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Questar (NYSE:STR)

Q1 2011 Earnings Call

April 27, 2011 9:30 am ET

Executives

R. Bradley - Executive Vice President, Chief Executive Officer of Questar Pipeline Company and President of Questar Pipeline Company

James Livsey - Executive Vice President and General Manager of Wexpro Company

Ronald Jibson - Chief Executive Officer, President, Director, Chief Executive Officer of Questar Gas Company and President of Questar Gas Company

Craig Wagstaff - Senior Vice President

Kevin Hadlock - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Michael Bates

Carl Kirst - BMO Capital Markets U.S.

Stephen Maresca - Morgan Stanley

Operator

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to Questar Corporation First Quarter 2011 Earnings Release Conference Call. [Operator Instructions] I would now like to introduce Mr. Kevin Hadlock. Please go ahead, sir.

Kevin Hadlock

Thank you, Michelle. Good morning, everyone. And thank you for joining us for Questar's First Quarter 2011 Earnings Conference Call. I am Kevin Hadlock, Questar's Chief Financial Officer. With me today are Ron Jibson, President and CEO of Questar Corporation; Jim Livsey, Executive Vice President of Wexpro; Allan Bradley, CEO of Questar Pipeline; and Craig Wagstaff, Senior Vice President of Questar Gas.

Before we begin, let me remind you that we will be making forward-looking statements during our call today, and actual results could differ from our estimates for a variety of reasons that we described in our SEC filings. Also this call may reference non-GAAP financial measures. Our earnings release provides reconciliations to these measures.

Yesterday, we reported first quarter earnings results and affirmed our 2011 earnings guidance range of $1.07 to $1.11 per diluted share. Questar's first quarter earnings from continuing operations totaled $69.9 million or $0.39 per diluted share compared to first quarter of 2010 results of $72.2 million or $0.41 per diluted share. Wexpro, our cost of service natural gas development company, grew net income to $22.3 million, an increase of 5% from the first quarter of 2010. Additionally, Wexpro generated about $51 million of EBITDA in the first quarter and increased its investment base to about $445 million or a year-over-year increase of more than 4%. First quarter net income attributable to Questar Pipeline, our Interstate Natural Gas Pipeline and Storage business, was $15.3 million, down from $17.2 million in the first quarter of 2010. Transportation revenues increased with the completion of the Overthrust Loop Expansion in March 2011. Pipeline's slightly higher transportation revenues were partially offset by lower revenues from natural gas liquids or NGLs. Overall, Pipeline's earnings were down primarily due to higher operating and maintenance costs and increased general and administrative expenses. Questar Gas, our retail gas distribution utility, reported first quarter 2011 earnings of $33.4 million, up 1% from the first quarter of 2010 and generated over $71 million of EBITDA. Questar Gas benefited in the first quarter from an increase in new customer connection, added revenue from the infrastructure cost tracker and higher margin associated with the Utah general rate increase that went into effect in August 2010.

With regard to cost, Questar's first quarter 2011 general and administrative expense totaled $33 million compared to $26 million in the same period last year. This increase was primarily the result of increased employee transition costs and higher share base compensation expenses. Excluding Questar Gas' demand-side management costs, which are pass-through dollar-for-dollar in rates, the corporation's consolidated operating and maintenance expense totaled $35 million in the first quarter of 2011, about $1 million higher than the same period last year. Production and other taxes declined at 7% for the quarter, consistent with the decline in the taxable value of natural gas. Production taxes are recovered in Wexpro's cost of service under the Wexpro agreement.

Depreciation expense in the first quarter of 2011 rose 1% versus the same period in 2010 driven by continuing capital investments. Capital expenditures totaled $76 million in the first quarter of 2011. Of that amount, Wexpro accounted for $24 million, Questar Pipeline invested $26 million and Questar Gas also spent $26 million.

We experienced strong cash flow in the first quarter of 2011. Cash flow from continuing operations before working capital changes totaled $146 million, a 25% increase over the first quarter of last year. Cash used in continuing operations for the first quarter of 2011 was approximately $22 million, which included a reduction in short-term debt of $156 million.

Questar maintains a strong balance sheet, which supports our A- corporate credit rating from S&P and A3 senior unsecured rating from Moody's. Consolidated debt to capital finished the quarter at 52%.

