Macquarie Infrastructure Corp. (NYSE:MIC)
Q4 2015 Earnings Conference Call
February 23, 2016 8:00 AM ET
Jay Davis - Head of Investor Relations
James Hooke - Chief Executive Officer
Ian Zaffino - Oppenheimer & Co.
Jeremy Tonet - J.P. Morgan
TJ Shcultz - RBC capital markets
Sameer Rathod - Macquarie Bank
Good day, ladies and gentlemen. Welcome to the Macquarie Infrastructure Corporation Fourth Quarter and Full Year 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions]
As a reminder, this conference call may be recorded. I would now like to turn the conference over to Jay Davis, Managing Director of Investor Relations. You may begin.
Thank you, Nicole. And thank you, everyone, for joining us for Macquarie Infrastructure Corporation’s earnings conference call, this one covering the fourth quarter and full year 2015. Our call today is being webcast and is open to the media. In addition, to discussing our quarterly and annual financial performance on this call, we published a press release summarizing the results and filed a financial report on Form 10-K with the Securities and Exchange Commission. These materials were released last evening and copies may be downloaded from our website at www.macquarie.com/mic.
Before turning the proceedings over to Macquarie Infrastructure Corporation’s Chief Executive Officer, James Hooke, let me remind you that this presentation is proprietary and all rights are reserved. Any recording, rebroadcast or other use of this presentation in whole or in part without the prior written consent of Macquarie Infrastructure Corporation is prohibited.
This presentation is based on information generally available to the public and does not contain any material non-public information. The presentation has been prepared solely for information purposes and is not a solicitation of an offer to buy or sell any security or instrument. This presentation contains forward-looking statements. And we may in some cases use words that convey uncertainty of future events or outcomes to identify these forward-looking statements.
Forward-looking statements in this presentation are subject to a number of risks and uncertainties. A description of known risks that could cause our actual results to differ appears under the caption Risk Factors in our Form 10-K. Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by the forward-looking statements. Additional risks of which we are not currently aware could also cause our actual results to differ.
The forward-looking events discussed in this presentation may not occur. These forward-looking statements are made as of the date of this presentation. We undertake no obligation to publicly update or revise any forward-looking statements after the completion of this presentation whether as a result of new information, future events or otherwise, except as required by law.
With that, it is my pleasure to introduce Macquarie Infrastructure Corporation’s Chief Executive Officer, James Hooke.
Thank you, Jay, and thank you to those of you participating in our earnings conference call this morning. We appreciate you taking the time to join us for this update on the performance and prospects of MIC. There has been enormous volatility in the markets over the past few months. This has contributed to a disappointing decline in MIC’s share price. While equity markets have been volatile and unpredictable, the performance of our businesses has actually been the opposite.
For the fourth quarter, our businesses performed ahead of our expectations. For the full 2015 year, our businesses performed ahead of both our guidance and consensus. And for the first 53 days of 2016, based upon the preliminary data, our businesses have continued to perform ahead of our expectations.
We have reaffirmed the free cash flow and dividend growth guidance we initially provided one year ago for 2015 and 2016. So while the world around us is volatile and excited, MIC’s businesses have been boringly predictable, that is just the kind of unsexy business model we want.
In our results, press release and 10-K published last evening, we reported $1.18 per share in adjusted proportionately combined free cash flow for the fourth quarter; and $5.71 per share for the full year. Both figures were ahead of our expectations. You will also note from our press release, that we actually excluded approximately $0.09 per share from free cash flow in the fourth quarter and full-year results.
In the fourth quarter, we received a $6.9 million tax refund. And while this was real cash in the door, we decided to exclude it from our adjusted free cash flow per share. Had we not excluded it, we would have been in the situation where we generated $6.5 million of positive free cash flow for the year from taxes. While our tax department is good, even we don’t view it as a long-term profit center.
Now, as foreshadowed in our third quarter call there was some noise in the fourth quarter year-on-year comparison due to maintenance CapEx. Our fourth quarter results overall were a bit better than we had expected. Indeed, as a consequence of the strong performance, we elected to make certain discretionary expenditures in the fourth quarter at both IMTT and Atlantic Aviation.
We accelerated this spending into the fourth quarter of 2015, partly because we had this $6.9 million tax cash refund, but it did have an impact of reducing our fourth quarter EBITDA. And in my mind, it was money well spent. So put simply, we excluded the positive free cash flow effect of the tax refund for the quarter, but the negative effect of the extra accelerated costs reduced EBITDA and therefore free cash flow.
From a net cash out-the-door or in-the-door perspective we were slightly ahead. This was in addition to the previously disclosed acceleration of maintenance CapEx into 2015 at Atlantic Aviation, to give us even more financial flexibility in the future. The timing and amount of spending on maintenance CapEx slightly complicated our results in two ways.
First, the timing of maintenance CapEx was very different in 2015 versus 2014. Indeed, had we spent maintenance CapEx evenly in 2014 and evenly in 2015 our Q4 2015 free cash flow per share would have been up on Q4 2014 rather than down. As we put it in our press release, more than 100% of the fourth quarter decline in free cash flow per share was due to just the timing of maintenance CapEx.
The second issue is the amount of maintenance CapEx we deployed. And the amount of maintenance CapEx we deployed at Atlantic Aviation and Hawaii Gas was measurably and intentionally higher than has historically been the case. In aggregate, we spent $69 million on maintenance CapEx at MIC in 2015. In 2016, we would not expect this figure to exceed $55 million. So just to reiterate, we spent $69 million in 2015 and we would not expect 2016 to exceed $55 million.
On the basis of these results, the MIC board has authorized a dividend for the fourth quarter of 2015 of $1.15 per share. The cash dividend will be payable on March 8, 2016, to shareholders of record on March 3, 2016. The fourth quarter dividend increase was in line with the dividend increase for the third quarter.
Including the upcoming distribution, MIC will have paid out an accumulative $4.46 per share for the 2015 calendar year. That figure represents an increase over the $3.89 in cash distributions in 2014 of 14.7%, slightly ahead of our 14% guidance. Further our free cash flow per share growth was greater than the dividend growth, meaning that our dividend coverage ratio also improved in 2015.
We have elected to return to our practice of providing a single year’s guidance. However, that should not be viewed as a lack of confidence in our continued ability to grow. Rather, it’s consistent with what we had been doing each year prior to the last year, when as a result of the BEC acquisition, it was appropriate to project performance for two years to clarify for the markets we expected full year contribution from BEC.
While the underlying fourth quarter result was pleasing, the real story is the full-year result and the $5.71 per share in adjusted proportionately combined free cash flow generated. $5.71 per share represents a 17.7% increase over the free cash flow per share generated in 2014 and a result that surpassed our expectations.
The full-year result was driven by substantial increase in the contribution from Atlantic Aviation and to a lesser extent from IMTT, consistent performance by Hawaii Gas together with a slight underperformance on the part of the businesses in our Contracted Power and Energy segment.
The softness in CP&E relative to our expectations was primarily weather-related. I’ll discuss each of our businesses in turn and make a few observations on their performance in 2015, as well as on the current trading environment and what we foresee for the year ahead.
As a reminder, for those of you or for those of you who may not be familiar with our business, we both manage and capitalize our businesses with a focus on the generation of EBITDA and free cash flow. In general, you won’t hear us discuss revenue as a driver of our financial results, as changes in reported revenue reflect primarily fluctuations in the cost of energy inputs: jet fuel sold by Atlantic Aviation, heating services provided by IMTT and gas sold by Hawaii Gas, for example; not the value of the products and services provided.
