operation segment, which includes Minnesota Power, Superior Water, Light and Power, and our investment in the American transmission company. Net income for this segment rose from $14.4 million for 2012 to $16.3 million in 2013, an increase of 13%.

Operating revenue for this segment increased $18.8 million, or 10% from 2012. Kilowatt hour sales rose 2.2% over the same quarter last year, resulting in a $4.2 million revenue increase. Sales to other power suppliers were higher than the same period a year ago.

Sales to residential and commercial customers were also higher due to extremely mild temperatures in 2012. Kilowatt hour sales to industrial customers decreased 4% from 2012, primarily due to a short-term fixed price contract last year. Revenue from our municipal customers increased $3.1 million from 2012, due to higher rates under the cost-based formula. The formula methodology is set at July 1 each year using estimated costs and the true-up for actual costs occurring the following year.

Fuel adjustment cost recoveries were up $5.2 million over the same quarter last year due to higher fuel and purchased power costs attributable to our retail and municipal customers. Cost recovery rider revenue increased $1.1 million from 2012, as the Bison 2 and 3 wind generating facilities were in service for the full quarter of 2013.

Transmission revenue increased $2.2 million from 2012, primarily due to commencement of recovery of our transmission system upgrade to support Essar’s project and from our investment and CapEx 2020.

Revenue from gas sales at Superior Water, Light and Power were up $2.4 million over 2012, due to unseasonably warm weather in April of 2012 and higher purchased gas expenses.

Looking at the expense side, regulated operations operating expenses increased $17 million or 10% over the same quarter in 2012. Fuel and purchased power expense increased $6.6 million from 2012 due to an increase in kilowatt hour sold and higher purchased power prices.

Operating and maintenance expense increased $6.7 million primarily due to a combination of increased purchased gas expense due to higher gas sales at Superior Water, Light and Power in 2013 and increased operating and maintenance expenses at the Bison 2 and 3 wind generating facilities, which were in service for all of 2013.

Regulated operations also posted higher property tax expense compared to last year due to a larger taxable plant balances and higher tax rates. Depreciation expense increased $3.7 million and interest expense was up $500,000 for the quarter, both attributable to the capital investment program at our regulated operations.

Earnings from our investment in ATC were slightly higher than the same quarter of 2012. Income tax expense decreased $500,000 from 2012, primarily due to higher federal production tax credits in 2013, related to the Bison 2 and 3 wind generating facilities. ALLETE’s investments in other segments, which includes results from BNI Coal, ALLETE Properties, ALLETE Clean Energy, and other corporate income and expenditure reported a $2.3 million net loss compared to a break-even quarter in 2012. Higher state income tax and interest expense contributed to the change from last year.

Our effective tax rate in the second quarter of 2013 was 23%, compared to 25% for the same period last year. We anticipate the effective tax rate for 2013 will be approximately 20%. We experienced good cash flow again this quarter, year-to-date our operating activities generated a $111 million in cash and we carried a 47% debt-to-capital ratio.

Before I turn the call back to Al, I would like to call your attention to the updated five-year capital requirements table in the 10-Q. In it you will see that our expected capital expenditures for 2013 have increased by $65 million and for 2014 have increased by $280 million from our previous estimates.

The updated table reflects the acceleration and increased size of the Bison 4 project, the revised timing of expenditures for the Boswell 4 environmental upgrade project, and expenditures to rebuild a portion of our hydro system. If you recall, our Thomson Hydro facility was damaged last year during the June flood.

We currently intend to continue to finance these capital expenditures as we have in the past, using a combination of internally generated funds by issuing equity and debt that keeps our capital structure and ratios near current levels. We believe our equity needs can be met using our dividend reinvestment and periodic issuance of equity plans.

Our financial results for the quarter and year-to-date are in line with our expectations and as Al mentioned, support our full-year guidance range of $2.58 to $2.78 per share. Al?

Alan R. Hodnik

Thank you, Mark. I would like to make some additional comments before we open up the line for your questions.

