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Questar (NYSE:STR)

Q4 2013 Earnings Call

February 20, 2014 9:30 am ET

Executives

Kevin W. Hadlock - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Ronald W. Jibson - Chairman, Chief Executive Officer, President, Chief Executive Officer of Questar Gas Company, Chief Executive Officer of Wexpro, President of Questar Gas Company and President of Wexpro

R. Allan Bradley - Executive Vice President, Chief Executive Officer Questar Pipeline and President of Questar Pipeline

Analysts

Danilo Juvane - BMO Capital Markets Canada

Operator

Good morning. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth quarter year-end 2013 earnings release conference call. [Operator Instructions]

Kevin Hadlock, you may begin your conference.

Kevin W. Hadlock

Thank you, Stephanie. Good morning, everyone, and thank you for joining us for Questar's Full Year 2013 Earnings Conference Call.

I am Kevin Hadlock, Questar's Chief Financial Officer. With me today are Ron Jibson, Chairman, President and CEO of Questar Corporation; Jim Livsey, Executive Vice President and Chief Operating Officer of Wexpro; Allan Bradley, President and CEO of Questar Pipeline; and Craig Wagstaff, Executive Vice President and Chief Operating Officer of Questar Gas.

During this call, we will be referencing our full year 2013 earnings presentation that can be found on our website at www.questar.com. Moving to Slide 2. Before we begin, let me remind you that we will be making forward-looking statements during our call today and actual results could differ from our estimates for a variety of reasons that we describe in our SEC filings. Also, this call references non-GAAP financial measures. Our slides in the appendix of the presentation provide reconciliations to these measures.

Let's begin with a review of the full year on Slide 4. Yesterday, we reported full year 2013 adjusted earnings of $213.6 million, or $1.21 per diluted share compared to net income of $212 million or $1.19 per diluted share in 2012. Full year 2013 adjusted earnings exclude the impact of a $52.4 million noncash after-tax impairment charge for the Eastern segment of Southern Trails Pipeline taken in the third quarter. Including this impairment, we reported net income of $161.2 million or $0.92 per diluted share for the full year. Adjusted EBITDA was strong in 2013 totaling $595 million, an increase of about 5% compared to 2012. Despite inflationary cost pressures, combined O&M and G&A expense was down $6.3 million or 2% compared to the prior year. Capital investment for 2013 was $503.7 million, including the $104.3 million Wexpro acquisition in the Vermillion Basin made in the third quarter of 2013.

Turning to Slide 5. All business units performed well, with Questar Gas and Wexpro earning record net income in 2013. Consolidated adjusted earnings were up $1.6 million or $0.02 per diluted share versus 2012.

Moving to Slide 6. Questar Gas, our local natural gas distribution utility, showed a $6.3 million increase in gross margin during the year to $335.2 million. Adjusted EBITDA was higher by $8.7 million and net income was up by $5.7 million compared to 2012. This improvement was due to higher recovery of infrastructure replacement investment, customer growth and effective cost controls. Questar Gas' capital investment in 2013 was $166.2 million, an increase of $4.1 million over 2012, driven primarily by spending on infrastructure upgrades and system reinforcement.

Turning to Slide 7. Wexpro, our natural gas development and production company, grew adjusted EBITDA to $258.7 million in 2013, up $22.6 million or about 10% compared to 2012. Net income was up $6.7 million to $110.6 million, an increase of 6% over the prior year. These results were driven by a higher 12-month average investment base, which increased $33.4 million by higher oil revenues and by tax benefits resulting from the IRS section 199 domestic production activities deduction. Including the Wexpro acquisition in the Vermillion Basin, Wexpro invested capital of $249.5 million in 2013, up $105 million compared to 2012.