Instead, we focus on gross profit as a better indicator of the top line of our businesses and an indicator of the growth in volume and/or margins. For the sake of clarity, however, MIC’s consolidated revenue increased by 21% in 2015, largely as a result of acquisitions. And this was partly offset by the decline in the cost of energy inputs related to the drop in the price of oil.
Atlantic Aviation produced another very good result for the fourth quarter and full-year of 2015. Contributions from both existing sites and those acquired over the past 18 months continued to drive strong top line growth. Gross profit was up in the quarter by approximately 6.8% and by more than 13% for the year.
Fluctuations in the cost of jet fuel, driven by underlying volatility in crude prices, saw Atlantic report a year-on-year decline in revenue. But that was more than offset by an even greater decline in the cost of goods sold services. In other words, Atlantic did a very good job of increasing the volume of fuel sold and the margin on those sales in 2015.
Atlantic continues to take increasing advantage of the data it has access to with respect to aircraft and aircraft movements, to more effectively upsell and to optimize the value of its network. The team at Atlantic was successful in managing the rate of increase in expenses as well. Growth in SG&A, reflecting primarily the addition of new locations to the network, was considerably slower than growth in gross profit and resulted in improved margins.
As I mentioned in our third quarter results, the level of maintenance capital expenditures at Atlantic Aviation was intentionally elevated in 2015. The outperformance of the business at the gross profit line allowed us to pull forward certain expenses into 2015 that would likely have been incurred in future periods, thereby creating an increased financial flexibility for the business going forward.
Atlantic deployed a total of $21.5 million in maintenance CapEx for the year. That compares with $9.9 million in 2014 and an average of around $7 million for each of the last eight years. In spite of the increased maintenance capital spending and a slight increase in cash interest expense associated with acquisitions, Atlantic generated an increase in free cash flow year over year of 22%. The 22% increase in free cash flow was on the back of improvement in flight activity in the U.S. during the year. According to data produced by the FAA, general aviation flight activity increased by an aggregate 1.2% in 2015, including a 2.1% increase in domestic activity.
As you might expect, the bulk of activity at Atlantic Aviation is tied to domestic activity. As noted in our 10-K, the aggregate increase in flight activity at airports where Atlantic operates was better than the industry at 1.6% versus the 1.2% figure industry-wide.
The increase was broadly consistent with what the industry has seen each year since the bottoming in the wake of the financial crisis in February of 2009. In other words, an approximately 2% increase in flight movements translated into a 21.3% increase in EBITDA and a 21% increase in free cash flow; with normalized maintenance CapEx, that figure would have been closer to 30%.
In short, 2015 was a good year for Atlantic Aviation. So what are we seeing thus far in 2016 at Atlantic Aviation?
First off, trading through the first six weeks of the year has been a continuation of what we saw in 2015. Atlantic is again enjoying year-over-year gross profit growth, posted in part by the acquisitions concluded in the year of Orlando, Salt Lake City and Carlsbad. The increase has been slightly tempered by reduced level of deicing activity compared with past years.
What do we expect from Atlantic in the remainder of 2016? In the post-financial-crisis period, is an if the post-financial-crisis period is an indication, in a year of roughly 2% growth in flight movements and assuming no acquisitions, we would expect mid to high single-digit percentage increases in EBITDA. To be clear, we do expect Atlantic to continue to execute on its strategy of opportunistically adding to its network via bolt-on acquisitions. So growth in EBITDA could be better than that.
And in 2016 specifically, we expect the full-year contribution from the bases at Salt Lake City and Carlsbad, which were acquired very late in 2015, to be a positive.
A number of investors have asked about the risks associated with this business in the event of an economic downturn. Unfortunately, I suspect most of you only have a memory of what happened to general aviation during the financial crisis in 2008-2009 and not the performance of the industry during a garden-variety slowdown.
As we said many times, the difference in 2008-2009 was the fact that the financial crisis hit the user-base of general aviation in the form of both a decline in economic activity and the wealth of it generally. These were exacerbated by the public relations nightmare created when the three auto company executives each flew to Washington in separate private jets to pick up bailout checks. That was bad for business.
In general, however, economic slowdowns have not had much if any impact on general aviation utilization. However, based on the current performance and capital structure underpinning Atlantic Aviation, we have estimated that if we saw a 10% decline in flight activity it would have a less than 4% impact on mix free cash flow per share, well within the buffer in our payout ratio.
But to be crystal clear, this is all hypothetical, as we have not seen any deterioration in performance at Atlantic in the first part of 2016. In terms of the growth of Atlantic Aviation, we certainly expect the business to continue to execute on the key components of its strategy. These include opportunistically building out its network of FBOs and, where appropriate, pruning that network with an eye to reinvesting in markets with better growth prospects or ones that are simply a benefit with the network overall.
Atlantic added three sites in 2015 and the industry continues to consolidate. And that consolidation is expected to create additional opportunity. We remain sensitive, not to tip the balance in the MIC portfolio overall too far in the direction of what could be a more economically sensitive business. But adding two, three or four FBOs per year would not seem to us to be excessive.
Atlantic Aviation’s balance sheet and liquidity position is strong. We ended 2015 with Atlantic’s leverage below three times net debt to EBITDA, and with no refinancing needs prior to May 2020. With that as an overview of Atlantic, let’s take a look at IMTT.
Revenue from core activities at IMTT, storing and handling bulk liquids remains strong during the fourth quarter. Revenue from ancillary services, heating heavy products, spill cleanup and rail services were down year over year, although they were not outside of the historically normal range as a percentage of total revenue. The fairly substantial downward move in the Canadian dollar versus the U.S. dollar also had an impact on IMTT’s results.
Collectively, the ancillary services and other factors contributed $11.7 million of the decline in revenue in the fourth quarter, or more than the aggregate decline of $10.8 million. However, I’ll remind you once again that gross profit is the true top line we use at MIC for IMTT and our other businesses. However, given the equity market paranoia about midstream businesses, I wanted to provide this detail about revenue at IMTT.
Gross profit for the full year increased by nearly 3%, and a better than anticipated level of expense management contributed to an increase of EBITDA of more than 6%. Excluding the anomalous ancillary service matters I just mentioned, EBITDA would have increased by approximately 9.7%. In short, IMTT delivered results in line with our expectations. The contribution from core activities is a function of what we call firm commitments and firm commitments are a blend of utilization and pricing.
Utilization of the available capacity at IMTT remained at historically normal level 94.9%, up more than 2% from the year end 2014, with the return of certain tanks to service during the following year, following a period of cleaning and inspection. Utilization rates at the current levels are in essence at the maximum, given that some amount of capacity remains - sorry, given that some small amount of capacity will always be out of service for cleaning or between products, or customers.
Pricing is a function of location, product type, duration and throughput, with pricing power being reflective of supply-demand dynamics in the particular market. While there is no homogenous pricing metric, overall, pricing remained positive in 2015.
As noted previously, with the volatility in the energy market earlier in the year, counterparties had sought shorter durations and brought the average of all firm commitments down to 2.33 years at the end of the third quarter. The duration of firm commitments signed in the fourth quarter was longer than the remaining average and resulted in an increase in the average duration to 2.62 years.
We view this as a positive for the business and potentially an indicator of a bottoming in this measure. To be fair, however, we have relatively few data points to refer to in making this observation.
