Shell Midstream Partners LP (NYSE:SHLX) Q2 2016 Earnings Conference Call August 4, 2016 11:30 AM ET
Courtney Selinidis – Investor Relations
John Hollowell – Chief Executive Officer
Susan Ward – Chief Financial Officer
Maura Shaughnessy – MFS Investments
Matt Niblack – HITE Hedge Asset Management
Good morning. My name is Ester and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2016 Shell Midstream Partners Earnings Call. All participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]
I would now turn the call over to Courtney Selinidis, Investor Relations Officer. You may begin your conference.
Thank you. Welcome to the second quarter earnings conference call for Shell Midstream Partners. With me today are John Hollowell, CEO of Shell Midstream Partners; Susan Ward, CFO; and Kevin Nichols, Vice President, Commercial.
The presentation materials shared this morning can be found on our website, shellmidstreampartners.com, under the Events and Conferences section. Slide 2 contains our Safe Harbor statements. We will be making forward-looking statements related to future events and expectations during the presentation and Q&A session. Actual results may differ materially from such statements and factors that could cause actual results to be different are included here, as well as in this morning’s press release and under Risk Factors in our filings with the SEC.
Today’s call also contains certain non-GAAP financial measures. Please refer to this morning’s press release and Appendix One of this presentation for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures. We will take questions at the end of the presentation.
With that, I’ll turn the call over to John Hollowell.
Thank you, Courtney. Good morning, everyone, thanks for calling in. As always, we appreciate your interest in Shell Midstream Partners. This morning, I’ll start by reviewing our strategy and how we are executing our plans. I will walk you through the operational highlights for the quarter and then turn the call over to Susan.
Since the IPO, our strategy has focused on growing and building a flagship portfolio of fee-based assets with predictable cash flows, while delivering top-tier distribution growth to our unitholders. Our assets complement our sponsors’ upstream and downstream footprint and are strategically located along the U.S. Gulf Coast and other markets across the United States.
We have acquired $1.9 billion of assets from our sponsor all in immediately accretive deals for our unitholders. Each acquisition has helped us to built scale. With our most recent acquisition of additional interest; Zydeco, Bengal, and Colonial, being the largest to-date. This puts us well on track deliver our 2015 target of completing $1 billion to $1.2 billion in acquisitions which is in line with our 2015 delivery.
The cash generated from the acquisitions and organic growth in our systems has allowed us to increase our distribution every quarter since we went public in late 2014. The current quarter distribution announced with $0.25 per limited partner unit. This represents an increase of more than 50% above our first quarter distribution in less than two years as a publicly traded partnership, which is in line with our intent to be a top-tier distribution growth MLP. We often get asked what does top-tier distribution growth mean, and for 2016 we believe this is around 25%.
Let me now discuss the strong alignment and support we maintain with our sponsor. Shell, as many of you know, completed the acquisition of BG earlier this year, and with that refreshed its strategy.
Let me highlight how the priorities of Shell and the priorities of the partnership remain very well aligned. First, Shell intends to reshape the company to be a world-class investment, generating high returns for its investors. Second is clear expectations and priorities for the portfolio, which is comprised of cash engines, which will generate stable returns and cash flow today; growth priorities, which are businesses with heavy capital investment like chemicals and deepwater.
And future opportunities where selected investment will be made to generate material businesses for the future. And lastly, Shell will manage the down cycle to ensure the financial framework of a company remains sound. Our sponsors refer our strategy, reaffirms the importance of Shell Midstream Partners as solidify our foundation of growth.
With the creation of the MLP, Shell demonstrated its appetite to reshape and leverage its midstream assets in a way that none of its peers have. This gives us a competitive advantage with the strongest MLP sponsor in the sector.
Shell intends to invest between $25 billion and $30 billion, a year across its strategic themes. A large portion of that investment is expected to be directed towards North American projects with associated midstream components that could qualify for inclusion into the MLP.
And Shell manages the down cycle, divestment to the partnership allow Shell to monetize assets while retain in important strategy control. This makes us the preferred hole for Shell’s high quality midstream assets which will help fuel our growth.
