Questar Corporation. Q2 2010 Earnings Call Transcript

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Questar Corporation. (NYSE:STR) Q2 2010 Earnings Call July 28, 2010 9:30 AM ET

Executives

Martin Craven - Vice President, CFO & Treasurer

Ronald Jibson - President & Chief Executive Officer

James Livsey - Executive VP & General Manager, Wexpro

Allan Bradley - Executive VP & President & CEO, Questar Pipeline

Analysts

Lasan Johong - RBC Capital Markets

Kevin Smith - Raymond James

Tim Schneider - Citigroup

Operator

Good morning. My name is April and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2010 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn the conference over to Mr. Martin Craven, Vice President and CFO. Please go ahead sir.

Martin Craven

Thank you, April. Good morning everyone and welcome. This is Martin Craven, Questar's Chief Financial Officer as of July 1st. We want to thank you for joining us today for Questar's second quarter 2010 earnings conference call.

What's a new era for Questar? On July 1st, we completed the spin-off of QEP Resources Questar's E&P and midstream field services businesses. And we returned to our roots as an integrated natural gas company comprised of three complimentary businesses, Wexpro, Questar Pipeline and Questar Gas.

With me today on the call is Ron Jibson, who became Questar's President and CEO on July 1st, following this spin. Ron succeeds Keith Rattie, who now serves Non-Executive Chairman of the Board for both Questar and QEP Resources. Also here today are Jim Livsey, EDP and General Manager of Wexpro, Allan Bradley, EDP and CEO of Questar Pipeline, Craig Wagstaff, VP and General Manager of Questar Gas and Sam Brothwell, VP Investor Relations for Questar.

We were very excited to meet with many of you and the investment community during our two week investor road show this past June. Since then we're pleased to report that in connection with the spin, release as front of safety credit rating with a stable outlook on Questar Pipeline and Questar Gas's debt and a P2 short-term rating up at the parent level.

In standing forces raised its credit ratings to noshes on both Questar Pipeline and Questar Gas debt from BBB+ to A with a stable outlook and we're pleased they also raised Questar's short-term rating from A2 to A1 helping our commercial paper program.

Yesterday, Questar reported second quarter 2010 earnings from continuing operation of 28.7 million, which included a one time after tax charge of 7.1 million or $0.04 per diluted share with Questar share of expense associated with the spin. Excluding these charges, earnings for the quarter totaled $0.20 per diluted share. We affirm 2010 earnings guidance of $1 to $1.5 per diluted share before these charges.

Now we will be making some forward-looking statements during our call today and I remind you that actual results could well vary defer from our estimates for a verity of reasons.

Questar income from continuing operations grew 8.5% in the second quarter compared to a year ago. Wexpro grew our net income 11% to 22 million in the quarter and this was driven by a 6% increase in investment base. As you know under the Wexpro contract, Wexpro develops natural gas and oil on a define set of producing properties in the Rocky's and typically earns about 19% after tax unleveled return on its net investment base.

Wexpro delivers its natural gas production from these properties to our utility Questar Gas at a cost of services that includes that return. So our Wexpro's production similar to that of an -- its operation is similar to that of an E&P company. Its economic model is structured more like a regulated utility.

Questar Pipeline, our inter-state natural gas pipeline and storage business grew net income 6% to 15.9 million in the second quarter. We benefited from higher transportation contract demand related to completion of an expansion project late last year and we also enjoy higher revenues from natural gas liquids sales.

Our retail natural gas distribution utility, Questar Gas, lost 2.2 million in the second quarter slightly more than a year ago. Remember though that Questar Gas typically generates all of its annual net income in the first and fourth quarters each year and reports a seasonal net loss in the second and third quarters. For the 12 months ended June 30th Questar Gas's net income rose about 3% driven by continued strong customer growth in our service area.

On the expense front combined operating and maintenance general and administrative expenses totaled $64.3 million in the quarter compared to 59.6 million in the second quarter of last year an almost 8% increase. Higher second quarter expense however was primarily the result of higher Demand Site Management or DSM cost that were incurred at Questar Gas. As well as higher overhead and employee cost of each company in the period.

Recall though that Questar Gas recovers these DSM cost dollar-per-dollar in rates. So excluding those higher cost, consolidated O&M and G&A expense rose a more moderate 3.7% quarter-over-quarter.

