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AGL Resources (NYSE:GAS)

Q2 2014 Earnings Call

July 30, 2014 9:00 am ET

Executives

James Anderson -

Andrew W. Evans - Chief Financial Officer and Executive Vice President

John W. Somerhalder - Chairman, Chief Executive Officer, President, Member of Executive Committee and Member of Finance & Risk Management Committee

Peter I. Tumminello - Executive Vice President of Wholesale Services and President of Sequent Energy Management

Michael Braswell - Chief Executive Officer of Southstar Energy Services, President of Retail Energy and President of Southstar Energy Services

Analysts

Craig Shere - Tuohy Brothers Investment Research, Inc.

Mark Barnett - Morningstar Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 AGL Resources Inc. Earnings Conference Call. My name is Tahisha, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. James Anderson, Director of Financial Reporting. Please proceed.

James Anderson

Thank you, Tahisha, and thanks to everyone for joining us this morning to review our second quarter 2014 results. Joining me on the call for today's prepared remarks are John Somerhalder, our Chairman, President and Chief Executive Officer; and Drew Evans, our Executive Vice President and Chief Financial Officer. We have several additional members of our management team available to answer your questions following our prepared remarks. Earnings release and earnings presentation are available on our website, and we filed our Form 10-Q earlier today. To access these materials, please visit aglresources.com.

Let me remind you that we will be making 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 margin, adjusted net income and earnings per share and economic earnings. A reconciliation of those items to comparable GAAP measurement 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'm going to turn the call over to you.

Andrew W. Evans

Thanks, James, and good morning, everyone. As you can see in our earnings release and presentation, it was another very strong quarter of performance for us with nearly all of our businesses performing well relative to expectation.

Turning to Slide 3 of the presentation. Our consolidated second quarter 2014 earnings before interest and tax were up 18%, which excludes the impact from the pending sale of Tropical Shipping, which we'll discuss in a moment. EBIT from distribution operations was up 10% year-over-year. EBIT from our retail business rose 50% compared to last year, and EBIT for our wholesale business was up $12 million compared to last year.

Excluding wholesale services and the impact of the Tropical Shipping transaction, which is now reported as discontinued operations, EBIT improved by $10 million year-over-year. The improvement was largely the result of higher revenue from our regulatory infrastructure programs and lower operating expenses at distribution operations. We also had higher operating margin in the retail businesses as a result of the acquired additional customers last year.

On Slide 4, you will find our consolidated results for the year through June. The solid results in the second quarter built upon our record first quarter, and year-over-year, our EBIT increased 76%. Most of our business segments had improved performance, and our year-to-date results were favorably impacted by $0.16 as a result of significantly colder-than-normal weather.

Taking a closer look at each segment, starting with Slide 5, our second quarter EBIT for our distribution business increased by $11 million compared to the second quarter of 2013. This was driven primarily by reduced depreciation expense and increased regulatory infrastructure revenues. You may recall that we implemented a new composite depreciation rate at Nicor Gas in the third quarter of 2013. For the first half of 2014, the main drivers of the $32 million or 10% increase in EBIT was colder-than-normal weather. Excluding higher variable expenses related to this colder weather, O&M expense was up just 2% in the first 6 months for the distribution segment.

Turning to the retail segment on Slide 6. Second quarter EBIT was up 50% year-over-year. The primary driver of the increase was the benefit of an additional $3 million in operating margin from our June 2013 acquisition of 32,000 customers and slightly colder-than-normal weather impacting our largest customer bases in Georgia and Illinois.

For the first half of 2014, EBIT increased by $18 million or 22% for largely the same reasons. These results were slightly offset by increased gas cost and lower retail price spreads. The performances from both our acquisitions in 2013 at retail operations have exceeded our expectations.

Operations and maintenance expense for the second quarter and first 6 months was up $2 million and $8 million, respectively, mainly related to the acquisition I had just noted as well as higher customer care marketing and bad debt expense.

