CH Energy Group, Inc. Q3 2009 Earnings Call Transcript

Oct.26.09 | About: CH Energy (CHG)

CH Energy Group, Inc. (NYSE:CHG)

Q3 2009 Earnings Call

October 26, 2009 2:00 pm ET

Executives

Steven Lant – President & CEO

Kim Wright – VP Accounting & Controller

Christopher Capone – EVP & CFO

Stacey Renner - Treasurer

Analysts

Daniel Fidell – Brean Murray, Carret

James Heckler – Unspecified Company

Maurice May - Power Insights

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the CH Energy Group conference call. (Operator Instructions) I would now like to turn the conference over to your host, Mr. Steven Lant; please go ahead.

Steven Lant

Good afternoon and welcome to our quarterly conference call. With me today are Christopher Capone, Executive Vice President and Chief Financial Officer, Kim Wright, Vice President of Accounting and Controller and Stacey Renner, our Treasurer.

After my introductory remarks Kim Wright will cover our quarterly results by business unit in detail and Christopher Capone will discuss our business environment and future prospects. We’ll then take your questions.

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

Stacey Renner

Thanks, Steve. I’d like to first remind listeners that the presentation slides for this conference call and our supplemental third quarter financial information are available in the Investor Relations section of our website at www.chenergygroup.com.

I refer you now to the paragraph on forward-looking statements at the bottom of this morning’s press release. If you’re following along with the presentation slides please reference page three.

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

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

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

I’ll now return the call to Steve Lant.

Steven Lant

Thank you Stacey. Our earnings per share for the third quarter of 2009 were $0.34 versus $0.18 in the third quarter of 2008, an increase of $0.16. Our earnings for the first nine months of 2009 were $1.71 versus $1.51 for the first nine months of 2008, and increase of $0.20.

The increase in earnings for the quarter was primarily at Central Hudson although Griffith did better as well. Central Hudson’s improvement was due to the implementation of new rates on July 1, 2009. As we’ve explained over the past several quarters, Central Hudson’s prior rate agreement which expired on June 30, did not provide adequate revenues to cover our costs despite our best efforts to reduce costs to offset the revenue shortfall.

The new rates are recalibrated to provide us a better opportunity to earn and appropriate rate of return and in the third quarter we began to see the recovery in earnings that we’ve anticipated. Our team did a good job of justifying our increase as necessary and I’m pleased that the PSC also recognized that we are a lean and efficient company and that the increase was necessary.

While the earnings are certainly much stronger under the new rate plan, we remain challenged to earn our full authorized return due to less then full recovery of some of our costs in the rate order and escalating uncollectible accounts and property taxes, which are symptomatic of the recession’s lingering effects.

Central Hudson has implemented its Austerity Plan filed in compliance with the PSC’s June, 2009 order. On July 30 of 2009, Central Hudson filed a rate case for new rates to become effective on July 1, 2010. We did so reluctantly given the difficult economic environment we face, but we felt it was necessary in order for us to continue to provide the high quality service our customers demand.

The size of the proposed increase is much less then the recent increase. This new case is progressing through its usual 11 month schedule. We are in the discovery phase now and the testimony of the PSC staff and other parties is scheduled to be filed on November 17.

We will then assess whether settlement negotiations could be fruitful or whether it will be necessary to litigate the proceeding to its conclusion. I would note that while Griffith had a loss of $0.22 for the quarter which is expected during the summer, the loss was $0.06 less then the third quarter of 2008 reflecting the operating expense reductions we implemented late last year.

I would also like to mention the significant change in our senior management team. Carl Meyer, who is President of Central Hudson, has decided to retire on December 31, after a very successful 40 year career with the company.

We thank Carl for his many contributions, especially over the past decade as President of Central Hudson. Replacing Carl will be James P. Laurito, who until recently served as President of New York State Electric & Gas, and Rochester Gas & Electric, within the Energy East organization.

