Innergex Renewable Energy, Inc. (INGXF) CEO Michel Letellier on Q2 2018 Results - Earnings Call Transcript

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About: Innergex Renewable Energy Inc. (INGXF)
by: SA Transcripts

Innergex Renewable Energy, Inc. (OTCPK:INGXF) Q2 2018 Earnings Conference Call August 14, 2018 10:00 AM ET

Executives

Michel Letellier - President, CEO & Director

Jean Perron - CFO

Karine Vachon - Director, Communications

Analysts

Nelson Ng - RBC Capital Markets

David Quezada - Raymond James Ltd.

Sean Steuart - TD Securities

David Galison - Canaccord Genuity

Benjamin Pham - BMO Capital Markets

Adnan Waheed - ational Bank Financial

Mark Jarvi - CIBC Capital Markets

Jeremy Rosenfield - Industrial Alliance Securities

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Innergex Renewable Energy's 2018 Second Quarter Results Conference Call and Webcast. [Operator Instructions]. I would like to remind everyone that this conference call is being recorded.

I will now turn the conference over to Karine Vachon, Communications Director. Please go ahead.

Karine Vachon

Thank you. Hello, everyone, and thank you for joining us today. I'd like to specify that this conference will be held in English. Members of the media are invited to ask their questions by phone after this call. A presentation supporting today's discussion is available as we speak on the front page of our website at www.innergex.com.

This call may contain forward-looking statements within the meaning of applicable securities laws. Although the corporation believes that the expectations and assumptions on which forward-looking statements are based are reasonable under the current circumstances, listeners are cautioned not to rely unduly on these forward-looking statements as no assurance can be given that it will prove to be correct. Forward-looking information contained herein is made as of the date of this call, and the corporation does not undertake any obligation to update or revise any forward-looking information, whether as a result of events or circumstances occurring after the date hereof, unless so required by law.

During this call, we will refer to financial measures that are not recognized according to International Financial Reporting Standards. Please refer to the non-IFRS measures section of the quarterly report for more information.

Our speakers today will be Mr. Michel Letellier, President and CEO; and Mr. Jean Perron, Chief Financial Officer.

I'll now turn the conference over to Mr. Perron.

Jean Perron

Thank you, Karine. Good morning, everybody. Welcome to the presentation where we're presenting some of the results for the quarter and six months. Production was 100% of the long-term average. I think this is a very good result comparing to many of our peers, so it is a good sign that we are already or always on the long term are able to meet our long-term production.

So this 100% production translated into an increase in the revenues of 37% over the last three months compared to the last year. And similarly, the adjusted EBITDA also increased by 15%. The difference in the increase between the revenue and the adjusted EBITDA is mainly due to the fact that HS Orka, the Icelandic asset and the geothermal asset, they have a margin that is much lower than our other facilities, so it's the first quarter that we've seen that entire effect of the lower margin on our result. So it's not that our facilities didn't perform as expected or anything like this. It's only that it's going to be more the future of the business would be reflected that this type of asset has lower margin.

The adjusted EBITDA proportionate also increased by 28%, so that includes the proportion of the strategy that are not consolidated in our numbers. So it's only our share of these results that we're adding to the adjusted EBITDA proportionate. The net earnings increased a bit, mainly due -- the main elements are the increase in the EBITDA that we got after the finance cost that were higher and depreciation and amortization. These are the main elements. So it also explains the adjusted net earnings. Adjusted net earnings is basically the net earnings of the business from which we subtract the volatility coming from all the related instruments. So when we noticed the volatility, it shows the lower adjusted earnings for the quarter. Again, I think it's due to the fact that maybe the margin is a bit lower than what we have seen before. But if we look at the cash flow on the next page, when we get there, I think the cash flow are still showing a large improvement over last year.

For the six months, we also see large growth, whether it's in the production, the revenues, we are 45% above last year. The adjusted EBITDA is 30% above last year, same thing for the margin that are lower, mainly due to HS Orka. The adjusted EBITDA proportionate shows the 38% increase over last year. So all our numbers are showing large increase over last year. I think that result showed the acquisition of Alterra, and also there's some of the facilities that were put in services, Upper and Boulder, at the beginning of the year 2017. So now we're seeing the full result from these facilities.

If we turn the page and we go to the free cash flow, free cash flow also show the good improvement of 21% compared to 2017. And as a result of that, our payout ratio is improving, coming down from 93% last year to 88% this year for the trailing 12 months. So it's a good improvement over only one year.

With that, I'll pass the conference to Michel.

Michel Letellier

Thank you, Jean. So as usual, for the second quarter, we like to go back to the long-term plan and the objectives that we have setup at the beginning of the year. Just to have a look on what we have done during the year and where we're going in terms of focus and objectives. So first, I'm quite glad to see that our diversification of asset has proved again that it's quite resilient in some places we had weaker wind. On other places, it was stronger. And overall, we have achieved our long-term goal for this quarter. So I'm quite pleased to see that mix. And we have actually increased this mix of adding now some Chile hydro and solar assets in Chile that will further diversify our portfolio. So the aim is basically having a very wide distribution in both technology and geography so that we will be, I guess, immune to swings in different markets in terms of variability of the natural resources. It's always the goal to be diversified and have a long-term view on the assets and the production. Very important also, whenever we're acquiring something, we're focusing on establishing credible and conservative long-term approach in terms of production and also maintenance of the assets. That's what we've done in the past, and that's what we're going to focus in the future.

