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Risk Rotation Portfolio: A Strategy For Retirement Accounts

Summary What is the Risk Rotation portfolio? How to construct and manage a Risk Rotation portfolio inside a 401K type of account. How does a Risk Rotation portfolio perform compared to the broad market? What is the Risk Rotation Portfolio? The Risk Rotation (or Asset Rotation) portfolio is not something new. One can find many variations for such a portfolio on the Internet. In the SA community, you can find several articles and contributions on similar and other Asset Allocation strategies by Frank Grossmann , Varan , Joseph Porter and others. In brief, the core principle in a Risk (or Asset) Rotation portfolio is to periodically move (or rotate) assets out of an asset with a higher downside risk to an asset that has lower downside risk and higher upward momentum. Such a portfolio aims to provide much lower volatility and drawdowns while capturing similar (or better) returns as the broader market. Though such a portfolio can be constructed inside any brokerage account, I personally find them more appropriate for retirement accounts. Risk Rotation portfolio for retirement accounts Investing successfully has never been easy. Even for the most disciplined investors, the market’s volatility sometimes takes its toll. The past few months have been an emotional rollercoaster for many folks, especially for those closer to retirement. If your horizon is very long term, this is simply market noise and best be ignored. However, for anyone who is already retired or close to retirement, any sharp correction has the potential to derail their near and medium-term planning. The big question is how do you protect yourself from a market downturn or an outright crisis like the one we had in 2008? Furthermore, most retirement accounts like 401K accounts do not provide the flexibility to buy individual stocks or even ETFs (Exchange Traded Funds). A vast majority of them provide just a handful of funds to invest. So, you cannot select your own dividend paying stocks and follow a DGI strategy. In my opinion, one good option is to construct a Risk Rotation portfolio. In my own experience, and also based on back testing, such a portfolio will provide market-beating returns in most situations while providing a high degree of risk protection. A disclaimer: I am also a believer in DGI strategy, and personally invest the majority of my investible funds in individual stocks that pay and grow their dividends. However, for accounts where I cannot invest in individual stocks, I follow the Risk Rotation strategy for about 50% of such assets. If you are interested in my other portfolio strategies, I publish a ” Passive DGI Portfolio ” and another portfolio that is Income-centric named ” The 8% Income Portfolio ” on SA. How to construct a Risk Rotation portfolio: I believe in keeping things simple so they can be easily followed long term. As an example in this article, I will use two securities (a pair of two securities). This pair can be easily implemented inside a 401k type account with moderate risk. There can be more aggressive pairs or strategies that promise higher returns (with higher risk obviously), but they cannot be easily implemented inside a retirement account. Moderate Risk strategy: SPY and TLT pair SPDR S&P 500 ETF (NYSEARCA: SPY ) is an ETF that corresponds to the price and yield performance of the S&P 500 Index. Almost all of the 401K or retirement accounts would offer something that is equivalent of S&P500 index. SPY is taken as an example to illustrate, but any similar fund or ETF can be used in place of SPY. iShares 20+ Year Treasury Bond (NYSEARCA: TLT ) is a 20+ year Treasury fund and oftentimes provides the inverse co-relation with stocks. One can find something similar to TLT inside a retirement account. If nothing similar is available, it could be replaced by cash or cash-like money-market funds. However, the back-testing results by using cash are not as impressive as with TLT. One reason is that TLT provides some yield and at times meaningful appreciation, but cash provides neither (though money market funds do provide some minimal yield). On the first of every month, compare the performance of each of the two funds with a 3-month (or 65 trading days) look-back period. – Invest 70% of the allocated amount in the fund that has better performance over the last 3 months – Invest 30% of the allocated amount in the fund that has worse performance over the last 3 months – If the look-back period performance has been the same or nearly same, invest 50% in each of the two securities. – Repeat every month, on a fixed date of the month. It can be 1st of the month or any other date. Low Risk strategy: SPY, TLT and Cash For more conservative investors, a strategy that involves adding cash to the basket (SPY