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Southern Union Co. (NYSE:SUG)

Q3 2009 Earnings Call

November 5, 2009 9:00 am ET

Executives

Jack Walsh – Vice President of Investor Relations

George Lindemann – Chairman and Chief Executive Officer

Eric Herschmann – President and Chief Operating Officer

Rick Marshall – Senior Vice President and Chief Financial Officer

Rob Bond – Senior Vice President, Pipeline Operations

Roger Farrell – Senior Vice President, Midstream Operations

Analysts

Ross Payne – Wells Fargo

Carl Kirst – BMO Capital Markets

Faisel Khan – Citi

Jonathan LeFebvre – Wells Fargo Securities

[Mark Rogers]

Operator

Welcome to the Q3 2009 Southern Union Company earnings conference call. (Operator Instructions). I would now like to turn the conference over to your host for today's call, Mr. Jack Walsh, Vice President of Investor Relations.

Jack Walsh

Welcome to Southern Union's third quarter 2009 earnings call and webcast. Presenting on today's call will be George Lindemann, Chairman and CEO; Eric Herschmann, Vice Chairman, President and COO; Rick Marshall, Senior Vice President and CFO; Rob Bond, Senior Vice President of our Pipeline Operations; and Roger Farrell, Senior Vice President of our Midstream Operations.

A replay of this call will be available for one week by dialing 888-286-8010 and entering pass code 34044559. A replay of the webcast will be accessible through our website at www.sug.com.

Today, we will be discussing our third quarter 2009 results, significant events and outlook. This morning we issued a press release announcing our results which is available on our website. Following our prepared remarks, we will be happy to address your questions. If you have any further questions after the call, please contact me at 212-659-3208.

Before beginning, I would like to remind everyone that the information discussed on today's call pertains to the financial results of Southern Union Company. Certain amounts and variance explanations for the transportation and storage segment may differ compared to Panhandle Eastern Pipeline Company's standalone financial statements due to consolidating adjustments.

I would also like to caution you that many of the statements contained in our call may be based on management's current expectations, estimates and projections about the industry in which the company operates. These statements are not guarantees of future performance and involve risks. The company undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise. Such statements are intended to be covered by the Safe Harbor provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934.

I would also refer you to the cautionary statement regarding forward-looking information in our earnings release.

I would not like to turn the call over to George Lindemann, George?

George Lindemann

I am pleased to report adjusted third quarter 2009 earnings of $43 million or $0.34 per share. This amount includes certain adjustments for mark to market accounting and hurricane-related items that were identified in our press release.

As you know, less than 20% of our overall business is exposed to commodity prices. During the last several months, we have actively managed our hedging portfolio at Southern Union Gas Services, our gathering and processing subsidiary.

We have been successful in adding significant positions to our portfolio for both 2010 and 2011 at what we feel are attractive prices. One of the main goals of the company is to effectively manage our exposure to commodity prices so that we can continue to show stability and growth in both earnings and cash flow.

Finally, I am happy to reaffirm our adjusted earning guidance for 2009 in the range of $1.75 to $1.90. Rick Marshall will discuss the numbers in greater detail. With that, I would like to turn the call over to Eric Herschmann. Eric?

Eric Herschmann

We are pleased with the performance of our business segments during the quarter. We continue to focus on the stable nature of predominately-regulated businesses and are constantly looking to optimize each of our assets. To that end, we have been proactively managing the rate structures within each of our various business units.

As you probably know, earlier this year, we filed for a $32 million annual rate increase at our Missouri Gas Energy Division. Our request is currently pending before Missouri PSC. Our new increased rates will go into effect no later than March 1, 2010.

Florida Gas Transmission, in which Southern Union has a 50% interest, recently filed for a rate increase reflecting $107 million increase in its annual cost of service. The increase is primarily driven by significant capital expenditures since our last rate case.

The amount requested, approximately $80 million per year, would be incremental to FGT's current revenues. By law, the increase rates, subject to refund, will take effect no later than April 1, 2010. We expect the FERC will set a procedural schedule sometime in November.

We continue to work through the commissioning process of our Trunkline LNG Infrastructure Enhancement Project. As you would expect with a complicated project of this nature, we have encountered some items that need to be addressed before we put the project into full service. We are diligently addressing these items.

When we finish our prepared remarks this morning, we will address your questions. With that, I would now like to turn the call over to Rick Marshall, our CFO, to give an overview of our third quarter results. Rick?

