ITC Holdings Corp. (NYSE:ITC)
Annual EEI Financial Conference Call
November 8, 2011 10:30 am ET
Cameron Bready - EVP and CFO
Good morning, everyone, and welcome to ITC Holdings presentation for today. My name is Cameron Bready, Executive Vice President and Chief Financial Officer for ITC Holdings Corporation.
Today, I'd like to make a little less formal perhaps than usual. The timing for this is a little awkward in the sense that we have scheduled our Investor Day for December 5. So I don't have a tremendous amount of new information to tell you on today.
I will go through my prepared remarks relatively quickly and then leave ample time hopefully at the end for whatever questions the audience may have as relates to our business strategy, performance and outlook, be happy to cover whatever might be on your mind as relates to company.
So let me first say thank you for your interest in our company. We do very much appreciate it. I trust that everyone is having a good conference so far and is enjoying all the festivities to the extent you can. But I would like to say thank you for coming as I am the conference chair this year. We do appreciate everyone's participation and look forward to seeing you next year and many years to come.
As a reminder, when we do get to the Q&A part of the discussion, if you could please just wait for the microphone to be provided to you as we are webcasting this and I do want to ensure that the questions can be heard by the audience participating by webcast.
As I mentioned before, my comments today will be fairly brief, but I will just quickly run through the materials we have put together and just make sure everybody has a good understanding of who ITC is and how we think about our business, our strategy and our outlook.
So first of all, we are the only pure play, fully regulated, independent transmission publicly-traded entity in the country. And we think our transmission-only business model provides us a number of advantages.
First and foremost, we have a single regulator as it relates to the economics of the business, and we believe that's attractive from an investor perspective, because you don't have to keep track of what state regulator acts are in a particular state day-in and day-out. You have one regulator. That's FERC as it relates to the economics of the business.
FERC policy doesn't tend to shift dramatically day-in and day-out. So in terms of understanding our business and understanding the regulatory climate for our business from an investor perspective, we think it's a pretty attractive opportunity to have a single regulated entity like ourselves that has the diversity of asset based opportunity that we do.
We do have and do benefit from a FERC policy environment that continues to incentivize transmission investment in U.S. I'll talk a little bit more about why that is in a few moments. But certainly as it relates to the returns we're able to achieve out of this business, the regulatory construct that we have as being a transmission-only utility, we believe provides a very attractive platform to create value for shareholders. Well investing in transmission infrastructure that provides tremendous benefits to customers.
Our business model is really relatively straightforward. We have existing utility operating companies that we manage. And we have a development platform that we have established over the course of the last, call it, five years that looks to find opportunities for us to extend our infrastructure, our capabilities into new markets and through new opportunities to invest in transmission infrastructure.
And this might be large regional transmission projects that span multiple states or numbers of miles within a state. And in other markets, this may be participating in the build-out of new reliability projects, smaller activities where there is a need or where there hasn't been that by the other transmission owners within a particular market.
As we think about our strategy, it's relatively straightforward. First of all, we are first and foremost an operator of transmission systems. We own about 15,000 miles of transmission assets today. We operate in five different states, and we serve about 25,000 megawatts of peak loads. We have a relatively large transmission system depending on how you measure us, whether it's miles or load served or net transmission PP&E. We're somewhere between the seventh and ninth largest transmission owning company in the U.S.
As it relates to our operating business, our goal is to be a best-in-class transmission provider. And those of you that have heard me present or heard me speak before, you will probably remember that I like to sort of characterize this as we only do transmission so we better be good at it. And from an operations perspective, our goal is to be a best-in-class transmission provider.
We think by disaggregating transmission our of vertically-integrated utility, you get more focus on transmission investment, you get better operating protocols, you get better maintenance for the calls; and overall, you get better performance out of the transmission system.
So as we think about our operating companies, our goal is to be best-in-class. And that's across our maintenance practices, reliability, performance or able to garner from the system, safety for our employees as well as ultimately the financial rewards that our shareholders are able to achieve from those investments.
And then secondly, we leverage that platform we have as an owner and operator of transmission systems with all core capabilities that we have around designing, engineering, constructing, operating, transmission assets, compliance with various rules and regulations. We have leveraged that platform through our development channel to seek new opportunities to invest in new transmission infrastructure in markets that we find attractive.
As it relates to the broad outlook for transmission investment, why do we like this business, why are we solely focused on transmission, one of the principal reasons is that the outlook for transmission investment in the U.S. remains quite strong. We are at the heels of probably a two or three decade period of underinvestment in the transmission system by and large. And there has been much more focus over the course of the last 30 to 40 years on investing in generation assets and distribution assets and all types of other activities that utilities found themselves engaging in over the course of time.