Jim is very experienced and knows New York well. Jim officially starts on November 1 and we welcome him to our team.

Now I would like to turn the call over to Kim Wright.

Kim Wright

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

Beginning with our consolidated results as Steven noted, you can see on page five that we earned $0.34 in the third quarter of 2009, a $0.16 increase from last year’s third quarter earnings of $0.18. This increase was expected given the implementation of Central Hudson’s new rate order which includes revenue decoupling mechanisms, or RDM.

The new rate order corrected the revenue shortfall we experienced in the third quarter of 2008 under the prior rate agreement. Moving on to page six, Central Hudson’s earnings of $0.55 were $0.18 higher then the third quarter of 2008. The primarily driver of the higher earnings was the implementation of the new rate order I just mentioned.

As we’ve discussed on prior calls in the third quarter of 2008 our earnings were negatively impacted by the sales forecast reflected in our rates; it was too high, and therefore provided insufficient revenue to cover our operating costs.

The new rate order which was effective July 1, 2009 should prevent significant revenue shortfalls such as those we experienced during the three year rate settlement. Looking at some of the details provided on the bottom half of the page, and starting with the $0.43 from the new rate order, you can see that unlike the situation we experienced earlier in the year, the impact of our new rate order was sufficient to cover the increases in the normal cost of our business, such as depreciation, tree trimming, taxes and interest charges.

In total we saw an increase of $0.18 in the cost to operate our business over the same period a year ago. The new rate order was also sufficient to cover the $0.13 impact of lower sales volumes relative to last year, $0.08 of which was due to cooler weather in 2009.

Given the seasonality of our business and assuming normal weather we do not expect the impact of the new rate order to be as large going forward. Despite our higher earnings overall, we continue to experience higher uncollectible expenses as more customers struggle to pay their bills.

This is despite a significant reduction in our revenue, due to much lower electric and gas supply costs. This increased our uncollectible account reducing earnings by an additional $0.05 in the third quarter of 2009 relative to the same period last year, bringing the year to date total to $0.15 higher then the first three quarters of 2008.

As I noted last quarter, while our new rates do reflect an increased recovery to these costs, given the continued impacts of the weak economy, particularly the increase in unemployment rates, we expect that our expenses will continue to exceed the amounts recovered through our rates.

We continue to monitor these costs closely and have implemented a variety of measures to reduce the impact of these costs on earnings. You can see the result of one of these measures by looking at the top half of the page, where you see a favorable offset of $0.03 to these costs.

During the third quarter of 2009, the Public Service Commission approved our petition to defer the bad debt write-offs our gas business experienced in 2008. They were in excess of the amount we recovered through rates.

The Commission determined that the electric write-offs did not meet all of its criteria for recovery. We expect to file in the fourth quarter for recovery of our excess write-offs for the rate year ended June 30, 2009.

Moving on to page seven, you see that Griffith’s results were $0.06 higher the third quarter of 2008. As Steven pointed out in a period during which seasonally low volumes are expected to produce a loss, we are very pleased with the improvement over last year’s results just largely driven by lower operating expenses.

As we discussed last quarter given the level of conservation we began experiencing last year, we took a close look at our expenses to ensure they were in line with the lower sales volumes. The results of this review reduced our costs adding $0.03 to our third quarter earnings relative to last year.

You also see that in the third quarter higher margins partially offset the impact of our lower sales volumes. While still higher then the third quarter of 2008, margins were tighter in the third quarter of 2009 then during the first quarter due to rising wholesale oil prices.

Wrapping up on page eight with the other businesses and investments, our earnings were $0.08 lower then 2008 due to higher income taxes as well as interest expense on the holding company’s long-term debt issuance.

In terms of the higher income taxes, the benefits the holding company receives from filing as a consolidated entity was lower in the third quarter of 2009 relative to the same period in 2008 as a result of lower taxable income at Central Hudson.

