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CH Energy Group, Inc. (NYSE:CHG)

Q1 2008 Earnings Call

April 28, 2008 2:00 pm ET

Executives

Steven Lant – Chairman, President, Chief Executive Officer

Stacey Renner – Treasurer

Donna Doyle – Vice President Accounting, Controller

Chris Capone – Executive Vice President, Chief Financial Officer

Analysts

Maurice May – Power Insights

Operator

Ladies and gentlemen thank you for standing by and welcome to the CH Energy Group conference call. (Operator instructions) And your host and speaker Steven Lant, please go ahead sir.

Steven Lant

Welcome to our quarterly conference call. With me today are Chris Capone, Executive Vice President and CFO, Donna Doyle, Vice President Accounting and Controller and Stacey Renner, Treasurer. Following my introductory remarks, Donna Doyle will review our first quarter 2008 results by business segment. Then, Chris Capone will discuss our outlook for 2008 including our revised earnings guidance. I’d now like to ask Stacey Renner to review our cautionary statement regarding reliance on forward-looking statements. Stacey.

Stacey Renner

Thanks Steve. I’d like to first remind listeners that the presentation slides for this conference call and some supplemental first quarter financial information are available in the investor relations section of our website at www.chenergygroup.com. I refer you now to the paragraph on forward-looking statements at the bottom of this morning's press release. If you're following along in the presentation slides, please reference page 3.

During this conference call presentation and in the question and answer session to follow, CH Energy Group participants may discuss management's intentions, beliefs, expectations, projections or make other statements that are not historical in nature. Please note these forward-looking statements are subject to assumptions, risks and uncertainties that could cause actual results to differ materially from the forward-looking statements.

These risks are disclosed in more detail in our form 10-K for the year ended December 31, 2007 under the section labeled risk factors. That 10-K is available in the investor relations section of our website at the link for SEC filings. I'll now return the call to Steve Lant.

Steven Lant

Thanks Stacey. Our earnings per share for the first quarter of 2008 were $1.23 versus $1.38 for the first quarter of 2007, a decline of $0.15 per share. Central Hudson’s earnings per share contribution was down for the quarter by $0.10 due primarily to increased reserves for uncollectable accounts and reduced delivery revenues due to conservation by our customers.

We believe this conservation was driven by higher commodity prices which are being passed through to our customers through our purchased energy adjustment clauses and this affect may have been enhanced by a weakening economy and declining consumer confidence. There were a number of other less important variations at Central Hudson that Donna will cover in detail.

We have taken the first quarter results into account in deciding last week to reduce our earnings guidance range, along with our expectation that at currently prevailing energy price levels, price induced conservation beyond what we’ve projected in our business plan for 2008 will continue for the rest of the year.

Central Hudson continues to experience customer growth, albeit at a slower rate than last year or the past few years. [Clearfoot’s] first quarter earnings per share contribution was down $0.03 for the quarter but weather normalized was up $0.03. This weather normalized growth is due to our recent acquisitions. There were other smaller variations that Donna will cover in detail.

As in the case of Central Hudson, we’ve extrapolated the conservation trend we’re seeing through the rest of 2008 and updated our guidance range for Griffith. Our other business segment was down $0.02 due to reduced interest income due to a smaller average investment balance in 2008 than in 2007.

We continue to see a significant gap between the revenues projected in our rate plan and what we are experiencing and the gap appears to be widening. This gap is much greater than we can offset through expense management and as a result, our rate of return on equity or ROE is falling well below our allowed ROE. We now expect our earned ROE in 2008 to be between 7-8% versus the 9.6% we’re allowed under our current rate plan.

As a result of this ROE shortfall we’ve determined that it’s necessary for us to file rate increase this summer to go into effect when our current rate plan expires on June 30, 2009. I’ll now turn the call over to Donna Doyle who’ll review our quarterly results in more detail. Donna.

Donna Doyle

Thank you Steve and good afternoon everyone. For those of you who are following our website presentation, my remarks are going to relate to pages 5-8. And on page 5 we’ve presented a bar chart which shows the earnings per share by segment in the first quarter of 2007 and 2008 and as Steve Lant indicated, Energy Group earned $1.23 in the first quarter of 2008 compared to $1.38 in the first quarter of 2007.

And this $0.15 reduction as Steve indicated was mostly due to the $0.10 lowing earnings from Central Hudson with Griffith and our other businesses also being lower by $0.03 and $0.02 respectively.

And now I’d like to take you through pages 6-8 and focus on the detailed factors which lowered earnings for each business segment. On page 6, we show the major components of the earnings variation for Central Hudson which earned $0.73 per share in the first quarter of this year compared to $0.83 last year.

