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Parkland Fuel Corporation (OTCPK:PKIUF)

Q1 2014 Earnings Conference Call

May 5, 2014 6:00 AM ET

Executives

Tom McMillan - Director, Corporate Communications

Bob Espey - President and CEO

Mike Lambert - SVP and CFO

Analysts

Kevin Chiang - CIBC

Derek Dley - Canaccord Genuity

Tom McMillan

Good afternoon. My name is Tom McMillan, Director of Corporate Communications for Parkland Fuel Corporation. At this time, I would like to welcome participants to Parkland Fuel Corporation Results Conference Call for the First Quarter of 2014, with president and Chief Executive Officer, Bob Espey, and Senior Vice President and Chief Financial Officer, Mike Lambert. After their remarks, there will be a question-and-answer session.

At this time, all lines have been placed on mute to prevent any background noise. Please note, that while talking about our results and answering questions, Bob and Mike may make forward-looking statements. These statements are subject to known and unknown risks, and future results may differ materially.

For more information, please review the forward-looking statements and business risks section of Parkland's first quarter 2014 Management's Discussion and Analysis which along with this quarter's news release and our unaudited financial statements can be found on our web site at www.parkland.ca, as well as on the SEDAR website. Dollar amounts discussed in today's call are expressed in Canadian dollars and are generally rounded.

I will now turn the call over to Bob Espey to review the quarter. Bob?

Bob Espey

Great. Thanks Tom. I am really pleased to announce our Q1 results and as many of you have asked me through various meetings over the last three years, what's the number one thing that kept me awake at nights, and it was obviously that Suncor contract and successfully replacing that, and I am really pleased to say that our first quarter, more than a decade without refiners margins has been very successful and speaks to the strength of the base business, and how we successfully executed against our plan.

Our agenda today will be to review the quarter and the reasons why it exceeded our expectations. The stars really did align for us, cold weather, good acquisitions, the streaming of new supply arrangements and organic growth, both [ph] gained together this quarter. Following this review, we will talk about the Parkland Penny plan and then confirm our guidance.

Last year, we recognized we weren't delivering on organic growth, so we put a big focus on it. Commercial cold weather and sales effort were able to drive the 5.5% increase in fuel volumes. In the first quarter, our commercial team signed an additional 30 million liters in annualized volume. In Parkland's company-owned retail network same store sales increased by 3% year-over-year. We believe this reflects increased traffic at our sites, coupled with strong in-store programs helped to increase same store convenience sales by 10% year-over-year.

Our acquisitions also delivered above plan. SPF Energy is performing, delivering C$5.2 million in adjusted EBITDA for the quarter. Sparlings' volumes were also above plan and Elbow River Marketing delivered C$16 million in adjusted EBITDA, as a result of strong LPG sales, due to the cold weather in the East during Q1, and I will also remind you that it's the first full quarter of ERM, of Elbow River. So last year we only had them in for half the quarter.

This is a good segue into supply. Our vision for supply has really come together. Our supply team worked hard to deliver the new supply contracts that started streaming in 2014, which are helping to offset the loss of our refiner's margin contract.

Elbow River was a powerhouse this quarter. Again, a lot of hard work going on over there, and they did a fantastic job, keeping Sparlings supply with propane in the first quarter, and most of the propane industry -- while most of the propane industry in Ontario really struggled. They also shipped diesel into North Dakota, allowing SPF Energy to grow its volumes year-over-year.

The supply platform that we have developed underpins the entire business, allowing us to deliver on our promise to the customer, to ensure they get their product, when and where they need it; and we have worked hard to ensure we can do this under almost any scenario, including the harsh conditions of the following winter.

Year-over-year both MG&A and OpEx were down this quarter, as costs did not increase as much as volumes. Total recordable injury frequency is also coming down, although we continue to work on it, to bring it in line with our 2016 objectives.

I will now turn it over to Mike, to review our financial results.

Mike Lambert

That's great. Thanks Bob. We delivered adjusted EBITDA of C$61.2 million for the quarter. Slightly higher than the record we set in 2013. However, as this was the first quarter we have reported since the conclusion of the refiner's margin contract with Suncor, we are going to use that saying that flat is the new up.