As an example, I think that the wind in France has been a little bit challenging over the last two years. But whenever we're making an acquisition, we are digging into the long-term forecast and we're putting even more weight in the last few years in terms of the wind balance, so that we hope that we're basically focusing and putting a little bit more weight into the last two years, so hence, probably reducing a little bit the long-term expectation of the P50 forecast for wind in France. That has been our strategy in the last few years.

Obviously, whenever we are bidding also on project, there's an independent engineer report and what have you, but we're focusing on our internal expertise to establish the long-term forecast. And I'm very confident that our guys have a long and conservative view. So quite supportive of our long-term forecast for the old portfolio.

So that being said, if you go back on the presentation on Page 10, we're doing a little bit of operating review of what we've done since the beginning of the year. I'm not saying that our guys has been very, very busy. We, following the acquisition of Alterra in February, we have focused on the commissioning of Flat Top wind farm, the 200 megawatt in Texas. Everything is doing very well. So quite pleased on the result.

We have also renewed in BC 2 PPA, Brown and Walden North hydro facility. Started construction and the acquisition of Phoebe solar project, the 315-megawatt BC project in Texas, done all these tax equity financing and the construction financing, started the construction. So, so far, so good. We are looking for an operation in the late -- beginning of the fall next year on that one.

One of the big project we're working also through the Alterra acquisition is Foard City. I must say that Foard City is one of the nice projects that Alterra has, and we're very happy to see it going and advancing the way it does. We have improved the financing. We're negotiating right now with a selected supplier of construction financing and tax equity. And we're very, very happy to see the type of proposal that we see. So I think that we'll be in a position next quarter to explain all the tax structure, the tax equity structure, and the project financing that we have put in place for Foard City.

Quite happy to also project the EBITDA, sustainable EBITDA for the first 10 years around 10 -- over $10 million. Mind you that this is only the part that we're receiving from the sale of [indiscernible] electricity. But as you recall, the Foard received also the PTC, which is in the range of $24 million, $25 million, $26 million for the PTC per year. So there's a little bit of that amount that is coming back as a pay-go. That equity structure is a little bit complicated, but it's adding up a little bit on the potential dividend that the equity provider Innergex will receive. So quite comfortable in seeing double-digit cash on cash on that project for the first 10 years. And obviously, depending on the price of electricity in Texas, we'll see a huge increase in the cash available after the tax equity partner has been repaid.

So if we bear with me and go back to Page 11. That's our long-term 5-year plan that we have put forward. And those are the main goals that we had put ourselves in order to meet the objective of the company. We said that we will remain exclusively in the renewable energy, that one is easy. It's in our DNA. So we had also the geothermal in the mix, but it's renewable energy. So we will be doing renewable energy for the longest period possible.

Consolidated leadership position in Canada. Even if Canada doesn't have as much potential for a new project, there is still some interesting pockets of growth in Canada and some acquisition. So we've done lately the acquisition of TransCanada. We'll talk about it a little bit later. We have also acquired the Ledcor participation in three hydro facilities: Upper, Boulder and Fitzsimmons Creek. And through Alterra acquisition, we also have four facilities -- operating facilities in Canada. So we're not forgetting Canada as our, I guess, own market. We're still quite active in there. And we have also participated in the Saskatchewan RFP, which we should know something early fall. September or October are supposed to be the target date where they will release the result.

International development. We've been working a lot on South America. We've been active in France. As you know, we've been very successful in France. Through Alterra, we have acquired HS Orka in Iceland. So again, international presence. And also, we have increased our presence in United States. But I guess, the biggest change this late quarter was the acquisition of the Energía Llaima participation and the follow-up acquisition of the Duqueco hydro facility through Energia Llaima. So quite happy to have now a foothold in the South America through the Chilean partner and still working towards being present in South America, perhaps in Peru and, obviously, furthermore in Chile.

We have said also that we would maintain a diversification of energy source. We had geothermal. We also are looking into Phoebe project, the large solar project in Texas. This is also increasing quite fast, our presence in solar. We like that project. We start the project. So we think that's a very nice complement in Texas, to have solar in Texas coupled with wind. So again, geographic and technologies, they're across in our portfolio diversification.

So with all that, if we go back to Page 12, I'm quite happy to report the type of growth that we have experienced in the last few months. Since the beginning of the year, we have, in addition of 1,239 megawatts of net capacity from acquisition since the beginning of the year. So actually, in 2017, we had about 1,124 megawatts. And in 2020, depending on the decision that we would have in terms of the selling the asset, we could have up to 2,700 megawatts by 2020. Just a little check on what we have established as a target of 2,000 megawatts. So very happy to see that we have, obviously, go beyond that 2,000 megawatts and very happy to support this growth. And obviously, we will not slow down -- well, not slow down, I think it would be difficult to keep the same pace, but we'll still be focusing on growing the portfolio.

