Southcross Energy Partners LP (NYSE:SXE)
Q1 2014 Earnings Conference Call
May 7, 2014 11:00 AM ET
Michael Anderson – SVP and CFO
David Biegler – Chairman and CEO
Jerren Holder – Goldman Sachs
Good morning, and welcome to the Southcross Energy Partners’ First Quarter 2014 Financial and Operating Results Call. As a reminder, today’s call is being recorded and your participation implies consent to such recording. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.
With that, I will turn the call over to Mr. Michael Anderson, Senior Vice President and Chief Financial Officer of Southcross Energy. You may begin sir.
Thank you, and good morning, everyone. We appreciate everyone joining us for the Southcross Energy first quarter 2014 financial and operating results conference call. With me today is David Biegler, our Chairman and Chief Executive Officer, as well as John Bonn, our recently appointed President and Chief Operating Officer. We’re pleased to have John joining our call today and now settled into his new role on the Southcross team.
Before we begin, I would like to remind all participants that our comments today will include forward-looking statements. It should be noted that a variety of factors could cause the partnership’s actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements. For a complete discussion of these risks, we encourage you to read the partnership’s earning release and our documents on file with the SEC.
Today’s call will also contain certain non-GAAP financial measures. You can refer to the press release we issued this morning for important disclosures regarding such measures and their reconciliations. You can obtain a copy of our press release in the Investor
Relations tab of our website at southcrossenergy.com.
And with those opening remarks, I will hand the call over to David Biegler, Chairman and Chief Executive Officer. David?
Thanks, Michael, and thanks everyone for joining us today. There were a lot of surprises in the first quarter. The adjusted EBITDA we reported today of $12.5 million was just above our guidance for the first quarter. Our processed gas volumes were down from fourth quarter, which we talked about on our fourth quarter call, mainly due to interruption of transportation on another pipeline, which we were using until our new Webb Pipeline is completed.
We are making progress in replacing the displaced gas volumes with newly contracted volumes added over the course of this quarter, although we have not yet fully recovered to averaging fourth quarter volumes.
Also you may have noted press coverage in late March of a pipeline rupture on our system caused by a boat strike, which shut in some rich gas volumes for several weeks. These events offset our progress in adding new volumes. And as a result, we anticipate second quarter adjusted EBITDA will be about the same as first quarter.
Since first quarter performance was in line with expectations, I’d like to focus my remarks of what we’re seeing in the Eagle Ford and where we see Southcross’ future. Then I’ll hand the call over to Michael to run through more detailed numbers.
First of all, as Southcross is a pure midstream business focused on the Eagle Ford, we’re in prime position not only to participate in, but also to see much of the activity around us through our operations and discussions with customers. And the Eagle Ford continues to demonstrate solid growth and strong upside potential.
For those seeking more information and confirmation, I suggest the quarterly earnings calls of major Eagle Ford upstream players such as Marathon, EOG, Swift Energy, Rosetta Resources, SM Energy and others.
Producers continue to deploy development capital in this high rate of return region, and we’re impressed by the ingenuity of producers who constantly redesign well completion techniques to maximize recovery and minimize costs. We’re also encouraged by the reaffirmation of the geology and the prospects of the new areas as discussed by producers.
We also continue to be encouraged by advancing announcements which offer an extended period of production growth and infrastructure development. It’s easy to be heartened by discussions of reduced spacing drilling, Eagle Ford geographic area expansion and application of the same technological advances to other formations in the regions such as the [indiscernible].
Amidst all of the attention in the Eagle Ford area, it’s also easy to miss the prolific traditional Gulf Coast producing areas. We are seeing meaningful volume additions from at least two play in our traditional Gulf Coast region, which we expect will be increasing volumes throughout 2014.
We believe our position as a midstream link between the Eagle Ford and Gulf Coast production areas and the Texas Gulf Coast markets, particularly the Corpus Christi markets just gets brighter every day.
And with that, let me talk a bit about what’s going on at Corpus Christi. Most of you recall that our strong market presence in the Corpus Christi area has been a key part of our strategy since day one. Southcross is a key conduit, a direct midstream connection for Eagle Ford production to reach Corpus Christi markets. And that’s exciting because big investments are being made now to develop projects at and near the port of Corpus Christi.
According to industry sources over $3.8 billion in projects are now under construction in Corpus and another $12 billion is in the permitting phase. It’s encouraging that we’re seeing the Corpus Christi port emerge as a major energy export port and it is a key component of our strategy. The opportunities for Southcross continue to be extensive, both on the export side and for new petrochemical and refining expansions.
On the natural gas side, Cheniere obtained further commitments during the quarter of sales of their LNG production, which enhances the status of their LNG project. Cheniere announced that they expect to complete steps to their final investment decision and begin construction by early 2015.
And another pipeline company announced that it expects to complete its 42-inch pipeline in the Mexico from the Agua Dulce hub, which we accessed just outside of Corpus Christi and have it in the service by December of this year. This provides yet another major opportunity for delivering natural gas.