From mechanical accounting perspective, I want to alert everyone that our segmented reporting has changed, whereas before, we only reported down to gross profit in each of our business divisions, we are now reporting EBITDA in each of our business divisions. This is increasing transparency, and should make it easier to follow, going forward.

We have also changed the presentation of the waterfall chart, to align with our new segmented reporting. Unlike our MD&A, while all of our 2013 acquisitions are now incorporated in their respective divisions in this chart, we break out SPF Energy separately in the acquisitions bar, so that our divisional results stand on their own merit without the tailwinds from SPF. Our plan will be to do that for all new acquisitions in any year that they are acquired.

Now looking at the chart, retail EBITDA was flat for the quarter, as a result of a significant increase in same store sales in the company's owned gas station network; an increase in fuel gross profit on a cent per liter basis, slightly lower operating costs in the base business, offset by lower volumes from our dealer business.

Commercial EBITDA increased as a result of 60 million liters in additional propane volumes in Sparlings. 5.5% growth in the base business due to cold weather, offset by lower margins on a cent per liter basis, and higher OpEx costs, due to severe weather conditions.

Supply in wholesale EBITDA was down C$5.9 million year-over-year, but this is really remarkable, when you think of how strong refiner's margins were last year. This reflects the progress our team made on Parkland supply initiative, and an outstanding performance from Elbow River Marketing this quarter, as they delivered C$16 million in adjusted EBITDA.

While we are on the top at Elbow River Market, we should talk a little bit about the potential impact of the new railcar regulations. As those on the call are likely aware, our entire fleet is leased. The immediate impact to us, is that we will need to retire between 20 and 30 older railcars. That's 20 and 30 on a total of about 1,400. While the full requirements for retrofitting tank cars have not been released, our analysis shows that retrofitting costs for our fleet, could cost us between C$1 million to C$3 million per year in incremental lease costs. However, we think that the scarcity of railcars may drive margins up, and offset the higher lease cost.

Now corporate costs were up C$1.5 million year-over-year on our variable share based compensation plan. What that means is, as our share price rises, our share based compensation plans cost a little more.

On the next slide, you will see that net earnings per share were down 32%, primarily due to a C$6 million increase in amortization and depreciation, and C$1 million increase in unrealized losses from changes in fair value of forward contracts, futures contracts and U.S. dollar forward exchange contracts.

The dividend payout ratio was 43% compared with 39% in the first quarter of 2013, due to an increase in shares year-over-year, and a decrease in distributable cash flow. Distributable cash flow was lower year-over-year, due to a C$2 million increase in tax expense, offset by a C$2 million decrease in maintenance capital expenditures, and C$0.2 million increase in adjusted EBITDA.

Our balance sheet continues to be strong. Net debt-to-EBITDA was 2.2 times at the end of the quarter, compared with 1.4 in the same period last year, due to the purchase of SPF Energy.

Now I will turn the call back to Bob, to review our strategic growth plan.

Bob Espey

Great. Thanks Mike. So as we look forward against our five year growth strategy which we launched a couple of years ago, we are making good progress along all three pillars, the growth, supply and operate.

On the growth side, we put a lot of emphasis on to our organic growth and you can see the benefit of that in the quarter, and on the acquisition side, we continue to -- we have made real strides in improving our acquisition capabilities, by adding new talent, and by continuing to refine our -- and basically to continue to deliver outstanding value, examples again being Elbow River Marketing, SPF and Sparlings.

From a supply perspective, again the quarter results really speak for themselves and the ability of the supply team to really fill that void that was left, through the Suncor contract. From an operations standpoint, we continue to integrate companies, and our ability to do that has improved significantly. We now have an integration team, that has made great progress with SPF Energy, by improving processes and then procedures to allow them the freedom to scale that business.