You'll find the second quarter of 2014 results for our wholesale services segment on Slide 7 of $23 million, up more than 100% over the last year. The continued strong performance is due mainly to improved commercial activity of $24 million related to our transportation and storage positions in the Northeast and Midwest regions. Additionally, we recorded hedge gains net of lower of cost or market inventory adjustments of $10 million compared to $5 million in the second quarter of 2013. This was offset by a gain of $11 million that we recorded in the second quarter of last year from the sale of Compass Energy.

For the first 6 months, EBIT for wholesale services was $316 million, a $290 million increase from last year, record commercial activity of $403 million, driven by robust valuations -- values for our storage and transportation portfolio--compared to $48 million in 2013. This was offset by increased storage and transportation hedge losses net of LOCOM of $33 million compared to $8 million last year. Additionally, as a result of the record EBIT, the incentive accruals at wholesale services increased proportionately.

As discussed with you last quarter, Sequent capitalized on the receipt and delivery basis differentials and weather-sensitive market demand as a result of pipeline constraints in high-demand regions. We've designed our wholesale services business to be profitable under low-volatility market conditions and to provide significant earnings uplift under highly volatile market conditions as we experienced in 2014, and it has performed accordingly.

Turning to Slide 8. As you know, we focus on economic earnings in evaluating the performance of this business. Economic earnings enable us to strip out the effects of mark-to-market accounting and assign the generation of earnings activity to the period in which it was earned. Economic earnings for the second quarter of 2014 were $9 million compared to 0 in the same period last year.

Additionally, the economic earnings for the first 6 months were $282 million, a $253 million increase from 2013. Based on our performance through the first half of the year, we have increased our wholesale services economic earnings expectation for the full year of 2014 to a range of $280 million to $310 million and full year reported EBIT within the range of $310 million and $340 million. This excludes mark-to-market hedge movements on 2015 and forward positions.

Looking at the midstream segment results on Slide 9. Excluding the multi-year true-up of retained fuel, which is essentially nonrecurring, we had lower margin mainly during the quarter as a result of reduced subscription rates at all of our storage facilities. However, in the first half of 2014, we did experience strong commercial optimization, particularly at Golden Triangle and Central Valley, related to an increased reliance on storage that was weather and demand driven.

Some balance sheet highlights are noted on Slide 10. Note that Tropical Shipping's assets and liabilities are recorded as held for sale. Additionally, we had $200 million of long-term debt, which matures in 2015, which we anticipate initially to be paid with commercial paper and refinanced with long-term debt later in 2015. Our strong cash generation during the first half of 2014, along with our expected proceeds from the Tropical sale, will help further strengthen our balance sheet and help fund capital investment.

Now I'll turn it over to John.

John W. Somerhalder

Thank you, Drew, and good morning. As Drew said, we had good second quarter performance adding to our already strong performance for the year. I just wanted to highlight a couple of key points here before we go to your questions.

On Slide 11, you can see some of our 2014 accomplishments and an update on some key initiatives. First, we are on track for closing our Tropical Shipping and Seven Seas sales transaction in August. We are awaiting final approval of the sale from the Florida office of insurance regulation, which regulates the Seven Seas Insurance business. When we close the transaction, we anticipate receiving net after-tax proceeds of approximately $220 million.

Also on the regulatory front, we are awaiting final approval by the Illinois Commerce Commission of our infrastructure program in Illinois which we expect to receive later today. Approval of the tariff would allow recovery of cost associated with approximately $170 million of infrastructure investment per year beginning in January of next year and occurring over a 9-year period. This would further enhance the integrity and reliability of our system at Nicor Gas and allow for systematic recovery of the cost associated with that capital deployment. This follows approval last week of a program in New Jersey that will allow us to invest an additional $15 million in upgrading our system at Elizabethtown Gas. Both of these are examples of our continued focus on replacing infrastructure, utilizing mechanisms that align recovery with the pace of capital deployment.

