InfraREIT's (HIFR) CEO David Campbell on Q4 2016 Results - Earnings Call Transcript

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InfraREIT, Inc. (NYSE:HIFR) Q4 2016 Earnings Conference Call February 28, 2017 1:00 PM ET

Executives

Brook Wootton - IR

David Campbell - CEO

Brant Meleski - CFO

Analysts

Greg Gordon - Evercore ISI

Operator

Good afternoon and welcome to the InfraREIT Fourth Quarter and Full-Year 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.

I'd now like to turn the conference over to Brook Wootton, Vice President of Investor Relations. Please go ahead.

Brook Wootton

Thank you, Amy. Good afternoon and welcome to InfraREIT's 2016 fourth quarter and full-year earnings conference call. Joining me today are David Campbell, Chief Executive Officer and Brant Meleski, our Chief Financial Officer.

Before we begin, I'd like to make everyone aware of certain language contained in our Safe Harbor statement. The company cautions that certain statements made during this call are forward-looking and are subject to various risks and uncertainties. Actual results may differ materially from our projections and expectations. These risks and uncertainties are discussed in our reports filed with the SEC. Our forward-looking statements represent our outlook only as of today. We disclaim any obligation to update these statements except as may be required by law.

In addition, during this conference call, we will make reference to certain non-GAAP financial measures. A reconciliation of these non-GAAP financial measures, are available on the Investor Relations section of our Web site.

I'll now turn the call over to David Campbell.

David Campbell

Thanks, Brook, and thank you to everyone joining the call this morning. I will open today with highlights from 2016, followed by comments about load growth in Sharyland service territory, regional market dynamics, Hunt's product development activities, our pending rate case, and Hunt's 13-D filing earlier today. I will then hand it over to Brant, for a discussion of our financial performance, capital expenditures forecast, our proposed leases in the rate case and commentary on potential taxes reform.

I’d like to direct your attention to the supplemental slides that we posted to our Web site earlier this morning.

Turning to Slide 3, we’re pleased to report solid results for the fourth quarter and full-year 2016. Lease revenue and net income increased in line with expectations, reflecting growth in rate base and revenue at Sharyland.

We invested more than $50 million in the fourth quarter and $230 million during the year enabling Sharyland to support customer and load growth and help to provide safe and reliable service to Sharyland's customers.

Slide 4 to 6 profiles the growth trajectory in Sharyland's distribution service territory. As a reminder our current asset base is roughly 70% transmission and 30% distribution. Transmission lines in the Texas, Panhandle comprise roughly 45% of our current rate base another 45% is in West Texas and the remaining 10% is in South Texas and other regions.

Slide 4, profiles a rapid growth of coincident peak load in the Sharyland system much of which sits atop a portion of the Permian basin. Due mainly to the rapid expansion the West Texas overall economy the coincident peak load grew double digits each year from 2011 to 2015. Strong growth continued in 2016 peak load exceeding 2015 by nearly 9%.

Slide 5 shows the similar pattern for total volumes to Sharyland distribution system. Sharyland is a small but remarkably high growth utility with annual increases in the double-digits from 2011 to 2015. The rate of growth slowed during 2016 mainly due to the impact of lower oil prices and regional economic activity. But its has been still been a strong year with the 6.5% increase during 2016 compared with the prior year. The fourth quarter showed a slightly slower pace of growth with total distribution load increasing 5.6% from Q4 2015 compared with Q4 2016.

Slide 6, present more detailed metrics related to residential and industrial customers. Sharyland's customer counts continue to expand with the 2.3% increase in resident for customers in 2016. The right hand graph focuses on industrial and large business customers and peak demand. This metric drives Sharyland's revenue for this group who represent our largest customer segment. The aggregate amount of build kilowatts continues to increase rapidly showing more than a 15% increase during 2016.