The warmer weather in the Northeast in 2015 compared with 2014, resulted in a reduction in heating revenue in the fourth quarter and full year. This is not news of course, as we had noted this impact in each of the first and second quarters of 2015 as well.
As we’d also noted in the first half of the year, IMTT subsidiary OMI Environmental Solutions, or the old Oil Mop, made a much smaller contribution to the overall results for the business in 2015, compared with 2014. The performance of OMI is notoriously difficult to project.
The decline in rail activity also contributed to a reduction in revenue at IMTT in the quarter and full year as well. The movement of Canadian heavy product into the U.S. has become less attractive, given the low price and ample supply of domestic product. As a result, firm commitments for rail slots were not renewed or extended and resulted in a reduction in revenue.
I take some comfort from the fact that IMTT didn’t invest heavily in rail infrastructure over the past couple of years. At the time, we were criticized by many for being too conservative on rail. However, in our opinion, it would have taken almost a decade for a rail investment to generate a payback in full. And we were not comfortable rail demand would last for 10 years.
This is not to say, we will never allocate capital to rail expansion at IMTT, rather it emphasizes that when we allocate capital, we take a long term view. And we assess the risk of a stranded asset. I’m sure we will make mistakes in the years ahead. But I’m pleased we did not make the mistake of constructing rail infrastructure that ended up stranded, as others have in the last couple of years.
The impact of the reductions in ancillary services on revenue was offset by improvement in cost controls and expense reductions generally. We noted in July 2014, that we expected IMTT to deliver approximately $10 million in savings in the year following. We also noted in August of 2015 that the objective had been achieved.
The management team at IMTT continues to make good progress with cost controls and further reductions in the second-half of the year. A Portion of the savings has come from reductions that one could have assumed, salaries and benefits related to departing and retiring employees, for example; but also from a variety of other areas including over $500,000 annually from reduced workers’ comp claims as a result of initiatives designed to improve safety in the workplace.
Over $1.3 million annually in insurance premiums related to MIC’s improved purchasing power and from the consolidation of vendors of services and products generally, and from the elimination of nearly half of the legal entities and bank accounts comprising IMTT. And we have more to go.
We are confident that the management team at IMTT will capitalize upon additional opportunities in the future. Maintenance capital expenditure at IMTT totaled $17.1 million and $37.7 million in the fourth quarter and full-year respectively. As we suggested, it would be in November. It was difficult to deploy $40 million of maintenance CapEx at IMTT over the full-year, particularly when spending in the first-half of the year had been as light as it was.
However, we certainly believe the assets of the business have been appropriately maintained and that their useful life has been protected. While 2015 maintenance CapEx at IMTT was down on 2014, it was also vastly different in terms of timing. While overall maintenance CapEx was down by a substantial 15% in 2015 compared to 2014, it was actually down by 68% in the first-half and up by 63% in the second-half.
For this reason, I believe it’s more important to look at the full-year results for IMTT than any quarterly number. The more important question has to do with the rate of reinvestment in those assets going forward. Going forward, we now believe that an amount of between $30 million and $35 million per year, roughly 10% to 12% of the EBITDA of the current business will be sufficient to maintain the integrity and value of the fixed assets.
The combination of effective cost management and the rightsizing of maintenance capital expenditures contributed to an increase in free cash flow generated by IMTT of better than 30% in 2015 compared with 2014.
So what’s the outlook for IMTT, how is it trading? As with Atlantic Aviation, through the first six weeks of the year, very little has changed versus 2015; that’s to say, utilization remains high, firm commitments are up, and the cold snap in the Northeast short-lived, though it was a mild positive from a heating revenue point of view.
But none of this should come as a huge surprise. This is not a business that is sensitive to what is going on in the exploration and production or an interstate movement. It’s a business that has some sensitivity to end-user demand, at least in the petroleum segment of its operations.
As a reminder, and we’ve updated this in our 10-K, 23% of the revenue in the business is generated in storage and handling of chemicals; 6% in the storage and handling of biofuels, vegetable and animal oils; 3% from crude and asphalt; and 13% from other ancillary services including spill response activity. 55% of the revenue of the business comes from storage and handling of refined petroleum products.
Viewed in the context of MIC as a whole, assuming every barrel that IMTT is equal in value, the EBITDA related to petroleum storage and handling constitutes only 25% of our aggregate results, just 25% and not from a portion of the supply chain that is being roiled by the volatility in the price of crude.
In essence, you can think of the petroleum portion of what IMTT does as serving as a regional distribution center for refined products, absence a protracted period of demand destruction. And we are actually currently seeing growth in end-use demand. IMTT is likely to continue to perform well and continue to serve as a platform for capital deployment.
A derivative risk that we’ve been asked about has to do with the counterparties to the firm commitments at IMTT, specifically whether or not we’re concerned about the creditworthiness of any of these. In general, we do not believe IMTT faces a meaningful risk with respect to the creditworthiness of its counterparties or that this risk has increased in any substantial way as a result of volatility in oil markets.
We believe that the entities with whom IMTT has contracted a generally well-capitalized, highly rated, and willing and able to abide by their commitments. In the unlikely event that IMTT does have a weak sister in the mix, we take comfort from, one, the fact that IMTT is paid in advance for services provided and to the extent a non-payer has product at one of our facilities they may find it more difficult to access that product; and, two, that the services of IMTT have provided largely on a demand-pull basis, and if one of our counterparties fails another is likely to take its place in serving the market; and thirdly, in the one instance in which a counterparty has gone bankrupt in the past, the bankruptcy court determined that access to IMTT services was essential for the restructuring of that business and stipulated that the terms of the contract be on it.
For the avoidance of any debt, we have had no bad debt issues in 2015. And we have seen no sign or glimpse of possible bad debt issues coming down the pipe. We really do - we don’t really do business with pure-play E&P companies who are the credit risks that people are really worried about in the energy space.
In short, we feel confident in the continued stable contribution from IMTT to our overall results. The business is simply not the macro-economically sensitive enterprise that has been implied in the strong correlation of our share price with those in the MLP world. Yes, there are similarities between IMTT and some of the midstream entities in the market, but the notion that IMTT equals oil and because anything associated with oil is bad, therefore IMTT is bad, is simply wrong.
So what do the prospects for growth in investment at IMTT look like at this point? Clearly, with the carnage in portions of the energy industry, investment in petroleum related products have been scaled back. We had to chuckle at Kinder Morgan’s announcement that they were cutting their backlog of growth projects by some $3.1 billion to only $18 billion.
However, it suggests that going forward there may be fewer petroleum-related developments in certain markets. However, at this point, we believe we’ll deploy growth capital at IMTT in the range of $80 million in 2016, essentially unchanged from the average of the past five years.
Let’s move now to our Contracted Power and Energy segment. CP&E did not quite have the year we expected in 2015 when we forecast the performance of the businesses due to two things we can’t control, the sunshine and the wind. The output from the solar and wind facilities in CP&E, and therefore the revenue produced, was lower than anticipated, as a result of below average amount of sun and wind resources in 2015 compared to normal years.
Importantly, however, the level of wind power and solar power we generate, given the amount of wind and sunshine was in line with our expectations. Put another way, the equipment worked just fine when the resource was there. All in all, the underperformance versus expectations in the renewable portion of the portfolio was a couple of million dollars, not huge, but it’s not a large portfolio to begin with.
