OGE Energy's CEO Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 8.13 | About: OGE Energy (OGE)

OGE Energy Corp. (NYSE:OGE)

Q2 2013 Results Earnings Call

August 8, 2013 9:00 AM ET

Executives

Todd Tidwell - Director, Investor Relations

Pete Delaney - Chairman, President and CEO, OGE Energy Corp.

Sean Trauschke - President, OG&E and CFO, OGE Energy Corp.

Analysts

Paul Fremont - Jefferies

Brian Russo - Ladenburg Thalmann

Andy Bischof - Morningstar

Sarah Akers - Wells Fargo

Operator

Good day, ladies and gentlemen. And welcome to Q2 2013 OGE Energy Earnings Conference Call. My name is Anna, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the company’s remarks we will conduct a question-and-answer session, and instructions will be provided at that time for you to queue up for questions. (Operator Instructions)

Please be advised this conference is being recorded for replay purposes. And now, I’d like to turn the conference over to Todd Tidwell, Director of Investor Relations. Please proceed, sir.

Todd Tidwell

Thank you, Anna, and good morning, everyone. And welcome to OGE Energy Corp.’s second quarter 2013 earnings call. I’m Todd Tidwell, Director of Investor Relations and with me today I have Pete Delaney, Chairman, President and CEO of OGE Energy Corp.; and Sean Trauschke, President of OG&E and CFO of OGE Energy Corp.

In terms of the call today, we will first hear from Pete, followed by an explanation from Sean of second quarter results and finally as always, we will answer your questions.

I would like to remind you that this conference is being webcast and you may follow along on our website at oge.com. In addition, the conference call and accompanying slides will be archived following the call on that same website.

Before we begin the presentation, I would like to direct your attention to the Safe Harbor statement regarding forward-looking statements. This is an SEC requirement for financial statements and simply states that we cannot guarantee forward-looking financial results, but this is our best estimate to date.

As a reminder, since the midstream partnership plans to pursue an IPO, we are limited by SEC regulations on the details we can provide you until the S-1 is filed. I would also like to remind you that the presentation of our results reflect the 2-for-1 stock split which was effective July 1, 2013.

I will now turn the call over to Pete Delaney for his opening comments. Pete?

Pete Delaney

Thanks, Todd. Good morning and thank you for joining us this morning. At early this morning we reported second quarter 2013 earnings of $0.46 per share, compared to $0.47 per share in 2012. Our earnings, while basically flat quarter-over-quarter are in line with our expectations.

However, assuming normal weather going forward from here, we anticipate being towards the upper end of our guidance of $1.68 to $1.80 per share again post-split, due in large part to the positive impact of the Enable Midstream partnership.

The utilities earnings increased quarter-over-quarter due to earnings associated with our higher FERC jurisdictional transmission rate base. Our continued focus remains on managing costs and effort to protect the customer’s bill and that has also helped keep the margin of the retail utility earnings from declining, living in line with our volume growth so to speak.

And since 2010 we have been focused on driving productivity gains to make room for the eventual environmental compliance impact on rates. Although, we are not expecting to earn our allowed return in Oklahoma this year, we are not intending to file a general rate case until we have more clarity on our environmental requirements.

As you know, the recent 10th Circuit Court decision on Regional Haze which subject to our appeal, which we will provide some clarity as to the compliance timeline to be incorporated now into our regulatory strategy.

Accordingly, we have made a technical filing last week with the Oklahoma Corporation Commission that will extend the Smart Grid riders beyond 2013 and continue our commitment of customer savings of $12 million annually.

Our customer base growth and the resulting sales growth helps to minimize the negative impact on our return from rising uncontrollable costs and regulatory lag on our investments, some $700 million since the last rate case.

We added 7,500 customers compared to the second quarter of 2012, which is in line with our historical growth rate considering approximately 2,500 meters lost due to the May tornadoes and more.

We do expect that a majority of these customers should be back online by the end of 2013 or the first quarter 2014 as they continue to recover from the devastating losses. We see no reasons this time for this pattern of growth will not continue.

The five-year $1.5 billion transmission spending program is winding down at the end of 2014. These investments enable us to integrate more renewables, improve reliability of our system and reduce costs through more effective use of resources on a regional basis.