The objectives of 2018, we said that you would have to integrate the Alterra activities. Obviously, we've been busy since the beginning of the year. You will see in the second part of the year, some administrative synergy that was created in the first few months that we have had the Alterra under Innergex. So most of the synergy and through O&M has been done in the first few months. And you will see a little bit more improvement in terms of O&M from the Alterra activities during the next quarters.

We said we would pursue growth opportunities. I think we have achieved that. We have advanced the prospective project in the U.S., working on Foard City, obviously, and focusing also on creating more value with the wind and the solar portfolio that we have in the U.S. Obviously, we have pursued opportunities in Canada by completing the Cartier transaction, the acquisition of the Chilean participation, and we also have concentrated our development in France in our own greenfield portfolio.

Advance project under construction. We want to make sure that the project of Flat Top would be finalized. We have started the construction of Phoebe, continuing the project construction of Brúarvirkjun in Iceland. And we want to start construction for Foard City somewhere in the end of October, beginning of November. [indiscernible] date by -- as soon as October, November of next year.

So just to go back as we have put some slides on Phoebe, Chile and the Cartier overview. I think we've covered those in separate calls during the quarter. But it's nice to have those slide in and be on our website. So if you want to have a little bit more color on those, you can definitely look into our website.

Just perhaps going on Page 15, the Chile overview. We haven't had the chance to speak too much about it. But we are looking into other potential acquisition in Chile, as well as developing the portfolio of project, namely the Frontera and El Canelo hydro facility. They are advancing in terms of finalizing all the little permits we need. But also, we're looking to put financing and looking forward also long-term PPA for these power plants.

We also had a small acquisition in Chile in terms of a very early-stage wind portfolio. So we acquired some good data for potential site, wind site in Chile. So that's going to be the -- little bit the cornerstone for us to start our own greenfield project as well in wind in Chile. The idea is to build out a portfolio where we would have solar, wind and hydro in Chile so that we could be diversified and have the ability to sign long-term contract on a portfolio basis.

So on that note, we would open up the question period. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of Nelson Ng from RBC Capital Markets.

Nelson Ng

Just first question relates to the Harrison Hydro facilities. I was just wondering whether you could provide a bit of background on the water rights dispute? And I guess, explain how, I guess, reorganizing the structure of the company could potentially change that liability? And then also, like will any other hydro facilities you have in BC, like the water rights cost increases, could that potentially impact other facilities you have?

Michel Letellier

I'll start and perhaps Jean might come in. But this, you won't see a big difference because we have, obviously, in the last almost four years expensed the water license. So it's not a new charge. We were hoping to be able to have the court changing the administrative decision that was made in BC. So there is no negative or difference between what we have reported in the past, it's just that we were hoping to reduce the cost. It's a little bit long to explain how that came along, but it was in the creation of the Harrison. All the water license was put under the general partner instead of the limited partnership because for some reason, in BC, it's difficult to have the LP calling a water license, a little bit crazy. The rest of Canada is not like this. So they have actually put all the water license under one company. And the way it works in BC is that the more production you have in one entity, the rate on the water license increase. So by putting all the licenses of Harrison into one entity, the rate on per gigawatt or megawatt hour went up. So the idea now is to try to have the water license being we attribute it into smaller GP that would basically have one GP, one LP. And that might trigger some disposition on the municipal taxes and a onetime charge, but theoretically, it would reduce the water license rate for the Harrison going forward in the future. So theoretically, we could exchange onetime municipal taxes transfer for an almost $4 million-something per year -- $1.4 million.

Jean Perron

No, it's $1.6 million per year. So we did a onetime charge for the then transfer tax. It will be beneficial in the long term for the same amounts that we're going to be able to achieve.

Michel Letellier

So actually, we were hoping to have a positive answer and have basically the expense being reinforced around $4 million, $5 million. That's what I was getting at. But the savings going forward will be probably over $1.5 million per year. So I guess it's a good news in a way for the future. We were just hoping to have had some reimbursement from the past.

Jean Perron

One little thing I can add to it that it's true that we've lost on the year that we went into court, but there's still two years earlier that we also have stayed and expensed, so about $3.2 million, that we are still disputing. And this is dispute on different grounds. So that is not touched by the decision that was granted. So we still feel that there is a possibility that we would be reimbursed for these amounts in the future.

Michel Letellier

So again, to make a long story short, going forward, after the restructure, we should see a diminishing charge of about $1.5 million a year.

Jean Perron

And we don't expect that any of our other facilities in BC will be attacked or will be touched by this way of assessing the water tax.

Nelson Ng

Okay. And then just kind of moving on the development side. In terms of the 10-megawatt Brúarvirkjun hydro development in Iceland, just looking at the numbers, it looks like you're building it at around 17x EBITDA. Is the -- I believe the facility is not contracted, right, it'll just feed into the pool of power that you're generating at -- or selling at HS Orka. Is that the case? And I guess, longer term, I presume you're expecting realized power prices to increase at Iceland?

Michel Letellier

A little bit more than we indicated in that. We have a contract that should be put into effect with Thorsil. It's a silica metal...

Jean Perron

Smelter.