Central Hudson’s lower taxable income was driven by higher tax deductions for contributions we made to fund our pension plan. As we discussed last quarter, the increase in the holding company’s interest expense was expected as we issued $50 million of long-term debt during the second quarter of 2009.

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

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

Christopher Capone

Thank you Kim, good afternoon. The third quarter was an especially critical quarter for CH Energy Group because as been mentioned a few times in the call, new delivery rates went into effect at Central Hudson.

The rate agreement does contain revenue decoupling mechanisms or RDM’s, and together with the delivery rate increase served to improve the financial risk profile of Central Hudson. This is especially important for CH Energy Group because Central Hudson is by far our largest business unit in terms of assets and earnings.

At Central Hudson our third quarter results which Kim just went through in detail reflect the impacts of these rate increases and the RDM’s. The new rate agreement is a significant improvement compared to the prior three year agreement regarding the necessary resources that we require to serve our customers and the new rate agreement also dampens the risk due to the variability of customer usage, again via the revenue decoupling mechanisms or RDM.

However there are still certain items that will make it very difficult to earn our authorized return of 10% which is embedded in the current rate agreement. The amounts we recover for uncollectibles and property taxes are based on historical experience and not a forward-looking estimate.

In the current environment of increasing uncollectibles and significant property tax increases there will be an under collection for those items in the current rate year and a corresponding negative impact on earnings.

For either item if the rate year under collection reaches a certain threshold we will file for deferral treatment for the shortfall. We will measure our actual experience compared to the amount actually collected in rates through June, 2010 which is the end of the current rate year, and since we’re only about three months into the current rate year, its too early to determine if either item will qualify for deferral treatment.

Regarding uncollectibles, we are taking steps to address our accounts in arrears but the biggest factor driving uncollectibles will likely be the unemployment rate as well as when the economy does begin to grow again.

We will continue to challenge tax assessments to assure ourselves that we are paying appropriate amounts as well. As I mentioned uncollectibles and property taxes are the primary reasons why we believe it will be very difficult to earn the authorized ROE.

Steven mentioned earlier in the call Austerity, and as part of all recent rate orders, the PSC has included an Austerity component in response to the difficult economic environment that began for the broad economy last fall.

We have been extremely focused on costs during virtually the entire period of our last rate case given the significant revenue shortfall during that time and we continue to manage costs. We feel there are limitations on further reductions available without impacting the service quality for our customers and any shortfall relative to any Austerity requirements would also negatively impact earnings.

But despite these challenges our earnings and risk profile are much improved under the current rate agreement compared to the prior agreement that expired at the end of June. Additionally our capital structure is stronger and contains approximately 48% equity which is slightly above the level on which delivery rates are set.

We feel this level of equity is more supportive of a single A credit rating and we continue to feel that a single A credit rating is critical to being able to access the capital on reasonable terms and in virtually all market conditions.

Regarding CapEx and rate based growth as we’ve mentioned in prior calls, our system even during these times of slower economic growth, our utility infrastructure continues to require a significant investment.

These investments lead to rate base growth and the equity component of this rate base drives our earnings. The CapEx program we are projecting in the current rate year of approximately $85 million should provide us with the resources to maintain the integrity and reliability of our delivery infrastructure.

Now I’d like to make some comments about Griffith, in the third calendar quarter Griffith’s results improved year over year by $0.06 as been described earlier in the call primarily due to a continued focus on expense management as well as increases in margins.

Declining usage per customer continues to be a challenge for the entire industry. Margin expansion and cost management are the primarily tools to address changing customer usage and increases in the cost of providing service.

Due to the efforts of Randy Groff, President of Griffith and many others, Griffith’s results continue to improve. We believe that with these levels of earnings returns that Griffith warrants the capital that we have allocated to this business and we will continue to look for and find ways to improve performance in the future.

We are continuing our strategic review of fuel distribution with the objective of getting the most value out of CH Energy Group’s investment in Griffith over the long-term and we expect our review to be concluded by the time of our call to discuss year end results which is typically in mid-February.