Moving to Slide 8. Revenue at Questar Pipeline, our interstate natural gas pipeline and storage business, was down $11.3 million in 2013, primarily due to lower returns from natural gas liquids -- sorry, lower revenues from natural gas liquids and lower processing and storage revenues. Questar Pipeline delivered adjusted earnings of $60.6 million, down $4.1 million versus 2012. Including the noncash asset impairment of the Eastern segment of Southern Trails Pipeline, Questar Pipeline reported net income of $8.2 million. Capital investment at Questar Pipeline in 2013 was $73.4 million, which was $12.8 million higher than the prior year. This reflects the completion of several key expansion projects in 2013.

Moving to Slide 9. With regard to costs, Questar's 2013 consolidated operating and maintenance costs were down $6.5 million compared to 2012 due to lower demand side management expenses and effective cost controls. Despite inflationary pressures, general and administrative expenses were flat compared to 2012. Production and other taxes were $9.5 million higher, driven by higher natural gas prices at Wexpro and higher property taxes at Questar Gas. Depreciation in 2013 was up $13.2 million compared to 2012 due to higher capital investment. Consolidated interest expense was $1 million lower due to the replacement of Questar Gas' debt at lower interest rates and the use of interim short-term borrowings.

Turning to Slide 10. Through all of 2013, the company generated operating cash flow before working capital changes of $498 million, a decrease of 5% compared to 2012. At the end of the year, Questar had net available liquidity of $490 million, comprised of $16 million of cash and $474 million of unused commercial paper capacity. During the fourth quarter, Questar Gas issued a total of $150 million of 30-year and 35-year private placement notes. The weighted average coupon rate for both tranches of debt was 4.8%.

With that, let me turn the time over to Ron to discuss operations and Questar's outlook.

Ronald W. Jibson

Welcome, everyone, and thanks, as always, for taking the time to be with us today. And thanks, Kevin, for that summary. And I'm very proud of our employees' accomplishments in 2013, including successful efforts to control costs and deliver excellent results. All of Questar's businesses executed extremely well in 2013. We finished the year with a strong fourth quarter and delivered adjusted 2013 earnings of $1.21 per diluted share, exceeding our narrowed 2013 earnings guidance range of $1.16 to $1.20 per share. Let's start with 2013's highlights on Slide #12.

Questar Gas posted record net income of $52.8 million, representing a 12% earnings growth rate for the year. Questar Gas benefited from a strong Utah economy, which drove annual customer growth of 1.6%. During 2013, Questar Gas invested $56.9 million in its infrastructure-replacement program, which is currently focused on replacing a high-pressure aging pipe in its distribution system. Cost recovery for this investment increased full-year gross margin by $8 million.

Employees continue to perform exceptionally well in meeting customers' needs, and demonstrated by superior customer satisfaction results that remained at all-time highs. Questar Gas concluded hearings for the Utah general rate case that was filed on July 1, 2013. During the process, Questar Gas entered into a settlement stipulation with interveners to expand the infrastructure tracker to include aging intermediate high-pressure lines and to increase the amount of capital spending to $65 million annually. The parties also agreed to other revenue requirement adjustments. The remaining disputed items to be addressed by the Utah Public Service Commission's order include the rate of return and rate design issues. We expect the commission to rule and issue an order before March 1.

Let's turn to Slide 13. Wexpro achieved several key milestones in 2013. First, early in the year, the Utah and Wyoming Public Service Commissions approved the Wexpro II Agreement, which provides a mechanism for Wexpro to add new cost of service properties to its development and production inventory. Subsequent to the commission's approvals, Wexpro acquired an additional 42% working interest in the Trail Unit in the Vermillion Basin, our lowest gas producing area. I am happy to report that last month, the utility commissions from Utah and Wyoming approved the inclusion of the acquired properties under the terms of the Wexpro II Agreement. We consider it a monumental achievement for the company and our utility customers to not only get the Wexpro II Agreement approved, but to have received approval from both the Utah and Wyoming commissions to add the newly acquired Vermillion assets to our natural gas development inventory. We do appreciate the long-term perspective of the Utah and Wyoming commissions to approve the addition of these properties in our lowest-cost development area. The acquisition has the potential to materially add to the long-term, low-cost natural gas supplies available to our utility customers, and helps to perpetuate the Wexpro model that has saved customers over $1 billion since the Wexpro agreement was signed in 1981.