Slide 7 profiles the growth in oil production in the Permian basin region and West Texas and Southern New Mexico. This area continues to be the most active of the North American oil basins. Though even in the Permian the pace of growth slowed during the first half of 2016 following the drop in oil prices. However, the reason saw an increase in oil production in the later part of the year as producers responded to oil prices consistently trading the low 50s per barrel. If sustained, continued drilling activity increases in total oil production should leads the corresponding increases in power demand and infrastructure investment opportunities.

Slide 8, demonstrates the total number of wind generation interconnections agreements in the Texas Panhandle region. While the addition of the second circuit and the synchronous condensers will expand the export capacity of the existing transmission system, further grid investments will be required to be accommodate significant new wind installation. The growth fundamentals that we see in the Taxes Panhandle and our west Texas service territories complimented by discussions with customers about their expected new projects and electrical needs and form Sharyland's annual capital expenditures planning process.

Brant will provide more detail about our 2019 capital expenditures estimates during this call.

For a context, it is important to note that we have made significant upgrades since 2013 to our west Texas system in the Stanton area more than doubling the size of that system over the past three years. Similarly by the end of 2018, we will significantly expand the capacity of our Texas Panhandle transmission assets to the additional of second circuit and to synchronous condensers. The incremental capacity of these investments have created along with our focus on meeting the identified needs for the system, contribute to the lower level of expected capital expenditures in 2019 relative to recent spend levels. However, we remained bullish on the long term fundamentals of our core service territories driven by the resource potential of oil in the Permian Basin and renewables in the Panhandle.

Turning to Slide 9, an important element that increase growth strategy is the acquisition of transmission product developed by Hunt, our development partner. Two of the projects highlighted on the page, the Golden Spread Connection and Cross Valley Transmission lines were placed in service during 2016 and are currently owned and operated by Sharyland. InfraREIT expects to have the opportunity to reengage in discussions about the potential acquisition of these two projects at a later date as market conditions evolve.

Of note, the Cross Valley project is expected to have up to 17 million of incremental CapEx over the next two to three years, increasing its current asset base by up to 10%. Several other development products progressed during 2016. Sharyland is engaged in discussions with several renewable developers who are interested in connecting InfraREIT's existing transmission system in many cases these generation interconnections would involve relatively small amount of footprint CapEx, and a larger amount of capital expenditures investments that would be a row [ph] for project, funded by our development partner.

Additionally, during 2016 Sharyland submitted a proposal for ERCOT's Regional Planning Group or RPG regarding the addition of South Plains Transmission Project to support the integration of more Texas Panhandle wind power. Sharyland believe that the ERCOT economic criteria have been met to justify this project, which potentially involve up to 250 million of new transmission. Off course the product of this size will undergo vigorous scrutiny before moving forward.

ERCOT's RPG is expected to review the South Plains proposal during the first half of 2017. If the RPG supports the process, the review process will then advance to the ERCOT Board. If endorsed by the Board, the project would then advance to the PUCT for a consideration of a new CCN, in a process that typically takes up to 12 months. If the product advances, the majority of the South Plains spend will be a ROFO Project.

We also continue to monitor the potential integration of Lubbock Power & Light or LP&L in the ERCOT market. As we have described, LP&L submitted an application to join ERCOT in last 2015. If ultimately approved, the related transmission integration will likely involve touch points with the Sharyland system and thereby create opportunities for transmission development for Hunt or for Sharyland. Currently following our request by the PUCT, both ERCOT and SPP are preparing reports to evaluate the cost benefits and technical considerations associated with LP&L's request application.

The PUCT will be the decision maker on LP&L's request and for any follow-on decisions regarding which transmission interconnects will be authorized. Some of the proposed lines supporting the South Plain transition project and the LP&L integration terminate at the same Sharyland facilities so the two projects together will be complimentary providing further economic support for both initiatives. As a follow up to its open felicitation process the South land project in Southern New Mexico and Arizona is working with interested parties to determine the optimal commercial frame work for this large potentially promising development project. In February of 2017, the Arizona Corporation Commission approves a certificate of environmental compatibility for South line. The [indiscernible] authorizes the construction of the non-WAPA owned transmission facilities in Arizona.