At BEC, it turns out there are some things we can’t control and some things we should have controlled better. The weather in the Northeast in the fourth quarter in 2015 was unseasonably warm. There were some things that we could have controlled better with respect to BEC. For instance, when we bought the facility, we underestimated the impact of changes in congestion pricing on BEC. Call it the dumb tax associated with getting into a new line of business, call it whatever you want. But it’s not a mistake we’ll make again.
As with the solar business - as with the wind and solar portion of the portfolio, the impact of the warm weather and the issues in diligence were relatively minor, a couple of million dollars, but aggregating just the same. In total, the impact of these issues on the segment performance amounted to approximately 1% of MIC’s total EBITDA for the year.
One thing that BEC has done is to add marginally more seasonality to MIC’s businesses, given that more earnings are generated in summer than fall and early winter. While BEC is free cash flow per share accretive to MIC on a full-year basis, we estimate that it was mildly dilutive in the fourth quarter when one quarter is viewed in isolation.
Expense is not an issue in the CP&E segment, although we continue to look for opportunities to streamline the back-office functions of the businesses. After putting together, a well-priced sustainable capital structure at BEC in August, we are confident in the cash generating capacity of the portfolio and look forward to the additional one quarter of contribution from BEC in our 2016 results.
So where do we stand with CP&E at this point and what are the prospects for this segment in 2016? The El Niño in the Pacific Ocean appears to be dissipating, generally that would mean that historically normal levels of sun shines should return to the Southwest, and historically normal wet windy conditions should return to the Pacific Northwest. It also means that the Northeast will be having something that feels more like a winter.
Through the first six weeks of the year, our wind and solar facilities in the CP&E segment have performed in line with historically normal parameters. We’ll keep you posted, but once again this is not a significant part of our story. Warmer winter or cold, it still makes very good financial sense for us to expand the BEC facility, as we said we plan to do when we acquired the business about this time last year.
Since then, in connection with the proposed expansion, we have first acquired the land under the existing BEC plan; we completed the purchase at the end of the year, and announced it in a press release on January 11.
Second, in the same press release, we announced that we were commencing development of a gas pipeline running from the Spectra gas mainline on the western end of IMTT’s land in Bayonne, to the BEC facility on the eastern end. The 7,000 foot pipeline that runs across IMTT land will provide an additional less-expensive source of gas to the facility, and of course, lower input costs mean better margins. The pipeline development will be carried out over the course of this year.
Third, we also noted we had entered into an agreement with Siemens for the two additional generating sets that will be needed to complete the build out of the additional 130 megawatts of capacity. The deal with Siemens is subject to receipt of regulatory approvals to proceed with the project.
Fourth, on that front, our team at BEC continues to make good progress. And we remain confident in our ability to secure the appropriate permits, complete the contracting and construction in a timeframe that would have the plant operating in late 2017 or very early in 2018. Once, we’ve installed the incremental two units of capacity, the 130 megawatts we’ve referred too, and have seen the impact on our transmission cable, we will then assess whether to add another unit of approximately 65 megawatts.
The basic premise regarding BEC that building additional efficient generating capacity on land that we own in Bayonne, where we have access to low-cost gas and can deliver electricity into a capacity-constrained market remains intact. In fact, that premise may well be applicable to the western end of the IMTT property as well.
We have continued to explore the potential in building new gas-fired generation capacity serving the PJM North New Jersey market. We believe that very similar circumstances to those that exist on the eastern end of the property exist on the western end; specifically, one, we already own the land and the land can be developed as a power plant from a permitting point of view; two, we have access to relatively low-cost gas from the Spectra mainline with the tapping the pipeline construction I just mentioned; and three, the facility is proximate to the growing demand in North New Jersey power market.
Assuming this turns out, as we currently believe it will, we could develop as much as 500 kilowatts to 1 gigawatt of state-of-the-art power generation on that portion of the IMTT property.
For those of you who may have been concerned about our pipeline of growth opportunities, you can relax a bit. A project of this size will keep us busy for a while. It’s also fair to say that the depreciation from both projects could well push the date at which we become a federal income tax payer out beyond the late 2019 currently in our guidance. There are a couple of things keeping us busy at Hawaii Gas in 2015 as well.
Overall, the core business continued to perform well. Gas sales were up, expenses were down. The business generated an expected level of EBITDA and a respectable 5.5% increase in free cash flow in 2015, compared with 2014. There is a bit of noise in the full year and fourth quarter results associated with changes in the value of propane hedges. The changes are non-cash, but they flow through the P&L in the cost of product sales line.
Because the adjustments in the quarter were a negative of approximately $4.6 million, it makes it look like gross profit declined by almost 20% versus the fourth quarter in 2014. From a cash point of view, it did not. That’s simply one of the many vagaries of GAAP accounting we have to deal with.
We started hedging propane prices at Hawaii Gas after the surge in prices caused by the polar vortex in 2014. And as our 10-K, notes our propane expense is now at least partially hedged into 2019. We believe the benefit of hedging to our shareholders and our customers is clear. It removes a potential source of volatility in our cash generation. Conversely, it adds volatility, although non-cash, to the GAAP top line at Hawaii Gas.
As we said at this time last year, the focus of the Hawaiian Public Utilities Commission has been appropriately on the Hawaiian Electric-NextEra transaction. However, this has caused Hawaii Gas to defer the filing of a general rate case.
As of now, it seems unlikely that we would file a rate case before the summer of this year, as we struggle to see how the Hawaiian Electric-NextEra deal is concluded before the third quarter. And the PUC will lack the resources to address both matters simultaneously.
One additional note on the Hawaii Gas and the Hawaiian Public Utilities Commission, earlier this month the HPUC approved the refinancing of the $80 million term loan and $60 million revolving credit facility at Hawaii Gas. With that, the maturity of the debt has been extended from August 2017 to February 2021. We expect continued performance on the part of Hawaii Gas as has been the case thus far in 2016.
The results for the quarter and the full year for the Corporate and Other segment are largely the reconciling items in our financial statements. These include the line items related to management fees, interest on holding company level debt instruments, and the impact of federal income taxes.
Fees payable to the MIC manager were higher in the quarter and the full year periods. Base fees increased as a result of the increase in the market capitalization of the company.
Total fees were higher in 2015 versus 2014 as a result of the performance fees incurred in the first and second quarters, given the total return generated compared with our benchmark index. With respect to performance fees, I would note that given the structure of the performance fee arrangement and the fact that there must be outperformance in both the quarter and cumulatively for a fee to be payable, in other words there is a high watermark associated with the structure, MIC must recreate substantial value for shareholders before a performance fee can be generated in the future.
As of last Friday, the hurdle was approximately $2.5 billion. I would suggest that the structure of the arrangement including the high watermark is clearly therefore shareholder-friendly.
We’re quite comfortable with the capitalization of our businesses in the current environment. In general, our leverage is relatively low, particularly given the visibility we have into the cash generating capacity of our businesses. Our all-in debt cost is low as well and our need for new sources of capital in support of our growth is largely nil.
At year end across the entirety of MIC, our leverage was 4.3 times EBITDA, excluding non-cash items. This includes the fact that we consolidate the solar and wind portion of CP&E as the sponsor equity, even though we have a minority interest in certain of these entities. Moreover, these businesses have fully amortizing debt tied to the duration of the power purchase agreements behind them and they are nonrecourse to MIC or any of our other businesses.
So in the case of a solar facility with a 20-year PPA, the debt portion of the capital structure in that business will amortize over a period of 19 years. In short, there is no refinancing risk associated with solar and wind projects in the portfolio. On the other hand, the solar and wind projects carry a relatively higher level of debt given the contracted nature of their off-take agreements. The utilities being supplied by our operations are obligated to purchase 100% of the power that we produce during the duration of the PPA.