Regarding what we call our other business and investment segment, this is the segment that houses our ethanol, biomass wind and landfill gas investments and inter company financing activities. Regarding ethanol, crush margins have improved in recent weeks as corn prices have risen less then ethanol prices, but ethanol markets continue to remain volatile.

At Lyonsdale, which is our biomass investment, capacity factors have been at levels that are more in line with expectations. We may also be able to take advantage of an element in the 2008 [farm] bill that would reduce the cost of our wood supply, which is the primary fuel source for the plant.

Any benefit to be gained would not begin until late this year, but more likely in 2010. Our minority interest in CH-CWE, the wind investment with assets in Atlantic City and Bear Creek continues to perform well. Construction continues at the Auburn landfill gas facility and completion is projected at the very end of this year or very early in 2010.

Overall capital markets appear to be improving but we have not yet seen a noticeable increase in competition for projects. And regarding the capital markets and liquidity overall, while market conditions continued to improve further in the third quarter, we continue to focus on maintaining access to adequate liquidity.

We have approximately $20 million in cash at the holding company, in addition to $150 million of committed credit and $125 million of committed credit at Central Hudson with no net balance outstanding at this time.

And as evidence of our ability to access capital, in late September we issued 30-year fixed rate debt at Central Hudson at a rate of 5.8% pre-tax.

At this point I’d like to turn it over to the operator for the question-and-answer period.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Daniel Fidell – Brean Murray, Carret

Daniel Fidell – Brean Murray, Carret

Just a couple of questions, I guess first housekeeping question, can you talk about or give us a little color on the other income net line, down 1.3, versus 41,000 pull in last quarter. Just any kind of color on what was driving that line.

Kim Wright

That was really an accumulation of relatively smaller items that were not worthy of discussion.

Daniel Fidell – Brean Murray, Carret

Okay, can you also maybe just give us a little bit more detail on the rate case filing. I know I saw some of the official release for the new filing and I know you asked for a number of items that you covered just now, just wondering if there exists a potential for any specific tracking mechanisms in that filing. What I’m really going after is, is a more formalized bad debt track or a CapEx track or those kinds of items a possibility to come out of the next case.

Christopher Capone

Regarding uncollectibles the current methodology or the current approach that’s imbedded in our rate agreement is a backward look. They go back, again in the rate year that we’re in now, they went to the period ending March 31, 2009 and looked at the trailing 12 months. And so that is a kind of a backward lagged view and that’s continued to deteriorate.

We are looking for something at a minimum that will update through March 31, 2010 for the trailing 12 months, but that’s in effect a placeholder right now. We would like to gain something that’s more forward-looking and we have filed testimony based on our review that is a forward-looking view.

But in a one year rate case which is what we have filed, the Commission and staff are atypically reluctant to provide any sort of deferral treatment on that basis. And the other one on CapEx, again there, what we have filed in the rate case for a capital [map] that we believe will allow us to serve our customers adequately and provide the infrastructure necessary to maintain the type of reliability our customers have come to expect.

But that’s a process underway. The rate case process is underway right now. We expect to get staff testimony on November 17 or thereabouts so we’ll have a much better idea of what staff’s view is on many of these items.

Daniel Fidell – Brean Murray, Carret

Last question, sort of a broader context question on the three megawatt landfill project, and just wondering if the potential exists for you to do similar type projects going forward. I know that the ongoing strategic review continues for Griffith and I think in the past you’ve talked about these kinds of projects as being areas you may be interested in going forward with. Is that still the case?

Steven Lant

It is, one of the things that we’re trying to make sure that we I guess can assure ourselves going in is that any project we invest in going forward has a sufficiently stable and predictable cash flow and earnings profile. And these landfill projects we’ve gotten involved in to date, we felt met that test.