Certain regulatory items and unusual events which reduced earnings in 2007 had a small impact on the comparison to the 2008 results. But the more noteworthy items include the rate increase in weather, which was favorable and conservation and provision for uncollectable accounts which reduced earnings.

Since our 2006 rate order provided for an interim rate increase in July of 2007, this increase favorably affected the 2008 first quarter earnings by $0.07 per share and this increase covered higher operating expense which we incurred in 2008, including interest and property taxes. The weather also had a favorable impact on 2008 results compared to last year.

The billing degree days in Central Hudson’s service territory, although lower than normal, were 8% higher than last year and this contributed $0.06 compared to last year’s earnings. In the first quarter of 2008, we have noted a reduction in customer usage which we attributed to customer reactions to higher commodity prices and the overall slowing of the economy. And this conservation reaction lowered earnings by $0.05 compared to last year.

And associated with the customer conservation is an increase in uncollectable accounts and the aging of accounts receivable. In response to this, we increased our provision for uncollectable accounts by $0.05 a share. But please be aware that we expect a tax deduction of about $0.02 for this in the future if and when the accounts are actually written off.

Other 2008 expenses which exceeded last year include tree trimming and storm restorations. Our trimming program in 2008 was ahead of the first quarter of 2007. And 2008 has been considerably stormier than last year. So that summarizes the primary reasons for the first quarter earnings variation for Central Hudson.

And if you move along to page 7, on this page of the website presentation we show the results for our fuel distribution company, Griffith. Earnings were $0.37 this year compared to $0.40 last year, down $0.03 as Steve indicated. However, if we normalize for the effect of weather, the 2008 results were $0.03 above last year, since there was about a $0.06 difference between the two quarters.

And unlike the Central Hudson territory, the Mid-Atlantic region which covers the largest part of Griffith’s business had 8% lower degree days than last year. But again like Central Hudson, Griffith is experiencing price induced conservation which lowered its earnings by $0.03 and we also increased the provision for uncollectable accounts at Griffith by $0.02.

Other expenses of operations, for example truck fuel, also increased by $0.02. But we were able to offset the $0.04 increase in all expenses by $0.04 of improved margins on petroleum sales and services. And these prior comments on Griffith exclude the recent acquisition and they added about $0.05 per share compared to the acquisitions made in the first quarter of 2007.

And this contribution from the acquisitions went a long way to offset the negative weather, the conservation impacts of the base company Griffith. Now moving to page 8 which will be the conclusion of my remarks. We have the results of CH Energy Group’s other businesses and these businesses include our legacy, partnerships and the newer investments of Central Hudson Enterprises, our wind, ethanol and biomass projects, plus the interest income of our temporary cash investments and other results at the holding company.

And this final segment of our business had earnings of $0.13 per share for the first quarter of 2008 compared to $0.15 for the first quarter of last year. And the $0.02 reduction resulted from lower earnings in the cash investments of the holding company, as these investments were redeployed for new businesses and other cash needs.

The Corn Husker ethanol investment earned $0.03 less than last year, due mostly to high corn prices which lowered margin, even though ethanol prices were somewhat higher. However, fully offsetting this was the $0.03 contribution from the Lyonsdale Biomass plant which had a 91% capacity factor in 2008 compared to 49% in 2007. And that was due to the operating and fuel supply problems experienced in the first quarter of 2007 which we had corrected by 2008.

So that ends my remarks on the first quarter financial results and now I’d like to turn our presentation over to Chris Capone who will discuss business conditions and outlook. Chris.

Chris Capone

Thank you Donna. Good afternoon everybody. As indicated in our press release, our 2008 Central Hudson guidance is now $1.80 to $1.90 per share. Now in total this guidance reflects $0.25-$0.35 per share of earnings shortfall due to sales levels being below the levels imbedded in our current rate agreement, a $0.05 increase in our uncollectable reserve as Donna mentioned earlier and the $0.05 weather impact.

When viewing our earnings in this context, we here at CH Energy Group certainly feel that the earnings potential of this business unit are much higher than the current guidance range reflects. And as was also mentioned earlier in the call, our service territory is beginning to feel some of the impact from the slowing economy and the troubles in the housing market, but our customer growth as Steve said remains positive, though it has slowed modestly.

More significantly, impacting our businesses and our customers is the dramatic increase in energy prices, which again as we have mentioned earlier in the call, does appear to have caused our customers to reduce their energy usage. Spot natural gas prices have increased over 60% since last fall and electricity prices have increased about 30% over that same period.

The energy usage per customer that we have experienced is well below what was included in our current rate agreement and this gap is most likely to continue to widen because in our rate agreement, customer usage throughout the term of the agreement is projected to increase modestly each year of the rate case.