The company also maintains sufficient liquidity to meet the growing needs of our businesses. At March 31, 2011, we had $86 million of commercial paper outstanding. We expect continued strong cash flow to result in paying down commercial paper balances to near 0 during the second quarter of this year, which is the seasonal low point of our working capital needs. Commercial paper balances will begin to grow again as we approach the fall gas injection and heating season. Our commercial paper program is currently supported by $600 million of committed bank credit line. At the end of the second quarter, the $250 million, 364-day credit facility will mature. Currently, we do not plan to renew this facility and believe the $350 million facility maturing in 2013 will be sufficient to manage the liquidity needs of the company.

As you recall in December 2010, Questar Corporation issued $250 million of 2.75% notes that mature in 2016 to replace short-term debt issued to fund the equity infusion in QEP Resources just prior to the spinoff. Given the current and anticipated strong cash flow position of the company, we are expecting lower floating rate commercial paper balances in the coming years. To take advantage of today's low interest rates and steep yield curve, Questar executed a fixed-to-floating interest rate swap on $125 million of Questar parent company debt. We estimate that this transaction could reduce 2011 interest expense by up to $2 million depending on short-term interest rate fluctuations. Lastly, Questar Pipeline has debt maturities of approximately $180 million in 2011. We expect to refinance these maturities in the capital markets during the third quarter of this year. With that, I'll turn it over to our President and CEO, Ron Jibson, to discuss operations results and Questar's outlook.

Ronald Jibson

Good morning, everyone. And thanks, Kevin, for that summary. As always, we appreciate all of you joining us today. I'll comment briefly on our first quarter results and update our outlook for the remainder of 2011 and beyond. We've come through the first quarter of 2011 in good shape and have enjoyed visiting with many of you over the past 9 months about the newly rebalanced and refocused Questar and our unique integrated mix of natural gas businesses. As one analyst recently wrote, the new Questar is the old Questar, meaning that the company looks much like it did 10 to 15 years ago before the exploration and production arm began its rapid growth. But it also means that the new Questar continues to provide the same long-standing tradition of creating strong value for our shareholders. We'll continue to be on the road often this year answering your questions about what we believe is the most compelling investment opportunity in our space. We are on track to meet our earnings guidance this year of between $1.07 and $1.11 per diluted share. Our 3 businesses, Wexpro, Questar Pipeline and Questar Gas, should generate $192 million to $200 million of net income this year from continuing operations. We anticipate strong cash flows of between $520 million and $535 million of EBITDA and expect to earn about 17% to 18% return on our average common equity. We then cap our story with strong dividend growth evidenced by the 2 recent increases of almost 8% last August and 9% last month. Our projections are to continue to grow future dividends by 5% to 10% annually.

Let's review individual business unit results and forward projections starting with Wexpro, our most distinctive and unique competitive advantage. Wexpro earned a 20.3% after-tax unlevered return on its investment base for the 12 months ended March 31. Largely due to drilling efficiencies and lower finding costs during the first quarter, we have recently increased Wexpro's 2011 capital budget to $108 million, up from our previous capital budget of $100 million. Wexpro's average investment base for 2011 is now forecast $458 million compared to $444 million in 2010. The growth of Wexpro's investment base is impacted by bonus depreciation, which increases deferred taxes used in the calculation of the investment base. That said, even with 100% bonus depreciation in 2011, we estimate that the announced $8 million of incremental spending by Wexpro, we'll still grow the investment base by about $4.5 million, assuming successful development drilling. Wexpro is unique in the industry. The company develops natural gas and oil on a defined set of producing properties in the Rockies and earns an approximate 20% after-tax unlevered return on its net investment base. The natural gas produced from these properties is delivered to our utility, Questar Gas, at a cost of service that includes the 20% return. So while Wexpro's operations are similar to those of an E&P company, its economic model is much like that of a regulated utility noted for its stable and predictable earnings and cash flow, but without the need for rate cases. Over the past 12 months, Wexpro produced 50 billion cubic feet of natural gas, about 1/2 of Questar Gas' annual supply requirement. We continue to expect that Wexpro will invest between $500 million and $700 million over the next 5 years in our low-cost and low-risk development drilling program.