And while we have received notice to construct approximately $300 million of transmission lines starting in 2016 as we talked about on the last call, any additional significant transmission project in the Southwest power pool would be likely secured under FERC order 1,000 competitive bid rules. We intend to leverage our substantial transmission experience to bring additional transmission growth opportunities to OGE Energy.

From a capital standpoint, the Regional Haze Compliance Plan will be the driver in the intermediate term. Much to our disappointment, the 10th Circuit Court of Appeals on July 19 rejected our petition for review by 2-to-1 vote.

Disappointed for several reasons, of note were the factual errors in our belief about the record, as well as accepting an EPA design scrubber control, that technically will not work on our units.

We have requested a rehearing from the entire 10th Circuit Court by the September 3 deadline, request is granted then our current stay will remain in place, if the hearing is denied we will have 55 months to comply with the court order from the time the stay is lifted. As you are no doubt aware the implication to our customers is significant when you consider adding four scrubbers to the cost of over $1 billion to rate base.

As noted in the dissent of Judge Kelly that even under the EPA’s own calculations adding scrubbers will have little or no impact on visibility, but the OGE -- OG&E rate payers we left with a huge bill. We will continue to do what we can to protect our customers from this unfortunate regulatory action.

If we are not successful in our rehearing efforts, our compliance strategy is to mitigate cost increases for customers while maintaining fuel diversity for the long run. As noted on the last call, we were notified by the Department of Justice about potential litigation relating to the EPA’s new source review violation and on July 8th, the EPA filed suit against OG&E pertaining to our coal plants, it’s our strong belief that we have not violated the Clean Air Act.

On the utility operating front, we continue to execute our plan of leveraging our Smart Grid platform to create improved customer experiences with improved interfaces and operational effectiveness.

We were very pleased to again be informed of our number one JD Power Residential Customer Satisfaction rating among large utilities in the Southern region. We believe our Smart Grid programs combined with other operational changes have made a difference.

One of those programs making a difference is our demand response effort spearheaded by our Smart Hours program with 76,000 customers enrolled for this summer’s peak, which I might add we are still waiting for that peak. But our goal, we are almost to our goal of about 80,000 customers.

The company received the prestigious EEI Edison Award recognizing the success of this program. The success of Smart Hours is key to deferring incremental baseload generation until 2020.

Another important initiative to protect the customer bills, the comprehensive work underway in our operations area related to cost performance and these are ideas driven by our members in the field.

We are faced as other utilities with the potential for significant employee retirements in the coming years which is going to require different method changes and make the investments that is going to allow us to maintain operational excellence in this new environment.

The Smart Hours program that I mentioned earlier, I want to mention not only reduces our peak demand for long-term savings but also reduces the customer’s bills today by providing daily price signals to reduce usage during high demand and high cost periods.

With Enable Midstream Partners’ ongoing formation, we are going through the process of rationalizing with CenterPoint Energy, the corporate services OG&E provides to the partnership.

We have been managing our corporate services headcount closely over the last year or so in preparation for reducing corporate cost and step with lower allocations to the partnership. The Midstream partnership with CenterPoint Energy progresses.

Enable Midstream Partners now has a senior operations leadership in place led by Chief Operating Officer, Keith Mitchell, who is a seasoned midstream natural gas executive. In addition to Keith, the senior management team has the expense and expertise within the Midstream space to transform the combined entity into a significant and successful competitor.

Their initial focus, of course, is on capturing synergies associated with the integration project already identified and the growth opportunities associated with operating the partnership assets on an integrated basis.

As you know, the CEO has not been named at this juncture, meanwhile I have great confidence in the ability of the senior operations leadership team to provide the leadership required to deliver on the synergies and commercial opportunities ahead.

Turning to the financial results of the Midstream business, though the partnership’s earnings were down slightly, they are in line with our expectations. Gathering and Processing volume growth continues as expected in the Midcontinent areas, while lower NGL prices pressure the processing margin.

Producers are continuing to deploy rigs and increase production in our dedicated areas in western Oklahoma and the Texas Panhandle. Gathering volumes did decline in the Haynesville but gathering margins there are largely protected in that by a minimum volume obligation.