and TLT) will work a little better. This will also work better during times when both stocks and Treasuries are headed down. This strategy will provide much lower drawdowns, however, at the cost of some performance or overall returns. – On the first of every month, compare the performance returns of each of the three funds with a 3-month (or 65 trading days) look-back period. Performance of cash being taken as 0%. – Invest 60% of the allocated amount in the fund that has better performance over the last 3 months – Invest 30% of the allocated amount in the fund that has second worse performance over the last 3 months – Invest 10% of the allocated amount in the fund that has worst performance of three funds over the last 3 months – Repeat every month, on a fixed date of the month. It can be 1st of the month or any other date. Performance comparison: RRP Strategies vs. S&P 500: (click to enlarge) Image1: Performance/Returns – RRP Strategies vs. S&P 500 The table above shows the performance/returns of the Risk Rotation portfolio (RRP) starting with the year 2006. Row 12: Shows how the portfolio would have performed versus S&P 500 if we had invested $100,000 on January 1, 2006 and remained invested until 10/30/2015. Row 11: Shows how the portfolio would have performed versus S&P 500 if we had invested $100,000 as of January 1, 2007 and remained invested until 10/30/2015. And so on… Notice, except for two starting years (2012 and 2013), the RRP either matches or handily beats S&P 500 with much lower drawdown. The main benefit that stands out is that it moves the portfolio away from the risk in a crisis situation that we witnessed in 2008. I did not go back to the year 2001-2002, but I expect similar behavior. (click to enlarge) Image2: Growth of $100,000 starting on 1/1/2006 – RRP strategy vs. S&P 500. (click to enlarge) Image3: Monthly drawdowns since year 2006 – RRP strategy vs. S&P 500. (click to enlarge) Image4: Maximum drawdown since year 2006 – RRP strategy vs. S&P 500. Risks from this strategy: Let’s consider some potential risks: The first risk comes from the fact that we are seeing the performance comparison based on back-testing results. As the adage goes, past performance is no guarantee of future results. TLT or any other equivalent fund would invest in a treasury based bond fund. In a rising interest rate environment, TLT may have inferior performance compared to past. However, this risk should be mitigated by the fact that we are checking the performance of the two securities every month and switching if necessary. Lack of Diversification: For the stocks component, we are investing in SPY (equivalent of S&P 500), so there is not much exposure to any of the international markets or other asset types like gold or commodities. However, this is partially mitigated by the fact that the companies inside S&P 500 earn a lot of their revenue from outside of the US. Another risk comes from the fact that oftentimes, the performance of this portfolio will be different than the broader market. If it happens to be negative compared to the broader market for a couple of years, the investor may lose conviction and the discipline and may abandon the plan mid-course. This probably is the biggest risk. Concluding Remarks: As they say, hindsight is 20:20. It is hard to predict with any certainty that such a strategy will work as well as it has worked in the past. That’s why it is important to not keep all of your eggs in one basket and depend too much on any one strategy. In my opinion, for the long haul, this strategy should at least match S&P 500 performance with much lower drawdowns, and hence should allow much better sleep at night. I am starting out a sample portfolio with $100,000 initial capital allocated as of November 3, 2015 and will provide regular updates. I plan to publish the performance comparison of the two securities (SPY and TLT) with the previous 3 months’ look-back period on or after the first trading day of every month. This will indicate if a switch of assets is required for the strategy. Here is the relative performance of SPY and TLT as of November 2nd with 3-month look-back period: Price (adj. close) on 11/02/2015 Price (adj. close) on 7/31/2015 Performance/Return Over last 3 months TLT 121.95 121.75 0.16% SPY 210.33 209.36 0.46% Source: Yahoo Finance Since the performance is nearly the same for both, the strategy will invest 50% of $100,000 in each of the two securities. Full Disclaimer: The information presented in this article is for information purpose only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Every effort has been made to present the data/information accurately; however, the author does not claim for 100% accuracy. The portfolio or other investments presented here are for illustration purpose only. The author is not a financial advisor, please do your own due diligence.