But transmission clearly wasn't a focus of transmission investment. And it really took the blackout of 2003 to sort of highlight to some degree the lack of investment that has been made in transmission and how fragile the existing transmission infrastructure we have in the U.S.
So as it relates to the fundamental premise that supports transmission investment, we believe we are at the prepuces of years of significant transmission investment opportunity as it relates to a number of different things. One is it's simply investing in the underlying transmission assets we have today to replace aging infrastructure and to improve the reliability of the system we have today.
Two, it's ultimately investing in a 21st century transmission system that is planned, designed and engineered on more of a regional basis. If you think about how transmission investment occurred over the course of time, there was each individual integrated utility investing in the transmission that they needed to move power from their generating resources to serve their load. There has been very little design of the system on a regional basis. There has been very little focus on enhancing the competitive nature of markets through transmission investment. And there is very little what I'd characterize as more a tops-down approach to transmission investing as opposed to a bottoms-up. And that's where we're evolving to today.
If you overlay the transmission system we have in the U.S. against either the natural gas pipeline system, the national highway system, what you see is there is a huge disconnect in terms of the way we've invested in transmission and the way we've developed our transmission platform vis-à-vis what has happened in the natural gas space or how the national highway system was developed over the course of time. And we're working to change that.
And then lastly, there is going to be tremendous opportunities as we see it to invest in transmission as we further our efforts in the U.S. to diversify our generating fleet and begin to turn over the generating fleet that really largely supports the power needs of the nation today.
If you look at power generation, power consumption in the U.S., about 50% of the power we consume comes from coal generating resources. On average, those plants are more than 30 years old and some of them are frankly going to become either uneconomic or incapable of meeting new environmental standards on an economic basis going forward.
So as we continue to see more renewable penetration, we continue to see environmental standards become more stressed or stringent. So we continue to see a renewed focus on perhaps gas being the fuel of choice for the future and nuclear what was originally premised to be a renaissance now is probably on hiatus after the Fukushima disaster.
Regardless of what fuel becomes the fuel of choice or what fuels pool become the fuel of choice in the future, having a robust transmission system that efficiently moves power from generating resources to load will be critical. Regardless of what we choose, I think the old model of building generations resources in city near load is probably a thing of the past. There is going to be much more focus on building generation where fuel sources are located or remote from load centers and moving that power efficiently to serve load through a robust, well-planned, regionally-planned transmission system.
As we think about what those opportunities ultimately mean to us, we're very focused on two principle regions as it relates to our transmission development platform. And there is really a couple of reasons that we're focused on these two regions.
The first region is what we call our North Central region. The North Central region is one that we find particularly attractive, because one: they have a recognize need for transmission planning, and the North Central region by the way is really what we would characterize as MISO and some of the adjacent stage. That will recognize me for transmission investment. They have progressed more current regulatory policies to support planning and the cost allocation of new transmission investment.
We have a strategic footprint in that market that causes us to feel like we can be successful with our development platform. So in MISO, we have the largest TO or transmission owner. We feel like we are well positioned from a competitive dynamic in that particular market. And that market has been very progressive and promoting new rules, regulations for the planning and cost allocation in new transmission facilities.
Very similarly, the SCP region or what we call our South Central region from a development perspective also has key attributes that we think we need to be successful in those markets. Again, there is a recognized need for transmission investment. They have promoted progressive cost allocation and planning principles to allow that need to be filled over the course of time.
And three, we have relationships, partnerships and a developing footprint in that market that causes us to feel as if we can be successful ultimately in our participation in that market. Those two markets, if we think back to where is FERC driving regulatory policy, FERC is promoting more regional planning. FERC is promoting more progressive cost allocation principles that allow the cost in new regional transmission investment to be borne by those that ultimately benefit from that investment.
We have seen SCP and MISO really be at the forefront of that movement. And national policy is now somewhat catching up with what MISO and SCP have been trying to accomplish now over the course of the last several years. So we find these markets particularly attractive, because they are at the forefront of this movement in the U.S. to develop more regional transmission, to plan for the grid in a more efficient manner and to provide the right cost allocation and cost recovery vehicles to allow transmission investors like ourselves to feel confident that we can make the investments in the grid and recover those costs from the customers who ultimately benefit from those investments.