Transportation margins were flat to slightly down due to lower volumes associated with lower basis differentials. The Bakken prospect, as you know a new play for the Partnership continues to move ahead having recently received some BLM permits. The Partnership continues to have a solid backlog of organic growth opportunities.

I want to spend a moment on our dividend policy in light of the recent changes, based on our midpoint of our guidance we remain below our target payout ratio of 60% on a consolidated basis despite increasing the dividend for the past seven years and accelerating the dividend growth rate for the last three years. Our focus remains on growing dividends in a prudent manner.

As in the past, the Board will review the dividend policy at the December meeting after careful consideration. In management’s view the IPO of Enable Midstream Partners and having a definitive environmental compliance plan are two important considerations and we are recommending changes to be made to our current growth rate.

With that, I’m going to turn it over to Sean, who will review our financial results in more detail. Sean?

Sean Trauschke

Thank you, Pete, and good morning. For the second quarter we reported net income of $92 million or $0.46 per share as compared to net income of $94 million or $0.47 per share in 2012. Year-to-date consolidated earnings per share were $0.58 in 2013, compared to $0.66 last year. The contribution by business unit on a comparative basis is listed on the slide.

Before moving on to our businesses, I would like to point out that the $0.01 loss at the holding company is primarily a result of transaction costs associated with the formation of Mid -- Enable Midstream Partners.

At OG&E, net income for the quarter was $79 million or $0.40 per share, as compared to net income of $73 million or $0.37 per share in 2012. Second quarter gross margin at utility increased approximately $4 million or 1%, which I will discuss on the next slide.

O&M was $8 million lower for the quarter primarily due to the timing of scheduled power plant maintenance and lower employee costs. And finally, income tax expense increased $3 million due to higher pre-tax earnings compared to the second quarter of 2012.

Turning to the second quarter gross margin, as I mentioned earlier, utility margins were up for the second quarter despite the impact of weather compared to 2012. There are two primary drivers for the increase in gross margin.

First was an increase of wholesale transmission revenues contributing $11 million from an additional investment of approximately $250 million over the last year and secondly, growth from new customers increased gross margin by $3 million.

Partially offsetting these increases was mild weather compared to 2012. Looking closer at weather, cooling degree days were 5% below normal and 25% below last year for the second quarter. This translated into $5 million in lower gross margin compared to normal and $11 million in lower gross margin compared to last year.

Looking at the full year impact, recall we had a benefit in the first quarter from weather, which offset the second quarter impact to gross margin. The weather impact year-to-date on gross margin was $1 million lower than 2012 and flat compared to normal. We are still projecting a 1.5% sales growth for the full year as oil field sales are expected to increase in the second half of 2013.

Turning to the Midstream business, we closed on Enable Partnership on May 1st and as a result we have one month of Enogex and two months of Enable Midstream earnings in the quarter, which makes it difficult to compare prior periods and for you to model until the S-1 is filed, let me explain.

You are familiar with how we previously reported results from the Enogex -- from Enogex including the ArcLight interest. Going forward, OGE is the consolidating Midstream results and has dominated the financial reporting of Enogex’s prior business segments.

What we can tell you is that the financial results for the second quarter, $14 million of net income or $0.07 of earnings per share was in line with our expectations. As Pete mentioned, we continue to have the headwinds of lower liquids prices, particularly ethane and though higher than last year, continued weakness in natural gas prices. As expected, the volumes continue to grow in Western Oklahoma and the Texas Panhandle.

Regarding the S-1, the company after consultation with the SEC has determined that the formation of Enable is to be considered a business combination and for accounting purposes CenterPoint Field Services is to be treated as the acquirer of Enogex. This will require an appraisal to determine the fair value of assets and liabilities of Enogex as of May 1, 2013.

We expect the appraisal to be completed in the third quarter and any change of value in Enogex will not have an impact on OGE and OGE will not be reporting a gain or loss as a result of this transaction.

We look forward -- we will continue to report our results based on historical value and we look forward to providing you with more detailed information in the S-1 in the very near future.

Before answering your questions, I want to discuss our 2013 earnings guidance. It remains unchanged at $1.68 to $1.80 per share. However, there have been some adjustments made to some of our individual businesses.