Rick Marshall

Before I begin, I would like to point out that our discussions today will focus on adjusted net earnings and adjusted EBIT, both non-GAAP measures. In accordance with Reg G, our release issued this morning contains reconciliation of those non-GAAP measures.

For the quarter ended September 30, 2009, Southern Union had adjusted EBIT of $114 million compared with adjusted EBIT of $106 million in the prior year. The increase was primarily due to increases in the company's Transportation and Storage, Distribution, and Corporate and other segments offset partially by a decrease in the Gathering and Processing segment.

For the third quarter, adjusted net earnings were $43 million or $0.34 per share. This compares to adjusted net earnings of $36 million or $0.29 per share in 2008. Reported earnings for the quarter were $45 million or $0.36 per share compared with $42 million or $0.34 per share last year.

As George mentioned earlier, adjusted net earnings and EPS include adjustments for the mark to market accounting treatment on our hedging portfolio and the reduction of a provision for repair and abandonment costs related to damage caused by Hurricane Ike on our Sea Robin pipeline.

The adjustments for mark to market accounting include two components. The first is the inclusion of a portion of the $0.30 per share gain booked during 2008 that related to our 2009 processing spread hedges. The portion being added back in the third quarter is equivalent to $0.08 per share. As you will recall, we removed the noncash gain out of adjusted earnings last year since it pertained to our 2009 hedges.

The second component is the revaluation of our open processing spread hedges based on future expected commodity prices. The amount being deducted related to this component is also $0.08 per share. This is a noncash item that will reverse over the life of the hedges as they settle for cash.

In terms of segment results, Transportation and Storage, including our investment in Citrus, had adjusted EBIT of $97 million for the quarter compared with EBIT of $94 million in the prior year.

The increase of $3 million was largely attributable to higher operating revenue at Panhandle Energy coupled with lower net hurricane-related costs in 2009 compared to 2008 offset by an increase in environmental reserves, outside third party service costs, and depreciation expense at Panhandle Energy.

Panhandle's operating revenue increased by $3 million during the quarter largely due to higher average realized rates on Panhandle and an increase in LNG terminalling revenue partially offset by lower parking revenue and lower transportation usage revenues as a result of decreased volumes. Adjusted operating expenses decreased $4 million compared to the prior year, largely due to a net reduction in hurricane-related expense compared to last year.

Depreciation expense increased $2 million year over year due to $166 million increase in property, plant and equipment placed in service after September 30, 2008. Our Gathering and Processing segment generated $8 million in adjusted EBIT for the quarter compared with adjusted EBIT of $13 million in the prior year.

The decrease was largely driven by lower realized natural gas and natural gas liquids prices and a fire at our Keystone processing plant in July curtailing production volumes offset partially by a reduction in operating expenses as a result of ongoing cost cutting measures being applied throughout the company.

Our distribution business generated EBIT of $5 million for the quarter, compared with EBIT of $1 million in the prior year. The increase was partly due to higher operating revenues of $2 million, largely a result of $3.7 million annual rate increase at our New England division, coupled with a $2 million decrease in operating expenses, primarily due to lower bad debt expense at our Missouri division.

Our corporate and other operations generated EBIT of $3 million, an increase of $5 million over the prior period. The increase was primarily due to a reduction $3 million in litigation-related fees in 2009, compared to the prior period and the collection of a $2 million litigation settlement in the current year.

During the quarter, we invested approximately $107 million into our operations. Growth capital accounted for $36 million, while maintenance capital was $71 million. From a segment standpoint, our transportation and storage segment invested $76 million, $24 million for growth and $52 million for maintenance.

Our gathering and processing segment invested $13 million, $3 million for growth and $10 million for maintenance. Our distribution segment invested $11 million, $1 million for growth and $10 million for maintenance. Finally, our corporate and other segment invested $7 million of growth capital. As of October 30, the company had $420 million in committed revolving credit facilities with $80 million outstanding.

I'll now turn the call over to Rob Bond, who will discuss our transportation and storage segment.

Rob Bond

Our transportation and storage businesses performed well during the third quarter of 2009 and we continue to make progress on our major capital initiatives. One of our major capital initiatives is the Florida Gas Transmission Phase VIII project. We have a 50% interest in and serve as operator of Florida Gas Transmission through our investment in Citrus Corp.