Looking forward to the financial model that we have as a business, as I mentioned in my opening comments, we are a transmission-only utility. We are a fully cost of service regulated business like any other regulated utility would be. We have a few specific attributes to our model that frankly provide from our perspective what we would characterize as a superior regulatory construct. And they are really very simple at the end of day.
But they all work in harmony to create a very powerful and efficient model as it relates to transmission investment and insuring that our shareholders are rewarded appropriately for those investments in our transmission assets.
First of all, we have all formula base rates. And that essentially means that we don't have to go through annual rate case processes at the state level to reset our rates or to change our rates. Our rates get reset annually, automatically based on formula-based tariffs that are approved by FERC. So once those formulas are established, we provide new inputs to those formulas each year and we post our new rates that reflect the new inputs each year.
The formulas are also forward-looking. So in terms of rate lag and the issues that a lot of utilities experience around rate lag, because they're always based on historical test years or very limited forward-looking information, all of our rates are set based on projection for the future year. And we project forward our O&M expenses, our R&D expenses, our capital expenses. We project forward an average rate base for the period. We project forward our financing costs and we project forward load to produce an expected rate.
And then that tariff mechanism also has a true-up mechanism. So that at the end of each year, we measure the actual revenue we brought in the door through our forecasted rates. We compare that against our revenue requirements, and any difference either under-recovery or over-recovery, we get the collective rates in the future period. So that really mitigates for us and essentially eliminates for us the whole risk of timely recovery of our return and other non-capital and it really eliminates the under-recovery risk that a lot of utilities face particularly at the state level.
At the operating company level, we are capitalized based on FERC-approved capital structures that keep us on equity and 40% debt. And then we incorporate some level of holding company leverage on top of that of fund a portion of the equity requirements in the business, not unlike any typical utility holding company.
We're able to get a little more out of that, because we have chosen to be a transmission-only utility and we have only formula base rate. So we don't have the same regulatory construct that a lot of state utilities have. And as a result of that, one of the benefits we get from foregoing other investment opportunities outside of transmission is that we have a very pure model.
One of the things our models affords us the luxury of doing is being able to make capital investments in our system efficiently, to capitalize those very effectively going forward, be able to grow the business that pays us more rapid perhaps another typical utilities, while also rewarding our shareholders currently with the dividend.
We do anticipate continuing to grow the dividend as we continue to grow our business, and I'll talk a little bit more about that growth in a moment. But that is an important aspect to how we think about kind of returning capital to shareholders as to our dividend.
Our yield is obviously relatively compared to typical utilities largely because the growth prospects of the business remain quite robust. And our focus is balancing, efficiently and effectively capitalize in the growth prospects that we see for the business with a dividend policy that reflects that we have a significant need for capital investment in the business over time.
If you look at our growth prospects for the company over the course of the 2011 to 2015 time period, we envision investing about $3.9 billion of new capital investment in our business. And this is on a rate base that is comprised today of roughly about $2.7 billion, $2.8 billion. So essentially doubling our rate base over the cost of the next five years is through our transmission investment. That yield is earnings per share growth in the range of 15% to 17% over that time period on a compound annual basis.
So again, from our perspective, very visible, very attractive growth proposition that we feel we'll be able to deliver over this next five years and feel confident in our capabilities to do that.
As I mentioned before, that $3.9 billion, the capital plan, will result in rate base that grows to about $5 billion at the end of 2015 to go successful in investing in that total capital investment plan of about $3.9 billion.
So in the interest of gravity, I'll wrap up and leave ample opportunities for questions from the audience. But let me just conclude by saying: number one, we as a management team at ITC put up a tremendously high premium on our performance as a company as it relates to how we provide reliable service to our customers and the bargain that our customers are getting for the incentives that are in place today for us to invest in transmission.
We also put a tremendously high premium on meeting the commitments that we set with all the investment community and our shareholders as it relates to the financial performance and operational performance of the business. And I think we have a tremendously good track record on that front.
We are well on track to meet our 2011 targets from both an EPS perspective and a capital investment perspective and we remain very much confident and on track as it relates to our overall five-year plan. Again, that's comprised of investing about $3.9 billion of new capital investments in our business, driving compound annual growth and earnings per share in that range of 15% to 17%, as well as growing our dividend as we move through that period at a pace that probably doesn't meet the same earnings growth pace, but certainly a pace that more than compensates for inflation as we move through the course of time.
The beauty of all this end of day is the entire plan that we have in vision in front of us can be capitalized without the need for fresh new incremental equity. So because of the efficiency of the model, we were able to capitalize the entire plan that we have, which over this five years, the total capital need for the business are about $5 billion.
