AGL Resources' CEO Discusses Q1 2014 Results - Earnings Call Transcript

| About: AGL Resources (GAS)

AGL Resources Inc. (NYSE:GAS)

Q1 2014 Earnings Conference Call

April 29, 2014 4:00 AM ET


Sarah Stashak – Director, IR

Drew Evans – EVP and CFO

John Somerhalder – Chairman, President and CEO

Peter Tumminello – EVP, Wholesale Services, and President, Sequent Energy Management

Hank Linginfelter – EVP, Distribution Operations

Scott Carter – SVP, Commercial Operations and Chief Regulatory Officer


Carl Kirst – BMO Capital Markets

Mark Barnett – Morningstar

Carl Kirst – BMO Capital


Good day, ladies and gentlemen. And welcome to First Quarter 2014 AGL Resources Earnings Conference Call. My name is Sheila and I will be your coordinator for today’s call. As a reminder this conference is being recorded for replay purposes. At this time all participants are in a listen-only mode. We will be facilitating a question-and- answer session following the presentation.

I would now like to turn the presentation over to Ms. Sarah Stashak, Director of Investor Relations. Please proceed.

Sarah Stashak

Thank you, Sheila and thanks to everyone for joining us this afternoon to review our first quarter 2014 results. Joining me on the call for today’s prepared remarks are John Somerhalder, our Chairman, President, CEO; and Drew Evans, our Executive Vice President and CFO. We have several additional members of our management team available to answer your questions following our prepared remarks.

Our earnings release and earnings presentation are available on our website and we filed our 10-Q earlier today. To access these materials please visit

Let me remind you 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 afternoon everyone. We foreshadowed in our press release three weeks that we expected to achieve record quarterly earnings during the first quarter of 2014 driven mainly by our wholesale services segment.

If you look at slide three you’ll see that consolidated earnings before interest and tax excluding the impacts from the pending sale of Tropical Shipping rose 100%. EBIT for the Distribution Operations segment rose 10% year-over-year, EBIT for the retail segment rose 17% compared to the first quarter of ‘13 and EBIT for wholesale was up by $278 million compared to last year.

Excluding those record results for wholesale services and the Tropical Shipping Sale EBIT improved by 9% driven mainly by colder than normal weather across distribution and retail.

O&M was up just 4% during the quarter on a consolidated basis, when excluding the pass through rider expenses and higher incentive compensation mainly at the wholesale services segment. This 4% was driven by additional expense related to the record cold winter experienced across many of our distribution service territories. John will take you through our updated guidance in a few minutes. But as you can see here our expected EPS range for 2014 excluding wholesale is $2.80 to $2.90, up $0.10 dispute our assumption that Tropical no longer contributes to income post-closing.

On top of that we expect GAAP EPS of around $1.55 at wholesale, however as you know wholesale expectations can change as we move through the year and account for potential mark-to-market impacts.

Taking a closer look at each segment starting with slide five. First quarter EBIT for our distribution business was up a strong 10% year-over-year. This was driven primarily by the coldest winter on record in Chicago area as well as colder than normal temperatures across almost all of our service territories. The possible financial impacts related to weather were somewhat muted however, by higher pay-roll expense related to overtime necessarily to keep our system running safely and efficiently during this extremely cold weather.

In addition, while we expect to accrue for incentive compensation expense in the same range as last year’s total we assumed a higher concentration in the first quarter in line with our strong performance. Stripping out the noise of riders and comp expense, O&M expenses was up just 3% in the quarter for just the distribution segment which is almost wholly due to the additional operational stresses on our system and for smell related to the weather.

Our customer count is up a solid 1% as Hank mentioned in our Analyst Day about a month ago conversion part increased about our mid-Atlantic and mid-West utilities are an all time high as end users evaluate the cost advantage of natural gas over heating oil and propane.

Turning to the retail segment on slide five, first quarter EBIT was up 17% year-over-year. Again the primarily driver of increase was colder than normal weather impacting our largest customer bases in Georgia and Illinois. Margin was higher by $15 million compared to normal net of weather hedges. We had an additional $12 million margin benefit related to acquisitions in 2013 as well. These positives were slightly offset by increased gas cost and lower retail price spreads.