The Phase VIII project is designed to add approximately 820 million cubic feet per day of incremental delivery capacity into Florida through the addition of approximately 500 miles of pipeline and over 200,000 horsepower of compression. We expect to receive our first certificate during the fourth quarter. We remain on target for our Spring 2011 in-service date.

We continue to have 74% of the expansion capacity contracted under 25 year agreements. One shipper has an election to increase its capacity to a level that will take us to 83% contracted. We estimate that the project will cost approximately $2.4 billion and generate operating income of $240 million to $260 million and EBITDA of $290 million to $310 million, when fully contracted. We continue to remain optimistic that we will have the remaining capacity contracted prior to the pipe going in service.

As Eric mentioned earlier, we were in the final stages of commissioning for the Trunkline LNG infrastructure enhancement project. As noted earlier, this is a complicated project. During start up and testing, we have encountered several issues with warranted equipment that needs to be resolved. At this point, we are diligently working through the open items and are hopeful that we can finish the commissioning process in the next several weeks.

To remind everyone, the project is fully subscribed by our customer, BG LNG Services for 20 years and is still expected to cost $430 million plus capitalized interest and generate EBITDA in the range of $67 million to $72 million. With that, I'd like to turn the call over to Roger. Roger?

Roger Farrell

From third quarter of 2009, we averaged just over 31,000 MMBtu per day of high value equity NGL volumes and approximately 8,000 in MMBtu per day of equity natural gas volumes. These averages directly reflect the impact of the fire we experienced at our Keystone processing plant on July 17.

The plant was completely shut down until August 1. However, throughput has steadily increased since that date and we are presently operating at about 9% of pre-fire volumes. We do expect the plant to be at full capacity by the end of this month. We have been able to utilize the flexibility of our system to reroute excess Keystone volumes to our Jal 3 facility and are pleased to report that system-wide NGL volumes now exceed pre-fire levels.

During the quarter, reduced volumes negatively impacted gross margin by approximately $5 million. Additionally, operating expenses were $5 million higher as a result of the write-off of equipment destroyed by the fire.

Despite the fire and its impact on third quarter equity volumes, we are now optimistic that we will be able to grow throughput and equity volumes moving into 2010. We continue to see opportunities in our North system to attach new supplies of sour NGL rich gas from a number of active oil-related plays. Our infrastructure within the play and expanded training capability at our Jal 3 facility has placed us in an advantageous position to successfully compete for these volumes.

As George mentioned earlier, we have locked in a substantial portion of our 2010 and 2011 equity value by adding to our hedge portfolio. For 2010, we are hedged on 40,000 MMBtu per day of equity NGL, using a combination of processing spread and natural gas swaps at an average realized price of $10.44 per million BTU. We were also hedged on an additional 5,000 MMBtu per day of natural gas at $5.33 per million BTU.

Our natural gas hedges include basis differentials for WAHA and Permian, our physical points of sale. We are also pleased that we were able to add positions for 2011 at attractive prices. We currently have 10,000 MMBtu per day of NGL hedged at $11.19 and 10,000 MMBtu a day of natural gas hedged at $6.14. We continue to actively monitor the forward markets and will look to add additional hedges to our portfolio as opportunities present themselves.

I would now like to turn the call back to George. George?

George Lindemann

Thank you, Roger. At this point we would like to open the meeting up to questions.

Question-and-Answer Session

Executive Name (with no title behind please)

Analyst Name – Company Name

Operator

(Operator Instructions). Your first question comes from Ross Payne – Wells Fargo.

Ross Payne – Wells Fargo

First question is on Florida Gas Transmission expansion. Do you have locked in contracts with contractors or is it more of a cost plus situation?

Eric Herschmann

No, it's locked in contract. It's a unit price contract so we're going to, the contracts are based on a per mile and at this stage, we're fairly locked in.

Ross Payne – Wells Fargo

Okay, great. Also, I just wanted to ask if you guys are seeing any impact as REX kind of comes across the top and ends up in Ohio as it relates to Panhandle, maybe that was more of an impact last quarter, but wanted to ask you if there was any impact this quarter and your expectations for next year.

Rick Marshall

No, not really. Actually, over the last several years we've managed to increase the contract life on many of our major customers on Panhandle, so we did not feel any difference in our revenues or our contracted volumes or our throughput on Panhandle in the most recent quarter. Quite frankly, I would expect as REX continues to make its way further East that the overhang of gas in the Lebanon area will ease. And perhaps we'll see some additional demand back into the Western Ohio market area.