Black Hills’ (BKH) CEO David Emery on Q3 2015 Results – Earnings Call Transcript

Black Hills Corporation (NYSE: BKH ) Q3 2015 Earnings Conference Call November 04, 2015 11:00 AM ET Executives Jerome Nichols – Director, IR David Emery – Chairman, President and CEO Rich Kinzley – SVP and CFO Analysts Dan Eggers – Credit Suisse Insoo Kim – RBC Capital Markets Operator Good day, ladies and gentlemen and welcome to the Black Hills Corporation Third Quarter 2015 Earning Conference Call. My name is Malerie and I’ll be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Jerome Nichols, Director of Investor Relations of Black Hills Corporation. Please proceed, sir. Jerome Nichols Thank you, Malerie. Good morning, everyone. Welcome to Black Hills Corporation’s third quarter 2015 earnings conference call. Leading our quarterly earnings discussion today are David Emery, Chairman, President and Chief Executive Officer and Rich Kinzley, Senior Vice President and Chief Financial Officer. Before we begin today, I would like to note that Black Hills will be attending the EEI Financial Conference next week in Hollywood, Florida. You’ll find our presentation materials and webcast information on our Web site at www.blackhillscorp.com, under the Investor Relations heading. During our earnings discussion today, some of the comments we make may contain forward-looking statements as defined by the Securities and Exchange Commission and there are a number of uncertainties inherent in such comments. Although we believe that our expectations and beliefs are based on reasonable assumptions, actual results may differ materially. We direct you to our earnings release, Slide 2 of the investor presentation on our Web site and our most recent Form 10-K, Form 10-Q another document filed with the Securities and Exchange Commission for a list of some of the factors that could cause future results to differ materially from our expectations. I will now turn the call over to David Emery. David Emery Thank you, Jerome and good morning everyone. I will be starting on Slide 3 of the webcast deck and then we will be following a format similar to that of previous quarterly calls. I’ll give an overview of the quarter and some highlights. Rich Kinzley will go over the financials from the quarter and then I’ll talk a little bit about forward strategy and then we’ll answer questions. Moving to Slide 5, the third quarter was another strong quarter for Black Hills Corporation. We posted solid earnings and made great progress on our growth goals for our existing businesses and we also made excellent progress towards our pending acquisition of SourceGas. Related to SourceGas on August 10th, which was less than 30 days after the deal was announced we filed joint applications for acquisition approvals in all four states. A week later, just a little over a week later, we received our Hart-Scott-Rodino antitrust clearance, we now have procedural schedules established in three of the states with the fourth state pending. The discovery process is ongoing and we still remain on track to close on the first half of 2016. Also, on the acquisition front we did close on July 1st, on our $17 million acquisition of about little less than 7,000 customers in Northwest Wyoming and notably related to that acquisition they were 100% integrated on to all of our systems and process on day 1 after close. From a business environment perspective, during the quarter we had warmer than average weather in our utility service territories, a slight positive for the electric utilities and a negative for the gas utilities and then energy commodity prices particularly oil and gas remained at very low levels. Moving on to Slide 6, utility highlights for the quarter, Black Hills Power is preparing to commence construction later this quarter on 144-mile, $54 million electric transmission line routed from Northeast Wyoming to Rapid City, South Dakota. Cheyenne Light recorded a new all time peak load of 212 megawatts on July 27th, that’s the third new peak for Cheyenne Light this summer, highlighting the strong growth in the Cheyenne area service territory. On October 21st, Colorado Electric received approval from the Colorado PUC to acquire the planned 60 megawatt Peak View Wind project which will help our utility meet the Colorado renewable energy standards. A third-party wind developer will build the project, we executed a build transfer agreement with that developer and we’ll take ownership upon commercial operations in the fourth quarter of 2016. Total cost of the project will be approximately $109 million. Our capital investment and a return on that capital and all expenses will be recovered through customer adjustment clauses and a base rate increase won’t be required for the first 10 years of the project. Moving on the Slide 7, a continuation of our utility highlights, we continued construction on our $65 million, 40 megawatt gas combustion turbine at our Pueblo Airport Generating Station, that’s being built for our Colorado Electric subsidiary and is expected to be in service in the fourth quarter of 2016. We also completed here just in a last couple of weeks our field service optimization project. We rolled it out to all of our utility techs in all of our states. Really that project is a deployment of tablet and GPS technology to automate and improve the efficiency of the lot of our field processes, including dispatching. We’re excited about the benefits of that project. On the non-regulated side or non-utility side we initiated a process to evaluate the possible sale of a minority interest in our Colorado IPP generating assets and we drilled the last of 13 horizontal Mancos Shale gas wells for our 2014 and ’15 drilling program in the Southern Piceance Basin in Colorado. We have six wells on production and we just started to flow back operations for the final three wells. We expect to have the test results on those three wells by year-end. And our results for the program continued to meet or exceed our expectations. Slide 8, which is corporate highlights for the quarter, the