Operations and maintenance expense was up $6 million mainly related to the acquisition I just noted as well as higher customer care marketing and bad debt expense. Our customer account for the retail energy business is up a total of 4% and our Georgia market share remains stable. For the warranty business service contracts are up 20% year-over-year due mainly to the acquisition we completed in January of 2013.

You will find first quarter 2014 results for our wholesale services segment on slide six. EBIT for the wholesale segment was a record $293 million compared to EBIT of $15 million in last year’s first quarter. The strong performance is due mainly the commercial activity of $377 million related to our transportation storage positions in the Northeast and Midwest regions.

Margin from storage optimization in all regions was also very robust. Commercial activity was offset somewhat by $47 million of hedge loses and low comp that we expect to realize over the next two years. Similarly to the fourth quarter of last year significant colder than normal weather conditions resulted in very high demand for natural gas from all types of consumers. While there is plenty of shale gas coming out of the Marcellus the pipeline capacity to deliver the gas to the high demand regions is constrained. We hold strategic positions on many of these pipelines.

Some of our capacity was already profitably hedged for future periods but some of our capacity was open allowing us to capitalize on the delivery basis differentials and severe weather sensitive market demand.

Sales from this open capacity coupled with additional asset management storage optimization opportunities translated into strong commercial activity. We’ve designed or wholesale business to be profitable under low volatility market conditions and to provide significant earnings uplift under highly volatile market conditions as we’ve experienced in the first quarter of this year.

Turning to slide seven, 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 assigns the generation of earnings activity to the period in which it was earned.

Economic earnings for the first quarter of 2014 were $273 million compared to $29 million in last year’s first quarter. Our economic earnings expectation for the full year of 2014 is now between $280 million and $300 million.

Now let’s move to the midstream segment on slide eight, we had strong commercial optimization during the first quarter particularly in Golden Triangle and Central Valley related to an increase reliance on stores that was weather and demand driven. However these improvements were offset by the expected roll off of legacy storage contracts that were above current market rates and a multi-year [trough] of retained fuel of Jefferson Island that is essentially non-recurring in nature.

Market fundamentals continue to be challenged in this – for this business segment due to low storage rates and abundant market supplies. As most of you likely know we announced on April 7th that we’ve entered into an agreement to sell our Tropical Shipping business to Saltchuk Resources. We expect after tax cash proceeds and distributions to be about $220 million when the transaction closes which we anticipate to be in the third quarter pending regulatory approvals.

Starting in the second quarter the earnings from Tropical Shipping and related businesses that we are selling will be reported in discontinued operations. As the train container leasing investment was not part of the sale transaction we will retain this investment and it will be reflected in our corporate segment going forward.

On an operating basis progress cargo shipping was in line with expectations for the first quarter. Some balance sheet highlights are noted on slide nine, our debt to capitalization was 54% at the end of the first quarter compared to 57% at year-end 2013. The improvement reflects our strong cash generation during the first quarter of 2014 which resulted in a reduction in short term debt year-over-year.

The significant cash generated from wholesales services this year along with our expected proceeds from the Tropical sale will help further strengthen our balance sheet. It will provide us some flexibility around funding our significant infrastructure investment programs as well as potential reduction of our long term debt financing requirements including the refinancing of the $200 million senior note maturity we have coming up in January of 2015.

I’ll now turn the call over to John to discuss some strategic highlights from the first quarter as well as our updated guidance for the year. John.

John Somerhalder

Thank you Drew. Turning to slide 10, I’ll begin by discussing some of our major accomplishments in the first quarter of this year. Adding to Drew’s comments on our financial performance in the first quarter we are more than pleased with our results. We had an indication earlier this year that we would generate strong earnings out of the wholesale services segments. And as we progress in the first quarter the extreme winter weather resulted in unprecedented market conditions that further benefited our diverse portfolio of unregulated assets.

While this is clearly a good story for our wholesale business and our shareholders it also means that our total share in payments to the regulated utility customers by our asset management agreements are expected to be up by approximately 60% year-over-year, so a win for stakeholders all the way around.

Operationally this was the most challenging winter in decades. We contented with everything from six feet of frozen ground in Illinois to Ice storms in Georgia, Virginia, New Jersey, Tennessee and Maryland and potential pressure issues on some of the interstate pipelines at some of our systems. Despite these conditions we continued to operate our systems safely and with very minimal disruptions over the course of the last several months. I am extremely proud of our employees and their response to these challenges.