Today, I wanted to provide an update on two of Shell’s growth projects that are included in our runaway; Appomattox in the deepwater, and the Pennsylvania petrochemicals complex within chemicals. Both have important midstream components.
As some of you know, I previously led the deepwater business for Shell in this part of the world. So the Appomattox project is one I’m very familiar with. Appomattox is a development that unlocks a new frontier in the Gulf of Mexico in the deepwater. Shell has 79% interest in the field and we operate the platform. The mega development is expected to produce around $175,000 barrels per day from the Appomattox and Vicksburg fields.
In the current price environment, Shell and industry are focused on reducing their breakeven cost for large developments in the Gulf with good progress made. Shell’s Appomattox project had a breakeven price of around $55 per barrel when the project was sanctioned. Currently the breakeven is less than $50 per barrel, and teams are working to bring that down even further in light of the lower commodity prices and to be competitive with onshore Shell production.
Our Shell pipeline company is building the Mattox pipeline to transport Appomattox’s volumes. The 89-mile pipeline will have a capacity of 300,000 barrels per day. The pipeline will have pre-installed connections to attract additional developers in the vicinity, including a recent exploration success such as Fort Sumter. So as you can see on the slide, the Appomattox hall is well under construction. The pipe for the Appomattox pipeline has been purchased and is currently being coated.
Now on to the exciting new chemical projects in the United States, Shell chemical strategy focuses on activities were Shell has a clear competitive advantage in key markets. And just two months ago, Shell sanctioned the Pennsylvania petrochemicals complex. This will be a world scale development and it’s expected to be the most cost comparative polyethylene producer in the U.S. More than 70% of the North American polyethylene market will sit within a 700 mile radius from the facility.
Shell pipeline will build a 94-mile common carrier pipeline to connect ethane from the Marcellus and Utica reservoirs in Pennsylvania and Ohio to the new Shell Pennsylvania petrochemicals complex. These are both exceeding new projects for Shell and could provide significant opportunities for Shell Midstream Partners.
Now moving on to activity and performance in the second quarter. Effective April 1, we acquired an additional 30% of Zydeco, 3% of Colonial, and Shell’s remaining 1% of Bengal for $700 million. And this is a highly accretive deal for our unitholders. The acquisition was funded with cash on hand borrowings and proceeds from an equity offering. We also took advantage of an opportunistic acquisition of a 2.62% interest in the Explorer Pipeline, which compliments Shell’s existing ownership.
The map on Slide 10, highlights the Explorer Pipeline, a well-known high quality, refined product line which transports gasoline, diesel, fuel and jet fuel to 70 major cities from Texas to the Midwest. We expect to close the acquisition next week and will fund it with cash on hand. So you can see the second quarter was busy for Shell Midstream Partners on the acquisition front.
Now let me move to our operations and starting with safety. From a safety perspective, we had no personal injuries, which I’m always glad to report. In April, however, we did identify a very small pinhole leak on Zydeco, and the line was immediately shutdown, repairs were completed within 36 hours. Approximately two barrels were released from the pipeline as a result of the leak.
The operational and financial performance at Bengal, Colonial and Lockport remains steady quarter-to-quarter. At Poseidon, we saw an increase in throughput primarily due to the receipt of barrels from another pipeline system that was under maintenance. At Zydeco, volumes on the mainline system were steady compared to the prior quarter. The other segments on Zydeco saw increase throughput following completion of refinery turnarounds and maintenance activity.
Last quarter, we discussed the number of growth projects that we’re investing in Zydeco. Let me update you on those today as we get closer to putting them into service. Our pump and electrical upgrades in Houma will be complete this month, which is I shared before, expands capacity from Houma to Clovelly by 100,000 barrels per day.
This investment helps facilitate our joint tariff agreement with LOCAP, which we filed earlier this week, which solves a bottleneck to St. James. Customers can now access additional capacity from Houma to St. James at the same rate as the existing segment on Zydeco. Response has been very positive regarding the new route and we expect customers to begin shipping volumes on the tariff in September.