Board last week declared the quarterly dividend of $0.405 continuing the level we’ve been at for this year equivalent to an annual rate of $1.62 per share. During the quarter, we entered into the $250 million of interest rates swaps, really to mitigate any future interest rate risk associated with some of our future debt issuances, primarily related to the SourceGas transaction. And we continued our cost containment efforts which we started earlier this year to really help mitigate the impacts of low oil and gas prices and the moderate weather that we had earlier in the year. Moving on to Slide 9, financial highlights for the third quarter we earned $0.64 per share as adjusted from continuing operations during the quarter about a 5% increase compared to the same quarter last year, a really good result considering the negative impacts of our oil and gas business. Slide 10 provides a reconciliation of our third quarter 2015 income from continuing ops as adjusted against our 2014 results for the third quarter. Strong performance in nearly all of our businesses more than made up for poor performance in our oil and gas subsidiary. With that I’ll turn it over to Rich for the financial update. Rich? Rich Kinzley All right, thanks Dave. As Dave mentioned our core utility and utility like businesses continue to demonstrate strong performance. In the third quarter each of these businesses improved operating income compared to the third quarter of 2014, in particular our electric utilities posted strong year-over-year operating results. Our oil and gas business continued to manage through a challenging commodity price environment. Despite that challenge we posted a strong quarter. On Slide 12, we reconcile GAAP earnings to earnings as adjusted on non-GAAP measure. We do this to isolate special items and communicate earnings to better indicate our ongoing performance. In each of the first three quarters of 2015, we’ve incurred non-cash ceiling test impairments at our oil and gas business and in the second quarter of 2015 we also impaired in an equity investment at our oil and gas business. These impairments are due to low natural gas and crude oil prices and our non-cash charges that are not reflective of ongoing operational results. We also incurred external acquisition related cost in the second and third quarters of 2015 associated with the SourceGas acquisitions, such as financing and other third-party costs which were non-recurring in nature. Our third quarter as adjusted EPS reflective of ongoing operations was $0.64 per share compared to $0.61 per share in the third quarter last year and our trailing 12 months as adjusted EPS was $3.05. Slide 13 displays our third quarter revenue and operating income, on the left side of the slide you’ll note that revenue was flat in 2015 due to the lower gas utility revenues from the lower pass-through gas cost in 2015 and lower revenue from the oil and gas business due to lower receipt prices. These revenue reductions were offset by strong revenue growth at our electric utilities. On the right side of the slide you can see that strong performance in the third quarter at our core utilities, coal mine and Power Gen businesses more than offset decreased performance at oil and gas, resulting in a more than 10% increase in consolidated operating income as adjusted year-over-year. I will elaborate on each business unit in the following slides. Slide 14 displays our third quarter income statement comparing third quarter 2015 to third quarter 2014 gross margin increased 7% driven by strong electric utility results. Operating expenses increased 6% due largely to margin additive activities at our electric utilities. DD&A and interest expense increased primarily from added plant in-service and borrowings associated with our October 1, 2014 in-service of the $222 million Cheyenne Prairie Generating Station. The DD&A increase was partially mitigated by lower ongoing depletion at our oil and gas business, which I’ll explain in a few slides, as adjusted EPS grew 5% year-over-year and EBITDA increased by 8%. Moving to our business unit results, Slide 15 displays electric and gas utilities’ gross margin and operating income. In 2015 we changed from discussing revenue to gross margin for our utilities, as we feel gross margin is more relevant to understanding ongoing results, since revenue includes fuel cost pass throughs. On the left side of the slide you’ll see our electric utilities’ third quarter 2015 gross margin increased by 14 million from 2014. 9.5 million of this increase was driven by additional return from investments in our generation facilities with completed rate cases in late 2014 and early 2015 in Colorado, South Dakota and Wyoming. Gross margin also benefitted by nearly 3 million from the combination of higher commercial and industrial demand and the addition of two small Wyoming natural gas utility acquisitions in 2015 that Dave mentioned. These small utilities our subsidiaries of Cheyenne Light and we report their results in the electric utilities segment. Residential usage was favorable across our electric service territories and totaled up 4.6% comparing third quarter 2015 to 2014. Cooling degree days in our electric utility service territories for the quarter were 36% above 2014 adding 3.3 million to margin year-over-year. Overall weather impacts at our electric utilities were $300,000 favorable compared to normal. Operating income during the third quarter for our electric utilities improved by 8 million or 19% year-over-year, as a result of increased gross margin and solid cost management. Operating expenses including depreciation increased only 6 million year-over-year despite the addition of Cheyenne Prairie and the two small Wyoming acquisitions, the combination of which accounted for approximately half of the $6 million expense increase. Looking at the right side of Slide 15, our gas utilities gross margin increased slightly in 2015 compared to 2014. Increased margins from a rate case completed in Kansas in late 2014 and higher transport and industrial volumes were