As Drew mentioned earlier this month we announced the sale of Tropical Shipping. Since our acquisition of like Nicor 2.5 years ago we have managed this business well and shepherded a return to profitability. However given that the shipping and logistics business was not core to our strategy of owning and operating natural gas related assets we were pleased to find the right fit with Saltchuk. In addition as we’ve discussed at our Analyst day we entered into an agreement with Williams to construct a 106 mile pipeline that is a lateral off of Transco’s system in Georgia. Our investment is approximately $210 million and completion is targeted for mid-2017.

Extension of this pipeline provides access to Marcellus Shale gas supply and helps to serve growing natural gas demand in North Georgia. The pipeline capacity is fully committed under a long term contracts including one with a gas line.

On the regulatory front you may recall that last year Illinois approved a program called QIP to allow for wider base recovery of spending on pipeline replacement and system reinforcement initiatives. While Nicor Gas is precluded from implementing new rates until December 10th of this year we proactively filed to gain the approval of the rider. Our projected annual average QIP investment for the years 2015 to 2017 is approximately $170 million. The duration of the program for Nicor is expected to be nine years and we will file updated plans in spending expectations periodically. We look forward to response from the ICC by early August.

Finally as Drew mentioned we have updated our 2014 guidance to reflect the positive weather of impacts through March, our strong first quarter wholesale results and the pending sale of Tropical Shipping. Our updated 2014 guidance is shown on slide 11, our primary EBIT and EPS guidance ranges excluding wholesale services as mark-to-market accounting movement make GAAP earnings difficult to predict. They also exclude the goodwill impairment and income tax expense related to the pending sale of Tropical Shipping as well as earnings that we would have expected to generate from that business post-closing.

EPS, excluding wholesale is now expected to be between $2.80 and $2.90 per share. This is up from our prior guidance range of $2.70 to $2.80. Importantly we were able to increase the midpoint of our EPS guidance range by 4% even when excluding approximately $0.06 of earnings that would have been related to Tropical Shipping.

Looking at each segment you can see the projections for both distribution and retail have increased from the guidance that we gave in February, primarily reflecting the benefits of weather. Or mid-stream range is the little lower than our prior projections reflecting the non-recurring true-up at Jefferson Island as Drew mentioned offset by better optimization at Golden Triangle and Central Valley. The corporate segment expense has been modified to reflect the inclusion of Triangle. In addition our interest expense projection is slightly lower.

Looking at wholesale we are forecasting EBIT from the segment of around $310 million for the full year, which translates into EPS of around $1.55 and brings our consolidated earnings per share range to between $4.35 and $4.45. We always provide the caveat however that our projections for wholesale can change meaningfully as we progress in the year due to mark-to-market accounting adjustments that reflect market pricing and other economic activity.

Again a remarkable quarter for AGL Resources. The fundamentals and long-term growth expectations of our regulated businesses remain consistent with our prior projections and in the short term we were bolstered across virtually every business unit by unique set of circumstances during an extreme winter. Our strategic positioning at both regulated and non-regulated assets allowed us to generate the best quarterly earnings in the company’s history.

Thank you for your time and for your continued interest in AGL Resources. Operator I’ll turn the call back over to you to begin the Q&A session.

Question-and-Answer Session


(Operator Instructions). And your first question comes from the line of Carl Kirst of BMO Capital. Please proceed.

Carl Kirst – BMO Capital Markets

Thanks, good afternoon everybody. Nice, certainly nice results. Just a few sort of micro questions maybe and Drew first off the mention of the retained fuel impact of Jefferson Ireland. Can you give us what that is on an absolute on a $1 million basis?

Drew Evans

By about $7 million.

Carl Kirst – BMO Capital Markets

And then also just looking for little bit better color turning to the LDC and recognizing the rise in the O&M impact and appreciate the additional color as far as what the perhaps core rise was versus the variable the incentive, plus the weather related. I didn’t know of the $25 million $26 million delta year-over-year and higher LDC O&M if it could be broken out as far as how much was in fact due to weather, something that we should for instance net against the $17 million of margin benefit versus what perhaps is the greater I believe incentive component that you said for the year will be basically somewhere to 2013 but maybe perhaps little bit more was lumped in the first quarter?