Michel Letellier

Smelter, thank you, that should start construction somewhere in the first quarter of 2019. It's for about anywhere between 45 and 60 megawatts. And some of the past energy that was sold to Norðurál. This 10-megawatt Brúarvirkjun hydro, plus the expansion of the number four machine, would basically feed that contract. So we have this letter of intent. It's subject to their financing to be put in place. We're expecting them to have the answer, then confirmation by somewhere at the end of the October, beginning of November. So all that will be sold into a long-term contract in euro that is definitely higher than what we're selling under Norðurál. It will be in the range of anywhere between $45 to something higher than -- in $45. In U.S. dollar, I would say it's around $45 to $50 per year with an inflation. So we should see good revenue out of that contract.

Nelson Ng

Okay. But I guess, the EBITDA expectation of, I think, $3 million point something for the development reflects the Thorsil PPA?

Michel Letellier

Not fully, yes. Because it's not in full effect.

Nelson Ng

Okay, got it. And then just one last question. In terms of, I guess, looking at the Texas facilities, about 21% of the cash distributions at Flat Top are paid to tax equity, while about, I think, 64% of the cash distributions are paid to tax equity at Shannon? It seems high for Shannon. I wasn't sure whether it was just due to the like flatter results or it's just structured quite differently. But could you just explain the difference? And also, Foard City looks more like Flat Top in terms of the allocation of cash flow distributions?

Michel Letellier

Could we come back to you, Nelson, on that one? It's quite specific and general. We'll answer with Nick, perhaps.

Operator

Your next question comes from the line of David Quezada from Raymond James.

David Quezada

My first question is just on the, I guess, the broader topic of capital recycling that you mentioned at the start of the last acquisition. And specifically, on Blue Lagoon, I'm wondering if you can provide any color on how the profitability of that facility has ramped up just given the, I think, that expansion was completed late last year? And I guess, maybe kind of a related question, is the partner there maybe more open to a sale of that asset today?

Michel Letellier

That's a good question. The information we have is that the hotel, they have selected the -- to go easy on the first few quarters on the booking. Things are going well, but they are in the phase of making sure that all the services and everything has been, I would say, tried and improved in terms of the experience for the clients. This is a really high-end hotel, and we want to make sure that the people that get there have the most important or the most pleasant stays. So they purposefully are trying to keep up the booking to something around 50% to 60% of the hotel, making sure that they can get the personnel and everything being trained well. So what we have had gathered, the response from of the experience from the client is very, very, very good. So there's no weakness in the Blue Lagoon performance. Our partner believes that they would rather have a little bit time to make sure that the numbers are coming into the results and creating a little bit more, I would say, history of cash flow from that new hotel. So still in discussion with them on this, but this is definitely an obvious, obvious asset that we would love to be able to recycle.

David Quezada

Okay, great. That's helpful. And just my only other question here, on the Boswell site. I know that something that has been, I guess, deemphasized as part of your development portfolio. But is there any news on the, I guess, the setback you had there with the interconnection permit? Or any updates there?

Michel Letellier

No, we're still working, trying to define a solution to interconnect sooner. But the one thing is that we're pursuing the permitting in land acquisition for the transmission corridor. That is going very, very well. We're over 60-something, almost 70% of all the land acquisition private. So we're advancing very well, good response there on the ground to obtain the right of way. So on that side, the development side is going very well. But the discussion is slow with the PacifiCorp on the interconnection side, but still working on it. Obviously, it'd be a big win if we can be successful. But like I said, I don't want to put too much emphasis on Boswell for the time being because the people on the ground are working very well and the response locally is very supportive of the projects.

Operator

Your next question comes from the line of Sean Steuart from TD Securities.

Sean Steuart

A couple of questions. On the Frontera project, it sounds like the financing is underway and you've referenced work towards securing a PPA. Wondering, Michel, if you could give us a little bit more context on the PPA process and when you expect to secure that relative to the COD date for the project?

Michel Letellier

Well, obviously, it's a big project. So we want to make sure that we have some prospects on the PPA before starting construction. I must say that the merchant pricing in Chile is doing very, very well. We've seen some numbers this summer -- well, our summer, but their winter over there, in a range of anywhere between, on average, over $60 per megawatt hour with peak coming back to the $90 and even $100 per hour depending on the node. So the market over there is fairly strong in terms of spot market. So that provided us perhaps some good opportunity to talk to corporate PPA because, obviously, if copper is picking up, some mining company might like to hedge their supply of electricity given the fact that the short-term price of electricity seems to be strong. So that's basically what we're trying to do, is to make contact with a big corporate user and hope to have a letter of intent for potential PPA with Frontera. So we have hired through the acquisition of Duqueco. There were some people in the marketing side of Duqueco, the company was called Abrazo. So we have retained some of that personnel to be more aggressive in terms of getting out and having some marketing effort to secure long-term PPA for future project in Chile. That's our strategy for the time being.

Sean Steuart

Okay. I have one other question, a broader question on your prospective pipeline of 8,000-plus megawatts. Your company had a deep prospective pipeline for a long time. Wondering if you could just give us a little bit of broad context on how that 8,000-plus megawatts breaks down between geographies and power sources? And how much of that total are you looking to advance or are you working on at any given point in time? I assume it's a small percentage. But any context you can provide on that front.

