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AGL Resources (NYSE:GAS)

Q4 2013 Earnings Call

February 5, 2014 09:00 am ET

Executives

Drew Evans – Executive Vice President & Chief Financial Officer

Hank Linginfelter – Executive Vice President, Distribution Operations

Pete Tumminello – Executive Vice President, Wholesale Services

Sarah Stashak – Director, Investor Relations

Analysts

Operator

Good day, ladies and gentlemen, and welcome to the Q4 and Year-End 2013 AGL Resources Earnings Conference Call. My name is Morris and I’ll be your coordinator for today’s call. As a reminder, this call is being recorded for replay purposes. (Operator instructions.) I would now like to turn the presentation over to Ms. Sarah Stashak, Director of Investor Relations. Please proceed.

Sarah Stashak

Thank you, Morris, and thanks to everyone for joining us this morning to review our Q4 and full-year 2013 results. Joining me on the call for today’s prepared remarks are Drew Evans, our Executive Vice President and CFO; Hank Linginfelter, our Executive Vice President of Distribution Operations and Pete Tumminello, Executive Vice President of our Wholesale Services business.

Unfortunately John Somerhalder, our Chairman, Presdient and CEO is not able to join us today due to a death in his family. We have several additional members of our management team available to answer any questions following our prepared remarks.

Our earnings release and earnings presentation are available on our website. To access these materials please visit www.aglresources.com.

Let me remind you today that we’ll be making some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve matters that are not historical facts, and our forward-looking statements and projections could differ materially from our actual results. The factors that could cause such material differences are included in our earnings release and are more fully described in our SEC filings.

We also describe our business using some non-GAAP measures such as operating margins, adjusted net income, adjusted EPS and economic earnings. A reconciliation of those measures to the GAAP financials is available in the appendix of our presentation as well as on our website.

We’ll begin the call with some prepared remarks before taking your questions. Drew, I’ll turn it over to you to begin.

Drew Evans

Thanks, Sarah, and good morning. I wanted to take a few moments to highlight some of our significant accomplishments in 2013 before we walk you through the financials.

Starting on Slide 3, consolidated earnings before interest and tax rose 11% including some mark-to-market hedge movements in our Wholesale segment that Pete will detail for you. EBIT for the Distribution Operations segment rose 10% year-over-year and Hank will walk you through those drivers.

We achieved several key regulatory and legislative milestones during the year. We recorded solid growth in retail operations and cargo shipping and we saw strong commercial activity in wholesale services, offset by mark-to-market hedge losses I just mentioned.

On Slide 4 you can see that our earnings per share rose 7% compared to last year reflecting these accomplishments. Yesterday our Board of Directors approved our twelfth consecutive dividend increase. The annual dividend rate for 2014 stands at $1.96 – this is a 4% or $0.08 increase over last year reflecting the underlying strength of our regulated operations. Our dividend track record is shown on Slide 5.

Our stock price rose 18% in 2013 which is just ahead of our utility peer group and our total shareholder return was 23%. It was a great year to be invested in the stock market for our investors who tend to focus on stable businesses with reliable dividends, and we were pleased with our performance.

Moving into the more detailed financial results on Slide 6 you can see that the full-year consolidated earnings per diluted share were $2.64 which compares to guidance that we provided on our last call of between $2.75 and $2.85. The variance to guidance is due to $89 million of negative accounting marks related to our hedge positions in the wholesale segment.

Adjusting for these temporal losses, consolidated EPS would have been significantly higher than our guidance. Excluding the wholesale services segment diluted EPS was $2.66 which compares favorably to our prior guidance of $2.55 to $2.65.

The primary drivers for our strong year-over-year performance were colder than normal weather that benefited our distribution and retail segments, higher revenues from regulatory infrastructure programs, reduced depreciation expense in Illinois and significantly higher commercial activity in the wholesale services segment.

These improvements were offset partially by mark-to-market accounting losses at wholesale, higher incentive compensation expense due to performance above expectations, and a Q4 impairment loss related to the termination of development activities for the Sawgrass storage facility.

Some specifics on Q4 are on Slide 7. The main drivers of the EPS decline year-over-year were some of the factors I just mentioned, namely mark-to-market losses in the wholesale services segment, higher incentive compensation expense and the Sawgrass impairment.