Drew Evans

Let me try to maybe take a simple kind cut at it now might the correct at the table. But the estimate that the weather impact on a gross phases before expense was about $0.15 per share. And we think that the expenses related bad weather were probably around $0.05 a share, maybe a just a fraction less. And so we had about net $0.10 impact across distribution retail is about that amount.

And then the other thing that you picked on is that we are accruing incentive essentially the same rate as last year, but because more of the earnings were recognized in the first quarter of this year versus last year when it was mainly a fourth quarter item, the timing of it has changed and the scope of it has changed. So that’s the lion’s share of that difference.

John Somerhalder

And Carl, two of the important components of O&M cost, clearly, we would not expect to repeat under normal weather. We could look at the overtime compared to what we expected and that was driven a lot by the cold weather. That was one of the bigger pieces of that $0.05 a share. And then we have company field use for every frame from our own buildings to some of the equipment we have to operate from storage, the remaining equipment. That was another big piece of it. The rest of it was kind of smaller items, [inaudible] that’s the exact term.

Carl Kirst – BMO Capital Markets

Great, I appreciate the extra color. Maybe just one final question and certainly you guys had pointed out that on the midstream side as the re-contracting has happened and kind of as expected it’s a lower rate certainly than first quarter ‘13, my question is, is the as expected sort of just because of those lower or are we seeing any bit of life given this last winter that perhaps what was even laid out at the Analyst Day few weeks back might, I guess the rates coming in basically square on target or you seeing any signs of life, let me just ask it that way.

John Somerhalder

Karl, I’m going ask Pete to answer it in more detail, but in general what we saw was the ability for owners of our capacity, holders of our capacity to make more this winter than what they had in the past. And as an example [Sequent] was able to do that with some of the capacity they hold. We also saw that our ability to sell park them on in short term services from the optimization that Drew and I mentioned that, that was improved. But then when it came to recontracting very little of that in expectation of that moving forward was built in. And we saw very little value at this time as far as being able to recontract of higher rates. So we did see rates more in line with what we’d expected and Pete can add more on that.

Peter Tumminello

Yes Carl. To give a little more color we did budget rates obviously lower this year. And then they came at or near where we budgeting at Golden Triangle and at Jefferson Ireland, we were budgeting rates in the $0.025 to $0.045 range respectively and that’s about where we found the market. I think it’s a combination of market buyers probably not giving credit to the repeatability of this past winter. And secondly just a lot fewer market buyers, a lot fewer merchants in the industry and just a lot less folks bidding for the service. And we budgeted that and they came in very close, maybe tiny bit above but right for all practical purposes our regular budgeting for the year.

John Somerhalder

We still these weather events showed the value of storage. And longer term continue to show that in this environment storage is needed. But as Pete mentioned as Carl, as your question was phrased, it just has not yet translated in to an ability to recontract at higher rates than what we had earlier assumed.

Carl Kirst – BMO Capital Markets

No, understood. Hopes springs eternal these days. So I appreciate all the color. Thanks guys.

John Somerhalder

Yes, thanks Carl.


Thank you. And your next question comes from the line of Mark Barnett of Morningstar. Please proceed.

Mark Barnett – Morningstar

Hey good afternoon everyone.

John Somerhalder

Hey Mark.

Mark Barnett – Morningstar

A couple of quick questions. So the delta in pipelines looks at least after the kind of projects you have been looking for, you can provide the anchor commitments. That’s probably a very critical element in participating for you guys. Do you have, I guess what I’m trying to think of in terms of your capacity for further projects of similar size, maybe little smaller, maybe little larger. Do you have with the utilities do you have the bandwidth I guess to sort of replicate that agreement?

John Somerhalder

Yes, we believe we do have potential opportunities moving forward. One of the very good things about this winter thus far even though it was hard on our folks to operate in that environment they did a very good job and just performed well. But it also pointed out where we had additional needs for pipeline capacity and flexibility and I would say most of our jurisdictions it pointed out that it would be prudent for us to look at additional capability and pipeline opportunities into those areas. So everywhere from Illinois to New Jersey to Virginia all the way to Florida we will be looking at similar type opportunities. And we do think that is repeatable, but as you seen with – it takes a while to get back to really work well for the market. So it’s something we will be working over – working on over the next year or so. Hank has some more detail probably.

