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Chesapeake Utilities (NYSE:CPK)

Q2 2014 Earnings Call

August 08, 2014 10:00 am ET

Executives

Beth W. Cooper - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Corporate Secretary

Michael P. McMasters - Chief Executive Officer, President and Director

Analysts

Spencer E. Joyce - Hilliard Lyons, Research Division

Operator

Good morning. My name is Tanya, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Chesapeake Utilities Second Quarter 2014 Financial Review Conference Call. [Operator Instructions] Beth Cooper, Senior Vice President and Chief Financial Officer, you may begin your conference.

Beth W. Cooper

Thank you. Good morning, everyone, and welcome to Chesapeake Utilities Second Quarter 2014 Earnings Conference Call. We have prepared a presentation to accompany our discussion today. This presentation can be accessed on our website under the Investors section and Events and Webcast subsection or via our IR app. The Chesapeake Utilities IR app is free and can be downloaded through the App Store on an iPhone or iPad or through Google Play on an Android mobile device.

Turning to Slide 2. Before we begin, let me remind you that matters discussed in this conference call may include forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those in the forward-looking statements. Please refer to the Safe Harbor for forward-looking statements and the company's 2013 annual report on Form 10-K for further information on the risks and uncertainties related to the company's forward-looking statements.

Yesterday, we announced second quarter net income of $5.1 million or $0.53 per share for 2014. Summary financial results for the quarter are shown on Slide 3. 2014 earnings per share for the second quarter were $0.08 per share higher than the 2013 second quarter earnings per share. Excluding unusual items, earnings per share increased $0.03 or 6.7% over the second quarter of 2013. Our second quarter performance reflects continued growth in the Natural Gas Distribution and transmission businesses, a positive contribution from the Eastern Shore Gas acquisition and continued implementation of the Florida Gas Reliability Infrastructure Program, or GRIP as we commonly refer to it. We expect these initiatives to provide additional opportunities for future growth. I will highlight the key accomplishments and results for the business segments during the second quarter of 2014, and also briefly for the 6 months ended June 30, 2014. Detailed discussions of the changes in gross margin and operating expenses by business segment for both periods are provided in our press release and Form 10-Q, which were issued yesterday.

As shown on Slide 4, Chesapeake's Regulated Energy businesses, which include our natural gas, transmission and distribution and electric distribution operations generated operating income of $10.7 million in the second quarter of 2014, compared to $8.6 million in the second quarter of 2013. Growth in the Regulated Energy segment remained strong, with $2.1 million in additional margin generated from major natural gas expansions and customer additions, $1 million in additional margin from the acquisition of Eastern Shore Gas, and $643,000 in increased margin from the Florida GRIP. In total, Regulated Energy margin increased by $3.9 million during the second quarter of 2014, compared to the same period in 2013. The increase in margin was partially offset by a $1.8 million increase in other operating expenses, largely driven by growth, including higher depreciation amortization; asset removal and property tax costs associated with capital investments, as well as system improvements; other operating expenses associated with Sandpiper's operations; and higher payroll and benefit cost. Additionally, a change in vacation policy within our Florida business unit last year resulted in reduced payroll cost in the second quarter of 2013. These increases and other operating expenses were partially offset by the absence of a one-time sales tax expense of $759,000 in the second quarter of 2013 related to the Eastern Shore Gas acquisition.

On Slide 5, the Unregulated Energy segment reported an operating loss of $43,000 during the second quarter of 2014 compared to operating income of $447,000 during the second quarter of 2013. Unregulated Energy results are typically modest loss or gains in the second quarter, given the seasonal nature of the propane business. A slight increase in gross margin for the segment during the quarter was more than offset by an increase in operating expenses.

Moving to Slide 6. Slide 6 highlights the key variances between second quarter 2014 and 2013 results. The one-time sales tax expense incurred during the second quarter of 2013, associated with the Eastern Shore Gas acquisition, accounted for $462,000 or $0.05 per share of the improvement in earnings during the second quarter of 2014. Increased gross margin from system expansions, customer growth, acquisitions and the Florida GRIP contributed $2.3 million or $0.24 per share. This was largely offset by $2.3 million or $0.23 per share, and higher other operating expenses associated with growth. Other charges increased earnings by $332,000 or $0.02 per share. The margin contribution of $0.24 per share highlights the growth potential of the areas we serve and have recently added to our service territories, and the successful efforts of our team in seeking out, creating and cultivating profitable growth, including consummating and integrating acquisition opportunities like Eastern Shore Gas.