Taking a closer look at each segment, EBIT for our distribution business is on Slide 8 and for that discussion I’ll turn it over to Hank.

Hank Linginfelter

Thanks Drew, and good morning everyone. The Distribution Operations segment reported excellent results in 2013 and consistent with prior years the Distribution segment contributed approximately 80% operating EBIT in 2013. For the year the main drivers of the $51 million year-over-year EBIT improvement were colder than normal weather in 2013 compared to record warm temperatures in 2012 and higher revenues from our infrastructure investment programs.

In addition depreciation expense was lowered by $19 million as a result of the Nicor gas depreciation study approval that’s effective August 30th. You’ll notice that O&M expense is up 7% in 2013 as compared to 2012 and this is largely due to increased accruals for our incentive compensation related to performance above targeted levels.

As a reminder we paid virtually no incentive compensation in 2012 so some of this O&M variance is just incentive comp returning to normal levels with an additional amount accrued for the strong performance in 2013. Excluding this factor our expense control has been very disciplined this past year with O&M expense rising less than 2%.

Q4 EBIT was up $11 million compared to Q4 2012. This is mainly due to the same factors that influenced the full year.

With regard to customer growth we had a healthy increase in our total utility customer account in 2013 as compared with 2012 and relative to the last few years. Further, if you look at the growth of net new customer additions year-over-year the growth rate was a strong 57% improvement. Across all of our service territories we added more than 26,000 new customers last year.

Underpinning these solid results are several important regulatory and legislative milestones we achieved during the year. In Illinois we received approval to lower our depreciation rate which is translating into an over $50 million reduction in depreciation expense on an annualized basis. Also in Illinois we along with the other large natural gas utilities in the state received a favorable legislative outcome that will allow us to invest additional capital into our system for pipeline replacement and system reinforcements with minimal lag for cost recovery.

In Georgia the Commission continues to be supportive of our pipeline replacement, system reinforcement and customer growth initiatives, approving over $500 million in new capital spending over the next five years. In New Jersey we received approval to continue our efforts around pipeline replacement there. I’m extremely proud of our employees and what they were able to accomplish last year, and we’re off to a strong start in 2014 with some record cold weather and throughput in several of our service territories.

Our team and our systems have been put to the test and I’m pleased to say they continue to rise to the challenge. I’ll be happy to answer any questions you have on the distribution business during our Q&A, and I’ll hand it back to Drew to talk about the retail business.

Drew Evans

Thanks, Hank. Turning to the Retail segment on Slide 9 we recorded 2013 EBIT of $137 million, up 18% compared to the prior year. The primary drivers of the increase were the acquisition of retail service contracts in January of 2013, the acquisition of Illinois Energy customers in June as well as colder than normal weather. The two acquisitions we made in 2013 were accretive to earnings by $0.06 and we expect additional accretion in 2014 of $0.03 to $0.04.

For Q4 EBIT was $47 million, an increase of $10 million compared to the prior year with the same primary drivers as full year.

In Georgia, despite competitive pressures we retained our leading market share position, and in our retail services business the number of warranty contracts we are serving is up substantially year-over-year due to the acquisition I just mentioned. Our retail services segment contributed 19% of operating EBIT in 2013.

Sorry for jumping around a bit but I’d like to ask Pete Tumminello to discuss the results of the Wholesale and Midstream segments. Pete?

Pete Tumminello

Thanks, Drew. You’ll find 2013 results for our Wholesale Services segment on Slide 10.

The EBIT loss of $4 million compares to an EBIT loss of $3 million in 2012. The recorded losses however are more reflective of mark-to-market accounting than of the true economic earnings of the business, which I’ll take you through once we get through the GAAP results.

In 2013 we recorded hedge losses including lower of cost or market adjustments of [$90 million] which overwhelmed our strong commercial activity that was up $84 million compared to 2012. The mark-to-market losses are primarily related to our transportation positions and the supply constrain in the Northeast corridor.