The acquisition pipeline remains very robust. There are lots of opportunities in the marketplace. In terms of EBITDA, as you can see, in the next slide, we are very much on track. So again, towards the push to go to 250, we are over halfway there. That's made up of three things, so first of all, acquisitions, again, which we have delivered on. Synergies on those acquisitions and efficiencies; and we have realized all of the synergies that we set out to achieve in this area.

One of the things is, we are not actually taking credit for the growth in EBITDA we are seeing from ERM to date above the business case that we originally talked about, when we brought them forward.

Now I'll ask Mike to review our guidance and how this all fits into the year going forward.

Mike Lambert

Well thanks Bob. Last quarter, we provided a schedule of adjusted EBITDA distribution by quarter, to give you a greater understanding of our seasonality. This can be seen on the -- in the bottom right hand of the slide. If you take our expected EBITDA for 2014, account for the acquisition assumptions built into the plan, and the quarterly EBITDA distribution we provided on the slide, you probably would have come up with something between C$53 million and C$55 million of EBITDA for the first quarter.

Now if you do the same thing for the second quarter, you probably come up with something between C$37 million and C$39 million, and by the way, this is all just math. So with that said, despite a strong Q1, we are not adjusting our annual guidance. I say again, we are not adjusting our annual guidance.

What we are seeing in the business environment, makes us think that the strength of the first quarter will be offset by some softness in the second quarter. In other words, we don't want to our investors to get too excited. We definitely had a few bounces go our way in the first quarter.

I will turn it back to Bob to wrap things up.

Bob Espey

Great. Thanks Mike. So welcome to the new Parklands, the healthy and sustainable fuel marketing business without refiner's margins. We have demonstrated as a team, that we can deliver against our plan. We have grown rapidly. We have made good acquisitions, and this has made us the fastest growing fuel marketer in North America over the past two years.

We continue to make great progress on the penny plan to deliver accretive growth for our investors, and make sure that we realize the synergies that need to come to us. I'd really like to end, by thanking the Parkland team, for making the first quarter a great success and helping us to successfully transition our business away from refiner's margins. The teams worked very hard over the last three years, and we are certainly seeing the benefit of that hard work in the results of the business.

We will now open the call for questions.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions) The first question is from Kevin Chiang from CIBC. Please go ahead. Your line is open.

Kevin Chiang - CIBC

Hi. Good afternoon, good evening and congratulations on some good results here. Just quickly on Elbow River, another exceptional quarter, and I guess you kind of alluded to this in your prepared remarks. But are you still look at this as a normalized, call it C$25 million EBITDA business despite the strong kind of four to five quarters you put up already with Elbow River?

Mike Lambert

Well, hi Kevin and thanks for the question. When you say do we look at it as a -- I think what you're saying is a run rate, and we have given that in our previous call. Obviously, we are seeing some very good things from Elbow River, and if you look at the first quarter, what we are concerned about, is that everybody takes the first quarter and multiples it by four. It was a very good quarter for them, in terms of their run rate at C$25 million, they did better than that last year. I mean, if you look at their run rate last year, they are actually better than that. We are really pleased with their performance last year, and our hope is, that with the incremental business that we are building there, that they will actually do better than that. So our expectations for Elbow are higher than C$25 million, but I am reluctant to give a number.

Kevin Chiang - CIBC

Okay. No that's fair enough and you're right, last year was a good annualized number for them. And when I think of Elbow River, as leases come up and you refleet, how should we think about the economics of this on Elbow River? I presume some of these lease rates will increase to reflect some of the strong returns, such as removing crude and what not. How do you build that into your forward [ph] outlook for Elbow River, as you have to replace some of these cars every year?

Mike Lambert

So we did try to size that up. So if you take a look at our fleet of cars, its 1,400. We have got them laddered, so that the leases come up for renewal on an average of over five years, so 20% comes up in any one year. Of the total fleet, those DOT-111s, I think that's what you're talking about, the new requirements for the pre-2012 DOT-111s. About less than half of our total fleet in those cars, and of that amount, couple of hundred come off lease over the next three years. So of the remaining, we have about 500 of those DOT-111s are remaining.