We can capitalize about $2.4 billion of that through cash flow that we generate in the business and the balance can be funded through new debt, both long-term debt issuances as well as revolving credit facility. So the entire $3.9 billion capital plan with 15% to 17% compound annual growth and earnings per share that comes along with that can be capitalized without any equity issuances.
So with that, I will conclude and open up for questions from the audience.
When you talk about capitalization over new debt, do you have any plans to issue it and can you tell us what specific entities may be for the next year?
We do have new debt needs in 2012. We're pretty well satisfied on our entire financial calendar for 2011. For 2012, we'll have new debt needs at, at least two of our operating companies, potentially three. ITC Midwest will need new financing in '12. METC will need new financing in '12. And potentially, we may look to do some long-term financing for our ITC Great Plains subsidiary in 2012 as well depending on the timing of bringing our construction projects into service. We'll also need new financing at ITC Holdings in 2012 as well to continue to support the capital needs of the business.
I can't get too specific as it relates to the amount for each of those operating companies and for the holding company in '12, but the calendar for 2012 is fairly full as it relates to needs of the operating company and the holding company.
If we look forward to '13, the need is fairly significant. We have for the first time a couple of relatively sizable maturities that we need to manage, one at ITC Transmission for about $185 million and one at ITC Holdings for about $267 million. On top of those refinancing, we'll have new need for capital at each of those entities as well. So I expect 2013 to be a fairly heavy year for us as it relates for new debt issuances on top of 2012.
Recently in Massachusetts, perhaps in Ohio, there were some movements or activities towards moving to lower ROEs for transmissions. What would you have to say about that?
We have obviously been following that issue. It is one that certainly has gotten a lot of attention. We have a number of perspectives on it. But I'll try to be brief. One is when FERC established its transmission ROE, they look at it for the long term by the very nature. And part of the reason that FERC has utilized this zone of reasonableness methodology in sort of establishing rates is to suggest that there is no pinpoint answer.
And I think it's also to suggest that just because cost of capital changes everyday, every month, every year, it doesn't mean that we need to have processes that allow for every fluctuation to be reflected currently in new rates.
I think as it relates to the Massachusetts in particular, there was a complaint filed at FERC that suggested that the transmission ROE for the New England transmission owners is too high and that rate to be brought down.
I think one of the important factors to remember as it relates to the FERC construct is that the burden approved is on the complainant to demonstrate that the resulting rates or the rates that result from this ROE are unjust and unreasonable. And that's a very high hurdle from our perspective. The question or the operative question in this Massachusetts issue is not whether the rate should be 11 or 10 or 12 or 9. The question is the rate that is established or has been established is that unjust and unreasonable.
And I feel as if in an environment where new applicants have been able to demonstrate zones of reasonableness that are sort of 14%, 15%, I have a hard time envisioning that FERC is going to rule that in this environment that those rates are unjust and unreasonable.
FERC I think has a better appreciation for the fact that notwithstanding the fact tenure is that historically low levels from a treasury perspective. The cost of risk capital has actually increased over the course of time, not decreased. And I think one of the things the applicants or the respondents were able to doing in New England is paint a little better picture around the cost of risk capital actually has increased despite the quality as opposed to the cost of risk capital being lower as a result of the fact that you have an abnormally low tenure.
So all in, what does that mean? It means that I don't believe end of day that FERC is going to reset ROEs for historically-granted ROEs for people that have made transmission investments, for which there is a capital structure supporting those transmission investments. To the extent that you were to go and ask for a new rate today, well, I think that's a different issue. New rates we are seeing, the sort of zone of reasonableness perhaps being wider, but at the same time, the midpoints of those zones have been perhaps a little lower than what we've seen historically.
But as it relates to existing ROEs, I don't see a tremendous amount of risk that those are going to get rebased by FERC. I think FERC is going to say they are within a zone of reasonableness and it's hard to conclude as a result of that that they are unjust and unreasonable and there is no basis to burden approved hasn't been that that the resulting rates from those ROEs are unjust and unreasonable.
So I feel generally comfortable with where we are. I feel comfortable in demonstrating that our ROEs are still within a zone of reasonableness. And consequently, I think we are comfortable in concluding and being able to demonstrate that they not unjust and unreasonable. I hope that addresses the question.
I'd thank you again very much for your interest in our story and our company, and I hope everyone enjoys the rest of their conference. And I'll be available to answer some individual questions for the next few minutes if anyone has any? Thank you and I hope everyone has a great day.