The holding company loss is now estimated to be between $0.03 and $0.04 per share due to expenses associated with the formation of Enable Partnership. The utility guidance is unchanged between $1.40 and $1.45 per share and assumes normal weather for the remainder of the year, through six months that utility is on plan and as you know, the vast majority of our earnings occur in the third quarter.

Earnings from the Midstream business which will include five months of Enogex and seven months of the Enable Partnership are now projected to be between $0.35 and $0.45 per share due to the accretive impact of the joint venture. Overall, due to the Midstream transaction we now project consolidated earnings guidance to be near the top end of $1.68 to $1.80 range.

This concludes our prepared remarks and now we’ll open it up for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question comes from the line of Paul Fremont of Jefferies. Please proceed.

Paul Fremont - Jefferies

Thanks. So when I add the individual segments, I get $1.72 to $1.86. Is there something that’s preventing you from getting to, sort of, the some of the segments that’s keeping top end of your guidance range at a $1.80?

Sean Trauschke

Hi, Paul. This is Sean. Really, what we’ve done here is we recognized, we’ve increased our guidance for the Midstream businesses. What we were trying to communicate was the third quarter is such a large quarter for the utility and it’s based on normal weather. We’re going to leave that where it is. And when we come out of the third quarter, we’ll adjust the utility guidance at that time if necessary. So it’s really what this action is based on is the impact of the Midstream Partnership.

Paul Fremont - Jefferies

And I guess my follow-up question would be if the court denies your request for a rehearing, what should we assume is going to be your strategy with respect to compliance? I mean, would you plan on then appealing up to the Supreme Court level or would you at that point basically present some formal plan to the state?

Pete Delaney

Paul, it’s Pete. As I mentioned in my comments, we will appeal and what’s required is we need to get all of the 10 judges’ majority vote to hear our appeal. And of course, that is probably -- we’re fighting uphill on that one. And so -- and if we’re to lose that if you appeal to the Supreme Court the timeline, the stay would be lifted probably in most -- it could be continued. But that would be a real stretch, we believe.

So in fact, if you were successful the time would be pretty far down the road in our implementation. So we are now planning and doing everything we need to do to be able to implement a compliance plan within the 55 months, which may -- that clock may start ticking here this fall. So we’re moving ahead with our planning and design and everything we need to do to -- and of course, scrubbing is a preferred path that we are looking at this point in time.

Paul Fremont - Jefferies

And can you at all discuss, sort of, the options of going with gas versus scrubbing the existing coal?

Pete Delaney

Sure. I mean, it’s the economic analysis that we’re looking over the long term in terms of impact on customers. And I mentioned fuel diversity which is, I believe, over the long term continues to be a real issue that given not only the economic and pricing changes associated with natural gas versus coal. There’s a lot of operational issues as well that, in terms of fuel supply, the disruptions and under one set of conditions that you don’t get in the other.

We do operate here in Oklahoma in an environment of extreme weather conditions. And so, we really believe in having diversity. So we are going to look to maintain that. Of course, we are going to do what we can to mitigate the impact on our customers because it is significant.

Paul Fremont - Jefferies

Thank you.

Operator

Thank you for your question. The next line of question comes from Brian Russo of Ladenburg Thalmann.

Brian Russo - Ladenburg Thalmann

Hi. Good morning.

Sean Trauschke

Hi. Good morning, Brian.

Brian Russo - Ladenburg Thalmann

Sean, just a follow-up on the previous question on the guidance, if we assume normal weather at the utility in the third quarter, does that put you above the high end of the range of $1.80?

Sean Trauschke

Yeah. I think the way we’ve been thinking about, Brian, if you just assume the utility at the midpoint of the guidance range. Okay, assuming normal weather that’s $1.42, right. You take the midpoint of the Enable guidance range of essentially $0.40 and you assume a couple of pennies lost there at the holding company, you are right there at that $1.80 range. Right?

Brian Russo - Ladenburg Thalmann

Okay. Got you.

Sean Trauschke

So that’s why we are pointing you there. And so obviously if things go well and the weather improves this summer, that would be positive. If the weather doesn’t materialize or other things occur, it wouldn’t be as positive. But that’s how we got to that $1.80. Does that help?