Production and other taxes rose 31% in the second quarter. This increase was driven by a 74% increase in the field price of natural gas which used to calculate taxes on Wexpro production. Again these taxes are recovered in Wexpro's cost to service do terms of the Wexpro agreement.

And finally depreciation expense rose 5% in the quarter on net property plants and equipment that grew 6% quarter over prior quarter. Now as I mentioned Questar reported an after tax charge to earnings from continuing operations of $7.1 million this quarter for our share of cost associated with this spin. This amount maybe subject to some revision prior to your-end, but we don't expect it to change materially. QEP share of separation cost is included in our earnings from discontinued operations.

In the second quarter, we booked capital expenditure of $79 million for Questar in total and a 140 million year-to-date. Of that total, Wexpro spent 22 million in the quarter and 40 million year-to-date and that drove its investment base to 436 million by quarter end compared to an investment base 411 million at the end of second quarter 2009. Questar Pipeline spend 31 million in the quarter and 49 million year-to-date. And finally Questar Gas rounded out spending 25 million in the quarter and $51 million year-to-date.

To summarize, in the second quarter and our first quarter of reporting on post-spin basis, we realized solid results. All three Questar businesses executed well. We remain on track to reach our goals for the remainder of 2010 and beyond, with the spin we now offer investors a more focused investment theses and that's a rate based and investment based driven company offering exceptional visible growth, returns on capital that we think are very competitive with our utility industry peers.

If we execute we believe we can grow net income at mid to higher single digits rates over the next five years. And if we do that we believe we can grow the dividend at a compound annual rate of 5% to 10% over that same period.

Our balance sheet is strong. We plan to keep it that way. We're committed to a focused return on capital, cost control, customer service and execution.

With that I'm pleased to turn it over to Ron Jibson.

Ron Jibson

Thank you, Martin. Good morning everyone and thanks for dialing in this morning. We're pleased to have you join us on this our first earnings conference call following the spin-off of QEP Resources on June 30, of this year. Our comment on second quarter results from continuing operations as well as our outlook for 2011 and beyond.

We're off to a good start. The new Questar has returned to its roots as a Rocky's based integrated natural gas company. We offer a low risk investment and strong fundamentals of natural gas with strong investment return and income growth relative to our peers. We intend to translate that into dividend growth and a superior total return proposition for our investors. I'll spend the next few minutes going through each of our integrated business units, after which we'll address your questions.

I'll start with Wexpro. Wexpro ended 20.1% after tax on levered to return on its investment base for the 12 months ended June 30. We're allocating $100 million of capital to Wexpro in 2010. We've invested about $40 million in Wexpro in the first half of this year and we're on track to grow Wexpro's investment base 4% to about $450 million by year end. We've invested $98 million in development wells in the last year for a 6% year-over-year increase in Wexpro's investment base. We plan to invest between $500 million and $700 million over the next five years in Wexpro's low risk development drilling inventory.

As you know Wexpro developed reserves on behalf of Questar Gas on a defined set of properties in the Rocky's and earns a return on its net investment in successful development wells. Over the past 12 months Wexpro produced 48.5 billion cubic feet of natural gas which as you recall makes up about half of Questar gases supply requirements.

Turning to our natural gas transportation and storage business, Questar Pipeline earned an 11.2% return on equity for the 12 month ended to June 30th. Recall that in late 2009 our Pipeline team installed two new compressors on over trust pipeline which runs through the heart of Green River basin and moves gas between Old Pal and Warm Setter, the two largest natural gas hubs in Wyoming. The Overthrust compression project added 300,000 decatherms per day of capacity each to Warm Setter. Our Pipeline team has sold 160,000 decatherms per day at this capacity for delivery to Old Pal.

These contracts added $4 million to revenues to second quarter and $8.4 million year-to-date. Questar Pipeline manages hydro carbon due point on its system by extracting NGL's. Questar Pipeline benefited from strong NGL prices during the first half of this year. We added $3.3 million of incremental NGL revenue in the quarter and $6.6 million year-to-date. NGL prices I remind you weaken since the end of the quarter, so this revenue trend may not continue for the rest of 2010.

Finally Pipeline remains on track with another expansion of Overthrust. This is a 43 mile 36 inch pipeline west of Rock Spring Wyoming. This $100 million project is underwritten by long-term contracts to move gas west for delivery initially to Cream River pipeline and ultimately to Ruby pipeline. We expect to put this project in service by year-end.