We’re also expecting several new third-party connections into the Zydeco system to come online through the end of 2016 and early 2017. One of the connections, the Sun Connection to Nederland, Texas, is expected to be online by September 1. With this connection, we expect an incremental $2 million per month to Zydeco’s cash flows.
Now moving on to the Gulf of Mexico and our deepwater portfolio, and let me touch on Auger and Mars. Auger’s volumes were lower this quarter with almost 90% of the decrease driven by turnarounds at producers platforms. These turnarounds where completed at the end of April and volumes are recovering. The remaining decrease was primarily due to a well performance issue, which should be resolved by year end.
Mars had another quarter of strong performance. The Jack St. Malo field continues to ramp up and we saw a new production from the Julia field which came online in April. In addition, there was an increase in volumes following the completion of a producer turnaround activity in the first quarter. Mars also saw increased storage revenues over the quarter. However some shippers began to unwind their positions toward the end of the second quarter, based on their forecast of crude prices.
Let me take a moment to talk a little bit more about the Gulf of Mexico. We remain bullish about the future development of projects in the deepwater. Industry sources such as the EIA forecast growing offshore volumes to 2017 and 2018 from investments made oil price decline. Rig count onshore has decreased 80% since of third quarter 2014, while deepwater rig count decrease by only 13% during the same time period. Also industry is finding innovative ways to decrease development cost of new investments ranging from Tie Backs small platforms to mega projects.
The break-even process of these investments can range from $25 to $45 dollars per barrel, making deepwater investments very competitive with onshore sale production. Shell Midstream Partners intense to complete one more acquisition this year in line with our previously announced growth plan. While we can’t provide specific details in the next acquisition, we will likely include Gulf of Mexico assets from Shell pipeline’s significant offshore footprint that is concentrated around active development.
And with that let me hand the call over Susan to talk about the financial results for the quarter.
Thanks, John. Good morning everyone. Turning to Slide 14, net income attributable to the partnership for the second quarter with $63.8 million which shows an increase compared to the prior quarter primarily related to the benefit of the acquisition. Revenues for the period were $71.1 million, approximately $5.6 million lower than the prior period with most this due to the Auger’s contribution.
More than half of this reduction in Auger’s revenue resulted from the end in 1Q 2016, a project cost recovery related revenue associated with the project at Enchilada. That revenue averaged $4 million per quarter since year end 2014, only $2.2 million of the change in Auger’s revenue occurred because of lower throughput from 27 days of producer turnaround in the quarter and the well performance issues as John noted earlier.
In the aggregate, consolidated costs and expenses increased slightly compared to the prior quarter. The reduction in the partnerships consolidated operating income was for the most part driven by the reduced revenue. Income from equity investment and dividend income was $4.2 million higher for the quarter with Colonial increase, a function of the additional interest acquired by the partnership.
Now turning to Slide 15, adjusted EDITDA attributable to partnership was $77.1 million, driven by the higher ownership of the Zydeco in the second quarter. Cash available for distribution was $69.7 million, $10 million greater than the prior quarter. The partnership declared the distribution of $0.25 per unit for the second quarter. This was a 6.4% increase over the prior quarter distribution and our sixth consecutive increase since the IPO. We maintained healthy distribution coverage of 1.4 times in 2Q, 2016, and we expect this coverage ratio to track towards 1.1 times in the future as the partnership growth.
Turning to Slide 16, I wanted to provide an update to the full year 2016 expected growth and maintenance capital expenditures for the partnerships consolidated asset. Let me start with growth CapEx. At the beginning of the year, we expected to spend approximately $31 million in growth CapEx. A little over $30 million of that was targeted for the Zydeco system to cover upgrades at Houma, new connection and a potential pipeline expansion. This pipeline expansion was contemplated to ease a bottleneck on the Houma to St. James segment. With our LOCAP joint tariff arrangement, we eliminated the need for this CapEx and we’ll still benefit from the bottlenecking the system.
Now switching to maintenance CapEx. Maintenance is generally concentrated in the second and third quarters, in the Gulf of Mexico the waters are calmer and at Lockport, we avoid the winter months. At the start of the year, we forecast approximately $30 million for maintenance CapEx. We now estimate spending $33.6 million of maintenance CapEx this year on Zydeco directional drill project, a storm water project at Lockport and various other projects at Zydeco and Auger.