This outlook, based on Wexpro's expected cost competitiveness, versus today's natural gas forward pricing curve. Currently the forward curve indicates that Wexpro's cost of service gas will be increasingly competitive with market prices, especially as Wexpro’s finding and development costs are further reduced. Wexpro's current focus on our lowest-cost development plays in the Vermillion Basin and Powder Wash has resulted in finding costs that average less than $1 per Mcfe for recently completed wells in those areas.

Turning next to Questar Pipeline, our Natural Gas Transportation and Storage business. Questar Pipeline earned an 11.4% return on equity for the 12 months ended March 31. Questar Pipeline's processing activities continue to benefit from strong NGL pricing in the first 3 months of this year. The lower volumes reduced total NGL revenues by about $500,000. This decline in NGL revenues was more than offset by growing transportation revenues. In March, Questar Pipeline completed and put into service our Overthrust Loop Expansion project. This is a 43-mile, 36-inch diameter pipeline loop west of Rock Springs, Wyoming. This project is underwritten by long-term contracts to move gas west for delivery initially to Kern River Pipeline and ultimately to Ruby Pipeline, which is currently under construction. The Overthrust project, originally budgeted at $99 million, was completed on time and under budget resulting in a return on equity of about 12.9%. It also has additional unsubscribed capacity of approximately 300,000 decatherms per day that can be contracted in the future. The completion of Ruby Pipeline later this year could stimulate the demand for this excess capacity.

For 2011, Questar Pipeline's capital budget is about $105 million. We expect the company to generate positive cash flows before dividends of about $50 million this year and could generate cash flows in excess of capital requirements of about $350 million through 2015. These strong cash flows enable internal financing of projects across the Questar family of companies and support annual dividend growth.

Finally, turning to our gas utility, Questar Gas earned a 10.2% return on average equity for the 12 months ended March 31, 2011. We continue to benefit from above-average customer growth in our service area and added over 10,000 customers during the past 12 months, a 1.1% increase. This growth added over $1 million of incremental margin in the quarter. Effective August 1, 2010, Questar Gas' allowed return on equity in Utah increased from 10% to 10.35% in a rate case settlement that extended our revenue decoupling tariff indefinitely. Also approved by the Utah Public Service Commission was an infrastructure-cost tracker that allows us to earn on our multi-year, high-pressure pipeline replacement program as we place the new facilities into service. This cost tracker is extremely important for Questar Gas, for our customers and our shareholders. Everyone benefits as necessary improvements are made to the distribution system without costly and unnecessary rate proceedings. This large-diameter, high-pressure pipeline replacement program also continues our commitment to our customers and shareholders in our efforts to lower our risk profile by replacing the older pipe in our system. We continue our tradition of pipeline safety. In the 1980s, we replaced all cast-iron pipe. The very [ph] steel pipe was replaced during the 90s. And now we're investing about $45 million per year to replace our reconditioned steel pipe. Combined with the continuous strong customer growth outlook, this could drive 8% to 9% annual growth in Questar Gas's rate base through 2015. Questar Gas' approved capital budget, including the pipeline investment, is expected to be $132 million in 2011. Questar Gas continues to lead the nation in developing and improving natural gas vehicle fueling infrastructure. Over the past 18 months, we've substantially increased our capacity to refuel NGVs. Utah made a public policy decision to support NGVs nearly 3 decades ago. Questar Gas remains committed to support natural gas vehicles as a viable solution to air quality and energy dependence challenges.

To summarize, we affirm prior guidance of $1.07 to $1.11 per diluted share and remain confident we can hit this target despite anticipated impacts of higher interest expense, 100% bonus depreciation and lower NGL revenues. Wexpro is on track to grow investment base 4% to 8% annually through 2015. Questar Gas is expected to grow a rate base 8% to 9% annually. And our pipeline-replacement tracker will allow cost and return recovery without regulatory lag. Questar Pipeline looks to generate strong cash flows in excess of capital requirements that will help fund company-wide capital projects and support our 5% to 10% annual dividend growth strategy. As I've said at the start, Questar is unique. Still it's all about execution, and we have the balance sheet, the assets and experienced people to execute and deliver. Our integrated businesses provide what value-driven investors want most, stable high returns and strong cash flow to support a growing dividend and investment growth opportunities. And with that, Michelle, let's open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Stephen Maresca from Morgan Stanley.