From an operational perspective, Wexpro continues to perform well through the year and increased its year-over-year ending investment base by $58.6 million or 11%.

Moving to Slide 14. During 2013, Questar Pipeline completed 2 important projects that support customers in the heart of our system. Questar Pipeline finished the necessary capacity expansions to meet the delivery needs of the new natural gas-fired Lake Side 2 power plant under construction in Northern Utah by Rocky Mountain Power. Questar Pipeline and Questar Gas jointly bid on this project and provided a very compelling proposal to Rocky Mountain Power to meet their requirements. Winning this project demonstrates the success and importance of Questar's integrated model.

Questar Pipeline also completed its Uinta Basin expansion project that will help customers capture the value uplift from natural gas liquids. This project helps Questar Pipeline replace some of the revenue lost from lower NGL revenues at the Raptor plant on the southern part of its system that have declined due to upstream processing. Questar Pipeline continues to work closely with an affiliate of Spectra Energy Corp. to market the capacity of the Inland California Express Pipeline. The project consists of recommissioning the existing 96-mile western segment of Southern Trails Pipeline to crude oil service and constructing a rail unloading facility. This project is in the marketing and engineering phase and a decision whether or not to proceed with the development is expected in 2014. If market conditions and economics enable the project to move forward, it could be in service by late 2015 or early 2016.

Turning to Slide 15. In 2012, we formed Questar Fueling company to participate in the expanding market for compressed natural gas fueling facilities. The market continues to develop and provide opportunities for us to invest to meet growing demand for the low-cost transportation fuel. In 2013, Questar Fueling opened its first 2 compressed natural gas fueling stations in Houston, Texas and Topeka, Kansas. The Houston CNG station can fuel hundreds of vehicles daily, including 200 natural gas power trucks operated by Swift Transportation and Central Freight Lines. This location includes 5 lanes of high-speed public access fueling along with 120 private time-fill spaces where parked trucks can fuel. Swift's and Central's 200 trucks are projected to use about 5 million diesel-gallon equivalents of natural gas per year at the Houston facility, which is the largest CNG fueling facility in the United States.

The Topeka location serves fleets for Frito-Lay and Dart Transit Company and is also open to the public. At full capacity, the Topeka location can supply up to 3 million diesel-gallon equivalents of natural gas per year. In addition to the completion of these 2 facilities, Questar Fueling has a healthy backlog of stations under development for this year.

Moving to Slide 16. Questar's return on equity continues to be industry-leading. For the full year of 2013, we delivered an adjusted consolidated return on equity of 18.7%, excluding the impairment charge for the eastern segment of Southern Trails Pipeline. This superior return is supported by Wexpro, which provided an ROE of 19.9%. On a financial basis, Questar Gas delivered an ROE of 10.1%. Questar Pipeline's adjusted return on equity was 10 % excluding the impairment.

Turning to Slide 17 and our 5-year outlook. We plan to continue investing in the long-term growth of Questar and expect to maintain a compound annual growth rate averaging 4% to 6% over the planning horizon. While the U.S. economy is showing some signs of improvement, economists are forecasting that Utah's growth should be robust and outpace the national average. We continue to see strong signs of economic development in the state. Utah and Salt Lake City are consistently ranked high in business attractiveness lists compiled by major publications.

From a cost perspective, we anticipate ongoing cost pressures related to increasing regulatory and safety spending, higher debt costs and rising property taxes to impact 2014 results. Part of our success in 2013 was related to reducing our overall cost structure. As Kevin mentioned in his remarks, we successfully reduced operating and maintenance expenses by $6.5 million and held general and administrative costs flat despite inflationary pressures.

Let's move to Slide 18. I am very pleased that we were able to exceed our earnings guidance in 2013 due in large part to the extraordinary efforts of our employees to control costs in the face of continuing challenges with the economy and uncertainties such as tax variables, pension and benefits issues and other expenses. The 2012 retirement incentive helped to reduce direct employee costs. But more was needed and our employees found ways to do it. Looking forward, many of these same uncertainties continue and we could materially -- and could materially impact future earnings, including the outcome of the Questar Gas rate case.