We are currently estimating that the residential electricity usage is about 4-5% below that usage imbedded in our rate agreement but natural gas usage is roughly 9-10% below. And this does translate into a significant earnings impact again as we have quantified just a few moments ago at about $0.25-$0.35 per share.

In 2007 that figure was approximately $0.16 per share as I had mentioned in the call we had back in February. The 2008 expected ROE in our electric business is projected to be somewhere around 8.75% which is well below our allowed ROE of 9.6%. And on our natural gas business it’s actually projected to below 5%. And as Steve had mentioned earlier, the combined is projected to be around 7.75%.

We continue to bring this to the attention of the public service commission and we are pursuing some alternatives to find an interim solution. Now on a positive note we do continue to invest significant resources into our infrastructure to improve the reliability of our service for our customers and to meet the growth, again albeit modest in the Hudson Valley.

Over the last three years we have reinvested $67 million of equity back into Central Hudson. As we continue to invest in our T&D system, our rate base will continue to grow which should ultimately lead to an increase in earnings. As Steve mentioned, at this point, all indications lead us to believe that we will be filing on August 1 for new rates to take effect on July 1 of next year.

As you would expect, the issue of the sales forecast will be an important issue in the upcoming rate filing and there are a number of other issues that will be addresses as well, including allowed ROE. Now however, given that recent cases include a revenue decoupling mechanism, the recent view that is, the issue of usage per customer may be somewhat mitigated. We can’t project at this point certainly what the outcome of the filing will be.

In the meantime, as Steve mentioned, we are taking all possible steps to manage expenses, it still provides a level of safe and reliable service our customers expect. At this point I’d like to make some comments on the outlook for Griffith.

Our 08 guidance for Griffith was recently lowered to $0.20-$0.25 per share from our original guidance of $0.20-$0.30 per share. And that original guidance already reflected a $0.05 impact of warmer weather to date and $0.10 per share from our projection of full year conservation.

The recent reduction in the upper end of the guidance range is really to reflect projected additional conservation driven by even higher and what are now record high home heating oil prices. Heating oil prices at the end of March were roughly double year ago levels and were still 30% higher compared to year end 2007.

These are virtually unprecedented increases in prices and certainly they come at a time of well publicized housing woes and what are signs of a slowing economy. We have seen price induced conservation in prior periods and as prices moderated and stabilized we did see a reversal of some of that conservation. We believe that the conservation that we’re experiencing right now is not all permanent and some portion should be reversed if energy prices were to decline.

And giving the cost pressures facing all heating oil delivery companies, we feel margins may expand throughout the industry to offset some of these delivery cost increases. Given the additional pressures facing many of the oil delivery companies, we are seeing an increase in the number of acquisition opportunities. We’re very aware of the returns Griffith overall as a business has delivered over the last few years and the fact that the returns for that business, the entire business had been below our expectations.

However, as we look to allocate capital amongst our current and potential new businesses, the oil acquisitions that we are currently considering and those that we have recently closed on, we feel represent opportunities to earn attractive risk adjusted returns and returns that are significantly in excess of the Griffith base business and for that matter the allowed ROE of Central Hudson.

We acquired 12 companies in early 2006 through early 2007, so we have a full year of actual returns to judge those acquisitions. The 12 month weighted average ROE was significantly greater than the pro formas we have establishes which were based upon what we believe are appropriate and acceptable risk adjusted returns and these actual returns were almost double the earned return of Central Hudson.

We firmly believe that these acquisitions are adding to shareholder value. The recent industry turmoil has provided an increase in the number of potential acquisitions that we are considering and may allow us to adjust our pricing to potentially earn even better returns.

We’ve already closed on three acquisitions in 2008, as Donna had mentioned, and we’ll evaluate further acquisitions with the same rigor we have applied in the past and we will only close on those that we feel will provide appropriate returns and will provided increases in shareholder value.

At this point I’d like to make some comments on what we call other check. As Donna mentioned, this incorporates our wind, our ethanol and our biomass investment, Lyonsdale. When you look at the guidance for this business unit, it’s now $0.30-$0.35 per share versus the $0.25-$0.35 provided back in February.

Specifically for Corn Husker and the entire ethanol industry overall, 2008 continues the difficulties faced in the second half of 2007. As Donna mentioned, ethanol pricing has rebounded but corn prices have reached extraordinarily high levels, reducing the profitability and significantly straining the liquidity of the industry and Corn Husker as well.

Currently crushed margins are sufficient to cover variable costs and contribute modestly towards fixed costs. When we made our investment in Corn Husker we were fully aware of the potential earnings volatility and we have experienced our fair share during our ownership period.