Our year-to-date financial results are summarized on Slide 7. For the 6 months ended June 30, 2014, earnings increased by $0.36 per share or 18%. The growth in earnings per share has been driven by $15.8 million in additional margin, resulting from the impact of acquisitions completed in 2013, natural gas service expansion, colder temperatures in the first quarter, the Florida GRIP, natural gas customer growth, increased wholesale propane sales and increased trading activity and profits for Xeron, our propane wholesale marketing subsidiary. The higher margin was partially offset by $9.4 million in higher operating expenses to support the growth in the company's businesses.

Turning to Slide 8. For the 6 months ended June 30, 2013, the company reported earnings of $19.2 million or $1.99 per share. Unusual items, including colder-than-normal weather in the first quarter of 2014 and sales tax paid in connection with the Eastern Shore Gas acquisition accounted for $1.8 million or $0.19 per share in additional earnings for the 6 months ended June 30, 2014. Increased gross margin due to growth as a result of the factors we've previously discussed, added $8.1 million or $0.83 per share to earnings for the first 6 months of 2014. Increased other operating expenses associated with the growth in margins, including incentive bonuses resulting from the higher year-to-date financial results, reduced earnings for the for the 6 months of 2014 by $6 million or $0.63 per share. Net other charges reduced earnings by $342,000 or $0.03 per share for the first 6 months of 2014. In total, these changes resulted in net income of $22.8 million or $2.35 per share for the first 6 months of the year.

The company remains committed to maintaining a strong balance sheet to ensure access to competitively priced capital to fund our growth initiatives. Our equity to permanent capitalization is 64.2%, and equity to total capitalization is 56.9% as shown on Slide 9. Our objective is to maintain an equity-to-total-capitalization ratio of 55% to 60%. In that regard, we continuously review our financing plans to ensure a strong balance sheet, to provide sufficient liquidity for capital investments and to optimize our capital structure. Most recently, during the second quarter, under this financing plan, we successfully funded $50 million of new senior unsecured notes at a rate of 3.88%. In terms of short-term liquidity, we have access to a $165 million of short-term debt capacity under multiple bank lines of credit. At June 30, 2014, approximately $48 million was borrowed under these lines of credit. Given capital market conditions and our capital expenditures budget, the company anticipates accessing the capital markets over the next year.

As highlighted on Slide 10, capital expenditures for 2013 totaled $108 million. For 2014, we are currently forecasting capital expenditures to reach approximately a $146 million. While this would represent our largest capital spend in any one year, absent 2009 when we completed the FPU acquisition, we noted some of the project spending may carryover to 2015. The largest portion, $123 million, is expected to be invested in our Regulated Energy operations. Because of the levels of total shareholder return Chesapeake's stock has generated, which will be discussed later, and in particular the growth in our stock price, on July 2, 2014, the company's Board of Directors declared a 3-per-2 stock split, to be effected in the form of a stock dividend. Key dates associated with this split are shown on Slide 11. The record date for the dividend will be August 13, and the Distribution date will be September 8. Beginning September 9, the company's stock will trade at a split-adjusted price and per share financial results will be reported on a split-adjusted basis.

Slide 12 details the key sources and financial impacts of growth from recent service expansions and acquisitions for 2014. For the for 6 months of the year, these initiatives accounted for $8.2 million in incremental margin over 2013, and they are expected to contribute approximately $10.8 million in incremental margin for the full year.

Now I will turn the call over to Mike McMasters, President and Chief Executive Officer.

Michael P. McMasters

Thank you, Beth, and good morning, everyone. As Beth has highlighted, the second quarter of 2014 was another strong quarter for Chesapeake. We are fortunate to serve areas with significant opportunities and provide energy services that are friendly to the environment and low-cost to our customers. We possess some fundamental advantages, and our success this past year and over the past 20 years is ultimately a function of our people. Many service territories have growth opportunities, but our team has done a remarkable job of identifying and cultivating growth and then exercising financial discipline, effectively manage regulation to produce superior returns to shareholders, while providing clean, reliable and low-cost energy to our customers.

Turning to Slide 13. The environmental and economic advantages of natural gas continue to present opportunities, with the expansion of its use in our service territory and across the United States. Natural gas is an abundant, clean and inexpensive fuel and a significant reserve we have here in the United States provides security of supply and price. This is reflected in the comparison of energy prices, which shows that natural gas enjoys a significant price advantage compared to oil, and it's expected to maintain this advantage for the foreseeable future.