Hank Linginfelter

Yes Mark, the nice thing about [Delta] it matched up so well with a need for customer base as well as an opportunity to invest. But it really is a very fine model for how we can do this and on the stage John mentioned there is a pretty clear need in almost every one of our jurisdictions. And in fact, we think broadly our regulators will recognize that that if they haven’t already. But it’s probably good thing for us to move down back our customers if the company also could be an investor in it.

Mark Barnett – Morningstar

Great. And I do have one quick question. I’m not entirely clear on so with their quick filing. This is obviously a pretty nice improvement in Illinois. And looks like it could be a pretty sizable investment given your system. I’m just wondering with the timing of the filing and with the timing of when you might be going in for a formal rate case would that be included with a deliberation of – I guess what I am really getting at is like an ROE on those projects. Would that be something that we would see later on or can that be determined now to be implemented later and then see with the formal rate case a different consideration for return on equity for the existing plan.

Hank Linginfelter

Yeah, Mark this is Hank again and Scott Carter is here also, our Chief Regulatory Officer. The commission is authorized to rule on QIP as a single standalone program including the terms to go with that with the expectation that returns would be in line with existing returns for utilities. We don’t have the rate case plan in Illinois at this time and in fact things like QIP allow us to do a little more contemplate a about when we need a rate case in a place like Illinois we manage our costs very well, customer base is starting to grow again and so we’re in pretty good shape on that. But QIP is a standalone mechanism we feel really good about. Scott you have anything to add to that.

Scott Carter

No, that’s correct. We will expect to see the return be commensurate with the current returns and that will be potentially true about future rate case where they will look at the total cost of capital that’s why we would contemplate cost of capital be of interest for QIP and the greater raise in general.

Mark Barnett – Morningstar

Great. Thanks for the clarity on that. I just was a little bit confused about the treatment, so thanks appreciate it.

John Somerhalder

Thanks Mark.


(Operator Instructions). And the next question comes from the line of Carl Kirst of BMO Capital. Please proceed.

Carl Kirst – BMO Capital

Thanks. Just a quick follow-up. Just wanted to confirm I thought I saw that the Governor of Virginia had signed into legislation the ability to perhaps to add I think some reserves or E&P investment that we talked about at the Analyst Day. What I wanted to confirm if that was the case and I remember that, recall back correctly. Two, if that is indeed the case what are the next steps now towards evaluating what is the opportunity?

John Somerhalder

You’re right Carl the Governor Carl did sign the legislation and that now gives us the opportunity to seek out not only reserves of natural gas that we can make long-term commitments for our customers but also potential infrastructure to go with to carry that reserve capacity into the marketplace if needed. There is chance that they wouldn’t have to add infrastructure in every instance but we’ve now started dialogue with some producers around the opportunity to purchase reserves. We have to construct a deal that is, that we can support from the corporation but more broadly that can be approved by the State Corporation Commission in Virginia.

So we’re in the process of evaluating the potential of those opportunities and there is not a deal that we’ve got ready and we’re going to be very deliberate about and make sure we can construct a deal that would be good for customers but also has a good chance of getting approval for. But we’re very optimistic because of the array of supply sources there we could bring in that could be very competitively priced, give us a lock-in – price for years to come. But it has to work for producers as well.

So we will work for the next several months to see if it’s something that will work and when we have something we will prepare and give it to the State Corporation Commission for approval.

Carl Kirst – BMO Capital

Understood and just from I guess from a gaiting factor from a process standpoint, so as an opportunity would come together you guys would prepare something it would then go in front of the utility commission for approval and then if that happens you move forward there meaning that at no time for instance you all would be writing it on your balance sheet with the possibility of perhaps it getting rejected for instance?

John Somerhalder

That’s exactly right. It has to be deemed by the commission to be prudent in the public interest. And so once they deem that then we complete the deal and then it becomes part of the gas cost portion in our customer’s bill. So there is not a corporate risk around the approval process. Once it’s approved it’s deemed prudent at that time.

Carl Kirst – BMO Capital

Excellent. All right thanks guys.


Thank you. And there are no more questions at this time.

Sarah Stashak

Thank you everyone for joining us today. I’ll be available this afternoon and tomorrow if you have any follow-up questions.


Thank you. So ladies and gentlemen that now concludes your conference call for today. You may now disconnect and have a great day.

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