At the end of the day, the debt on these businesses represents about 8% of our total debt, but the structure skews the analysis of MIC. Therefore, we also provide you with leverage excluding the solar and wind portfolio. On that basis, MIC’s leverage stood at about 4.1 times at the end of 2015. Based on previous commentary from S&P, we believe we are comfortably within the range of leverage that will enable us to maintain our investment-grade rating.
To be clear, when we think of MIC’s leverage ratio and debt target and how we manage the business we exclude solar and wind assets. If we bought more of them, our consolidated headline leverage ratio would increase. But given the nonrecourse nature of such debt to MIC, I don’t believe there would be any increase in the underlying riskiness of MIC.
Again, in a spooked equity market, this is not the easiest message to communicate, but I believe it’s fundamentally true. Our debt costs are low, across the portfolio less than 4% at this point. To the extent we’ve used floating rate debt we have entered into hedging contracts that fix the LIBOR component of those facilities to a point one year short of the maturity of the underlying facility.
We do this on the assumption that the facilities will be refinanced at least one year prior to the maturity, and typically in the last year of the facility. By not having a hedge in place at that point, we eliminate the possibility that we have an out-of-the-money hedge contract in place and minimize the possibility that we incur swap rate costs.
I would note that our various revolvers by virtue of the fact that they are undrawn or/and that the drawn balance may vary are not hedged. Perhaps the most important element of our capital structure is the fact that we do not need to access new debt or equity capital to fund either existing operations or our growth CapEx pipeline of roughly $300 million in projects and $200 million in expected bolt-on acquisitions over the next two years.
We expect that the combination of retained equity, the capital not distributed as a dividend and drawings on existing committed credit facilities will be sufficient to fund these activities. Clearly to the extent that we are involved in a transformational sort of transaction that may not be the case, but the expected contribution from such a transaction would have to be - would have to take into account any new financing needs.
In brief, we are quite comfortable with the type and amount of leverage at each of our operating entities and the holding company; we have no near-term refinancing needs. We have very little exposure to rising rates; are well within the range of debt that would allow us to maintain an investment-grade rating and have leverage levels that we believe are manageable, given the cash generating capacity of the underlying businesses.
Moving now to guidance, so what does all that mean for the balance of 2016? It means that we are also comfortable with our guidance as previously noted. We expect that the MIC cash dividend will grow to between $5 per share and $5.10 per share in 2016 on the back of growth in free cash flow per share. When we gave our guidance for 14% growth in dividends for each of 2015 and 2016 in early 2015, a $5.05 dividend for 2016 was the mathematical outcome of such guidance.
Spookily, the midpoint of our latest guidance remains at $5.05 per share.
If you look at what has transpired in the year since, notwithstanding massive volatility in equity markets and commodity prices, our businesses had performed as we expected; indeed, a little better than we expected. It will always be quarters where one of our businesses does a little better or worse than expected, mainly due to timing. But in aggregate, we run unsexy businesses with limited volatility. Those of you, who have met me and seen me, will know that I am a fan of sturdiness over sexiness.
We are confident in the cash generating capacity of our businesses and anticipate that the growth in dividends in 2016 will be supported by continued growth in free cash flow. At this point, we expect that our payout ratio will remain well within our target range of 75% to 85% of the free cash flow generated by our business.
With the full year 2015 results in the books, I note that the compound annual growth in free cash flow per share produced by mix businesses has been an average of 13.7% per year for each of the last eight years. With the eight-year track record, I don’t feel as though we are being overly aggressive in our forecast for 2016.
Prior to the recent market gyrations, we ran our business on the basis of a model, that’s sought to balance leverage, reinvestment and dividend payout in a way that we believe to be prudent for the long-term. Given we thought it was prudent for the long-term, it should come as no surprise that nothing has changed at MIC as a result of the recent market gyrations. That’s not to say that we ignore the external environment as we run our business; rather, when times are good, we take that into account, and try to assess what is sustainable in the long term, rather than just froth and bubble.
In essence, we continue to view MIC as an attractive total return opportunity, that is a portion of the expected return on our investment in shares will be in the form of capital appreciation associated primarily with the increasing amount of cash generated and a portion will be in the form of cash dividend.
A number of you have asked us about using our excess capital to repurchase shares. The logic here would be that if we believe our stock is materially undervalued, it may be the best investment we could make, better than the return available to us on our existing or new businesses.
In certain circumstances, I think that’s probably wrong, perhaps even during the past few weeks, given the decline in our share price. But I also think our share price movement has not been tied to anything fundamental or structural. Allocating finite capital in an effort to address a transit reissue seems to me to be the opposite way most of you would expect us - the opposite what most of you would expect us to do.
I prefer to invest in a strong foundation for the long-term growth of the business and not to deploy capital on the shifting sands of market sentiment.
MIC is not a day trader of assets and are not inclined to become a day trader of my own shares, which lead to a full circle to our current strategy of capital allocation, based upon, one, and this is in order of priority. First, do no harm in allocating capital. It’s better to do nothing in the current environment than to do something dumb. Two, return a portion of the available resources to the owners of the company and let them decide if and when to redeploy that capital in the business. I am confident in our ability to generate sufficiently attractive risk-adjusted returns that we will attract additional capital, when and if we needed. And third, invest prudently in the long-term health of the businesses.
I hope that gives you a better feel for how we view our responsibilities to shareholders, as stewards of your capital.
In summary, MIC’s results for the fourth quarter and full-year were largely a continuation of the stable performance delivered through the first nine months of the year. On the strength of that performance, the MIC has - board has authorized a dividend for the fourth quarter of a $1.15, bringing the total cash payments for the year to $4.46 per share or 14.7% above that which was distributed in 2014.
We expect, based on the continued stable performances of our businesses that MIC will be in a position to distribute between $5 and $5.10 per share in the calendar 2016 consistent with previous guidance, the distribution growth of 14% per year in each of 2015 and 2016. We have an attractive approved list of growth projects that we expect to complete over the course of 2016 and into early 2017 with a current estimated value of more than $200 million.
In addition, we are confident in our ability to secure approval for what we are calling BEC II, the expansion of our power facility at Bayonne, and the deployment of an additional $130 million of growth capital in that effort. Our balance sheet is strong and we have no material exposure to the volatility in credit markets. None of our existing operating company-level debt facilities require refinancing before 2020.
Aggregate leverage is well within our target range and consistent with what we believe will enable us to maintain our investment-grade rating.
With that, I’ll wrap up the prepared portion of our call and turn the proceedings over to the operator, who will open the phone lines for your questions.
Thank you. [Operator Instructions] Our first question comes from the line of Ian Zaffino of Oppenheimer. Your line is now open.
Hi, thank you very much, James, good job just addressing all the issues that are going on there. I think that is very helpful to the stock price for sure.
Question would be on IMTT. It looks like the length of the terms of the contracts have extended or increased this year. What’s driving that? Are your customers feeling more comfortable you pushing towards longer-term contracts? What’s actually driving that, because you would think in this environment they’d be going the other way, that’s not the case, so..?
Yes. I think what we saw in the fourth quarter was some customers prepared to strike materially longer deals. And so there was a five-year deal which we’ve previously discussed. I think the other issue is that, in essence I think the industry is starting to accept that $30 is the new normal and adjusting to that.