However the partnership will be reimbursed approximately $12.3 million of these expenditures, resulting in a total cash outlay of $21.3 million in maintenance CapEx for Shell Midstream Partners in 2016.
Let me close by moving to our balance sheet on Slide 17. As you can see we have a conservative capital structure, which we think is important to allow us to deliver our growth plans in any market environment. At quarter end, we had total of $344 million outstanding and we now have a 1.1 times debt to EBITDA coverage when you annualize Q2 adjusted EBITDA.
Our debt facilities are provided by our parent at attractive rates and we can request increases in the size of those facilities if needed. Last year, we effectively conducted an all debt finance transaction into 2Q, 2015. In addition to financing other acquisitions with combinations of cash generated from operation, additional debt and new equity. The MLPs strong balance sheet and low relative leverage gives us much flexibility in this choice.
And with that we will now open the line for questions.
Thank you. [Operator Instructions] Our first question comes from line of Maura Shaughnessy with MFS Investments. Your line is now open.
I was just trying to understand the philosophy on equity offerings. Obviously the stock has had a tough performance this year and those offering within two months of each other despite the fact that you’re almost in that cash position with the borrowing costs de minimis. So can we just go through that philosophy of doing equity offerings?
Yes, Mara, this is Susan. We look at our financing position over the long-term and we’re in a good position now to finance acquisitions in any of the ways available. We have $169 million of cash on hand. We have capacity under our existing debt facilities. And so I think we will take a balanced and long-term position assess the market at the time.
So why, I mean, if my memory serves me right, those two offerings were within two months of each other. What was the rationale behind that? Because it’s obviously not helped the share price.
Yes. At a time we were concerned about the second half of the year and the Brexit approaching as well as the interest rate.
Okay. But in the cost of your deal with Shell in terms of the debt cost is de minimus, correct?
Debt cost is very attractive. Our average debt cost is approximately 2% at this time. But as we build scale in the MLP, it doesn’t take much debt to add multiple to that debt coverage ratio. So we want to be prudent.
Particularly in this environment.
Okay. Thank you.
[Operator Instructions] Our next question comes from the line Lin Shen with HITE Hedge Asset Management. Your line is now open.
Hi, this is Matt Niblack from HITE. Thanks for taking the question. So just a follow-up on the equity financing, I mean I think it’s pretty clear that if there are two to three sort of public certain normal equity offerings per year that the stock isn’t going to work for those of us that would like to hold it, just given how much sensitive the market is so that process. Is there any thought in the execution of that equity to trying to pull some leverage, they will make it less disruptive.
And one approach I think would be tremendously powerful would be a situation where for one of the – at least one of the offerings each year is not sort of publicly marketed offering, but it’s a combination of Shell taking back units. And then a smaller set of equity that gets placed in the private placement through reverse inquiry and then you can limit yourself to kind of one disruptive event a year. Is that something that’s attractive or plausible or considered or are there other ways you’re thinking about reducing the disruption?
Well, this is John. I think you hit on a number of things that we certainly have learned from this year and then you speak to the two events that, we would certainly consider doing more marketing in the future, if we did that. We do recognize that the two events in such a short period of time did create some disruption, we appreciate that. So as we continue to go forward, we’ll certainly take that into account as we decide on how to fund the next deals. We’re going to continue to look at all options that are available to us at the time of acquisition to do the right thing in terms of how we fund the opportunity. But we do appreciate the – and we do – get received advice on the disruption caused by the two events and we will certainly take that into consideration.
Thank you. We appreciate that. And if you do decide to do it privately, I hope you’ll give us a call.
Thanks for that.
Thank you. We have no further questions. I’ll now turn the call back over to Courtney Selinidis.
Thank you very much for your interest in Shell Midstream Partners. For additional follow-up questions, please direct all questions to me. My contact information can be found on the presentation materials as well as on our website, shellmidstreampartners.com. Thank you.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day.
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