Significantly lower than normal weather conditions in Q4 resulted in very high demand for natural gas from all types of customers. While there is plenty of shale gas coming out of the Marcellus the pipeline capacity to deliver the gas to the Northeast region was constrained. We hold positions on these pipelines. Some of our capacity was already profitably hedged for future periods resulting in the mark-to-market losses. But some of our capacity was open, allowing us to capitalize on the delivery basis differentials.

Sales from this open capacity coupled with additional asset management opportunities translated into strong commercial activity. These supply constraints in the Northeast have persisted through the significantly colder than normal weather during early 2014 which has likewise produced strong commercial activity thus far.

Turning to Slide 11, an alternative view to GAAP that management uses to evaluate the wholesale business is economic earnings. This metric essentially strips out the noise of mark-to-market accounting and tracks the generation of earnings from hedges in the period in which they were earned.

Economic earnings adjusts wholesale services EBIT by excluding mark-to-market accounting adjustments recorded during the current period offset by mark-to-market accounting adjustments reported in the prior periods related to Sequent’s natural gas transportation portfolio. Economic earnings further reflect the changes in wholesale services storage rollout value.

On that basis, economic earnings for 2013 was $69 million compared to $41 million in 2012, and our expectation for 2014 is in line with 2013 results of $69 million. This is in excess of the typical annual economic generation we would expect in a year of $30 million to $40 million due to significant volatility thus far in 2014.

So in the examples from 2013 and 2012 here on the slide, you can see that in 2013 we backed out the gain on the sale of Compass and we also backed out the $27 million of stored rollout value that was created prior to 2013. We then added $28 million for stored rollout value that we created in 2013 and added back the $73 million of mark-to-market losses on our transportation positions that will be offset in future periods. Finally, we added back $10 million of prior period mark-to-market gains.

I realize these sound like a lot of adjustments but this is the most informative way in our view to get a true sense of the value generated by the wholesale segment which was substantial in 2013. I wanted to take time to walk through this on today’s call as we will be reporting against this metric on a quarterly basis as we move forward.

Now let’s move to the Midstream segment on Slide 12. Midstream’s decline year-over-year is due largely to the roll-off of legacy storage contracts that were above current market rates as well as the decision in Q4 to terminate development of the Sawgrass storage development project in Louisiana. You may recall this project was in the very early stages of development when we acquired it as part of the Nicor merger.

Due to our expectation of continued low storage spreads, we along with our partner in the project, decided it was not economically prudent to pursue further development. As such we reported an $8 million loss which negatively impacted earnings by $0.04 a share.

Market fundamentals continue to be challenging for this business segment due to low storage rates and abundant market supply. As a result we have entered into shorter-term contracts at lower rates reflective of the current market and in some cases have further optimized the value of the assets through short duration transactions.

Drew will now wrap up our segment reporting and then provide you with some details on our 2014 guidance.

Drew Evans

Thanks, Pete. You can see the results for the Cargo Shipping segment on Slide 2013. 2013 results were $4 million or 50% higher than the prior year. We had an excellent start to the year with higher volumes and [through great trends]. We experienced improvements in volumes over the course of the entire year, however rates stayed strong and competitive pressures relative to our expectations in Q4. You can see the Q4 results were flat year-over-year representing higher volumes offset by slightly lower rates.

Some balance sheet highlights were noted on Slide 14. Our debt to capitalization improved modestly from 2012 to 2013 and was 57% at the end of the year. In December we received lender approval to extend our existing AGL capital and Nicor Gas credit facilities by one year to Q4 2017. We have no debt maturities in 2014 and we have a $200 million maturity in January of 2015. Our current plan is to refinance this maturity in Q4 this year.

Turning to Slide 15 and our outlook for 2014, I’ll begin by highlighting some of the opportunities and challenges that we expect for the year. First as Pete mentioned we expect to recognize offsets to the hedge losses we’ve reported in 2013 in our wholesale segment as well as strong economic earnings that is continuing into 2014. While we will be primarily monitoring economic earnings we expect the reported results to be strong based on what’s rolling in from 2013 and based on a colder than normal 2014 to date.

In the Distribution segment depreciation expense related to Nicor Gas will be incrementally lower in 2014 by about $34 million related to last year’s depreciation study approval. In addition, continued regulated infrastructure investment across most of our service territories is expected to generate solid returns. And as Hank mentioned we plan to file for a similar program in Illinois in 2014 that would begin in 2015.