Now, that’s a personal and a subjective view. But I think that there was a period where people were wondering whether low cost or a low crude environment was a blip below the new normal. I think the answer is it appears to be the new normal. Now, given that, when the industry decides that that’s the new normal, I think the answer is that probably means that it will be anything but what those people expect. It doesn’t really worry me if they’d be happy lock into that.
I think many of those people, and this is where I get down to the fact that we store essentially refined product rather than crude, we’re essentially in a central point in the logistic supply chain for them. And I think that’s the other thing, which is for many of these people, they are internally now starting to differentiate between what is capacity, and if you think about the oil majors, what is capacity that they have that I guess I would describe as swing capacity, and what is capacity they have that makes up a fundamental part of the supply chain for them.
And I guess it’s what we’re seeing is those for whom capacity is a fundamental part of the supply chain have realized that if it’s a fundamental part of their supply chain they need to lock it in for five years, rather than just locking it in for six months and hoping that in six months’ time they’ll be able to lock it in for six months for each of the next five years. But I think there is a number of factors that are driving that.
In terms of our approach, our approach has been I think to push for tenure where we think it’s prudent, but I guess in that sense it’s to push the tenure where there is an open door, but where there is brick wall, not to waste our time pushing for tenure.
Okay. And then another question would be, if you look at sort of your investments that you can make and your growth rate, maybe you could kind of disaggregate parts of your growth rate. For instance, how much would be pure organic? How much would be growth that you could fund from internally generated cash flow? And then, how much would you need of investments to increase that growth rate, because it seems to me that between organic growth and your cash flow, even after paying the dividend, you have a decent amount of growth in the business alone?
So I just kind of want to disaggregate. But how much of the growth is really being driven by, let’s just say, spending above and beyond internally generated cash flow versus what you’re generating from your current assets and your internally generated cash flow? Thanks.
Sure. So, in the guidance that we’ve given, and this is about 2015 and 2016, we basically said that we can deliver the growth of 14% with the organic growth of business and with the growth CapEx that we deploy of what I call bolt-on or building EBITDA projects that are non-transformative.
And we fund that growth CapEx through two sources as you’ll see. One is reinvestment of the amount of the free cash flow that we don’t dividend out. So the roughly 25% of free cash flow we generate that we don’t dividend out. Funds, I guess equity funds are portion of that. And the second is, we use the undrawn credit facilities, revolving credit facilities to provide the debt funding of that amount.
That basically means, the math of that means that we can fund somewhere in the $250 million to $300 million of growth CapEx per year without increasing MIC’s net debt to EBITDA from those sources of cash.
That’s enough to generate the growth that we’ve talked about and if you look then at what that gives us we’ve said that for this year that will give us essentially 14% per share growth. If we want to do something well beyond that we would need to access equity markets at this share price, that doesn’t seem hugely attractive. But I’d also say that that’s a function that depends what you’re buying and how attractive what you’re buying is. But by and large, it doesn’t seem very attractive to me.
So if you sort of said historically the way we thought through that, given that sort of - I think we said, it’s 13.7% free cash flow per share growth over that period, let me break it out for you. Roughly two-thirds of that comes from what I call organic growth, and one-third comes from capital deployment. Now, I also want to be clear in that, that distinction is a little harder and less clean than some people may like.
And the reason I say that is, if I deploy money in IMTT for adding heating capacity to an existing tank and that gives me a material step up in rate from a new customer, do I attribute all the step up in rate to the capital I deploy, or do I assume I would have got some step up in capital - some step up in rate anyway and so I only attribute some of the revenue - incremental revenue to the capital, or do I attribute all the revenue to the capital because I wouldn’t have rented the tank maybe without any edict?
The bifurcation of what is organic growth and what is growth CapEx related, is just not as mathematically clean as I know everyone would like it to be, because then we could model it in Excel more neatly than we can. But when we look at the business, and there’s these examples of that from Atlantic as well that I could give you, when we look at the business we basically say two-thirds of that growth in free cash flow per share is organic and one-third is capital related.
But you are right, from the capital we reinvest from free cash flow, and from the incremental debt capacity we have available to us without increasing our net debt-to-EBITDA, we have the resources to fund a substantial amount of growth CapEx going forward. All of our growth CapEx pipeline that we’ve outlined without accessing equity markets.
Okay, great. And then just one final question is on the acquisition side. How do you rank where you want to deploy your capital? Just given that you have some weather issues on the contracted power side, but the aviation business is doing very, very well, plus you’re probably going to see some divestitures or at least some forced selling from the mergers that are going on there, so how would you kind of rank where you would deploy your capital in what areas, and that’s [putting yourself on] [ph]?
Yes. So I’d say in terms of capital allocation, the first is we always take a view to the long-term in terms of capital allocation in terms of what’s the right returns in the long-term. Secondly, we do take into account the portfolio mix. And so whilst we would like to grow the aviation business, I think you’ll see us grow that sort of three, four, five locations a year rather than bigger amounts than that from a portfolio mix perspective.
At the moment, we are seeing attractive opportunities to deploy capital across all four of our businesses. I would say in the wind and solar segment of the Contracted Power and Energy business, they still appear to us to be a - it still appears to us to be a little bit too much the dumb money at the party in terms of that, whilst it’s no longer the yield because the counterparty is signing the overpriced checks has changed, probably has a Canadian accent now rather than a U.S. accent. So that - we still looking in that space, but we can’t see the returns that we want.
I also would say to people, in terms of the - I’m not unduly worried about the weather impact that weather had on our CP&E business, because I know that that will normalize over time. And whilst I agree it creates the jitters short-term in terms of any given quarter, actually we’ve always had a seasonality and weather-related impact at IMTT and across our portfolio. That doesn’t worry me.
But I would say, the long-term is where we look for the capital deployment and we see opportunities in all four of our verticals. And the real question is a portfolio mix and a return on that capital deployed.
Okay. Thank you very much.
Thank you. And our next question comes from the line of Jeremy Tonet with J.P. Morgan. Your line is now open.
Maybe just picking up on that last company as far as the M&A opportunities that exists in front of you right now. And how do you think about the midstream sector? It seems like there has been a lot of pain out there and I’m wondering how that grieving process is going and what type of opportunities that might be presented to you.
Yes. So I think, Jeremy, what I’d say is there is more pain to come is our view. But that’s sort of subjective view, whilst there’ve been sort of every now and then the market rallies on the back of crude price. I think when crude price falls, the market will tank again. And so a sort of hypothesis is there’s probably more pain to play out there.
I’d also say that what we are looking for, and I’d sort of almost refer to our own business in this regard, is businesses - a lot of the businesses we’re looking at have too high a level of ancillary revenue for us and not enough of core contracted revenue. And so, we still think there is a price dislocation. As we saw at IMTT this quarter, ancillary revenue is not as good revenue as contracted revenue.
We’re happy that at IMTT the ancillary is on the sort of 13% of the mix. But at a lot of the businesses that we’re talking about where there is a lot of pain when we dig beneath the surface, the ancillary looks like it is 40% or 50%.
And I think the real interesting thing that will play out this year is when people get their first quarter numbers and second quarter numbers and third quarter numbers. I don’t think people have got anymore provisions to release from their balance sheet. And what I don’t see other businesses doing unlike ours is overspending on maintenance CapEx in this year or pulling costs forward as we did into 2015 into the first, fourth quarter at both IMTT and Atlantic.