offset by unfavorable weather impacts. While weather isn’t a large driver for our gas utilities in the third quarter, it’s worth noting 2015 heating degree days in our gas utility service territories were 61% below 2014 and 57% below normal for the period, resulting in a 400,000 negative impact to margins in the third quarter compared to the prior year and compared to normal. So, if you take the electric and gas utilities combined weather was really flat compared to normal and total for the third quarter. Third quarter 2015 operating income at the gas utilities increased 800,000 compared to 2014 thanks to strong cost management which reduced operating expenses 600,000 year-over-year. On Slide 16, you’ll see Power Gen’s operating income improved by 1.4 million compared to last year’s performance. Power generation benefited from annual power purchase agreement price increases partially offset by decreased capacity payments since we sold the 40-megawatt CT2 to the City of Gillette in the third quarter of 2014. These last revenues were partially mitigated by the cost sharing benefits we enjoy as we operate this facility for the city. Cost management efforts at Power Gen have allowed us to reduce operating cost by 300,000 year-over-year. On the right side of Slide 16 our coal mining segment saw improved operating income in the quarter by $400,000 from 2014. While tonnes sold were slightly down year-over-year, our average overall coal price received increased 13% comparing Q3 2015 to Q3 2014. And strong cost management contributed to another solid quarter at the coal mine. Power Gen and coal mining continue to deliver solid results. Moving to oil and gas on Slide 17, you’ll see we sustained and as adjusted $7.2 million operating loss for the quarter. Commodity prices negatively impacted results in the third quarter of 2015 as our average received prices inclusive of hedges were down 27% for crude oil and 37% for natural gas compared to the third quarter of 2014. Overall, third quarter production increased 17% comparing the same period in 2014, driven by increases in both natural gas and crude oil production. On the cost side, our Q3 operating expenses increased slightly comparing 2015 to 2014 due primarily to employee severance cost as we reduced staff in the third quarter, which will reduce future period’s operating costs. Despite increased production volumes, DD&A decreased by $0.5 million in the third quarter compared to 2014 due to a substantially lower depletion rate. The reduction in the depletion rate resulted from a lower-cost pool due to the ceiling test impairments we incurred in the first and second quarters of 2015. In the third quarter we incurred a $62 million pretax ceiling test impairment charge related to our oil and gas holdings, in addition to the impairments we incurred in the first and second quarters. The ceiling test utilizes rolling 12 month average prices for crude oil and natural gas, prices for these commodities began to fall in the fourth quarter of 2014 and have remained low throughout 2015 compared to 2014. Consequently the average prices used in our ceiling test impairment evaluations have continued to drop each quarter in 2015. We are likely to incur an additional impairment charge in the fourth quarter, if crude oil and natural gas prices remain at current depressed levels. Also as a result of the third quarter ceiling test impairment we expect and a lower depletion rate again in the fourth quarter. Despite the challenges presented by the low commodity price environment we continue to be pleased with the momentum we have improving up our Piceance Mancos Shale play. We expect to substantially complete our drilling, completion and testing program as we finish out 2015. The play is well-positioned to potentially serve our cost of service gas model we filed in six states for regulatory approval and for additional upside value capture when commodity prices improve. We have right sized our cost structure in the oil and gas segment and expect a much lower depletion rate in 2016. We’ve also substantially reduced our expected capital spending in our oil and gas segment for 2016 and 2017. Dave is going to talk a little more about that in a couple of slides. Slide 18 shows our current plans for the SourceGas financing as well as other financing activities in the 2016-2017 horizon. We completed syndication of a bridge facility to give us flexibility with the timing and structuring for the permanent financings for the SourceGas acquisition. As previously disclosed we will be assuming 700 million of existing SourceGas debt and financing the remainder of the acquisition through potential asset sales and new debt and equity issuances. At our recent Analyst Day we discussed our financing plans for the SourceGas acquisition and indicated we will finance the acquisition in a manner that will support our strong investment grade ratings. We are currently reviewing our options for financing the recently announced $109 million Peak View Wind project and our other strong utility growth oriented capital activities in 2016 and beyond. To support an ongoing CapEx associated with our continued growth for SourceGas acquisition closing, we are considering the implementation of an at-the-market equity program in 2016. Slide 19 shows our current capitalization, at quarter end net debt to cap was 56.7%, an increase from June 30th that was primarily driven by the third quarter non-cash impairment charge in our oil and gas segment. Given expected cash flows from operations for the remainder of the year in our revolver capacity, we have ample funding available for planned CapEx and dividends in the fourth quarter. Slide 20 demonstrates our strong earnings growth performance over the last six years. Our third quarter results demonstrate the continuing strong operational performance and growth characteristics of our core businesses. While low crude oil and natural gas prices impacted our oil and gas segment in 2015 and tempered 2015 earnings growth, we expect to grow earnings again in 2016, which brings us to