That's where we came up with that number. If for instance, the new requirements requires a retrofit costing, 20,000 per car, which by the way, is a very meaningful amount. So that would be a hedge shield and [indiscernible] and valve cover, for instance. They would -- our lease is with the leasing companies right now, as they just build in a lease cost increment per month, and when you take that calculation, it cost us anywhere from C$1 million to C$3 million a year, on the lower end of that too. My best guess is under C$2 million.

Kevin Chiang - CIBC

Okay. I guess all the -- any potential lease rate pressure you would face, really just comes from the movement of crudes, the tank cars related to crude, and the movement of other commodities, do you think those lease rates are pretty static, as you build up here?

Mike Lambert

Yeah, crude and refined products, LPGs, all of them -- no. LPGs are not in the DOT-111s but any of the petroleum products are considered what they call dangerous goods, but not the most volatile. And so it's in about -- would be in about 500 remaining cars at the time.

Kevin Chiang - CIBC

Okay. And as a point of clarification, if -- these are half the cars I guess, in your previous comment, would that suggest about half your cars are moving crude, so about half the volumes are crude related, or is that too high of a percentage?

Mike Lambert

No. These cars, the DOT-111s are a general purpose car, and so their tankers that move many commodities. But those are the cars that we move crude in. we also move refined products in it too.

Kevin Chiang - CIBC

What percentage of your volumes would be crude? I think in the past, you said about one-third, if I am not mistaken. Is that a good rate?

Mike Lambert

Yeah, on an annualized basis, that's a good rate. Keep in mind, that we have added refined products, so refined products are going up as well.

Kevin Chiang - CIBC

Okay. No, that's helpful. Just moving on to the adjusted EBITDA, a bit better than last year, but I saw -- but I have noted that cash flow from ops was negative due to a big draw on working capital. Is this really, it's Elbow River and negative working capital has been an issue here for the last three quarters. So just trying to get a sense of how that seasonality should look, as we model out through 2014 here?

Mike Lambert

Yeah its part, but also part acquired working capital as well. So we had some working capital acquisition with SPF.

Kevin Chiang - CIBC

Okay. And how should we be thinking about -- of that evolving through the year. Should we think of that reversing?

Mike Lambert

Not completely, so one of the things that actually drives, and I can't give too much detail, because of the detail around the refiner's margin contract. But we were able to get out of some inventory we have to hold around that contract, but the offset to that was -- our terms with the new volumes are a little bit less than the -- not as favorable as the ones we have with the old contract.

Kevin Chiang - CIBC

Okay. That's helpful. And just last one for me. At a high level, how should I think about Parkland's commodity risk exposure moving forward? I see the loss on your risk management activities was up pretty significantly in Q1, and I think we saw a big bump when we compare 2013 to 2012 as well. So just trying to get a sense of how you think of your commodity risk exposure, given some of these acquisitions you've made over the past few years?

Mike Lambert

Well, so the first thing I should say about the loss on the risk management, that's a mark-to-market loss, but will reverse itself on the product ultimately delivered. And so we don't take much commodity risk on that, on at least what's recorded in the financials. Also in terms of Elbow River's methodology, most of the products that they move, they take no commodity risk and they take no U.S. foreign exchange risk. The exception to that tends to be LPGs, where you have seasonal fluctuations and you get an opportunity to play the seasonal game, and the other exception to that is the area we are getting into, which is refined product. So wherever possible, we try to do fixed price contracts at both ends, so we don't take that commodity risks, but we do have some of that commodity risk.

Ironically, we actually have less commodity risk today, getting out of some of our previous contracts than we had at, for instance, year end. But we may be increasing that risk and as we do, we will make sure that it's disclosed in our financials.

Kevin Chiang - CIBC

Perfect, that's helpful. That's it for me. Thank you.

Bob Espey

Thanks Kevin.

Operator

Thank you. (Operator Instructions) Next question is from Derek Dley from Canaccord Genuity. Please go ahead, your line is open.

Derek Dley - Canaccord Genuity

Yeah, thanks. Congrats on a great quarter guys. In relation to Elbow River, can you tell us how much of the increase in volumes or the incremental volumes that you had year-over-year was related to the weather impact?