On the NGL side, [indiscernible] is expanding their new doc facilities on the Corpus Christi ship channel and the OxyChem, Mexichem partnership continues to move forward with its $1.2 billion pound per year Ethylene Cracker at Ingleside near our Gregory plant.
And on the refining side, there is a $340 million, 70,000 barrel per day refinery expansion ongoing at Volero’s Corpus facility and $250 million upgrade at Koch’s Flint Hills Resources’ West refinery in Corpus just to handle more Eagle Ford crude. Refining capacity at Corpus Christi today is about 800,000 barrels per day or about 15% of total Texas capacity.
Southcross is investing to take advantage of its position serving markets near Corpus and to ensure we will continue to be a key participant in this growth market. Our acquisition during the first quarter of natural gas pipelines from Onyx is a good example of a bolt-on acquisition that further enhances our position in this market.
The pipelines are under a firm capacity long-term contract with an electric generator and we have potential upside through utilizing spare capacity of the pipelines for delivery of gas to other customers and the market gas to the contract party.
Now let’s take a look at current activity. Our Webb Pipeline is on schedule and on budget. We expect to be flowing rich gas into the pipeline and to our plants in the fourth quarter of this year. We recognized the pressure that investment in this pipeline has put on distribution coverage during the construction period, but view it as a merited part of the investment in this critical link to the Western Eagle Ford.
When the pipeline is completed, our anchor shipper will have a minimum volume commitment of 40,000 MMBtus per day, which alone is expected to generate more than $3 million per quarter in adjusted EBITDA. We expect volume flowing on the top line and we’ll exceed this 40,000 MMBtu per day minimum volume commitment at the time that flow commences.
We are putting a great deal of emphasis on marketing our pipeline and process and capacity. One of the key activity is that John Bonn has been involved in during his first two months at Southcross as they are meeting with existing and potential customers for the Webb Pipeline. And we continue to be encouraged by their activity levels and the opportunities these activities create for us.
We believe we’re making solid progress on securing additional long-term gas supply through this pipeline. If anything that continued positive statements from producers about the Western Eagle Ford area, make us even more encouraged about putting this pipeline into the service.
In the meantime, we’re adding volumes elsewhere on the system that we can accommodate during the course of the year while not impairing our ability to process committed volumes associated with the new pipeline when it comes online. We’re investing in additional pipeline interconnects to enhance our competitive position for new volumes.
I think it is really important to note and to emphasize that when we have the Webb Pipeline completed which we expect later this year, we will have in place an extensive pipeline system covering almost the entirety of the Eagle Ford gas common site area. We really like the competition position we have.
And the Webb Pipeline is just the next step in creating a greater Southcross platform. The existing Southcross system has the capacity for $20 million or more in quarterly adjusted EBITDA through filling our currently available processing and fractionation space.
The Webb Pipeline and the rest of our pipeline system will have the capacity to not only fill existing plant capacity, but also fill the next 200 million cubic feet a day plant that we have in our planning horizon.
We believe the financial returns on that next plant with little required investment in additional pipelines should be attractive with the prospects of additional rich gas production coming onto our system.
Turning to the first quarter, in the first few months of 2014, we achieved many things that are key components of our growth plan. We completed a $145 million follow-on equity offering. And then, with the offering we’re able to revert our prior credit terms which provided a number of financial benefits including enhanced facility size, more beneficial financial covenants and lower borrowing costs.
We acquired the Onyx pipeline assets which are performing well. We welcome John Bonn as our new President and Chief Operating Officer, and he is already making a tangible difference at Southcross. We also added to our market position in the Corpus area with a new long-term gas sales contract with a large petrochemical company for significant volumes. Sales under this contract are set to commence in the fourth quarter.
As we add processed gas volumes, we continue to take advantage of our geographic position to seek premium price markets for a residue gas which enhances our competitive position for natural gas supply.
Looking into the remainder of 2014, we’re focused on owning our operational performance and on capturing new gas supply which are the real near-term drivers for increasing profits and distributable cash flow.
We are meanwhile continuing to look for the right asset additions which would synergistically benefit from our position in the Eagle Ford area. Southcross has tremendous opportunities and we believe the progress we’ve made in building our integrated business will benefit our unitholders.
With that, I’ll turn the call over to Michael to discuss our financial performance and outlook. Michael?
Okay. Thanks a lot, David. As David mentioned, our first quarter adjusted EBITDA was $12.5 million and that was just above our guidance provided at our year-end earnings call.
Processed gas volumes were down sequentially as the results of the interruption of third-party transported volumes that David discussed earlier in the call. Specifically gas processing volumes during the quarter declined by about 8% from the fourth quarter from 269,000 MMBtu per day to about 246,000 MMBtu per day.
NGL volumes declined about 13% or about 16,500 barrels per day to about 14,500 barrels per day. Now, while they were down on a sequential basis, gas processing volumes were actually up on a year-over-year basis by about 3%, that’s comparing to the first quarter of 2013 and similarly NGL sales volumes were up by 41% on a year-over-year basis.