And if we can meet that test with future projects, we would invest and again if we felt they were perhaps too variable we would not invest. So if we can find more projects that meet that test we, I think we would invest.

Operator

Your next question comes from the line of James Heckler – Unspecified Company

James Heckler – Unspecified Company

On previous calls I think you’ve mentioned the earnings power at the utility if you were actually able to earn your allowed ROE and I think you might have said on an annual basis that might be around $2.50 for the electric and the gas. And I think you gave a sensitivity around that on an ROE basis and I was wondering given what you’ve seen from the third quarter and what you’re projected to do and in light of what you’ve filed in your rate case, what over the next 12 months or at least this rate period over which this rate case will be applicable, what kind of ROE you’re anticipating to earn over that time period or what kind of lag or a comparison to the 250 number, some sort of metric we can look at that will give us an indication of what the implied lag is for this particular rate period.

Steven Lant

I’ll try but predictions about the future are difficult as Yogi Beara said particularly relative to a couple of items. Last quarter we did talk about this a little bit and said we felt it was improbable that we would achieve the full allowed ROE but we thought that the drag that we experienced net of all of our efforts to offset it, would likely be rather small.

At this point we think if anything that is growing a little bit, that potential net drag is growing a little bit for two reasons. One is the uncollectible trend that we talked about earlier has accelerated and this is despite the fact that our revenues are down about 30%.

Supply costs have come down dramatically year over year which is a big help to our customers and to ourselves. But despite that, the bad debt expenses have continued to escalate. So what we’re seeing, we believe is a continued effect of the rising unemployment rate and Christopher referenced in the previous question our forward-looking forecast which is based on an expectation that the unemployment rate will probably not peak out for another quarter or two.

And that there will probably be even a little lag in our bad debt experience beyond that point. So we see that as something that is potentially going to be a little bit bigger drag then we thought when we first got the rate order based on the additional evidence of the last three months.

We are doing everything we reasonably can to offset that and to work with our customers to collect the money that’s owed us but there certainly are cases of real hardship where its very difficult for them to pay. The other issue that has I guess gotten worse has been the property tax bills that we received.

I think those of us who read the local and regional papers know that New York State’s fiscal situation both at the state and local level isn’t good and that government’s are pressed and certainly it is possible and we knew it was possible that we would be seeing significant increases in property tax bills but frankly the increases that we’ve been seeing recently were greater then we even feared.

So that is another potential source of drag and Christopher referenced that we’re looking at these assessments to see if they are reasonable or should be challenged. We haven’t reached any conclusions about that yet but clearly we are concerned about that situation that we will be bearing the brunt of the gap closing efforts by state and local government.

So those are the two areas that if anything have gotten slightly worse rather than better over the past quarter and would lead us to believe that the under earning might be a little greater then we thought at first. But I still think we’re not looking at a dramatic under run and I don’t want to give you a specific figure but we’re doing everything possible to minimize this and offset it where ever we can.

James Heckler – Unspecified Company

Can we think about what you file, your request in your rate cases, as a number where we might be able to derive, an under earning percentage either on a percent lag or are there other things included in that rate case that might make that a bad assumption.

Steven Lant

I guess we haven’t thought of it in that framework so I don’t have a ready answer for you. Clearly what we’re trying to do in that rate case is look at the period July 1, 2010 through June 30, 2011 and project our cost levels in that period of time and try to fully recover them, particularly these forward-looking costs which we see escalating strongly and any rolling 12 or historical figure is just going to prove to be too low.

So that’s been our perspective in this current rate case that those costs are going to be escalating from now until the next rate year and then we hope peaking, but there’s no assurance of that.

James Heckler – Unspecified Company

One final question, in your results presentation on slide six where you talk about the drivers from third quarter of 2008 to third quarter of 2009 for the utility, you show weather impact on sales as well as weather normalized sales impact, the total of those being about $0.13. Is the revenue decoupling mechanism offsetting that, and if so is that, can we consider that to be offset within the $0.43 rate order.