Michel Letellier

Yes. That's a good question. Obviously, that 8,000 megawatts, there's a lot of megawatts for the long term. We obviously cannot work on 8,000 megawatts. There's a lot of that in the hydro, where Alterra has also a lots of water license in BC. So we're going to make a little bit of a deeper look into what we have in BC in terms of water licenses. Fortunately, hydro in BC is perhaps less competitive than wind in many places. So we'll make a little bit of adjustment there. But we have something around a little bit over 2,000-megawatt worth of water license, mainly in BC. Wind, we have a lot of wind. The wind in U.S. We have some wind also in the BC. We have some in Saskatchewan. We have in U.S. We have in Québec. We have in New Brunswick. So we have all kinds of projects around 6,000 megawatts, almost of wind, and then a little bit of solar here and there with -- and some geothermal in Iceland. But it's about 2,000 megawatts of wind -- of hydro, mainly in BC and about 6,000 megawatt of wind all over North America. And now in France, we were getting closer to the 300 megawatts in France, which working very -- the one in France are probably more advanced in terms of possibility. But again, I think that Canada, on a long term, has some future in wind in Québec and Ontario and BC. Just a bleeding game, it doesn't cost us too much to have these sites. And we have some with First Nation participation, some with potentially some local municipality. So it's always nice to have those on hand and making sure that we could be ready if there's an RFP in the future.

Operator

Your next question comes from the line of David Galison from Canaccord Genuity.

David Galison

Just a couple of questions. The first one is on the silica smelter contract that you'd mentioned. Will the PPA that you are working on, do you envision having any ties to commodity prices similar to the -- some of the existing contracts that are tied to aluminum prices over there?

Michel Letellier

No, no, no. It's straight PPA. It's -- there's no tie to the commodity at all.

David Galison

Okay. And then on -- a few are successful with the Blue Lagoon sale. Would you envision any issues bringing the funds back to -- or out of the country? Or what will be a need to be reinvested in Iceland?

Michel Letellier

It depends. There's no more limitation on giving back dividend in Canada from Iceland. But if there's a good project in Iceland, would that be more useful to recycle that money through the new construction? But HS Orka has a lot of room on its balance sheet also for some leverage. So depending on how fast some opportunity actually could get up. But theoretically, we would rather have the dividend being paid out from the Blue Lagoon sale.

David Galison

Okay. And then just coming back to the cost in the quarter. You had mentioned that some of the decrease in margin was due to HS Orka. But wind and hydro operating and G&A costs were also higher. Was there anything behind there or is that just more reflective of the business going forward?

Michel Letellier

No. I think it's a little bit of adjustment in the Upper Lillooet. I must say that when we're having this close too much in the MD&A, that Upper Lillooet, we concentrated during the winter and late spring to make all the repair and the adjustment in order to have Upper Lillooet being in good shape. I'm very, very happy now with the result. Since mid-June, we have full flow in Upper Lillooet and we've been operating with the availability of over 98%, 99%, except for the, what we call, the quick flush, the period where we would open all the gates and flush the sand that is accumulating in front of the water intake. Remember, that was one of the solution we were seeking. And I'm glad also to report that all the environmental follow-up from these activities have shown no fish impact downstream in the rivers.

So very, very encouraging on the Upper Lillooet operation going forward and on the long run. The shaft seal are holding very well. Remember that the shaft seal last year was the main problem. We have to shut down and change them all the time. Now with the one that are in ceramic instead of teflon, everything holds very, very well. So quite happy with the result on Upper Lillooet. And I don't see a big, big issue, except for a few update on water intake in perhaps Stokke as well that could fix the long-term cost to clean up the dirt. Essentially, I don't think there's a huge discrepancy or a change in the overall cost of the hydro. There's one positive stuff in terms of water license. If we are successful in changing all the structure, we would feel, like I said, about $1.5 million reduction in the Harrison Hydro cost.

David Galison

Okay. And I didn't see any mention of updates to guidance. Are there any changes? Or did your previously revised -- or announced guidance still holding?

Michel Letellier

We're maintaining our guidance, obviously. We will have some contribution from Cartier as example, depending on when we will be closing the transaction. But given a little bit of the weakness on the EBITDA that we had experienced in the first six months, we kept the guidance. But I'm quite confident that we'll -- we should exceed the initial guidance, given the potential contribution of the Cartier. One thing that we would mention also on the Cartier from the initial price that we have announced of $630 plus about $10 million worth of all kinds of fees and financing costs, there's something that is worth mentioning is the fact that, that price has been established as of July 1. So any distribution across Canada we'll have from the Cartier partnership from July 1 to whenever the closing date. We're focusing to have this closing around mid-October. We think they're probably going to be about $8 million-plus payment to TransCanada, so that should reduce the acquisition price by the same amount.

Operator

Your next question comes from the line of Ben Pham from BMO.

Benjamin Pham

Your slide on the capacity expectations the next couple of years and even beyond, just pretty robust growth rate, probably one of the highest that you're maybe seeing out there relative to peers. I'm just wondering though, how do you guys think about how free cash flow growth trends over time? Because it looks like capacity growth is almost double or so over 3 years, which is pretty incredible. But what -- how do you think about free cash flow growth in general?