Mike Lambert

Well in terms of Elbow River Marketing or the business as a whole, I would say Elbow River Marketing, a lot of the volume that they delivered is stuff that they had pre-bought, so probably didn't contribute a lot to their volume. The commercial business on the other hand did see, because of the increase in heating degree days, they did see some volume lift year-over-year, which we talked about, which is part of the 5% growth year-over-year.

Derek Dley - Canaccord Genuity

Okay. And then on the retail side, I mean, I was expecting, given the weather, that some of the -- on a same site basis, the volumes might be a little bit more challenged. But you guys obviously reported really strong results. Anything in particular, or could you give us some more color on that?

Mike Lambert

Well I think, I mean, again the teams worked hard on the marketing side, in terms of marketing programs. So that has driven some of the same store sales on the fuel side. The other thing is, as we are seeing the impact of our network developments, we have done a number of refreshes over the last couple of years, and those do take some time to gain traction, but we are seeing that those are, for the most part, tracking above plan. So that's assisted, and then new capital that we put into the network.

On of the measures that I didn't talk about in the call was, but on an average volume per site, we are seeing increase. So one of things that you have seen, as our number of sites have come down over the last few years, but the average volume per site has gone up. So that's actually the metric that you want to drive, because it's again, signaling that we have got a stronger network to support the base business.

Derek Dley - Canaccord Genuity

And in your view, is that increase in average volumes per site, more of an -- are you seeing an increase in overall volumes in your markets, are you guys gaining market share?

Mike Lambert

No. I would say -- I mean, it's always difficult; because market share is a trailing measure, and we don't get accurate Stats Canada until well after the quarter. So at this point, we can't comment on market growth, in relation to that. But I would say that, that sort of robust growth, our feeling is, is that we are certainly at or above market with that.

Derek Dley - Canaccord Genuity

Okay, that's great.

Mike Lambert

The other thing is the C-store growth of 10%, that's definitely above market and that really does speak to some strong marketing, and category management done by the team.

Derek Dley - Canaccord Genuity

Right. I guess as finally, in relation to your balance sheet and to acquisitions. We have seen the leverage come up a little bit here, just in terms of -- versus Q4. Is your guidance's comfort range still that two to three times net debt-to-EBITDA and in terms of acquisitions, obviously still a robust environment. What are you guys seeing in terms of transaction multiples that they moved upwards, downwards or are things still relatively stable from when we last spoke?

Mike Lambert

Okay Derek, you asked more than one question there.

Derek Dley - Canaccord Genuity

Sorry. It’s a three part question.

Mike Lambert

I will talk a little bit about the balance sheet, to start off. As you recall, I think both Analyst Days, we talked about guiding between two and three -- two to three times, and we had been -- up until the acquisition of SPF well below the two, and I think what we signaled to the market was that, don't worry, the pipeline is very robust, and its great to have a great balance sheet. We think that 2.2 times is still a very solid balance sheet and projected cash flow should cause that to improve over the next year. So, we are feeling really good about the strength of our balance sheet.

In terms of the pipeline, I will let Bob talk a little bit about that.

Bob Espey

Yeah again, I mean, we don't give guidance and we can't predict what we will buy. But again, we have invested in the team, we do see lots of activity. It all comes down to timing of price. So it's being disciplined going forward.

Derek Dley - Canaccord Genuity

Okay. That's great. Thank you very much.

Operator

Thank you. There are no further questions registered at this time. I would now like to turn the meeting back to Mr. Espey.

Bob Espey

So one thing Derek, you did ask about multiples. So we will say that -- I think we have said more recently, that as much -- we talked historically on multiples that we have made acquisitions on -- that it does depend on the types of assets that we are looking at. So high quality retail operation could be in these seven times multiple. A wholesale operation could be in the three times multiple. So we haven't seen multiples move. We know that the type of asset will dictate what type of multiple we pay.

Tom McMillan

With that, that concludes the conference call.

Bob Espey

Great. Well thank you very much and look forward to talking again at the end of Q2. Thanks very much.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.

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