Ross Payne – Wells Fargo

And what is the average life on contracts on Panhandle now?

Rob Bond

A little over six years.

Ross Payne – Wells Fargo

And on Florida Gas?

Rob Bond

Nine or ten I believe.

Operator

Your next question comes from Carl Kirst – BMO Capital Markets.

Carl Kirst – BMO Capital Markets

Actually, the last question is what I wanted to touch on and to the extent maybe, Rob, you can throw in what the average contract life of Trunkline is. And also just to kind of be clear, understanding with average lives, if we get into a situation and it looks like basis is already kind of beginning to recover a little bit, but if we kind of get into sort of a for whatever reason, a sustained two-year very flat national basis. How do you think that could impact, if at all PEPL and Trunkline?

Rob Bond

Well first of all let me just answer the first question. Trunkline's average life is slightly over eight years. And a lot of Trunkline's longer term contracts are really moving gas from Texas to Louisiana or Louisiana to other points in Louisiana.

There are some long haul components to that. Typically they are done in concert with PEPL contracts because those customers typically want access to Gulf Coast supply as well as mid-continent supply. And I would note that those average contract lives are oftentimes blended down by seasonal contracts that are either field zone only or very path specific transactions.

And for example, I think our next major renewal on Panhandle is not until 2012 or 2013. Clearly big basis differentials are better for the pipeline business as a whole and we hope that as Rockies makes its way further east and as the new natural gas grid kind of settles down that we'll see a strong return of basis differentials across our pipelines.

Carl Kirst – BMO Capital Markets

But no major new re-contracting for PEPL at least until 2012?

Rob Bond

That's correct.

Carl Kirst – BMO Capital Markets

And also, just while we're staying on pipelines, and I don't know if you've got these numbers off the tip of your tongue, I think we were first looking at the year as far as potential volatility points. We were looking at park and loan expectations this year of around $35 million, kind of on par with last year. Given what we've seen kind of first nine months, is that still the case or are you seeing actually better or worse?

Rob Bond

I think year to date it's slightly better. Clearly the storage spread, the time spread around the storage assets is very, very strong. However, we're also at a point where storage utilization is very, very high. So the space available for parking is at a premium. I think the average rate that we're receiving on park and loan transactions is higher but I think the volumetric side of that has been a challenge.

Carl Kirst – BMO Capital Markets

Fair enough and then just a clarification on one of the things you said with respect to FGT Phase VIII. Did you say you were, let's call it, cautiously optimistic or maybe very confident for that matter as far as getting the rest of that pipe subscribed or project subscribed before it comes into service, did I hear that correct?

Rob Bond

Yeah, I mean there are a number of generation projects that we're aware of in the state of Florida that we're pursuing that would allow us to fully subscribe the remaining capacity in Phase VIII.

Operator

Your next question comes from Faisel Khan – Citi.

Faisel Khan – Citi

It's Faisel from Citi. Just a couple of questions, could you go back and just give us a little more detail on the FGT rate case? I missed some of those comments. You expect FERC to put a procedural schedule together I think this month, is that right? And then how do we go from there, and when do rates go into effect, how does that work?

Rob Bond

Well they go into effect April 1st, subject to refund. And then we'll obviously be working through the – I mean obviously if we were able to settle the case, prior to that the rates would go into effect prior to that. I think that's probably unlikely. The procedural schedule will be set here shortly and then it's in all likelihood, those proceedings will take place in the summer of 2010.

Faisel Khan – Citi

So rates in effect by April of next year –

Rob Bond

Correct.

Faisel Khan – Citi

I got you. And that would be on the full amount?

Rob Bond

That'd be on the full amount, that's correct.

Faisel Khan – Citi

And then in terms of when will you actually make your filing for why you think your rates should be higher than what you're asking for ROE and stuff like that.

Rob Bond

We have already made that filing. We made it at the very beginning of October.

Faisel Khan – Citi

And then just on the midstream side, question on volumes. Can you talk a little bit about what you guys have been seeing volumetrically, sequentially, kind of a first quarter, second quarter, or third quarter of how those volumes have been trending and what you guys expect over the course of the next quarter.

Roger Farrell

Because the first quarter and second quarter are relatively flat, obviously, because of the fire and the time it's taken to bring our facilities back up. Third quarter was down quite substantially, 16% drop in GL volumes.