Stephen Maresca - Morgan Stanley

First question is on the NGL sales decreases. Just how come, and I guess, what do you think the outlook is there, you mentioned, I guess, a third-party processing plant, hurt your sales in the quarter? Could you talk about that? What do you think going forward?

Ronald Jibson

Great question. I'm going to ask Allan Bradley, our Pipeline President, if he would cover that.

R. Bradley

Thanks, Stephen. The processing plant really is a new cryogenic plant. Obviously, with the current frac spread, it's able to extract more ethane out of the gas stream. It's in Uinta Basin. It’s actually a QEP field services Iron Horse plant. There's also the Chipeta plant, which is Anadarko's plant down there. They're both on now, and as a result, we are seeing less liquids in our southern system to process downstream in our Price Raptor plant, so we feel that's a permanent decline. Last year, we were probably extracting about 550 barrels a day. Now we are between 250 and 300 barrels a day, so that's going to be a permanent reduction we feel going forward.

Stephen Maresca - Morgan Stanley

And then you talked about the completion of Overthrust and the firm transportation of 325,000 decatherms a day, but you have additional unsubscribed of 300,000 decatherms a day that could be utilized when Ruby comes on. What is that opportunity there? How would that be utilized with Ruby coming online? How does that give you guys an opportunity? And how quickly could that be executed on?

R. Bradley

That's a great question, Stephen. Let me just back you up. Initially, we started with new interconnect to the WIC facilities out at Wamsutter. So in 2010, we were actually moving 160,000 decatherms a day. Those were early deliveries to Kern River that Ron spoke about. Then in March, we picked up the 325,000 decatherms, which were additive. Again, those volumes are going to Kern River until Ruby is completed. Like everyone else, we read the Ruby press releases. They're still targeting July of this year. So the remaining 63,000 decatherms a day come on in 2015 for a total contracted volume of 548,000 decatherms a day. So on top of that, we have the capability to move an additional 200,000 decatherms to Ruby at Opal and additional 100,000 decatherms a day east to Wamsutter in support of either WIC Cheyenne Plains or Rockies Express. The economics that Ron quoted were based on the current contracted volume, so obviously as this market starts to evolve and we're able to market that 300,000 decatherms a day, that obviously improves the overall project economics. Looking at how that will play, I was intrigued by FERC's new order authorizing more seasonal rates for the interruptible capacity that Ruby has. I think that will obviously incentivize hopefully some additional short-term volume and Overthrust to take advantage of that. At the moment, interest in long-term capacity by Rockies producers has [indiscernible] given the low prices, the decline in drilling operations in the Rockies. So in terms of early long-term contract commitments, probably not as optimistic that they'll materialize the day Ruby comes on. Those markets are going to have to show some growth, and production's going to have to increase as well in these key Rockies spaces.

Stephen Maresca - Morgan Stanley

Okay, thank you very much for the color. And last quick one. You've talked about targeting 5% to 10% dividend growth, and you've been closer to the high end of that. Given what you're seeing cash flow-wise for the company and growth opportunities, is that something that you think you can handle for the next couple of years staying at the higher end of that range?

Ronald Jibson

We certainly do, Stephen. I think we came out with that projection back in June last year. Certainly, the results in August and then again in February of another 9%, that was driven down by additional cash flows that bonus depreciation helped create. And we feel very confident that we can continue with that projection. We've talked about driving dividend to the 60% payout level and 5% to 10% is certainly something that we are very focused on, and our board is very focused on going forward.

Operator

Your next question comes from Carl Kirst from BMO Capital.

Carl Kirst - BMO Capital Markets U.S.

Just a couple of questions. First, just on the gas utility and, Kevin, you had mentioned that the consolidated G&A increase and you have -- I guess, the cost per meter was a little bit higher than we were thinking. You mentioned this, sort of, transition cost employee benefit. Is that something that has set a new baseline and will grow from here? Or has that been something maybe that blipped higher and we may see a trend back down?

Ronald Jibson

Yes, that's a very good question, and we appreciate it, Carl. I'm going to ask Kevin if he’ll just kind of drill down on those costs. I think we got some good explanation for that.