ALLETE is an energy company with multifaceted and multiyear earnings growth opportunities. These opportunities include organic revenue growth from new industrial development in mineral-rich northeastern Minnesota, as well as capital investments in environmental upgrades, renewable generation, and new transmission projects. We also remain disciplined and focused as we analyze potential energy centric prospects.

With regard to new industrial development, let me take a few moments to update you on the new Essar Steel Minnesota project, which is served by one of Minnesota Power’s municipal customers, the City of Nashwauk. As Mark mentioned a few moments ago, in April we began drilling Essar to recover our transmission investments related to their project.

Construction of the new taconite facility is continuing and Essar expect to begin blasting, mining, and commissioning equipment in 2014. Previously, we had expected this activity to occur during the second half of 2013. In any event, this type of activity requires an insignificant amount of electric power, so the change will not impact our lease earnings in 2013.

Given the projected startup transition, we are anticipating minimal earnings impacts from Essar through 2014. We expect Essar to begin increasing its electric power requirements as it ramps up production in late 2014 into 2015 and beyond. Essar has a 10-year iron ore pellet off-take agreement with ArcelorMittal for 3.5 million tons of pellets annually. The agreement runs through 2024. The Essar Taconite facility will ultimately result in up to 110 megawatts of new load for Minnesota Power.

Another potential new industrial customer, PolyMet Mining is expected to have its Supplemental Draft Environmental Impact Statements for SDEIS issued by the end of this quarter with the possibility of final permits being issued early next year. If successful, PolyMet’s new nonferrous mining operation could be online by early 2015. PolyMet has a contract in place with Minnesota Power to serve their operation, which is expected to consume 45 to 70 megawatts of hour.

Turning to capital investments, I already mentioned the Bison 4 wind generation project. On the environmental update front, we expect a decision this quarter from the Minnesota Public Utilities Commission with respect to our Boswell Unit 4 mercury emissions reduction project. The Minnesota Pollution Control Agency has already issued a report in support of our Boswell 4 initiative. With the MPCA construction permits issued, Minnesota Power has began work on its $350 million to $400 million project, a project that will ramp up more extensively in 2014.

Our updated capital expenditure plan includes the Boswell 4 project. We continue to move forward with our plans to build the great northern transmission line, a proposed 500 kilovolt line from the Province of Manitoba to Minnesota’s Iron Range. We’re currently finalizing (inaudible) planning activities for the proposed lines.

In addition, we’re working towards the filing of a Certificate of Need with the Minnesota Public Utilities Commission and the required Presidential Permit with the Department of Energy. We will keep you updated on the progress of the line, as we need key milestones.

As you may know, this line needs to be in service by 2020 in order to transmit 250 megawatts of renewable carbon free hydroelectric energy from Manitoba Hydro. Total project costs and cost allocations are still to be determined, however, at this time we expect our portion of the capital expenditures to range between $200 million and $400 million.

ALLETE continues to execute and move forward with its strategy for growth. I’m very pleased with our progress through the first half of 2013 and our broader positioning generally. As I already mentioned, we are on pace to meet our earnings guidance of between $2.58 and $2.78 per share.

At this time, I will ask the operator to open up the lines and Mark and I will be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Paul Ridzon from KeyBanc Capital.

Paul T. Ridzon – KeyBanc Capital Markets

Good morning. How are you?

Alan R. Hodnik

Good morning, Paul.

Mark A. Schober

Good morning, Paul

Paul T. Ridzon – KeyBanc Capital Markets

The $345 million allocated to Bison 4, does that include transmission, or that would be incremental to that?

Alan R. Hodnik

No, that includes a run out of the transmission to the new facility, so that’s all inclucive.

Paul T. Ridzon – KeyBanc Capital Markets

And Mark, just any updates on tire-kicking in Florida, what you’re seeing there?

Mark A. Schober

Yeah, we continue to, obviously push to monetize those assets as soon as we can. We continue to see increasing activity there and our optimistic, we will be able to close some small transactions by the end of the year, but nothing that would be of to have a material impact in our earnings this year.