With this in mind, our initial 2014 earnings guidance is between $1.18 and $1.28 per diluted share. We expect to spend approximately $440 million of capital in 2014 and earn a consolidated return on equity of 17% to 19%. In 2013, we reached our target dividend payout ratio of about 60% and expect future dividends will grow in line with earnings growth.

Turning to Slide 19. The long-term outlook for growth at Questar Gas remains strong. However, with significant outperformance in 2013 and higher expected costs, we are expecting 2014 earnings to moderate relative to 2013. Looking forward, we project compound annual earnings growth of 6% to 8% over the planning horizon. This growth rate reflects customer growth expectations in the range of 1.5% to 2.5% through the 5-year plan. We plan to increase our spending for the infrastructure replacement program to $65 million annually beginning this year. For 2014, we are forecasting total capital spending of $190 million. As I mentioned earlier, we expect a decision on Questar Gas' Utah general rate case on or before March 1. We also expect to file a general rate case in Wyoming in April of this year.

Moving to Slide 20. We are projecting Wexpro's compound annual earnings growth rate to be between 4% and 6% through the 5-year planning horizon. In 2013, we invested $104.3 million to acquire an additional 42% working interest in the Trail Unit in the Vermillion Basin and received approval from the Utah and Wyoming commissions to include this property in the Wexpro II Agreement. Since this property includes both undeveloped and producing wells, we expect higher production in 2014. In addition, as part of the stipulation to include the newly acquired Trail properties in the Wexpro II Agreement, Wexpro agreed to manage production to 65% of Questar Gas' annual gas requirements beginning in June of 2015. With 2013 production accounting for 59% of Questar Gas' requirements, we are very confident in our ability to successfully manage within this constraint. Consequently, our capital spending forecast for 2014 is expected to be lower than 2013. Our development activities will continue to be focused on Pinedale through 2014.

Over the next 5 years, Wexpro expects to invest between $500 million and $800 million, depending upon natural gas prices and acquisition opportunities. For 2014, Wexpro projects to spend about $100 million, split equally between development and property acquisitions.

Let's move to Slide 21. While Rockies natural gas production is forecast to be relatively flat over the 5-year plan, Questar Pipeline's strategic position centered around 4 key Rockies hubs remains very strong. Our long-term demand-based contracts mitigate the potential negative impact on transportation revenues in the core of our system over the 5-year plan. We expect Questar Pipeline's earnings growth to moderate in 2014 but accelerate through 2018. We are projecting a compound annual earnings growth rate for Questar Pipeline of 4% to 6%. This growth rate will vary depending on our ability to maintain a low-cost structure to develop incremental revenue projects like the Inland California Express and to renew expiring transportation contracts. We are expecting 2014 net income to be impacted by up to $4 million in one-time safety and integrity management expenses.

From a capital perspective, we are forecasting a significant increase in 2014 investment compared to 2013 due to about $30 million in pipeline replacement spending as part of our ongoing integrity management program. Overall, we plan to spend about $120 million in capital during 2014.

Turning to Slide 22. For Questar Fueling, we are forecasting capital investment of approximately $25 million in 2014, which is sufficient to construct 6 to 8 CNG fueling facilities. Earlier this month, we announced plans to build a CNG fueling facility in San Antonio, Texas. This facility will be anchored by Central Freight Lines and is expected to open in the summer of 2014. In addition, plans are in development for CNG fueling facilities in several other locations, including Arizona, California, Connecticut, Kansas, Utah, and multiple sites in Texas. Questar Fueling continues in discussions with many large national fleet operators regarding potential anchor tenant sites. While not expected to make a meaningful earnings or cash flow contribution in the early years, we are excited about Questar Fueling's long-term growth potential as the use of natural gas for transportation expands.