Faisel Khan – Citi

Excluding the fire, like what did you guys see in terms of volumes [inaudible] customers.

Roger Farrell

I would have expected, absent the fire, that volumes would have been above second quarter.

Faisel Khan – Citi

And one more question on Florida Gas Transmission. When would you guys expect to take any dividend form FGT this year?

Rob Bond

No we have not.

Faisel Khan – Citi

Is it fair to say that you probably won't see any dividends be taken from FGT over the next two years while the pipeline's under construction?

Rob Bond

That's correct. I mean sometimes in 2011 we'll revisit the dividend policy with an eye toward reinstituting those dividends.

Operator

Your next question comes from Jonathan LeFebvre –Wells Fargo Securities.

Jonathan LeFebvre – Wells Fargo Securities

Most of my questions have been asked, but just following up on Faisel's question on volumes, can you just give us a sense for the midstream where you're seeing or you're projecting 2010 or should we be thinking about it being flat or just how much do you think you have hedged at this point?

Roger Farrell

Well we have 40,000 a day of NGLs hedged.

Jonathan LeFebvre – Wells Fargo Securities

Well I mean percentage wise of what you expect to produce. Is that the full amount? Should we be thinking about it being –

Rob Bond

I think our 2009 guides has always been around 42,000 MMBtu a day of NGL. Obviously at this point we believe that 2010 will exceed that amount but we're not in a position now to give guidance for 2010.

Jonathan LeFebvre – Wells Fargo Securities

Got you, and then I think you said that you're seeing volumes flowing higher than they were prior to the fire. Is that just some pent up demand do you think or can you just give us a little color on that?

Rob Bond

The color is its actual growth.

Operator

Your next question comes from [Mark Rogers] – [inaudible]..

[Mark Rogers]

Good morning guys. I wanted to elaborate a little bit on the Trunkline LNG, the delay with the commissioning. Could you elaborate with what's going on there and when you might expect it to be in service and how much of that is in your 2009 guidance?

Rob Bond

Well we've had some failure of mechanical equipment on the NGLRU unit that has been sent back to the manufacturer and repaired. We expect that equipment to be returned to us next week and we'll reinstall it and get back to trying to get the plant back up and running. I think it's probably premature to speculate on exactly when exactly it'll go into service, but we remain optimistic that that'll happen in the next several weeks.

[Mark Rogers]

And then how much of that is in the '09 guidance, or if it comes in sooner would that be upside?

Eric Herschmann

Mark, as you're aware, we have a guidance range and as Rob said we're hoping that it comes into service as soon as possible. But we have taken in assumption that it will come into service before the end of the year.

[Mark Rogers]

And one other question, more broadly speaking I guess on Phase VIII as well. For some of these big projects like the LNG project and like Citrus, what costs are you incurring today for which there's no offsetting revenue? So whether that's debt you've taken on to build these projects, how much are you spending today on stuff that's not really in service yet, if at all.

Rob Bond

Well I mean, hopefully none. Certainly on IEP it's a formulistic driven contract and on Phase VIII we have negotiated rate agreements with our customers but it's in line with what exactly we expected when we designed the project.

[Mark Rogers]

And there's no leverage that you've taken on for those projects for which you're already paying interest?

Rob Bond

There is leverage, but incorporated into our decision-making process and the expected returns on those projects, the cost of the financing we put in place thus fare were factored into our decision to move forward. And so far the cost of financing specifically the $600 million that we raised in June of this year and the $500 million that we raised in or drew down on in I believe October of last year, the interest rates on those loans are in line with the interest rates that we incorporated into the economics of the project.

Operator

Your next question comes from Faisel Khan – Citi.

Faisel Khan – Citi

I have one follow up. The IEP project how much NGL can you actually extract at the plant?

Rob Bond

The plant's a Bcf a day plant and so it's really going to be a function of the heating content of the gas coming through will be. We should know it in gallons but I don't know it off hand.

Operator

There are no further questions at this time. I would now like to turn the call back over to Mr. Lindemann for closing remarks.

George Lindemann

I would like to thank everyone for attending today's call and participating. And we hope to have you all in our next quarter call and I hopefully it will be a better quarter than everyone anticipates. So again, thanks and speak to you all soon. Bye.

Operator

That concludes today's conference, thank you for your participation and you may now disconnect.

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