Michel Letellier

Well, that's one think we're focusing, Ben. And I want to make sure that we have, again, on -- you guys are going to get tired of listening to me in saying we have a portfolio approach and it has to be balanced and all that stuff. But it's so true in every aspect of our businesses. We are looking to make sure that we have a long-standing capacity to pay the dividend. And what you're saying in terms of growth of the cash flow versus capacity, it's true that we have some project with tax equity, as an example, or that -- of if we start the construction of a project, it might take quite a bit of time before we get to have the cash flow from the operation. So we want to focus to have a balanced approach with existing project, acquisition, that could generate cash on cash. And some very nice project that has, unfortunately, a profile of cash flow where you're going to have a lot more cash flow, either after the debt repayment, which, in the case of France, as an example, you have PPA around 15 years, but you get to have a repayment of all the project that's around 13 or 14 years. So obviously, with the long-term vision of -- and the total rate of return of a project in France, as an example, of around 13 years, if you repay all the financings in the first 13 years, there's not much cash on cash available for the first 10 years, but then it increased a lot once you have repaid the debt.

So what we're trying to do, Cartier is a good example, we will have a good cash on cash on cash for the first year compared to, as an example, an acquisition in France where the cash on cash is more acute in year 11, 13 or 14. And also, whenever we're doing some project in the tax equity side in the U.S., you won't see the big cash on cash, depending on how it's structured. Foard City could be probably one of the exception because it's a full greenfield project we have done. And I just said that we will be seeing a double-digit cash on cash in Foard City. I think it's a little bit of an exception. Foard City is very, very profitable in terms of total return. So that might be an exception sometimes when we look at tax equity. But you're right, it might look where we're having a bigger capacity, but that the cash flow is not coming with the same proportion of the capacity. But if you look beyond the first initial reimbursement of the debt, you'll see that the overall cash on cash or cash flow available for the portfolio is very, very strong on a long-term basis.

So our challenge is making sure that we have a decent cash on cash in the early years. But we're focused on looking into the long term and the sustainability of our dividend is the foremost important thing that we are thinking all the time. So for me, I'm happy to see that the long-term forecast is very, very strong, and we are growing the cash flow so that we will never be seeing a brick wall where we wouldn't have the cash flow to pay our dividend based on our long-term forecast.

Benjamin Pham

Okay, that's very helpful. And then can I ask you then on the dividend, too, and you had some contrasting commentary the payouts. You mentioned 88%, but then you also mentioned that you add back discretionary expenses, the payout's probably more 75% or, I mean, somewhere around there, if I do my math right. And I guess, peers -- some of your peers add back discretionary expenses, some don't, yet some differences in payout. So my question really is, how do you guys think about it then in terms of excess cash? Is it adding back discretionary expenses, that your payout's more 75%? Or is it more to 88% that you stated?

Michel Letellier

Well, it's an ongoing business. We need to spend prospective expenses if we want to grow and grow the company at the speed we're doing. So we have, on a basis of a full year, we have forecasted about $15 million, $16 million worth of prospective expenses. So obviously, if you would stop doing this and you only concentrate on operating the assets, then the payout is around 73%, 74%. If we want to grow the company and we want to be active on the M&A side, we think that something around $15 million is reasonable considering the type of development we want to have.

So personally, I think that $15 million is discretionary in a sense that if you don't spend it, it has no impact on the operating portfolio. But obviously, it would have an impact on our ability to grow the future of the business. I'm focusing more on the rate of success of that $15 million. So far, we're very happy with the mix of M&A and development projects. Foard City, as an example, is a great success of greenfield development. We're very hopeful that our portfolio in France in our early days of greenfield will help. We have some RFP going on in Saskatchewan. We're developing projects with expansion in Québec and in Canada for hydro sites. We're very, very active in many places. So it's your call. But I see and we can describe it as just discretionary because it doesn't affect the operating portfolio. If you stop developing, then obviously, the growth will be affected. But the operating portfolio, it doesn't need that $15 million to sustain it. In fact, if we would stop every development, perhaps it's even more than $15 million that we could develop and being expensed to a company's operating asset. It would definitely improve the payout ratio, but the growth would be affected.

Benjamin Pham

Okay. And maybe a follow-up lastly on that point. Is your near-term dividend trajectory then based on the 88% rather than the 75%, 73%?

Michel Letellier

Well, actually, if we're successful in developing projects in the $15 million, then, obviously, we will be able to grow the dividend faster if we -- if that $15 million per year turns a good success, then obviously, we'll grow the dividend accordingly. But what I said in terms of dividend growth, I'd rather have a steady, predictable range. Some of our peers have claimed in the last 4, 5 years that we could grow the dividend by 10% per year and then so forth and so forth. For me, that's a very, very difficult task to do on a sustainable basis and on a risk-adjusted basis. We are going to grow our dividend like we've done in the past and have that dividend sustainable and strong. So I have a long-term vision on being constant and being predictable and making sure that people can believe the dividend will be there.

Operator

Your next question comes from the line of Adnan Waheed from National Bank Financial.

Adnan Waheed

I'm going to be speaking on behalf of Rupert. I just want to start off with the EPA in Brown Lake and Walden North. How do they compare to the previous ones?