With our strong results through the first half of the year, we are reaffirming our EPS guidance range, excluding wholesale services, which we increased in April of 2014 to a range of $2.80 to $2.90. This range does not include the results of Tropical Shipping. However, based upon the strong second quarter, we expect GAAP EPS for wholesale services to be in the range of $1.60 to $1.75, an increase of $0.05 to $0.20 per diluted share. This is based on a reported EBIT range of $310 million to $340 million. Our expectations for wholesale services can change as we move through the year and account for potential mark-to-market impacts.

With that, I want to thank you for your time today and for your continued interest in AGL Resources. Operator, I'll turn the call back over to you now to begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question will come from the line of Malcolm Holick [ph] from AGL.

Unknown Analyst

The report is excellent. I'm very impressed with all the things you're doing. My only concern is, as mentioned a couple of times, we're still very much dependent on weather conditions. And when we got into Tropical Shipping many years ago, one of the ideas was to kind of get a little bit of a diversification in completely other areas. I'm just wondering are there any thoughts giving to get into something else that could level off that? One of my thoughts is, is there any thought of liquefied petroleum gas being shipped overseas to get some extra income there or other things? Again, my concern is the weather relation and how we can hedge against that just a little bit more.

John W. Somerhalder

Okay. First, let me go through the weather issue. And that is as we talked about in our businesses, in most of our distribution operations businesses, we have weather normalization in our Nicor Gas franchise. We do have a lot of that on the fixed bill part, but we choose -- and we've done this over the last several seasons, we choose to protect that with weather hedges. But it gives us some upside the way we put those in place. So the weather impact being positive is a good thing, but we do attempt to, through those type products, protect the downside so that we aren't as weather sensitive. And as Drew mentioned with our wholesale business, we've really positioned that to be stable in low-volatility conditions but if weather or other factors create volatility, then to have upside. So we like the profile of those. We do have an opportunity to participate when weather cooperates, but we have positioned them to have less downside because of those type factors. But we are looking at things. As an example we've talked in the past about liquefied natural gas. And with lower natural gas prices, less volatility, we are seeing -- on heavy, heavy transportation, from rail to submarine, we're seeing a stronger interest in that. So we are looking at using the fact that we're a big LNG operator onshore with all of our facilities. We are looking at those type of opportunities.

Operator

Your next question will come from the line of Carl Kirst from BMO Capital.

Unknown Analyst

This is Leah [ph] for Carl. My first question is on midstream. I know you're looking for a down year. But so far, are the results kind of tracking to your expectations, meaning we see an uptick in the second half of this year? And then what dynamics are going to drive that shift?

Peter I. Tumminello

This is Pete Tumminello. We had a reasonably good first half of the year where we were able to capitalize on some of the weather and extreme conditions at several of our storage facilities and particularly at Golden Triangle and at Central Valley. We did have to take some adjustments this year due to some historic true-ups on retained fuel and cavern size normal creep, so we've got that behind us. But we expect the balance of the year to kind of come in to expectations. We believe we've got the cost structure of that business in line to lower volatility market conditions, and we think we'll perform according to our expectations. We still think it's probably a couple of years away before we see some level of uptick when we see LNG exports, and additional gas-fired power generation require additional swing services from the market. So we believe we're positioned well when there may be an uptick in a couple of years down the road to our forecasting.

John W. Somerhalder

But consistent with I think what we've talked about over the last year or so, we see things stabilize. We have the cost structure where we want it. But as Pete indicated, this has historically been a cyclical business, and we really do not see the fundamentals improving most likely for the next several years until some power generation, industrial demand picks up and LNG export. So we really are forecasting a more challenging result out of that business for the next 2 years. That's our most likely scenario.

Unknown Analyst

Okay. Great. I just have another question on wholesale. First, kind of I wanted to understand what dynamic was driving the strong 2Q commercial activity given more kind of a shoulder season. Was it still kind of the Northeastern basis? Or what was driving that? And then also wanted to understand that you've increased annual wholesale guidance reflecting the better 2Q results, but what is kind of leading you to leave the second half of the year kind of lower for the rest -- for the balance of the year?