During the first quarter, gross operating margin was $27.2 million. And that compares to $28.2 million that we have in the fourth quarter. So down just a little bit. Operating and maintenance expenses were $10.9 million in the quarter and G&A expenses were $6.1 million. G&A during the quarter did include some unusual items including about $270,000 of litigation expense, $350,000 of non-cash compensation cost, $200,000 of employee recruiting and related expense and also about $300,000 of costs related to losses on our property damage that we had primarily the pipeline that David spoke about earlier in the call.
Cash interest expense was $3 million for the quarter and maintenance capital expenditures were $1.4 million. This let distributable cash flow of $8.5 million for the quarter and that compares to cash distributions of $13.8 million. As a reminder, on May 15 we will pay our first quarter 2014 distribution of $0.40 per unit to unitholders as of record of May 9.
During the quarter, growth capital spending was $9.7 million and about $5.6 million of this growth spending was related to growth capital investment for the Webb Pipeline and we continue to maintain our expectations for spending for the year of $130 million to $150 million of growth CapEx during the year with most of this going towards the Webb Pipeline.
Our debt at March 31 was approximately $171 million. And as a reminder, certain provisions of our credit facility reverted to our prior credit term shortly after the February equity offering that we completed. And the key benefits of this reversion included or do include no capital expenditure limitations, no restrictions on distribution growth, reduced pricing on our borrowings and also reinstating the original $350 million facility size.
At the end of the quarter, the credit agreement defined debt-to-EBITDA at March 31 was about 3.3x and that was well within our 5x covenant.
Looking forward, as David mentioned, we are replacing the displaced first quarter volumes with new volumes, but they are certainly ramping throughout the quarter. And with this ramp and also the impact from the pipeline ruptured early in the quarter, we have so far averaged modestly higher processed gas volumes in the second quarter versus the first quarter, which means we also expect to see Q2 about in line with Q1. That’s specifically we expect this to translate to second quarter adjusted EBITDA of approximately $13 million.
While we are working over the next couple of quarters to improve short-term processed gas volumes, we remain confident that we will see additional volumes when the Webb Pipeline [indiscernible] which we project to be in the fourth quarter. We expect the cash flow generated by the new pipeline will enable distributable cash flow to exceed our distributions and also position Southcross well for its next phase of growth.
And with that, I will turn the call back over to David for closing comments. David?
Thanks, Michael, and thank you again to everyone for joining us today. Hope you can see we’re focused on growth in 2014 and are profitable and well positioned Southcross.
With that, we’ll open the line for questions. Operator, please open the lines.
Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. (Operator Instructions) One moment please while we poll for questions. (Operator Instructions) Our first question is coming from the line of Jerren Holder with Goldman Sachs. Your line is now open. You may proceed with your question. Mr. Holder your line is open.
Jerren Holder – Goldman Sachs
Sorry, good morning. Just wanted to get your thoughts on M&A activity. I guess looking for the upstream, we saw an announcement this morning from Encana and its possible there are other I guess acquisitions or just in the works, just wanted to get your thoughts on maybe that increased M&A activity leading to incremental volumes on your system, your ability to compete for some of those volumes? Thanks.
Thanks. I would say just broadly whether it’s acquisitions, it’s transactions. I always say the best vote of confidence in a play is continue transactions and money basically people voting with their pocket will advance to the attractiveness of the play. So the Encana for example transaction today is I think just another verification of that. So each time it happens I would say generally I would call it positive trends because obviously the person displacing the transaction is using the capital elsewhere because of the organization and it’s going to someone who wants to accelerate generally what’s happening. I mean it’s just the obviously general observation.
I’d say second, as it relates to competitiveness, it always depends for each individual company, midstream company who the buyer is and who the seller is in terms of relationships. I think the net result of how we view upstream, or at least I do always, is that every time you’re doing an activity a sustained or increased, it’s a benefit to everybody because you’re creating that much more sustainable production growth trend the work that where you’re going to need midstream infrastructure.
And I think you got to look at the play. I think just to emphasize, we obviously listen to most of the quarterly calls of the upstream companies and you got to be encouraged generally by the ones I would say are most knowledgeable about the Eagle Ford are generally continuing to talk about it in terms of an extended growth period, this isn’t a peak by any means at the current time. So I would say generally I would call it a positive view that we had to look. Thank you.
Jerren Holder – Goldman Sachs
Thank you. (Operator Instructions) One moment please while we continue to poll. It appears there are no further questions at this time. I would like to turn the floor back over to management for any final remarks.
Well, we always appreciate your interest in us and spending time with us and thank you for the time this morning. You can probably tell it was a pleasure for us to have a quarterly call where we didn’t have any surprises in the quarter and we could focus really on the, what I would call, the strategic position of the company today and what we see happening in our principal friendly Eagle Ford. I’d hope you could tell the extent to which we continue to feel good about what’s happening in the Eagle Ford and the prospects we have as 2014 and into 2015 on those.
We have not diminished at all in our view as an enthusiasm about the play and potential for growth of Southcross. And with that, I’ll conclude. Thank you again for joining us.
Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you very much for your participation and have a wonderful day.
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