Turning to our gas utility, Questar Gas earned a 10.4% return on average equity for the 12 month ended June 30th. We continue to benefit from above average customer growth in our service area. We added over 15,000 customers over the past year up 1.7%. This growth added $4.1 million of incremental margin in the quarter.

We achieved a key regulatory objective during this quarter. On April 8th the Public Service Commission of Utah approved a settlement in our Utah General Rate case. Effective August 1st of this year are allowed return on equity will increase from 10% to 10.35%. This settlement in defiantly expands our decoupling tariff and also includes an infrastructure cost tracker. That tracker lets us immediately book into rate base investment that is related to our multi-year high pressure natural gas feeder-line replacement program. Recall that this program combined with our above average customer growth outlook will drive 8% to 9% growth in Questar Gas rate base through 2014.

We're pleased to note that during the most recent quarter, Questar Gas received its highest customer satisfaction rating since we began collecting survey data, keeping us among the very top gas utilities in the nation. You may have seen or heard some recent press discussion of [PASPO] Federal Support for natural gas vehicles and related infrastructure. Questar Gas is nationally recognized for its natural gas vehicle infrastructure development here in Utah and we're extending our partnership with the state using a federal grant to further expand our CNG filling station network this year.

In total we plan to invest a $129 million of capital in Questar Gas during 2010. We invested $51 million in the first half of this year, about 38% or $49 million of our 2010 budget is associated with the feeder-line replacement program. Again our infrastructure cost tracker means we'll begin earning our net investment without needing to file additional rate cases.

To summarize, we're on track to deliver 2010 net income of $1 to $1.5 per share. As a reminder, this guidance range includes interest on $250 million of incremental debt we took on its separation that excludes our share of separation cost associated with the spin. We continue to have good visibility on multiple growth opportunities in each of our businesses over the next few years. If we execute we believe we can deliver 5% to 7% earnings and cash flow growth through 2014. Coupled with our plans to grow the dividend, we believe this presents a compelling total return opportunity.

Thank you again for your interest in the new Questar. And with that April, let's open up the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) The first question comes from the line Lasan Johong.

Lasan Johong - RBC Capital Markets

Thank you, great quarter. Marty, can you give us a sense of what the breakeven price for Wexpro's production is included a 19% return. So you can compare it to the market gas price.

Martin Craven

Actually I'll refer that over to Jim Livsey who's with us today.

Lasan Johong - RBC Capital Markets

Okay.

Jim Livsey

Yeah. The price this year is pretty comparable to the market price. We're in the mid 450 range for a decade both for the cost of service gas and as well as purchase gas side of the utilities portfolio. So we're pretty comparable this year versus purchase gas.

Lasan Johong - RBC Capital Markets

Then as gas prices accelerate to the up side, what -- how fast can you press on the accelerator paddle for Wexpro?

Martin Craven

Well there is lead time associated with our drilling program with the permitting process. So we're well ahead of next year's program with respect to the permitting and everything we need to do. So we have some flexibility. But it's going to be related to the rigs. So we have employed as well as for mix. So whatever we do on a ramp up basis we'll take some period of time to do that.

Lasan Johong - RBC Capital Markets

Okay. Marty, couple of quick questions, the four cell extraordinary separation cost, is that included or excluded from your guidance?

Martin Craven

That's excluded from our guidance.

Lasan Johong - RBC Capital Markets

Perfect. Can you give us a sense of your seasonality in quarterly distribution of earnings going forward?

Martin Craven

I'm not sure what -- in terms of a dividend?

Lasan Johong - RBC Capital Markets

No. I'm talking about your earnings profile. It's going to be first and fourth quarter heavy and probably declining into same quarter. So I am guessing roughly, two thirds to two quarters of your earnings will come in the first and fourth quarter, correct?

Martin Craven

We're thinking that sounds fairly reasonable.

Lasan Johong - RBC Capital Markets

And your low points will be at second quarter, correct?

Martin Craven

Correct.

Lasan Johong - RBC Capital Markets

Okay. One, on the M&A front can you give us a sense of kind of what's going on? Are you keeping an eye out on the M&A situation? Are you interested; are there things that you can immediately capitalize on?

Ron Jibson

Yes Lasan. We are always looking for growth and expansion opportunities. But I think we don't need to make an acquisition to grow. We have very good visibility on 5% to 7% compounded organic net income growth over the next five years. So we're really focused right now on executing those plans. But we certainly would keep our eyes open and look for any opportunities along that line.

Lasan Johong - RBC Capital Markets

Great, thank you very much.