We see attractive opportunities for growth across our energy businesses as indicated on Slide 14. As in the past, we will continue to look for profitable, large project investments in the natural gas distribution and transmission businesses. As a result of past expansions, we have the opportunity to serve new customers and are continuing to enhance our conversion programs and processes. We will also look to provide additional services to our existing customers. And in Florida, we expect to continue to generate additional margins through our pipe replacement program. Providing natural gas service to power generators and finding new applications for natural gas are additional areas of opportunity that we see.

In the Unregulated Energy business, we expect to benefit further from the integration of previous acquisitions, and we will continue to pursue profitable opportunities within our footprint. Further success in our community gas systems strategy and startups like those in Pennsylvania, Cecil County should also generate growth. Additionally, compressed natural gas, propane vehicles, combined heat and power projects and midstream opportunities all represent potential avenues to supplement growth in this business.

As a shareholder return on Chart 15 shows, Chesapeake has produced top quartile total return to shareholders for the 1, 3, 5, 10, and 20 years ended June 2014. Over the past 20 years, Chesapeake shareholders have averaged more than 13% return on an annual basis.

As indicated on Slide 16, for the 5 years ended March 2014, Chesapeake has led its peer group in compound growth in earnings by delivering compound annual growth of 10.78%. We think that the formula for success is clear. While the amount of capital invested is important, it only benefits shareholders if the return generated justifies the investment.

As Chart 17 shows, the company has delivered return on equity well in excess of the peer group median for the 1, 3 and 5 years ended March 2014. Our average return on equity for the 5 years ended March 3014 was 12.2% percent compared to the peer group median return of 9.93%.

Slide 18 shows our continuous dividend growth. In May 2014, the Board of Directors increased the company's dividend by $0.08 per share annually for 5.2%. Compound growth in the dividend over the past 5 years has also been 5.2%. The growth in the dividend has been supported by growth in earnings as evidenced an average payout ratio of only 48% over the past 5 years. We understand how important dividends are to investors, particularly given the expectations for broad market returns. We also believe that superior earnings and dividend growth will enhance shareholder value going forward. We are committed to dividend growth, supported by earnings growth, and believe that our growth potential and our low payout ratio -- with our growth potential and our low payout ratio, we are well positioned to provide superior dividend growth in the future. It is the balance of investing relatively larger amounts of capital at higher returns that underlies our succes in generating above-average growth in earnings, which have allowed for higher-than-average dividend growth over the longer term.

The graphic on Slide 19 contrasts capital expending and return on equity for 43 gas distribution, electric and combination utility companies. As you can see, Chesapeake is one of the few companies in the upper right-hand high-return, high-investment quadrant. We believe that this has driven our past success, and we will execute our strategic plan with the goal of maintaining this position.

Slide 20 shows our investment proposition. We have engaged employees who are focused on cultivating profitable growth. They build our portfolio of strong, efficient utility and energy businesses and our strong balance sheet. They create new opportunities for growth in areas we know, using skills we possess. We believe this formula will continue to position us to deliver superior earnings growth, dividend growth and total return to our shareholders.

Slide 21 compares how we're doing in delivering value relative to our peers. I am proud to say that our employees have delivered top-quartile performance in 13 out of the 15 categories shown. We are working hard to continue to improve our performance.

Let me close by saying this. From where I sit, I think our future looks brighter today than ever. We have a tremendous about opportunities that we are working and some substantial opportunities that will be developed, some sooner, some later. As we have grown over the last 5 years, we have also strengthened our team on the Delmarva, in Florida and elsewhere. We have more work to do, but our future looks bright.

Thank you for joining our call today, and for taking interest in and/or being a shareholder of Chesapeake Utilities. We are proud of what our team has accomplished for shareholders in the past and are committed to maximize return going forward. We will now be happy take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Spencer Joyce from Hilliard Lyons.

Spencer E. Joyce - Hilliard Lyons, Research Division

Beth, maybe first question for you here. I just wants to make sure I heard you currently in your prepared remarks. You mentioned that you all do expect to access the capital markets within the next year?

Beth W. Cooper

Yes.

Spencer E. Joyce - Hilliard Lyons, Research Division

And would this -- I mean, this is debt plus equity. I mean, both would fall under that umbrella. Can we see something similar to the forward debt deals that you all announced, I want say, about a year ago, you took it down December or May, or is this targeted really more towards the equity side?