Brian Russo - Ladenburg Thalmann

Yes. It does. Thank you.

Sean Trauschke

Okay.

Brian Russo - Ladenburg Thalmann

And my next question just on the EPA compliance timeline. Assuming the court rejects the rehearing or votes against your stay in the rehearing and you have 55 months to comply, in terms of the timeline it seems like that would be sometime in early 2018. Is that accurate?

Pete Delaney

Yes. That’s springtime. Yeah. That is more or less accurate, Brian.

Brian Russo - Ladenburg Thalmann

Okay. And when would you think, if you did have to install scrubbers, when do you think that spend would start to pick up?

Pete Delaney

Well, we are doing a lot -- I don’t think we are ready to disclose that at this point in time. But what -- I don’t know when -- looking at Sean to see if he knows how long it takes to put a scrubber in, but you have got a lot of engineering and design work upfront. And so which is what we are really -- we’ve been studying that and we are going to accelerate that and to break ground, it is going to be still quite a ways away.

We are looking at what we can do. Of course, the best thing is to again defer that out as far as you can from a capital expenditure requirement and have them all go on that. If it is April 1 of 2018, I’m not saying that’s the exact date that you want them all to start that day and convert them over in terms of having the control systems, whatever.

But we have got outages and things to -- our scheduled outages and things to look at. So they are doing a lot of analysis to see what’s the best way and how we can back end the compliance.

Brian Russo - Ladenburg Thalmann

Okay. And lastly, just financing scenarios for this magnitude of CapEx. Is it -- can we assume that the cash flows from the Midstream joint venture combined with operating cash flow and debt can finance the majority of the spend, thereby mitigating any kind of meaningful external equity needs?

Sean Trauschke

Brian, this is Sean. I think that’s a fair statement that certainly the cash flow from Midstream will mitigate any equity needs. I think one variable in there is Pete mentioned we have 55 months to comply. And so as we shape our construction schedule, it is really going to be dependent to a large degree on the intensity and the timing of the investments over that 55-month horizon.

So, to say it another way if this is pretty flat each of the 4.5 years, that’s a little easier thing for us to handle then if it’s at all, it was front-end loaded or something. But I think your thesis is right. As we’ve said many times, Enogex previously was a use of capital for us. Now, Enable is going to be a source of capital for us and so our cash and it certainly will mitigate future equity.

Brian Russo - Ladenburg Thalmann

Great. Thank you.

Operator

Thank you for your question. The next line of question comes from Andy Bischof of Morningstar. Please proceed.

Andy Bischof - Morningstar

Hi. Good morning. Just a remaining question on competitor low trend, I guess in the quarter you have seen some of those competitors have kind of weak low trends. Can you provide a little bit more color on the trends across your customer base and how that aligns with your expectation?

Pete Delaney

Customer growth rates?

Andy Bischof - Morningstar

Yes.

Pete Delaney

Utility -- our customer growth rates we -- I mentioned we generally run 9,000 customers roughly a year. That’s just under 1%. It is a little over 1% now. That has picked up a little bit over the last two years. Our economy remains very robust. Our unemployment rates around 5% or so and we continue to see population influx -- inflows into Oklahoma.

And so we don’t really see that -- those trends reversing at this point in time. Oil field load has helped with our sales growth. And that -- we believe that from what we see in our Midstream business is from our oil production side that’s going to continue. I know, in Devon’s earnings call they talked about a new play in Oklahoma. I believe that they are excited about and looking to drive up their production as well as Continental resources in the scoop area.

So some of which we serve and some which we don’t. But -- so we pretty much see our continued customer growth of about that level and that’s really the biggest driver behind our sales growth assumptions about 1%.

Andy Bischof - Morningstar

Great. And how would you describe about July weather?

Pete Delaney

Golfer’s delight.

Andy Bischof - Morningstar

All right. Thanks very much.

Operator

(Operator Instructions) And the next round of question comes from Sarah Akers of Wells Fargo. Please proceed.

Sarah Akers - Wells Fargo

Thank you. Good morning, everyone.

Pete Delaney

Good morning.

Sean Trauschke

Good morning.