Martin Craven

Again I, I wanted to clarify; Wexpro earnings and Questar Pipeline earnings are pretty stable quarter-to-quarter. The only seasonality you'll see will be in the results of Questar Gas.

Lasan Johong - RBC Capital Markets

Right.

Martin Craven

Okay.

Operator

Your next question comes from the line Kevin Smith, Raymond James.

Ron Jibson

Good morning, Kevin.

Kevin Smith - Raymond James

Good morning, gentlemen. I think we touched on this little bit on last question. But what were really the variables from Wexpro's capital budget? Is it just your competitiveness versus to purchase gas?

Ron Jibson

Go ahead Jim why don’t you address that?

Jim Livsey

Well essentially we maintained approximately 15% of the utilities gas supply come from the Wexpro cost service gas. That’s a percentage that's worked well for us. Our plans going forward with the 500 million to 700 million over five years really call that we are going to increase that percentage potentially over 60% with the higher range of that capital spending. So we want to make sure that we will be able to deliver cost to service that will be competitive with purchase gas and those are the variables that we look at both our cost -- the final cost versus the purchase gas. But we do have upward headroom going forward with delivering more cost to service in the current mix.

Kevin Smith - Raymond James

Okay. So if I -- to summarize, I mean if gas price go up and you're refining cost at Wexpro essentially stay flat or go up just a little bit. But not as much as I think wholesale gas prices, that could beat the high end of the range. But if gas --

Jim Livsey

That would be the variable that allows us to be more towards the $700 million to the extent we can still be competitive with client cost.

Kevin Smith - Raymond James

Okay. Fair enough, thank you very much. One other question, I think you also kind of touched on this, on the dividend. But you guys are going to generating significant amount of free cash flow under your car business model. I assume you don’t do any acquisitions, I mean if the cash flow just going to go to increase the dividend and repay reduced debt?

Ron Jibson

I’ll ask Martin to address that to Kevin.

Martin Craven

Actually Kevin our capital spending plans will have us to be net consumers of capital fairly moderately over our planning period, maybe a 100 million or so a year. To the extent of those capital opportunities don’t come to pass, we'll certainly entertain and want to grow the dividend more aggressively.

Kevin Smith - Raymond James

Okay. That’s all I have. Thank you very much.

Ron Jibson

Thank you, Kevin.

Operator

You have a follow-up question from the line of the Lasan Johong, RBC Capital Markets.

Ron Jibson

Yes Lasan.

Operator

Your line is open.

Lasan Johong - RBC Capital Markets

I am sorry I was on mute. I apologies. You said last call that couple of hundred million dollars is what you expect, you mean CapEx over this year and next year. But longer term you kind of left it fuzzy and said maybe around a 120 million, is that still a good number to kind of think about?

Ron Jibson

I think that number would exclude any capital expenditures at Wexpro. That $120 million number would be pipelined in Questar Gas maintenance.

Martin Craven

Yes.

Lasan Johong - RBC Capital Markets

And then 5 to 7 --

Martin Craven

Lasan as far as maintenance capital within the two regulated businesses we would be looking around a 120 million to 125 million.

Lasan Johong - RBC Capital Markets

And then you have adds to that based on the $500 million to $700 million for Wexpro spending.

Martin Craven

That's correct.

Lasan Johong - RBC Capital Markets

Thank you so much.

Operator

Question from the line of the line of Tim Schneider with Citigroup.

Ron Jibson

Good morning Tim.

Tim Schneider - Citigroup

Hey good morning. Quick question, do you have the make up of year NGO barrel as a pipeline by product types. Ethane, propane and all that by percentage?

Martin Craven

We'll ask Allan Bradley to address that, Tim.

Allan Bradley

We don't typical report that. I will tell you that our barrel make-up is heavily weighted towards the heavier ends. Pentanes, butane and Protane not a lot of ethane. So when you compare our net prices in the press release they are going to be a little higher than you might typical expect. There is probably a lot of reasons for not doing that. But primarily just the intense competition up here in the Rocky's for processing. So we've chosen not to break that out.

Tim Schneider - Citigroup

Okay. No problem, that make sense. Thank you.

Ron Jibson

Thank you, Tim.

Operator

There are no further questions at this time.

Martin Craven

Alright. We again thank you for taking the time this morning. We appreciate you dialing in. And we look forward to visiting with you again next quarter.

Operator

This concludes today's second quarter 2010 earnings release conference call. You may now disconnect.

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