So, I guess, we still remain interested. We still remain hanging around the hoop. We still have dozens and dozens of meetings with investment bankers and counterparties and potential targets. But we’re going to be - I think the first rule of capital allocation which I outlined in terms of our priorities is, first rule, do no harm and don’t do anything dumb.
But I would say the sort of - to the extent that there is a barometer of the mood, I think that resigned acceptance that this is the new commodity price environment has not just infiltrated IMTT’s customers, it seems to have infiltrated some of the people we’re in discussions with, who essentially can see that in their current model with their current capitalization levels they don’t have a sustainable business model.
So that’s all I’ll say at this stage.
Yeah. That makes sense. It is amazing to us how that maintenance CapEx somehow continues to shrink for some of those guys. And maybe just extending that a bit further, at times you’ve talked about the outlook for potentially adding a new vertical, any updated thoughts that you could share with us on that at this point?
Yeah. At this point in time I would sort of say given where we see our share price and our cost of capital. We’re probably more focused on deploying capital into the full verticals that we’re in. We always kick the tires on other spaces. But I would sort of say, at this point in time we’re more interested in deploying our existing capital and our existing free cash flow into growing our businesses; and with the pipeline of opportunities we see, entering into a fifth vertical in any meaningful way would require a sort of capital raise.
And at this - I’m not sure that people who are raising capital in this environment have a huge amount of fund. So given that I am a weakling in pain of this, I would - my immediate reaction is to run from that car crash rather than to it.
That’s great. Not much fun at all. We appreciate your strong balance sheet. That’s it for me. Thank you.
Okay. Thanks, Jeremy.
Thank you. Our next question comes from the line of TJ Shcultz of RBC capital markets. Your line is now open.
Great. Thanks. Good morning. I guess, just first I wanted to - hey - try to get a little bit more granular on where most of the opportunity sits to invest organically at IMTT over the medium term. You laid out the contribution mix by products, so if we think about that 55% in refined, 23% exposure to chemical, are these are two areas you expect to spend the bulk of the growth capital over the next couple of years? Maybe if you can give a little bit more color on the $80 million you’re going to spend this year or just any view that the contribution mix by product shifts at all over the next few years?
Yeah. It’s a good question. I think the answer is of the $80 million that we have in the pipeline today, it splits between petroleum and chemical. Whilst vegetable and biofuels and animal oils are great, it would be hard to go heavily longer in that space without buying, I guess, specialty terminals in that space.
So I can’t see the mix essentially changing from those two. And I think in terms of the growth CapEx, what I think will probably occur is that you’ll see the chemical component increase slightly over time. Having said that, with the $50 million - with the $80 million we’ve got in the pipeline, probably more of that is petroleum related and that’s just because, if you think about where the majority of that comes from at the moment, it’s from our existing customers looking for us to provide new and additional services to them. And we have more additional customers in the petroleum space than we do in the chemical space, because it’s 55 versus 23.
So I think you will see them grow in rough proportion to each other, but may be skewed to chemical growing faster. But I don’t think there will be a material mix change other than if we rolled the clock forward five years, I wouldn’t mind it if chemical was at sort of 35%, but getting it from 12% - 23% to 35%, that’s a big lift. Well - sorry, getting it from 23% to 35% the way I want to get it from 23% to 35% is a big lift. We can put one of them in reverse and get them much faster, but I don’t intend to do that, so.
Okay. Fair enough. That’s helpful. I think next if you can address a little further on the counterparty discussion that continues to be a big dim for investors, maybe if you can discuss your biggest type of customers at IMTT or what percentage are investment-grade, just any additional color or details here would be helpful I think?
Yes. So let me go through, if you’re sort of talking about in the customer space, of the top - firstly, no one customer is material. The top 20 customers represent about 70% of our business. Of the top 20 customers, 16 are investment-grade and four are not rated. Of the four who aren’t - sorry three are not rated, one is sub-investment-grade but like the upper end of sub-investment-grade to the extent that is a meaningful statement.
And the other three who aren’t rated, it’s not like they’re not rated because they wouldn’t be quality counterparties. They’re generally not rated, because they’re private companies of the sort that receive a lot of publicity in the media, without naming names, for their non-energy related activities rather than for their energy related activities.
So I would say that they are all robust in terms of - that’s the sort of math as to how it works out. Even while counterparties have changed over time, if I went back and looked at this from the 2007 refinancing of IMTT, you have the same mix of investment-grade and the top 20% representing it. I think the real issue is, we say, Shell is a big customer of ours, and we think Shell is a great counterparty. They’re a good person to do business with. They’re an investment-grade company.
When we say, we don’t do business with E&P companies, someone then comes back and says to us, well, what about Shell, they do E&P. For which the answer is, okay, Shell and Exxon do E&P, but we still view them as good counterparties. When I say, we don’t have E&P exposure I mean we don’t have exposure to companies who do nothing but E&P, and are therefore weaker counterparties than that.
So that is the sort of to give you answer. We just - because of the - and it’s not through strategy or brilliance or anything, it’s just because of the product mix we’re in we don’t have E&P companies as our counterparties, because we don’t do crude gathering and processing, crude throughput and wellhead sort of related services.
I would say also though, and this is a clear thing, we get paid in advance for our contracts, 30 days in advance. We have the product sitting in our tanks, which is we call it as a New Jersey lien, which is if you want to get the product out of our tanks, good luck getting it out without paying us. And thirdly, we have the ability to transfer new customers in.
The only example over time we looked out at a customer who went bankrupt historically, it was what - the contract was washed through bankruptcy and we essentially had the same terms renewed. Unlike what I think people worry about in the sort of bankruptcy in the upstream world of an E&P company going bankrupt and the off-take or the basin reserve or capacity payment being rewritten through bankruptcy, because ours is demand-full product in a sort of refined product mix, if someone doesn’t honor the contract with us, whether it’s a chemical customer or a petroleum customer, they can’t run their business because we are at that point of the supply chain.
So I would say - and again, I’m not meaning to belittle shareholders’ sensitivity around counterparties. I get why people are focused on this. But of all the things that keep me awake at MIC at night, that IMTT counterparty exposure and the creditworthiness of the counterparty exposure doesn’t make it into my top 10 things of causes of insomnia.
It’s something we focus, we track and we work on. But to be honest, I’m more worried about counterparty risk at all of the other businesses than I am at IMTT. And that’s because there is a material counterparty risk at the other businesses, but historically, we just had more bad debt expense of the other businesses than we’ve ever had at IMTT.
It’s more of an issue elsewhere within our portfolio, but we never get questions on that. And I understand the nature of the questions. I’m just saying it’s not - it’s not giving us any grief.
Okay, great, very thorough. Just lastly on the tax commentary, I know you’re typically able to push that out as you invest. I think the current date you have out there is late 2019. But just so I understand this does not incorporate the 210 in new backlog or BEC II?
So it does incorporate the 200 in backlog. It doesn’t incorporate the 130 of BEC II, because that’s not in our backlog. If and when that goes into our backlog, we will then provide a revised tax guidance update. And it also and - I also want to clear on this, nor does it incorporate the 500 gigawatt of power elsewhere in Bayonne. And the benefit of BEC II and that potential plant, depending on whether it was built is getting bonus depreciation if we’re entitled to it on those looks of equity is pretty good, if we can do it.
Okay. And then just to remind me on BEC II, what’s the timeframe to get that into the backlog or are you in the regulatory process?