Beth W. Cooper

Well, right now, Spencer, our balance sheet, we're still sitting at around 58% -- 57%, 58% in terms of equity to total capitalization. But with the forecasted CapEx spending that we talked about, again, we do forecast that some of that is going to fall into next year. That would necessitate, if we're going to maintain our target capital structure, that we would be -- we would be accessing the equity markets at some point. But keep in mind, which I know, and you know we talked about this during some of our meetings with you for larger projects or initiatives that we undertake. When we're looking at them from a financial perspective, what we're looking at is that those projects are going to meet or exceed our target returns. We're looking at those to be either earnings neutral or slightly accretive coming out of the box, and we're always looking at those projects with our target capital structure in mind.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Absolutely. I know -- I see the updated forecast here, 140-plus on the CapEx side for '14. Do you have anything either in the queue or did I maybe miss a comment on what we might be able to expect in 2015? And then I guess, also if there's not a number, maybe you can talk about any projects that would or would not repeat, that could cause delta count of either way?

Beth W. Cooper

At this time, we have not -- we've not put anything out there in regards to our 2015 projections. I think with some of Mike's comments, I think what we're trying to relay along the way is that we are aggressively looking at a lot of projects, both within and beyond our current service territories. And I think our hope is that some of these projects will come to fruition and we'll be able to come out with some disclosures around them.

Michael P. McMasters

Yes, I guess, Spencer, I can add. I think Beth had that right on the money. We have a pretty high standard to get the stuff in these documents and we wait until we get things buttoned up pretty tight. And so we're working hard to develop projects and to meet customers' expectations in terms of things that they're looking for from us, and when we get to the place where they -- everybody's happy, then we start looking at what's the proper release of information on those. And so -- sometimes, that's going to mean that we're a little bit delayed in getting some information out, but you can tell by the capital budget that we're pretty far along on several of the forecast and we're pretty far along on some of those opportunities.

Spencer E. Joyce - Hilliard Lyons, Research Division

Yes. That is a pretty robust spend here this year. I guess, while we're talking kind of about the big picture, here, Mike. You noted CHP and midstream opportunities just very briefly during the prepared remarks, some longer-term opportunities. And I was wondering if you could give us a little color around what the timeframe there may be? I mean, is it close enough that some of the spend, either late this year, could be a project of that type or are we talking a year plus kind of down the road there?

Michael P. McMasters

Some of that stuff is -- until there's a contract signed, really, it's hard to predict. It's really, to a large extent, up to a customer if we're ready to provide service and the price is acceptable to the customer, the question is acceptable, 1 and 2 is from their perspective, is -- do they have some interest in moving fast or slow, whatever. So it's hard to predict that, and to some degree beyond our control. I would say that, as Beth mentioned, there could be some delay in the spending. There's likely to some delay, question is how big in that spend? But we -- that is, I guess, over the next, I think you could easily say, 12 months, it's pretty likely that those dollars will be spent on a variety of projects and opportunities.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay. Sticking here with kind of the CHP midstream idea. Are you all comfortable with the current regulatory framework in the constructs in the Maryland/Delaware area to move forward with those, or is there anything in the works that may either increase or decrease your appetite for those specific types of projects?

Michael P. McMasters

Maybe I can take the -- I'm not sure it's about the [indiscernible] balance constructs, but we take CHP for example. That's a technology that makes a lot of sense, both environmentally and economically. And there are, sometimes, challenges, probably the biggest challenge with us, I think, maybe does get to the regulatory construct with what's the impact on the ultimate price of power once you figure you're connected to the grid and possibly, a distribution system -- probably, a distribution system and that can get some difficult price signals coming to the customer, the CHP customer. So that's always going to be a challenge regardless, and although there is a, I guess, a national desire to try to use more CHP. The midstream stuff, that's going to be -- you could consider Eastern Shore Natural Gas as a midstream and you can look at that things more than that too. But we are, I think, comfortable with the regulatory jurisdictions we're in, and we're pretty comfortable with several others. We've been operating at the FERC, in Florida, Delaware and Maryland for quite some time. I had some experience in Pennsylvania. So we've got some -- we've got a lot of regulatory experience in the building, and I think it's more about how you approach the regulators. You got to show them respect, listen to what they have to say and be willing to take your time to work through things with them, and again, respect their point of view. And I think you can be effective in most jurisdictions, I can't say all, but I think most jurisdictions, if you do that.

Spencer E. Joyce - Hilliard Lyons, Research Division

Okay, fair enough there, and I probably should targeted that question a little more towards the CHP side. I guess, a couple of other companies we follow that have some CHP exposure have had some differing views about the particular tax structure and some of the incentives around those projects. But I think you addressed it kind of well enough there.

Operator

[Operator Instructions] There are no further questions at this time. I turn the call back over to Mike McMasters.

Michael P. McMasters

Well, I just want to thank everyone, again, for your time and in your interest in Chesapeake. And We look forward to talking to you next quarter, and have a nice weekend. Thank you.

Beth W. Cooper

Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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