Slide 21. In our press release on October 7th, we increased our 2015 earnings guidance range to $2.90 to $3.10 per share as adjusted which we reaffirmed with our press release yesterday. We also yesterday issued our initial earnings guidance for 2016 to be in the range of $3.15 to $3.35 per share as adjusted. The assumptions for this guidance are listed on Slide 21. Most notably the assumptions exclude the SourceGas acquisition any material asset sales and any significant new debt or equity issuances. If any of these items occur we will issue updated guidance. As we previously disclosed, we believe the SourceGas acquisition if closed in the first-half of 2016 as planned will be meaningfully accretive to 2017 earnings per share. And with those comments I’ll turn it back to Dave. David Emery Thank you, Rich. Moving onto Slide 21 forward strategy, we group our strategic goals in to four major categories and we’ve done this for a couple of years. The overall objective being an industry leader in all that we do. Those four major goals are profitable growth, valued service, better every day in a great workplace. On Slide 24, I noted this earlier but we’re making excellent progress on our acquisition of SourceGas, we’re on track for closing in the first-half of 2016 as I said earlier and we have a very experienced leadership team guiding our integration effort. Our goal on the integration is to be fully integrated by the end of the year 2016. Moving on to Slide 25, strong capital spending drives our earnings growth and we forecast the total of 1.25 billion of investment for 2015 through 2017. Our projected capital spending far exceeds depreciation driving earnings growth. It’s important to note that this table on Slide 25 does not include any capital related to either the SourceGas acquisition or capital spent in the SourceGas territories post acquisition. On Slide 26 as I said earlier, we’re continuing to make great progress constructing a new turbine at the Pueblo Airport Generating Station. We commenced construction in June, we’ve spent about 27 million to-date out of the projected total of 65, construction is a little over 20% completed and we have no safety incidents to-date. On Slide 27, Monday of this week we announced that we received the necessary approvals and executed the necessary agreements to purchase 109 million 60 megawatt Peak View Wind Project in Colorado. I mentioned this earlier it will help us meet the renewable energy standard in Colorado for our Colorado electric customers. We expect construction to commence in the second quarter of ’16 and be completed by year-end. Slide 28, our electric utilities have demonstrated solid earnings growth year-to-date in 2015 and Rich covered that earlier. One aspect of that has been strong industrial growth in all three of our electric utilities. The overall growth rate has been 16% year-to-date. That growth has come from several different industrial customers and industry segments with the data center load growth particularly in Cheyenne Wyoming being the most notable. On Slide 29 a significant growth opportunity that we are pursuing is this utility cost to service gas supply program that we’ve been talking about for a well over a year now. Under cost of service gas program our direct investment in natural gas reserves would provide long-term price stability for customers while providing increased earnings for shareholders, an excellent win-win situation. We submitted cost of service gas regulatory applications now in a total of six dates, we hope to pursue and receive approvals on those programs in 2016. We’re continuing to evaluate producing properties and growing prospects for inclusion in that program and that certainly includes our Mancos Shale gas properties in the Piceance Basin in Colorado. On Slide 30 and we discussed this in quite a bit of detail on our Analyst Day, but in light of continued low oil and gas prices, our oil and gas strategy is really focused on providing cost to service gas cost effectively to our utilities. We’re working to finish up our 2014 and 2015 Mancos drilling program and then focusing on minimizing other capital expenditures and operating costs. On Slide 31, there’s an illustration of the impact that low crude oil and natural gas prices have had on our quarterly forecast ceiling test that Rich mentioned earlier. We do expect another impairment in the fourth quarter as Rich stated earlier if product prices remain at current levels. Slide 32, provides a well by well detail for our Mancos drilling program, it includes all wells drilled from 2013 through 2015. The top-six wells on the page have all been placed on production in 2015. We have good test results on those wells. We just started flowing back the three final wells that we intend to produce this year, that are in the Whittaker Flats area and should be tested and on production prior to year-end. On Slide 33, we continue to be very proud of our dividend track record, having increased our annual dividend to shareholders for 45 consecutive years. On Slide 34, we do have a strong balance sheet, strong cash flows and solid investment grade credit ratings and as we’ve discussed last quarter all three agencies reacted favorably as we expected to our SourceGas announcement. Slide 35, illustrates the continuing focus we place every day on operational excellence and on being a great workplace. Our safety performance year-to-date has been outstanding, our total case incident rate for the year of 0.7 is the lowest ever for Black Hills Corporation. Finally, on Slide 36, is our scorecard, this is our way of holding ourselves accountable to you our shareholders, we’ve done this for quite a few years now, we lay out our goals at the beginning of the year and literally keep you informed as to our progress throughout the year as we make progress towards those goals. Now, that concludes all of our remarks. We’d be happy to take questions. Question-and-Answer Session Operator Ladies and gentlemen, we are ready to open the line for questions. [Operator Instructions] Our first question