So, where we’re at in the regulatory process is essentially we’re waiting on the New York ISO, where there is a connection class as I’ve learnt when dealing with regulators like that the how long is whatever number I pick it will be, two months longer. So I might as well say we’re imminent, in the remaining two months’ time we’ll get it.
But I think the guidance we’re comfortable giving is that that capacity will be online late 2017 or early 2018. But that’s the best I got for you at the moment unfortunately.
Okay. Thank you.
Thank you. Our next question comes from the line of Sameer Rathod of Macquarie. Your line is now open.
Hello, good morning. How are you?
Good, Sameer. How are you?
Good. A couple of, I guess, housekeeping questions, a few years ago MIC stopped disclosing year-on-year storage rates for IMTT. Could you tell us, I guess, anecdotally how the storage rates are compared to historical, like 2015 compared to 2014 or 2012 or whatever benchmark you want to use?
Yes. So I think what we said in the script is essentially that the prices continue to rise. One of the reason, and I want to take you back to the reason we stopped breaking it out, is because within firm commitments, given the way those contracts were being structured, the distinction between volume, price and then additional contracted services became something of a difficult component to unpack.
But I think what we said - so we commented on firm commitments. I think what we’ve said to people in this quarter is effectively what we’ve said over the last few, which is utilization which had dipped in 2014, because we had tanks offline for cleaning and inspection. And people sort of were spooked as to really offline for cleaning and inspection, will it ever come back or you’re just saying that because your utilization is down. We’ve noted to people, you can note that utilization is back up, so that’s really proof that it was offline for cleaning and inspection, and we’ve seen prices continue to increase.
I think what I would characterize in terms of prices though in terms of - to the extent that unpacking that makes sense is that the go-go days of 2009, 2010 of sort of double-digit price percentage increases, we’re not in that environment anymore. But I think as we said to people in 2009, 2010, by definition that stuff doesn’t continue in perpetuity. So the sort of pricing related increases have sort of tempered back to where you would more expect them to be in proximity to sort of CPI rather than sort of spectacular pricing increases. But I think that’s being something that really has played out over the last two years or so or three years rather than new. But I guess that should give some commentary or I guess that’s the sort of…
Right, right. In terms of the extending of lease durations, are the rates that - if someone signed a longer duration lease are the rates more favorable for them or how much more favorable are the rates? Have you seen any change in - are you adding any more carats [ph] to getting people to sign longer leases by lowering the rates?
Yes. So it’s an interesting question. Historically, I would say, overall the trade was, if you get a - the more term you sign up for, you get it at slightly lower rate, because in return to sacrificing flexibility you end up sacrificing - you end up getting a benefit for that. So I’d say, historically that’s been the case.
There have been instances actually where we charged a higher price for a longer period, because of effectively storage within a contango environment and people said, okay, I’ll pay up for that. But I would say, by and large, if you’re getting term you’re generally doing it at a lower amount. I am not sure actually, and this is a sort of view that, again, we have a sort of discussion with ourself over this, that actually customers are as well-served by signing short-term contracts as they are.
One of the issues for a customer when they sign a short-term contract is, at the end of the contract period they have to - they’re responsible for paying for the cleaning of the tank.
So if you only take a tank for one year, you include a cleaning expense on a one-year contract. If you take a tank for four years, you’re getting cleaning expense and amortize that over the four years. So I think customers going in and out of tanks and giving them back and not giving them back, actually if they look at the full cost, I think a customer is better off by staying in tankage for longer.
But I also appreciate with that that I sound like a salesman who’s having a conversation with himself as to why you should buy a 100-year annuity rather than a one-year annuity. But I think customers do better from signing long-term contracts, but…
So, basically, you are not offering any additional incentives to increase the leases in line with what you’ve been doing historically?
Yes, it’s not like we’ve been throwing money at people to sign up. And, as I said, one of the reason - in my comment - remarks I made previously is where our sales peoples or our commercial folks feel like their pushing against a brick wall, there is no point. And by that, I would say, there are just some organizations at the moment where the edict has come from on high from the CFO we will not sign a contract longer than 12 months, because cash is tight, yadi yada.
In those scenarios, like there is no point in us offering even a four year contract at a discount, because we know that the person has - the person we are dealing with has zero flexibility in negotiating that. So in that scenario, you’re sort of - it’s just pointless to discuss a multi-year contract, because the person you are dealing with doesn’t have the authority to do a multi-year contract.
In other cases, typically where someone has signed a five-year deal, they got the usual better deal for five year deals than they would have for a one-year deal. But it’s not - there’s no real - no, we haven’t sort of tactically responded one way or the other, if that’s the question.
Yes. That’s the question. I think historically, I’ve asked in the past, but a certain percentage of your capacity at IMTT is held by trading houses or financial institutions. Hypothetically, we’ve seen some people get out of commodity business. Let’s say hypothetically some of these people do go away and they don’t come back in the form of another trading house. Can you revamp that storage capacity quickly or do you think you would have to cut rate materially to move the capacity?
No, like - no, no - this isn’t a hypothetical question. It’s like Morgan Stanley has exited trading, JPMorgan has exited trading. All of that capacity has been rented to either new counterparties or the people they’ve flogged their business to. So this has been unfolding real time. It’s a situation I would say we’ve been dealing with ever since the preliminary announcement in the Volcker rules to some degree. And all of that capacity we’ve moved away.
In some situations, the exact same name is on the contract, because the person who was - the human being who was the trader at JPMorgan is now the human being who is the trader at such and such counterparty. And so, your question is a very real and live one, and one we’ve been dealing with the last, I guess, three or four years and we’ve been able to get the capacity away.
In each of those scenarios, we always have a decision in front of us, which is when the business is sold, we often have a consent right as to whether we will consent to novating the contract to the new counterparty. And by and large, so long as we think that counterparty is material - or is good, we will do that. If we think that counterparty is dodgy, we won’t do that.
But an example I would give you, and this is where there is somewhat false distinction here between counterparties of a fundamental nature as I described in this traders is, JP Morgan used to manage some of the product that came out of the Phillips 66 refinery in New Jersey, as JPMorgan exited the trading business Phillips 66 in-housed that capacity. The product that sits physically in our tanks at Bayonne is still the same providence. It still comes out of that refinery.
The counterparty’s name has changed, but again, it was - there are sort of two types of trader, I guess, is what I’m trying to say. There were those traders who are sort of what I would call speculative traders and there are those traders who are taking physical product either from a refinery or to a customer source and providing - being a conduit, either a marketing channel or a source of financing during that trade.
And so in that scenario from my worldview absolutely nothing’s changed. Like the product is coming from the same location, it’s fulfilling the exact same role in the supply chain. Technically, the counterparty has changed from being a trader to a refinery. But in reality, in my mind absolutely nothing’s changed.
Thank you. At this time I’m showing no further questions. I’d like to hand the call back over to management for any closing remarks.
Thank you very much. We will be on the road participating in a number of conferences and road shows over the next couple of months. And I’m sure you will be seeing many of you at these. Jay will also likely be in touch either way, whether you want him to or not, as always to make sure you have your say. Please save any difficult questions for Jay.
I would like to finally thank our lenders and our suppliers and our customers for the support they’ve given us over the year. And I would like to thank Gerard Adam and the team at IMTT headquarters in New Orleans for making sure that IMTT kept its SOX clean in 2015. Good compliance is good business. And we appreciate the effort of Gerard and everyone at IMTT for getting the business over the COSO and SOX hurdle for the first time.
Thank you and good bye.
Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may all disconnect. Have a great day everyone.
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