Peter I. Tumminello

Sure. This is Pete Tumminello again. Our Q2 performance really was driven by the strong portfolio of pipeline transportation assets that we built through asset management agreements as well as holding those transportation assets for our own account to really move gas out of the constrained regions of the Marcellus and Utica shales. But we've also continued to diversify the portfolio under the Midwest and acquire additional assets other than Midwest, in particular the Bakken shale. So when markets get constrained, production increases, and our needs greater take away capacity to move it out of market. Sequent is very well positioned to provide those services to the producers. So we've really enhanced our services to producers in those extreme cases of market constraint, which we saw more so in Q2 this year versus Q2 last year. So turning to your next question about what we see for the balance of the year, we do see things somewhat normalizing in Q3. We do see additional pipeline capacities being built to de-bottleneck some of these areas. So we have tempered a little bit our additional increases of commercial activity for the balance of the year based on additional infrastructure being built in the industry.

Operator

Your next question will come from the line of Craig Shere from Tuohy Brothers.

Craig Shere - Tuohy Brothers Investment Research, Inc.

So a couple of things here. On the -- you're talking about the industrial demand, the LNG export opportunity, obviously, new gas-fired gen. How do you see a lot of this playing out? Are these kinds of large future consumers going to be looking for kind of a service provider like a Sequent? And is that a primary tailwind for that business? Or do you think that most of this is just going to be -- they'll have their own business management, and they're just going to look for contracting assets that'll be more of a support for the midstream ops?

Peter I. Tumminello

Craig, this is Pete again. We see a mix of LNG exporters in that space, some of which will secure their own supply, manage it to the LNG export facility and then bring the LNG out to their country. We see another group of LNG exporters that do not have an upstream capability and upstream expertise that are reaching out to Sequent and engaging in conversation and potential future commercial transactions that can provide all the services to the LNG export facilities, including managing the swing. And so if you look at the portfolio of additional LNG exporters, by definition, there is going to be an additional need for swing in the market as ships come and go, as there are issues and maintenance and other offsets that happen naturally at LNG facilities. So our belief is that there will be an uptick in the need for swing services as LNG export occurs as well as new industrial demand and a new construction of gas-fired power generation which, by nature, is a variable load as well. So all of that combined we believe will add opportunity for Sequent services as well as Pivotal midstream's storage and lease opportunities.

John W. Somerhalder

And Pivotal -- I mean, excuse me, and Sequent has historically provided services for power generators, and that business continues. And it's very strong right now, and the team sees more opportunities to provide services for power generators. So both on the LNG front and the power side, direct opportunities for Sequent. On the industrial side, probably not as many direct opportunities. That's just demand growth that will help balance this oversupplied market that we see right now.

Craig Shere - Tuohy Brothers Investment Research, Inc.

I got you. And maybe if I can continue on that track, you're talking a little, Pete, about the constraints in the Northeast that contributed to some of the second quarter in addition to first quarter results of Sequent. You were saying that due to some de-bottlenecking, you didn't see as many opportunities in the second half. But I think, generally, consensus is we might be even be over piped by a couple of years from now, so all those opportunities may like be gone for quite a long time. So with all the things that you and John just discussed in terms of growing underlying demand, consistent demand out there from the industrials, the LNG, the new gas-fired gen but maybe basis blowouts becoming a thing of the past potentially, could we start to see the base at Sequent rise but these great quarters start to disappear, maybe making it a little more consistent business line?

Peter I. Tumminello

It's a great question. I certainly wish we could say it could be more consistent in terms of predicting the profitability. To your point though, as new pipeline capacity gets built and relieving the constraints, yes, we do see that that is likely in several of these regions. But we also see the constraints coming in play. We see as new capacities are getting built out of the Utica, it's going to push more gas back to the Gulf, back to the Midwest, which will grow constraints in some other areas. And we believe Sequent's positioned our business to be able to work towards those constraints and put asset management agreements and portfolio positions into play that can work when those things happen. One thing we do see is you never can anticipate everything in this market, and we do see that constraints do move over time. But to that point, if all constraints were alleviated, our growth in services, the producers in particular, are really relying on marketers more to manage their pipeline assets and bring that to market. So that's becoming a much greater service business. We see an increase in the power generators needing that service as well, provide service to the power plant. So we do see a significant increase in that part of our business as these opportunities could dampen over time.