In combination we expect the Golden Spread, Cross Valley and other development projects will if required, be important elements of improved growth strategy complementing the growth in our course of its territories.

Turning to Slide 10, I'll briefly touch on the rate case. On December 30, increased regulated subsidiary SDTS and tenant Sharyland, filed in amended rate case application with the PUCT. Amended filing was a result of the PUCT preliminary order issued in October of 2016. The order and series of requirement including the following. First a request for Sharyland SDTS to file separate rate filling packages, so the prudency of cost and returns on investment could be reviewed for both company. Second a request for PUCT approval of a tariff establishing terms and conditions for the leases between Sharyland and SDTS and finally a request for the PUCT to issues SDTS its own certificate of communes and assisting.

We believe that our amended rate filing package complies with the requirement of the PUCT's October order while also meeting REIT requirements. Brant will discuss the proposed leases in more detail in few minutes. As part of our submission, we requested a lab [ph] return on equity of 10%, maintaining the current capital structure of 55% debt and 45% equity and a reduction in the cost of debt to 4.97% down from 6.73%.

The rate case package consolidates Sharyland's two existing tariff one for its SBC service territories and one for its McAllen service territory into a single tariff that will set uniform system wide rates. This consolidation was one of the requirements established by the PUCT in Sharyland's 2013 rate case. The finally proposes minimal changes to the regularly delivery rates for the average residential customer and Sharyland SBC service territories. For the average McAllen residential customer in results in approximately $55 per month increase including writers. In McAllen’s territory the current rate case will be the first full review of rate since 2001. Sharyland has sub sized rates in this past 16 years. The rating highlights is significant investments made between the prior rate case and our 2015 test year. in Texas Panhandle we invested over $600 million in transmission to support to deliver wind power to ERCOT consumers. Additionally more than $300 million was added to the transmission and distribution system across Sharyland other territories.

In part that investment went toward renovating and updating the electric system acquire from the Cap Rock Energy in 2010. However, the bulk of the investment was required to support the double-digit annual load growth driven by the West Texas oil economy. I will conclude with comments regarding the amended 13-D which Hunt consolidated filed earlier this morning related to Hunt ownership and increase. Hunt's filing notes, that in light of the risk and uncertainties surrounding the pending rate case and possible federal tax reform legislation. Hunt may begin to evaluate scenarios that may involve possible alternatives to the current business structures and arrangements in place between InfraREIT, Hunt and Sharyland.

The filing also described alternative arrangements that Hunt may evaluate in this scenario announces such as the deretransaction, a sale by InfraREIT evolve or certain of its assets or operations to its third party, a business combination between InfraREIT and a third party, a business combination between InfraREIT and Sharyland and acquisition of InfraREIT buy or involving Hunt or other transactions. Hunt's filing notes that no decisions have been made to recommend or pursue of this potential alternatives versus maintaining the current arrangements that are already in place.

InfraREIT's Board of Directors and complex committee intend to review any proposed alternatives if and when any proposals are made. In addition to evaluating and responding to the developments in the rate case, federal tax legislation or other developments.

In summary, we continue to execute on our strategy of investing in infrastructure assets required to ensure reliability and support the rapid growth that has occurred in the Sharyland system. Although in 2016, we experienced our fair share of challenges, we remain excited about our opportunities.

I will now turn the call over to Brant.

Brant Meleski

Thank you, David. And let me begin with details of our key financial metrics for the fourth quarter which is summarized on Slide 11 and 12. Lease revenue grew 8% while net income and earnings per share increased slightly. Adjusted EBITDA grew 5% relative to the fourth quarter of year. cash available for distribution came in at $17.5 million and non-GAAP EPS came in at $0.28 in 2016. These results were driven by the fact that the depreciation and interest expense increased faster than cash revenues during the fourth quarter of 2016 versus the fourth quarter of 2015.