Kevin Hadlock

Sure. Thanks, Carl. Certainly, post-spin, our cost structure is higher as we were allocating costs across a larger base. In the first quarter, we did see some onetime costs, the nature of employee transition and share-based compensation costs that were higher that we do see as onetime. As we go forward, I'd expect in second quarter, we would see a higher cost relative to the prior year. But as we hit the third quarter, those costs should normalize when we compare those to the prior year. So I think overall, we know where those costs are, especially related to post-spin, and we're aggressively looking at opportunities to reduce those costs. And we'll -- it is clearly a focus for us this year.

Carl Kirst - BMO Capital Markets U.S.

In sort of absolute terms, could you kind of quantify what you think those closer to non-recurring items might be as far as in aggregate? Is it $1 million or $5 million or...

Kevin Hadlock

Yes, the onetime cost, if you see the increase of about $7 million year-over-year, the increase costs were about -- the onetime costs was about 1/3 of that number.

Carl Kirst - BMO Capital Markets U.S.

Great. Okay. Very, very helpful. I appreciate the color. And then if I could just switch to Wexpro. So some of the costs or lower F&D we're seeing in the Vermillion, I guess -- I know Powder Wash was mentioned, as well, but I guess I'm harping back to the Vermillion of 2 to 3 years ago that didn't really work unless we had $7 gas. What is that exactly? I mean, kind of, what success are we seeing there that's different from several years back? And is this -- are we -- the money that is being spent now, the increase in the CapEx at Wexpro, is that actually backing out some Pinedale production or Pinedale activity or are we just now incrementally spending more in these other fields?

Ronald Jibson

As you know, Carl, we moved rigs from the Moxa Arch area into the Vermillion to take advantage of the low-cost commodity prices. And we have seen tremendous success there. I'm going to ask Jim Livsey if he'll give some additional color on what he's seeing there in Vermillion and also why those costs are so low.

James Livsey

Yes, Carl, the main difference with our story now with Wexpro versus what we spoke of a few years ago would be this drilling we're doing is in the shallow Mesa Verne [ph] target which is 6,000 to 8,000 feet. Previously QEP, our company that was spun off, they were targeting the back and deeper [ph] objective that really required that $7 finding cost that was spoken of -- or $7 market price that was spoken of at that time. What we're going after is in the shallower Mesa that we produced from for a long time. And the good news is we see increased development with down spacing. And with continuous drilling, we're able to really drive costs down. So those are two different objectives from a geologic standpoint, and the shallower has given us the good results. With respect to the Pinedale, we still have 17 wells planned for our capital program in Pinedale. And that's operated by, again, QEP. And that isn't changing. This uptick in capital is the result of being able to drill the wells quicker. And having better results with the finding cost, it's going to allow us to drive additional capital at Wexpro.

Carl Kirst - BMO Capital Markets U.S.

Great. I appreciate the color, guys.

Operator

[Operator Instructions] Next question comes from James Bellessa from Davidson and Company.

Michael Bates

This is actually Michael Bates here with Jim. I wanted to ask a question. Are you getting any signals suggesting that there is a new gas-fired generating plant that will be built in Questar service territory that you might be the gas supplier for in the next few years or so?

Ronald Jibson

Well, we are aware of a couple of things happening that way. I know our local power company is looking at a potential new generating plant in the future. We've had some preliminary discussions with them. Certainly the trend nationwide, and we're no different here, would be to move to a lot more natural gas transmission. But we also have some local issues. Maybe, Craig, you could elaborate on some of the things we've been working on there.

Craig Wagstaff

Yes, Michael. We appreciate the question. We have been working with a company in Central Utah that we can't give a whole lot of information on. It's looking at a substantial power gen facility potentially. So we're just in initial stages of looking at location and supply and whatnot on that. So that's kind of the latest that we have at this point. That's very preliminary, and that's all we have at this point.

Ronald Jibson

Certainly, with our low cost structure and our low rates, we continue to see good opportunity for using natural gas for that generation, and we would anticipate that going forward.

Michael Bates

Sure. Any idea what the timeframe might be on these plants?

Ronald Jibson

We really can't give much more detail on that, Michael.

Michael Bates

Sure thing. All right. Thank you.

Operator

I have no further questions at this time. I turn the call back over to the presenters.

Ronald Jibson

All right. Well again, thank you very much for taking the time this morning. We appreciate it. And as always, please feel free to give us a call after this, if we can answer any question specifically for you. With that, have a nice day.

Operator

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

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