Craig Shere - Tuohy Brothers Investment Research, Inc.

And last question. If these anomalies move kind of further west, are there any prospects for Illinois kind of giving Sequent the same kind of win-win relationship on some of the Nicor-related assets that you have in all your other jurisdictions?

Peter I. Tumminello

Craig, that's an area we think we could certainly add value to the customers in Illinois. We believe all of our jurisdictions have appreciated the sharing of dollars that we've been able to send back to the customers to really save money. There's a longstanding history in Illinois that we've got to overcome prior to our ownership that our strong regulatory team is working towards continued collaboration and discussion with the commission. We still see this as a little bit farther down the road, but we firmly believe that there's a benefit we could add to the customers in Illinois there.

Operator

[Operator Instructions] Your next question will come from the line of Mark Barnett from Morningstar.

Mark Barnett - Morningstar Inc., Research Division

Just a couple of quick questions. You had talked about the out performance versus plan on the retail, and I know that that's still a smaller chunk of the business. But given that it's one you've been fairly active in, adding new businesses last year, can you talk about the out performance against plan and what might moving that?

Andrew W. Evans

Yes. I'll let sort of Mike give you the larger parts of this, but generally, we've just been trying to grow the retail customer base as much as we can in logical states where it makes sense for both us and for Piedmont. And retail does have some exposure to weather, both consumption and price and I think proved pretty profitable in the first 2 quarters of this year. I don't think that we're really out looking overly aggressively for additional properties, but we'll add them where they make sense. Really, now the goal is to grow the -- organically grow the base that we've gotten now that we've got a little bit more critical mass in Illinois and really such a good position in Georgia. But, Mike, you want to -- is there anything else you want to describe around what he's asked?

Michael Braswell

Drew, I think you answered it well. I would say the acquisitions certainly were a huge driver this year with favorable operating conditions both in weather and on the commercial side, and that enabled us to exceed plan.

Mark Barnett - Morningstar Inc., Research Division

So you had mentioned that now you're looking a little bit more organically. Is that generally -- could be generally assumed that you might be done kind of acquiring at this point? Or is there still some out there that you have been taking a look at?

Andrew W. Evans

Opportunistic is the best way to think about us in that -- in this area.

Michael Braswell

We're certainly always looking at opportunities.

Andrew W. Evans

We don't really view that we need to have growth through acquisition necessarily given the bases that are already established.

Mark Barnett - Morningstar Inc., Research Division

Okay. And now is there any particular reason you're waiting until 2015 to fully refinance? Or is this -- that just...

Andrew W. Evans

We're waiting on proceeds from Tropical. We're sort of evaluating performance at Sequent and the strong cash generation there. We probably don't have a need to refinance the $200 million directly, but we want to evaluate versus pipeline opportunities whether it's Dalton or other. But really, no need, given our fixed-to-floating mix and debt-to-cap, to do much aggressive financing this year. '16 is a really big year in terms of financing. And so more likely, we would accelerate some of that activity into the beginning of '15 just to make sure that we've got more staggered maturities in the future.

Operator

All right, ladies and gentlemen, the queue is clear. So I will now turn the call back over to Mr. Anderson for any closing remarks.

James Anderson

Thanks to everyone for joining us this morning and for your questions. We look forward to Sarah returning next quarter. However, if anyone has any additional questions, please don't hesitate to contact Steve Cave or myself.

Operator

Ladies and gentlemen, that will conclude today's conference. Thank you for your participation. You may now disconnect, and have a great day.

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Source: AGL Resources' (GAS) CEO Michael Braswell on Q2 2014 Results - Earnings Call Transcript

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