Slide 13 and 14, covers the same metrics for the full year ended December 31, 2016, for that period lease revenue grew 14% while net income increased to $69.3 million. This was primarily due to increase lease revenue and a decrease in G&A expenses related to the 2015 IPO, offset by increased depreciation and interest expense.

Earnings per share grew from $0.31 to $1.14. Adjusted EBITDA grew 11% relative to the same period of 2015. Cash available for distribution increased 3% while non-GAAP EPS remained flat between the two years. These metrics were in line with our plans for 2016, as we incurred higher interest expense from the $400 million of debt when refinanced in December of 2015 along with the $100 million of long-term debt we issued in January of 2016. The $500 million of long-term debt bares an interest rate of 3.86%.

Slide 15 lays out InfraREIT's liquidity as of December 31, 2016. We ended the year with $205 million of available liquidity and our long-term debt totaled $718 million.

On slide 16, I’d like to point out that our growth in financing strategy has remained consistent since our IPO. Our strategy is to grow our dividends per share through investments in footprint projects and acquisitions of T&D assets. As we have described, we expect to fund our footprint project capital expenditures through the end of 2018, without issuing additional equity, while continuing to target our consolidated credit metrics of 60% debt to total capitalization and 12% adjusted FFO to debt deduct.

Slide 17 highlights our projected capital expenditures. We are reaffirming our 2017 and 2018 footprint capital expenditures ranges and expanding our outlook to add 2019. Our expected range for 2017 is $175 million to $240 million and our 2018 range is $75 million to $150 million. For 2019, our expectation in the range of $25 million to $110 million. As a result our 2017 to 2019 capital expenditure range is now $275 million to $500 million.

Regarding 2019 and as David noted during his remarks we see a lower level of base footprint capital expenditures, as we will have substantially updated and expanded the transmission system in the Stanton area from 2013 through 2018. In the Texas Panhandle we are also expecting a lower level of large discreet capital expenditures as we expect to complete a large expansion of that system in 2018.

In the context of the recent uptick in the West Texas oil economy, Sharyland is in discussions with large industrial customers in the Stanton areas whose projects may require related transmission investments. Due to the long lead time associated with transmission projects we do not expect to see the related capital expenditures added to our forecast until post 2019.

As David mentioned we remain bullish on the medium to long-term outlook for capital expenditure and load fill opportunities to support new load growth in an around Sharyland service territory.

Slide 18 through 20 provide the summary of the detailed of the proposed leases and the amended rate case application that David mentioned earlier in the call. The amended rate case application proposed that InfraREIT and Sharyland will terminate their existing leases and enter into two new leases that will be directly regulated by the PECT. The two leases will be organized by asset type transmission and distribution instead of the company's current five leases which are primarily based on geography.

The proposed leases are designed to comply with the true lease requirement and other rules applicable to REITs including provision to provide Sharyland with approximately 3% and the projected return on rate base that SDTS would have been entitled to earn if it owned and operated the T&D asset rather than leasing them to Sharyland. Under the proposed lease agreement Sharyland will continue to pay base and percentage rent. Sharyland will pay monthly fixed base rent to SDTS while percentage rent will continue to be quarterly.

PUCT will establish the base rent rate, percentage rent rate and the annual percentage rent break points in this rate case. The baseline payment will be updated through [indiscernible] and DCRF filings with PUCT. These updates will replace the current rent supplement and validation process in the company's existing lease structure. The percentage rent will be in an amount -- annual amount equal to the percentage rent rate multiplied by the adjusted gross revenues collected by Sharyland during the year in access of an annual percentage rent break point.

The transmission lease will have a one tier annual percentage rent break point while the distribution leases will contain two tiers of annual percentage rent break points in percentage rent rate. The percentage rent rate and annual percentage rent break point will not change in between rate cases. The two tier break points in the distribution lease provide a mechanism for SDTS and Sharyland to allocate revenues between the two companies associated with normal load growth.