Michel Letellier

Yes. Walden, we never publish Walden. But it's all -- we handle letter of intent with BC Hydro on that when we make the acquisition. Mind you that Walden was owned by First Nation so BC Hydro had some kind of an arrangement for past, I wouldn't say, infringement on their territory because that's probably strong, but anyway, BC Hydro has seen the Walden as a way to compensate for some past negotiation with the First Nation. So it didn't change that much. It's something around $0.07 per kilowatt hour around, and we're not allowed to disclose completely with BC Hydro. But that one is a little peculiar. And Brown has a growth profile that has a lower start, but will catch up eventually with that type of project. So all in all, they're not bad. Obviously, those were already built projects. So they're not the new one that -- like our last one, Boulder or Upper Lillooet, that has an average close to $0.10 per kilowatt hour. But they're good pricing and there's good inflation built in them and therefore 40 years. So we're happy to have been able to secure that with BC Hydro.

Adnan Waheed

Okay, understood. Going on to Texas. I'm just wondering what led to the weakness of the Shannon plant? And would you be able to give some guidance on the Texas market in general?

Michel Letellier

For Shannon?

Adnan Waheed

Yes.

Michel Letellier

Well, yes. We'll try to give you a little bit more. Shannon is a little bit more complicated. There were some availability or restriction on distribution that affected us, still a little bit. The authority are trying to fix these problems. And this summer, Texas had seen some challenging time when they really needed the power and actually price has spiked in a few occasions in Texas. But in terms of availability, also of production, we have agreed with GE. We have a blade erosion problem. So we have agreed with GE that it will repair these and that should improve also a little bit the performance of the machine. So that should help as well. In terms of forecast, it's a little bit difficult to provide the forecast in terms of congestion. But this should improve next year. Apparently, the operator of the line will have finalized all the upgrades by the end of the year. So we are hoping that the availability on -- or the construction on the distribution system would be reduced next year.

Adnan Waheed

Okay, understood. And your plant in Chile, could you give us a little bit more color on the growth pipeline, those two hydro projects of 125 megawatts and some of the early-stage projects? Would you be able to tell us specifically on the projects that you thought are highly progressing and if there are any challenges?

Michel Letellier

Like I said, I think that the Frontera project, I answered a question regarding the long-term PPA that we're trying to seek. That one is big. So it's a little bit of a challenge to start the construction without a PPA. So we want to make sure that we have some good leads before starting the construction. The other one, the Canelo project, is a little bit smaller. So that one, we could start the construction without a PPA and it wouldn't be a big issue to finance and to have negotiation during the constructions you have and off-taker. And also, I would say that as a portfolio approach, we could sustain to have that project being merchant for a while, given the view that the Chile market has a strong floor in terms of PPA pricing. I don't know if you remember what I was saying about Chile, why we like Chile in terms of pricing.

Remember that Chile doesn't have oil and doesn't -- or has very limited amount of coal and doesn't have natural gas. And this is probably where if the strongest point it doesn't have natural gas and the natural gas they're using lately is coming from LNG. And in order to produce electricity from that natural gas coming from the LNG, usually, they get to have a pricing around anywhere between $8 to $9 to the gigawatt -- gigajoule. So that translates into pricing of producing electricity with that natural gas north of $0.06 easily. So that's why you're seeing some price floor around $45 to $50, and that's the lowest, lowest price they're seeing in Chile. And it doesn't last long and you're peaking, you're seeing some spike in the price around $90, $110 per megawatt hour easily in Chile these days. So what we are saying is that if we can build a project and be profitable at $45 per megawatt hour, we feel comfortable that on the long run basis, we can find a buyer to stabilize electricity.

And in the meantime, we can support the development and the cash flow on the basis that the floor, our perception of the floor in Chile is around $0.45. Plus, you get -- the hydro gets to have a capacity payment that can be anywhere from $0.005 to $0.015. So if you have the capacity payment, which is not subject to the spot market, it's a payment established yearly by the administration of the system and they pay it on a monthly basis. So with those two things together, hydro facility can fetch easily $55 to $60 per megawatt hour. So this is why we like Chile in terms of spot market. We don't like spot markets in general. But over there, we think there's a cost structure that justify the floor around $45 to $50, plus capacity of payment, which support the development of project. It's just that Frontera is fairly big to start construction on those assumption. So that's why we would rather have a lead order for the PPA to start Frontera.

Adnan Waheed

Okay, great. I have one last question if there's time. I just wanted to ask over -- about Iceland, on the 10-megawatt project that's in development. You're under appeal, the claim avoiding of the payment. What does that mean for the project? And what do you expect the outcome to be? Are there any concerns?

Michel Letellier

Well, it's not very much out for us, right? We own 53% of the 10 megawatt in Iceland in terms of the -- so we're not so concerned. Management over there thinks that the claim is not based on a real impact. They're trying to be technical and slow down any development in Iceland. We've won into the first appeal. I don't see any big problem other than slowing down potentially the project to be built. But management over there very strongly believe that we shouldn't have any problem, and we're not very concerned about it.

Operator

Your next question comes from the line of Mark Jarvi from CIBC Capital Markets.

Mark Jarvi

Just wanted to go back to the comments about conservatism on long-term average expectations for wind, given the results in France. How does that impact how you guys think about bringing in future RFPs or margin of safety when thinking about development projects?