comes from the line of Dan Eggers with Credit Suisse. Your line is now open. Dan Eggers I guess, if we step back and kind of think about the priorities around the earnings outlook, the commodity price assumptions in the E&P business are above the street, can you just explain how you kind of got to those numbers, or the sense to at least slog and kind of why you guys have settled, decided to settle above the curve right now? David Emery The curve changes every day and typically what we do Dan is we take a basket of multiple forecasts and try to use that to come up with a reasonable estimate for the future year. I mean, literally the curve changes every day and if we revise our forward look every time the curve changes, that’s all we do. So, we try to look at several forecasts, and bank forecasts the strip and other things, obviously weighted a little more heavily probably towards the strip and some of the other things and set a forecast at the beginning of the year that we think we can live with regardless of whether that price fluctuates up and down a little bit throughout the year. Dan Eggers And then, did I hear you currently say that on the Wind acquisition that there is no base rate increase for the first 10 years? David Emery Correct, yes, the way that we are going to get recovery for that is it’s basically going to flow through three different cost adjustment clauses that we have and we’ll earn the same amount basically but it’s going to go through the adjustment clauses, and then it’s going to be up to us to decide whether we want to continue that or go in for a base rate case in year 10, I think the commissions preference at least at this point would probably be that we do a base rate case in year 10. Dan Eggers Now we’re going to see a distortion in your tax build because the DTC is being generated will bring your tax expenses down, so a part of the return is going to come on that asset through the tax line effectively? David Emery That’s correct, Dan. Dan Eggers And then how much will that effect the tax rate for the next year or the year after if we want to try and bear any expectations? David Emery It won’t affect ’16 obviously because it’s going to go into service late in ’16 but in ’17 I don’t even want to guess. Dan Eggers I am sorry maybe I should ask what’s the right utilization rate you guys are expecting off the project? David Emery Yes, high-30s, low-40s right in there for our capacity effects. Operator [Operator Instructions] Our next question comes from the line of Insoo Kim with RBC Capital Markets. Your line is now open. Insoo Kim Just back to SourceGas, are you able to give any more guidance on potential timing of the equity issuance whether it’d be before the end of the year or after? David Emery Basically what we wanted to do is get our third quarter financials out and then essentially we’re going to watch the market conditions and be prepared to go to the market. There is obviously some holiday and things in there, but we’re looking at anytime basically between a couple of weeks from now and closing would be our idea of timing. And we’re just going to evaluate market conditions and make a decision on timing as things evolve. Insoo Kim And regarding the financing of the deal, are you currently actively looking for buyers of your non-core E&P assets to help with the funding or is there not really a good market right now given the lower oil and gas prices? Rich Kinzley Yes the non-core assets in E&P aren’t going to generate I would say a material amount into that the Colorado IPP is the big thing there obviously. So we’ll opportunistically look for opportunities on the non-core E&P but it’s not going to be a huge number. David Emery Yes, it’s more just cleaning up the portfolio on the labor involved in managing it all than it is about big dollars on the capital side. Rich Kinzley Right. Insoo Kim And finally if the deal does close on time in the first-half of ’16, I know in ’17 you do expect some material earnings accretion, but in ’16 do you still expect some neutral to slightly accretive scenario for the ’16? David Emery It really depends on timing Insoo and if you think about SourceGas is no different than most gas utilities that makes a huge portion of its income in the first quarter. And so if you called after the first quarter as already you have relatively small piece of the income remaining and a relatively large piece of the expenses remaining for the year. So it’s going to depend on timing if we close right after winter for example we’re going to have three quarters of a year of expenses and roughly and half a year in income. Insoo Kim And then just one more question if I may, at the utilities with the strong industrial growth there that you’re seeing for the year is there any re-through to forecast for 2016 and potentially beyond? David Emery Well, I think we’ve accounted for that growth in our guidance if that’s what you’re asking. Insoo Kim Yes, I was just wondering if, I mean it’s pretty 16% industrial growth you say that is very strong and just wondering modeling out for ’16 kind of what levels we should be expecting? David Emery Well we’ve talked a little bit — the biggest piece that will be continuing is really the Microsoft piece and there is quite a few public disclosures around Microsoft they have made some announcements in Cheyenne related to their plans and they are continuing with additional expansions of datacenters there in Cheyenne. So we expect that to continue for a while. Operator Thank you. [Operator Instructions] I am showing no further questions. I’ll turn the call back to David Emery for final remarks. David Emery All right, well thank you everyone for attending the call this morning. We certainly appreciate your continued interest in Black Hills and for those of you who are going to be at EEI we look forward to seeing you next week. Thanks and have a great day. Operator Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. And you may all disconnect. Everyone have a great day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com . Thank you!