Additionally, the current regulatory construct does not have an existing mechanism for updating an asset company's rate to account for load growth in its tenants distribution service territory in between rate cases. In the amended filing SDTS and Sharyland have responded to this gap by announcing in an intent for unregulated parent companies of SDTS and Sharyland to enter into a transition payment agreement related to InfraREIT's distribution asset.

Although we have proposed a way to regulate our leases the outcome of the rate case is uncertain. We have entered in the settlement discussions but there is no grantee that they will be successful. The current timeline for initial hearing is to be held March 29th through April 7th with a final PUCT order expected in the third quarter of 2017.

Finally, I would like to make a few comments on the proposal to change federal tax legislation and to reiterate our plans for guidance.

As many of our utility peers have mentioned, our company in the industry are closely monitoring proposals to change current federal tax rules, needless to say the ultimate impact of many tax reform proposals is dependent upon the final form of the legislation. In our case, unlike non-REIT utilities, a reduction in the corporate income tax rate would reduce our revenue requirement without a corresponding reduction in the tax rate reported in our GAAP income statements. For this reason, we believe that proposals involving a significant reduction to the corporate income tax rate would likely be dilutive to our net income per share and cash. However, the amount of dilution if any will vary based on the final legislation and a related implementation steps and rates.

As we mentioned last quarter, we are not providing earnings per share cad guidance until after the rate case, so we have clarity as the amount of payments in terms under the new leases Once the rate case is resolved, we’ll schedule an investor day provide information regard our earnings, dividends and growth plans.

Thank you again for your interest in InfraREIT and participating in our call today. We will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Greg Gordon of Evercore ISI.

Greg Gordon

2019 CapEx, you guys have to a greater or lesser degree than marking your CapEx from market as economic conditions have ebbed and flowed in the service territory. Are there any factors that could drive a significant change in the ranges you articulated for 2019 for here on out, or was I right in hearing that, to the extent that you've got, line of sight on a potential economic -- continuous economic expansion that you're fairly confident that this range would stay in place, but it would just add to post 2019 CapEx?

Brant Meleski

Greg is Brant, it’s a little bit of two party answer to that. if we saw a significant increase in economic and oil and gas activity, especially out in the Permian and in our Stanton service territory, we could see an uptick in distribution CapEx in the 2019 time period. But from a transmission prospective especially for larger projects that would require regulatory approval and a CCN process, just given where we stand today in the timeline associated with those projects and permits that are required ahead a time, those would likely occur post 2019.

Greg Gordon

Got it, and I don’t know how much you can comment with regards to the statements made in the 13-D but, is it fair to assume that whether anything happens as a result to that review would be a function of the final rate decision and what the economic consequences of that decision are and so we shouldn’t think about any action before that point.

David Campbell

Greg this is David, I think that it's obviously Hunt's filing, it's not InfraREIT and as a -- but Hunt cited in their -- in the filing that they're evaluating scenarios that relate to, a potential rate case outcomes or federal tax legislations. So I think you're -- I can't finally got to speak to it, but it does stay, that their evaluating scenario is related to those two factors both of which unfold over time.

Greg Gordon

Okay, and then I guess, did you guys mention, I'm sorry if I was distracted, what the twos of the outside date of potential settlements could potentially be or if you haven’t traditionally what in sort of the deadline in a public utility of commission of Texas rate. The cadence of a republic commission of Texas rate filing with settlement becomes less likely?

David Campbell

There has been across different, for seems -- there are examples of settlements at all different time, it is not atypical to get to settlements before hearing, but it's not universally that it happens before hearing. After hearing when you get into the briefing phase and then you have a ALJ decision. So it would be a reason the [indiscernible] do it before hearing, our hearing is scheduled for the start at the end of March, I think March 27th. But there is no set timeline, if it isn’t resolved through settlement than we expected that the ultimate decision will be made filing the ALJ, and then we will go to the PCT, probably in the third quarter.

Greg Gordon

Okay. Thank you, gentlemen.

Operator

[Operator Instruction] There are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Dave Campbell for any closing remarks.

David Campbell

Thanks, everyone for your interest in InfraREIT. And have a great afternoon.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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