An improving economy and continued low natural gas prices are also providing us with opportunities to bring new customers onto our system which we also expect will have a positive impact on 2014.

Looking at our challenges, on the infrastructure investment side we have completed one of the largest CAPEX programs in our company’s history, the Georgia Pipeline Replacement Program in December of 2013. This is a tremendous accomplishment, one which we invested more than $830 million in over a 15-year period and replaced over 2700 miles of bare steel and cast iron pipe. However, completion of the program results in lower [AF UDC] collection than in prior years which is also embedded into our guidance.

Looking at our non-utility businesses, the retail business in Georgia continues to face competitive pressure so we routinely launch new marketing campaigns and pricing plans that are allowing us to maintain margin. Our 2014 guidance is shown on Slide 16 and reflects those opportunities and challenges.

Our EBIT and EPS guidance excludes wholesale services as mark-to-market accounting movements make GAAP earnings difficult to predict. EPS excluding wholesale is expected to be between $2.70 and $2.80 a share. Once you back out the $0.11 of weather favorability in 2013 results the year-over-year EPS increase is 8% when using the midpoint of the guidance range.

You can see that our 2014 EBIT expectations are higher for each segment compared to 2013 with the exception of the Midstream segment. If you exclude the 2013 Sawgrass impairment our guidance is a few million dollars lower due to contract roll-offs, the ones that Pete previously mentioned.

A bridge of our 2013 results to 2014 guidance excluding wholesale is on Slide 17. You can see that on a weather-normalized basis the largest driver for improvement from 2013 to 2014 is expected to be improvement in the distribution segment, the details of which are on Slide 18.7

After normalizing for weather, EBIT for the Distribution Operations segment is expected to rise over 4% underpinned by rate-based growth of about 5%. Infrastructure programs and new customer growth are driving higher margins as well. On the expense side lower depreciation expense and lower pension expense are offset by slightly higher compensation expense, the absence of roughly $12 million of [AF UDC] related to the PRP Programs that is now fully in service, and $5 million of synergy sharing that will accrue annually for our Georgia utility customers.

We are earning close to our allowed rates of return in nearly all our jurisdictions and we do not have any rate cases planned for 2014 or 2015 at this juncture, however we continue to monitor our financial outlook and operational needs and will file rate cases as conditions warrant. We are required to file a rate case in New Jersey in 2016 in accordance with the order which granted the recent approval of our infrastructure investment programs in that state.

Turning to Slide 19 you can see the detail behind our guidance assumptions and here we’ve provided some information on our expectations for the Wholesale Services segment. Using the economic earnings metric that Pete just walked through you would normally expect the wholesale business to add around $0.20 per share in 2014. Excluding mark-to-market adjustments that may occur as we progress through the year for 2014 this could look more like $0.70, reflecting roughly $0.20 of economic generation expected in 2014, $0.30 of hedge offset from last year, and an additional $0.20 related to significant market volatility that has possibly impacted 2014 to date.

As a reminder Sequent’s wholesale business model is based on asset management and optimization, and our very first priority is meeting the [size] and delivery requirements of our asset management customers. And with excess capacity and asset optimization we have the opportunity to benefit greatly during periods of higher price volatility.

In closing you can see your 2014 priorities on Slide 20. These have not changed substantially since 2013 which in our view is positive and represents our safety and customer-focused, steady-growth culture.

To reiterate what we have collectively said this morning 2013 was an outstanding year for us. Our employees met some very stiff challenges operationally for us last year and continue to do so as we have faced record cold temperatures across our service territories in early 2014. I can’t say enough good things about the hard work and dedication of our employees which has translated into strong financial results for our shareholders.

Thanks a lot for your time today and your continued interest in AGL Resources. And Operator, with that I’ll turn it over to you to begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) Sir, you have no questions at this time. I would now like to turn the call over to Sarah Stashak for any closing remarks.

Sarah Stashak

Thanks to everyone for joining us today. If you do have questions I will be around today and over the next few weeks. We expect to file our 10(k) shortly and we are happy to address any questions that you have. Thank you.

Operator

Thank you very much, ladies and gentlemen. That concludes your conference call for today. You may now disconnect and thank you for joining.

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