Alan R. Hodnik

Yeah, continue to improve.

Paul T. Ridzon – KeyBanc Capital Markets

And PolyMet, what was the timing on the SDEIS?

Mark A. Schober

PolyMet is expecting, and has said so in their public documents, that it is expecting the issuance of the SDEIS sometime this quarter. And hopefully, if they were to have that happen, they have suggested they could complete final permitting and be in operation sometime in 2015.

Paul T. Ridzon – KeyBanc Capital Markets

And what’s the political climate like around that issue? I mean, is it still supportive?

Mark A. Schober

Well, obviously, the permitting process is our stakeholder base, and so there is a variety of views on nonferrous mining and Minnesota. But I think the permitting process at least what I see in the public documents and the dialogue between the state and the company has been positive and constructive.

Paul T. Ridzon – KeyBanc Capital Markets

Okay. Thank you very much.

Alan R. Hodnik

Thanks Bob.

Operator

Thank you. And our next question comes from the line of Brian Russo from Ladenburg Thalmann.

Brian Russo – Ladenburg Thalmann

Hi, good morning.

Alan R. Hodnik

Good morning, Brian.

Mark A. Schober

Good morning, Brian.

Brian Russo – Ladenburg Thalmann

Just maybe if you could just help us a little bit on the ramp up of the Essar taconite mine, just in terms of – from a modeling perspective and the demand charges, I mean should we assume any demand charge contribution in 2014, or should we assume part contribution in 2015 and full contribution in 2016? Just trying to get a better handle on the timing and the demand charts contributions?

Mark A. Schober

Yeah. Brian, this is Mark. We’ve kind of talked a little bit about this before, that as you bring these large projects online, it is really difficult to estimate the timing of when we’ll have a material impact on ALLETE’s financial.

Specifically, I would be very cautious of what I put in 2013 and 2014, probably no demand charges, what our understanding and what Essar has disclosed that they anticipate ramping up on late in 2014, starting that process, again, we’ll have a minimal, as Al mentioned a minimal impact on our earnings for 2014. And I would envision them a ramp up not turning, not a full turn on at the 110 megawatts, but a slow ramp up starting in 2015 through the end of 2015.

We continue to work with Essar as they disclose the information, we’ll certainly share that with you as we have updates, but that’s our best estimate today.

Alan R. Hodnik

Yeah. I think that’s fair Brian this is Al, these mineral projects whether it’s PolyMet and the nonferrous with the question earlier and or Essar, these are large capital projects. They are long winded in nature, both long-winded in permitting in the case of PolyMet and long-winded in terms of construction.And so the ebb and flow through various cycles, but I think Mark’s characterized it properly at this point in time based on Essar’s public disclosures.

Brian Russo – Ladenburg Thalmann

Okay. Is it possible to be a little bit more specific on the external capital needs to finance the updated CapEx forecast, how much is funded by operating cash flow and debt and then equity?

Mark A. Schober

Yeah. We don’t disclose those specifics, but you can – it would be very similar to as we’ve done it in the past Brian. So I’d look at the ratios that we’ve used in the past and you will see that we’ve used in the past and you’ll see that that’s doing that going forward here. So we think that we’re reasonable as we look at these capital spend starting now and 2013 through the first quarter of 2015, that will continue to raise debt and equity in the proportions that we’ve done in the past to maintain the cap structure and to maintain our credit ratings.

Brian Russo – Ladenburg Thalmann

Okay, great. Thank you.

Mark A. Schober

Yeah.

Alan R. Hodnik

Thanks, Brian.

Operator

Thank you. (Operator instructions) And I see no further questions in the phones at this time. I will turn the conference back to Mr. Alan Hodnik, for any concluding remarks.

Alan R. Hodnik

Well, thank you again everyone for your time this morning and for your investment in ALLETE, and frankly, for your continued interest in our multifaceted multiyear growth strategy. We look forward to reporting our continued progress as our initiatives continue to advance. Thank you and have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a good day.

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