Kim Wright

A portion of that would be reflected in the $0.43 but its important to note that the $0.43 and the RDM are calculated against our actual results versus what we filed in the rate case and was approved as part of the rate order as opposed to the $0.08 and the $0.05 you were referring to that are relative to last year.

So a subcomponent of those numbers is reflected in the $0.43.

James Heckler – Unspecified Company

I’m not sure I understand completely but are you recovering all of your under recovery from weather and lost sales through the RDM, that’s just another way I guess of asking it.

Kim Wright

The vast majority, most of our customers, service classes are subject to the RDM.

James Heckler – Unspecified Company

Okay but there’s some component that’s not, could you quantify roughly of the $0.13 in weather impacts and weather normalized sales, how much was actually recovered through the RDM.

Kim Wright

I can’t quantify in terms of the $0.08 and the $0.05 again because those are relative to last year’s results, not our rate case. We did have over a couple of million dollars worth of weather that was reflected in the RDMs however. It was a sizable portion.

Operator

Your next question comes from the line of Maurice May - Power Insights

Maurice May - Power Insights

I want to pick up on James’ line of questioning on the authorized ROE and what kind of attrition you might experience because if I recall correctly in the first quarter conference call, after you had gotten the hearing examiner’s recommendation, I think you mentioned the potential for 50 to 75 basis points of attrition off the 10%. After the second quarter you’re a little more optimistic and you thought it would be less then that. Today, you’re a little more pessimistic. I’m wondering whether you’re back to your level of pessimism of the first quarter conference call, i.e. 50 to 75 basis points or not back quite that far or back further then that.

Steven Lant

I wish we could pin it down with such precision.

Maurice May - Power Insights

Okay I know, but in your bones do you feel like its more like what you were talking about after the first quarter.

Steven Lant

I don’t like to think about how my bones feel but its I think clearly directionally you’re right. That’s been sort of the way the pendulum has swung in that we were a little bit more optimistic after the rate order came out but then maybe we have swung back a little bit based on the experience over the past quarter and the news that we have seen and perhaps a little bit of an extrapolation of that trend, especially on the uncollectible accounts, which we see continuing to deteriorate rather then to peak, at least right now.

We’re all hoping that the recession is over and the recovery that we’ve read about is going to manifest itself in terms of unemployment rates and our customers wherewithal to pay their utility bills. But I think there is a lag there, that it just takes a while for people who’s reserves have been depleted to kind of rebuild their household balance sheets.

Christopher Capone

One of the other things and we’ve alluded to it a few times over the time period you described, part of it as well as we’re mentioning are the property taxes. When we came out with our call we didn’t have the bills that we receive in the fall and there again the mechanism that is used right now, it’s the prior year’s actual, then grown forward by a fairly modest increase, something resembling more like inflation and New York’s situation has deteriorated since that time and we saw some much larger increases.

So that’s one of the other key drivers as to why we were of the belief that we had in the first quarter, after the first quarter again the little bit of optimism after the second and why we’re a little less optimistic now.

Maurice May - Power Insights

Second question has to do with Griffith, I like to track the amount of equity you have invested in the unit, and I think after the second quarter, Kim you said you had $73 million invested in it as of June 30 of this year. I was wondering whether you could update that number or is it still pretty much the same.

Kim Wright

Pretty much the same.

Maurice May - Power Insights

And final question you have $20 million of cash at the holding company, I just wanted to tap your brains on what your intentions are with this cash.

Steven Lant

Well I guess we don’t have a defined answer for you at this point. It’s the season where we’re developing our annual business plans and I guess that stew isn’t quite cooked yet. We’re not able to give you a lot of color on that at this point.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Steven Lant

Well it appears we’ve exhausted the questions for today. We thank you very much for your time and attention and of course if questions do arise, please contact Stacey Renner and he’d be glad to help you. So once again, we thank you very much and look forward to our next conference call.

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