Michel Letellier

Well, it's a very good point. We've seen that we have a been competitive in bids. The thing is that our philosophy is to rather have more conservative approach, and hence, have a more conservative cash flow or potentially internal rate of return on project and accept that and based our dividend growth based on those assumptions. And if we're around and we have a better price or better output in the long-term forecast, then it's much easier to have a better result than a lower result. So that's why I've been skeptical sometimes with the industry, seeing that they grew making great returns and that you can see double-digit return in here or in there. It all depends on the assumption you're using, right? So I'd rather have my board and, ultimately, you guys and the investor looking into more conservative potential internal rate of return on these projects, but that we can meet the long-term forecast and not be disappointed on the potential output. But I must say that everybody is concerned about the wind in France. In the last two years, France has experienced lower wind regime than what is perceived to be the P50.

Any time we're making acquisition, usually obviously, the seller has independent engineer reports and bankers and our own report are showing always lower output and we're basing our long-term forecast on that. But even our -- what we perceive conservative long-term forecast in France have shown that there's definitely something, I wouldn't say something wrong, there's something unusual happening in France in the last two years. Mind you that, that can change and we could have the next two years being way over the P50 long-term average. So we still believe that the long-term average in France, based in our conservative approach, is the right approach. But obviously, we would love to see some improvement on the short-term basis just like you guys. We like France. We believe that France is a great market. But we can't wait to see that wind blowing back to the normal activity.

Mark Jarvi

Okay, makes sense. And then last question, just on I think you have a couple of more renewals in Québec with Chaudière and SM-1. Can you tell us an update on when you think those will be settled and what your expectations are for those contracts?

Michel Letellier

Well, they will be, as I said, back a little bit from the price that we have. We have gone through Windsor and St-Paulin and it has been a little bit of a challenge to have a higher price than what we just have in St. Paulin and Windsor. But we're happy to see the numbers filtering out from the long-term contract that Hydro-Québec has won with New England. Based on those public numbers, the price of electricity that the Hydro-Québec is receiving in Canadian dollar is probably north of $0.06. So that's encouraging in terms of negotiations. So that means that they were starting way back then and saying that the electricity in the other spot market in the New England was around $0.45. So it's an improvement. But unfortunately, I think that we'll have to accept to have a lower price than what are the numbers that are existing in our PPA. But in a way, something over $0.06 is not bad these days. And with some inflation and a renewal of 20 years, that's not a bad outcome either compared to other markets in North America.

Operator

Your last question comes from the line of Jeremy Rosenfield from Industrial Alliance.

Jeremy Rosenfield

So maybe just a question on the Itau debt financing in Chile. I think it was a little bit lower in terms of the total amount relative to what you had originally expected. Maybe you could just provide some color there?

Michel Letellier

Yes. Remember that we have to put out -- there's a $10 million discrepancy. We decided to lower the bank financing by $10 million because they were asking to have a $10 million LC as a standby, and we kind of find it was not a useful arrangement. So we decided to reduce the outcome by $10 million but not providing the LC to support the $10 million increase. So this is the only setback. Well, it's not a setback, it's a changing our -- yes, yes.

Jeremy Rosenfield

And what are you seeing in terms of the market for hedging the interest rate on debt?

Michel Letellier

In Chile or something else?

Jeremy Rosenfield

Yes, yes.

Michel Letellier

In Chile, yes, we were insistent to hedge completely the Chile investment because we were -- we're still thinking of perhaps putting something different than the financing of Itau. Itau was provided through the acquisition. But usually, our philosophy is to hedge. So I think that in the next quarter, depending on the discussion we're having with our project financing team, we might put a hedge in place in Chile.

Jeremy Rosenfield

Okay. And you don't have some notional idea as to what the range of the cost of that would be or...

Michel Letellier

I'll have to go back, Jeremy, on -- but the hedge shouldn't be much higher than we had already placed in our forecast, some room for the hedge. But I would have to come -- sorry, it's...

Jeremy Rosenfield

No, it's okay. Maybe you could just comment on Saskatchewan. You said you were involved in bidding there. I'm just wondering what your expectation was, whether you think it's going to be a very competitive process based on number of competitors notionally that you hear from and what the strategy is in the bidding.

Michel Letellier

Well, like I said, usually, we're not commenting on our strategy to bid, right? But it will be competitive. Definitely will be competitive. We think we have two nice projects. We have one of 100 megawatts with First Nation. And also, we have another one called Mi'gmaq in partnership with Kruger and First Nation. So we have 300 megawatts in partnership with Kruger and First Nations in Saskatchewan. We've tried to design our bid to reflect what Saskatchewan was hoping to have is local component and First Nation participation. So we'll see how the SaskPower will ascribe value to the soft quality of these components. But definitely, our strategy was trying to mimic the demand of the RFP and have First Nation participation and the maximum local component in our bid, hoping to have some soft point on those issue.

Operator

SMs. Vachon, I turn the call back over to you.

Karine Vachon

Thank you. Thank you, everyone, for taking part in this conference call and webcast. We look forward to speaking with you at our next results conference call in November.

Michel Letellier

Thank you very much.

Operator

Ladies and gentlemen, you may now disconnect your lines.