Let's wrap up on Slide 23. In conclusion, I want to emphasize Questar's unique strengths. Our integrated operations span the entire natural gas value chain from wellhead to burner tip. Our constructive regulatory relationships produce appropriate risk-adjusted returns. Questar has an attractive growth outlook and we're excited about the new opportunities for Questar Gas, Wexpro, Questar Pipeline and Questar Fueling. Finally, our conservative balance sheet supports our earnings growth and long-term strategic plan.

We are very pleased with our strong performance in 2013. Our goal is to consistently outperform. Competitive and consistent growth in earnings, dividends and especially Questar's share price will be the ultimate measure of our success.

With that, we'd be happy to take your questions. Stephanie, we'll turn the time back to you?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Carl Kirst from BMO.

Danilo Juvane - BMO Capital Markets Canada

This is Danilo, filling in for Carl. Quick question on Southern Trails. What is the progress on you guys, securing contracts there?

Ronald W. Jibson

Great. Allan, why don't you cover that?

R. Allan Bradley

We continue to meet with potential shippers. The meetings have been very encouraging. I think what we're hearing from the shippers is that a 2016 schedule may actually fit them better. It also puts a more conservative development schedule in front of us. So the team is working hard to secure sort of anchor commitment. We hope to have secured that by the first quarter of 2014 and I think that would have probably kept us on end of the year 2015 in service state. But I think more realistically now, we're looking at later in the year to move forward on that front. On the permitting side, we continue to have 2 very good sites and we're evaluating the one that we'd like to go ahead and file for a conditional use permit on. So that work continues apace. So we both, Spectra and Questar Pipeline, feel very good about the project and continue to be encouraged by the markets.

Danilo Juvane - BMO Capital Markets Canada

That's good. I guess, I wanted to make sure that you guys, in the release, mentioned that you'll make a decision to go or not to go forward with the project at some point this year. You weren't necessarily seeing anything that would suggest that this is not moving forward. Is that right?

R. Allan Bradley

That's correct.

Danilo Juvane - BMO Capital Markets Canada

Okay. I guess my second question is on guidance. I realize that the midpoint is relatively flat relative to 2013. Is there anything that could swing you to the higher end of guidance?

Ronald W. Jibson

Well it's a great question, Danilo, and we always like to be realistic this time of year. We, as always, we look at the headwinds that we're potentially going to experience. I really believe that there are some things that we can continue to do, I think last year was an excellent example of our ability to look at our outlook and find ways to control costs and do the things that we needed to, to exceed our original guidance perspective. But as always, there are things out of our control that we need to watch closely. We had some one-time benefits of things during the year that we wouldn't experience this year. But again, over the 5-year planning horizon, we expect to continue to see that 4% to 6% growth. Any additional color, Kevin, that you want to give on that?

Kevin W. Hadlock

No, I think a lot of it is going to be depended on how well we continue some of the trends that we saw in 2013, namely effective cost controls, investment in Wexpro properties and are we going to be able to benefit from some of the things we did in pipeline that were a little bit unexpected. Hence, we have a pretty wide range. We do know that within pipeline, we're going to have some headwinds with some regulatory costs that are there and a very large important and difficult pipeline and replacement project that's going through some pretty tough terrain. But I think, by and large, it's going to be, can we consistently execute on cost controls and find those opportunities to -- on the margin, improve revenue in some of those areas?

Ronald W. Jibson

I think one thing, Danilo, on the opportunity side there is that if commodity prices continued to stay low, that will provide, on the opportunity side, the opportunity to look at some Wexpro additional acquisitions and so forth that could become available. So there's upside that we certainly will work on developing throughout the year. At that midpoint, it puts us about $0.02 above our 2013 EPS.

Operator

[Operator Instructions] And there are no further questions from the phone at this time. I'll turn the call back over to the presenters.

Ronald W. Jibson

Thank you, Stephanie. And again, thank you to all of you for taking the time this morning and we appreciate it. As always, we look forward to seeing you soon on our investor trips. And we look forward to visiting with you. If you have questions about today's earnings, please feel free to give us a call. And otherwise, again, thank you for taking the time today.

Operator

And this concludes today's conference call. You may now disconnect.

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