The difficulty in accessing financing for new ethanol facilities coupled with the requirements of the renewable fuels standard should bring the supply demand situation back into balance. The energy bill signed towards the end of last year did include a significant increase in the renewable fuels standards. The RFS for 2007 was 6.3 billion in 07, 9 billion gallons required in 08 and 11 billion gallons required in 09.

And these kinds of levels of required blending should support ethanol prices to a certain extent. In addition, we’re looking for ways to link the price of corn to the price of ethanol through off-take agreements. Regarding our Lyonsdale investment, again Donna talked about the improvement in the capacity in the first quarter of 2008 to what is a record level under our ownership to over 90%.

And when you look at the earnings, again, compared to the first quarter of 2007, there was a significant increase. It’s certainly our intention to put all our efforts into maintaining this higher possible capacity factor and managing the other day to day expenses as well.

Auburn is a project that we had mentioned towards the end of last year and we did mention in the end of year call that we had in February. This project is slated to be constructed, fully constructed by the end of this year or early 09. And if it goes as currently planned will certainly contribute to earnings in 2009.

More broadly, to our redeployment efforts, just to give an idea of what our remaining redeployable capital is, we have about $45-$50 million of latent debt capacity left to grow our businesses. And as we look at these opportunities, just generally, we will be guided by what we believe are those opportunities that will best add to shareholder value, including a share buyback if the rate of return on that type of use of our financial resources becomes more attractive than the other investments that we could make.

Overall 2008 certainly is turning out to be a very challenging year. We are working to address the usage per customer shortfall at Central Hudson as well as all the preparations that go into an upcoming rate case filing. We will continue to invest significant capital in Central Hudson which we do believe will contribute to future earnings growth as we’ve mentioned earlier in this call.

And we will continue to seek out and hopefully close integrated attractive oil acquisitions as those opportunities make themselves available as well as pursue other energy related acquisitions. As Steve mentioned in one of the earlier releases that we had put out, 2008 should represent a trough in earnings, not a trend and I do believe along with the rest of management that we setting the stage for an improved earnings profile going forward.

Again specifically the rate case filing for Central Hudson, acquisition candidates at Griffith that should provide very attractive and appropriate returns, the completion of Auburn and again other projects that we are now considering. At this point I’d like to turn it back to the moderator to open the call up for questions.

Question-and-Answer Session

Operator

(Operator instructions) We do have a question in the queue from the line of Maurice May, Power Insights, please go ahead.

Maurice May – Power Insights

Yes, good afternoon folks. Could you give us the actual megawatt hours and MCFs of gas that are in your forecast for Central Hudson electric and gas for 08 and 09 in the current rate deal.

Steven Lant

We can, we don’t have them at our fingertips I don’t believe Maury that it would be a simple matter for us to go back and look at the settlement agreement and provide those figures.

Maurice May – Power Insights

Okay can you give us the percentages one more time, I didn’t quite get them the first time.

Steven Lant

The percentages that you’re referring to are the percentages by which we’re under-running those projections?

Maurice May – Power Insights

Yes Steve.

Chris Capone

Sure, Maury on the electric side it’s approximately 4-5% and on the natural gas side it’s roughly 9-10%.

Maurice May – Power Insights

Okay and those are first quarter?

Chris Capone

That’s just a general under-run when you look at the GP levels, but yes those levels would apply to the first quarter as well.

Maurice May – Power Insights

Okay so they are the kind of the run rate off of the forecasted consumption.

Chris Capone

Yes they are.

Maurice May – Power Insights

Okay and then the second thing, hate to bother you on this one, but Community Wind is one of your renewable investments and you didn’t mention it and I was just wondering how it was going.

Steven Lant

Actually we’ve seen improved operations there as well. The troubles there were, there’s two sites, one in Atlantic City, New Jersey, what we call Jersey Atlantic Wind and others is Bear Creek, Pennsylvania. New Jersey is GE equipment which has been running and operating very, very well.

In Bear Creek it was [Gemesa] equipment and for 2007, especially the early part, there were some issues there. But from the second half beyond, they are up to the levels that we had expected, so that project is running along actually rather well.

Maurice May – Power Insights

Okay, great, thanks folks.

Operator

(Operator instructions)

Steven Lant

Well hearing no further questions, thank you very much for your attention and look forward to speaking to you again on next quarter’s call. If in the meantime you have any questions please call Stacey Renner or Chris Capone. And once again, thank you for participating, have a good day.

Operator

And ladies and gentlemen that does conclude your conference, we do thank you for joining while using AT&T Executive Teleconference. You may now disconnect. Have a good day.

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Source: CH Energy Group, Inc. Q1 2008 Earnings Call Transcript

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