Sarah Akers - Wells Fargo

Just a follow-up on the NGL discussion, I guess, first, how are ‘13 prices looking, relative to your expectations headed into the year? And then also, if you could just share your thoughts on your overall view of NGL prices over the next few years and to what extent higher NGL prices would drive new Midstream growth projects?

Sean Trauschke

Hi Sarah. This is Sean. There are -- obviously they are a little lower than we forecasted in our original guidance. But we are hopeful that it is going to begin strengthening. We’ve said a couple of times that we think there is more upside to the commodity price environment than there is downside considering where we are.

Certainly, if we did see some improvement in commodity prices, we think we are in an advantageous position that would spur additional growth. And then, I think the other point is as far as commodity sensitivity, I think it’s important to note that there’s not -- in the former Enogex business there wasn’t a lot of commodity sensitivity, but because of the fixed fee conversions but as part of the bigger Enable, there’s just very little commodity sensitivity.

Sarah Akers - Wells Fargo

Okay. Thank you. And then, one on the utility side, you mentioned that any new transmission projects would likely be under the FERC 1000 competitive process. When do you expect that process to be ironed out and to start competing for some projects there?

Pete Delaney

You know the -- couple of things going on. One we do have legislation in the state of Oklahoma that passed around as another surrounding states. 300 KV and below would not be subject to the competitive FIN rules, but would be -- again, we’d continue with the right of first refusal based on who is owning and maintaining the assets.

Lot of concern particularly given the type of storms that we have had and the tornadoes, ensuring that power restoration is always done as quickly as possible, as safely as possible and efficiently as possible. The rules of the SBP are -- I know FERC rejected some of the provisions that the SBP had for running there and excluding certain lines from the competitive bid process. And that -- I still think we are probably a good six to maybe nine months away from clarity on that.

I don’t know if anybody has any other, Sean or -- better data than that. But there’s of course a lot of movement. And we continue to look for what’s the best way to approach that market and again we have constructed a lot of transmission assets. So particularly in the SBP, we believe that we do have expertise to bring to bear there. We do believe there is a lot of still constructions particularly in seams areas and the area of Arkansas, of course, we have a small presence there.

So we’re continuing to have a group that’s studying that. And we hope to make something happen there. We like transmission investment. Of course, it’s obviously different set of operating conditions when you have competition, but again, there’s much more clarity around how that competition is, how you are going to select the winner. It’s really hard to comment on one’s competitive position. So we are anxiously weighing that clarity as I know you are.

Sarah Akers - Wells Fargo

Great. And then actually a follow-up to my first question, are you seeing any response, any negative response in terms of drilling activity to the lower NGL prices or can you comment on the economics in some of the areas where you are seeing growth and how the lower NGLs are impacting volume growth?

Pete Delaney

I know -- and I guess, Sean and I both talked about this one. I know talking with Keith over the last month or so that in terms of when we’ve talked about that, the impact on our volumes, that the zones that they are targeting is the more heavy crude oil zones as opposed to the natural gas zones.

And that’s impacted us where in terms of volumes we have already reported and lower volume growth although we have volume growth. It was not as you know as high as we had once thought several months ago. Was a switch to, again, targeted more of the crude oil.

But we continued to see with the NGL prices, there are a lot of continued activity in scoop and some of the other areas. And hooking up -- continued to really be very busy at Enogex hooking up wells. So it seems to be a continuation of what we have seen in the last couple of months. Sean, do you have any, anything to add to that?

Sean Trauschke

No.

Sarah Akers - Wells Fargo

Great. Thanks everyone.

Pete Delaney

Thank you, Sarah.

Operator

Thank you for your questions. Ladies and gentlemen, that now concludes the question-and-answer session. I would now like to turn the conference over to Pete Delaney for closing remarks.

Pete Delaney

Thank you, Operator. In closing, I want to thank our members for their efforts and overall achievements. It has been a very trying quarter from an operational perspective. Of course, the devastation of the May tornadoes that was well publicized nationally, but what you may not know there has been numerous other storms over the quarter that continues to place heavy demands on our members.

In the Midstream business, integrating two businesses into one takes a great deal of work and brings on additional stress. And I’m grateful for our members’ patience and dedication to keep us moving forward. Thank you again for your interest in OGE Energy and have a great day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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