Northwest Natural Gas’ (NWN) CEO Gregg Kantor on Q3 2015 Results – Earnings Call Transcript

Northwest Natural Gas Company (NYSE: NWN ) Q3 2015 Earnings Conference Call November 3, 2015, 11:00 am ET Executives Nikki Sparley – IR Gregg Kantor – CEO Greg Hazelton – SVP & CFO Analysts Spencer Joyce – Hilliard Lyons Operator Good day and welcome to the Northwest Natural Gas Third Quarter 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 that this event is being recorded. I would now like to turn the conference over to Nikki Sparley. Please go ahead. Nikki Sparley Thank you, Kasia. Good morning, everyone, and welcome to our third quarter 2015 earnings call. As a reminder some of the things that will be said this morning contains forward-looking statements. They are based on management’s assumptions, which may or may not come true. You should refer to the language at the end of our press release for the appropriate cautionary statements and also our SEC filings for additional information. We expect to file our 10-Q later today. As mentioned, this teleconference is being recorded and will be available on our website following the call. Please note these conference calls are designed for the financial community. If you are an investor and have questions, please contact me directly at (503) 721-2530. Media may contact, Melissa Moore, at (503) 220-2436. Speaking this morning are Gregg Kantor, Chief Executive Officer and Greg Hazelton, Senior Vice President and Chief Financial Officer. Mr. Kantor and Mr. Hazelton have some opening remarks and then will be available to answer your questions. Also joining us today are other members of our executive team, who are available to help answer any questions you may have. With that, I will turn it over to Mr. Kantor for his opening remarks. Gregg Kantor Thanks, Nikki. Good morning, everyone and welcome to our third quarter earnings call. I’ll start today with highlights from the period and then turn it over to Greg Hazelton to cover the financial details. Finally, I will wrap up the call with a brief update on our regulatory proceedings and our priorities for the remainder of the year. Let me begin with the quarterly financial results. We had a solid performance with higher utility margin and lower expenses in the period. Margin gains were largely from customer growth which increased to 1.5% from 1.3% last year. This growth rate translated into an additional 10,500 new customers on a rolling 12-month basis. On the expense front, we reduced O&M levels by almost $1 million on a quarter-over-quarter basis and I’m proud of the work we have done this year to control costs after the negative financial impacts of a record warm winter and a significant regulatory disallowance. As we look forward, there are several factors that suggest our local economy continues to experience solid growth. For example, in Portland Metro area about 40,000 new jobs have been added year-over-year which equates to over a 3% increase. And Oregon’s average wage today is the highest it has been relative to the national average in at least a generation according to the Oregon Office of Economic Analysis. Another metric of economic growth obviously is the unemployment rate which in September fell to 5.2% in the Portland Metro area from 5.9% last year. Also in the period home sales were up about 25% in Portland and average home prices increased by almost 6% compared to the third quarter of 2014. In Vancouver, Washington, home sales were up about 13% in the quarter compared to last year and average home prices were up just over 8%. All of these factors are signs that our local economy continues to move in the right direction. Due to following natural gas prices over the past year, we filed and received approval for a 7% rate reduction for Oregon residential customers, and a 14% reduction for Washington residential customers during the quarter. This decrease means our customers will be paying less for their natural gas this winter than they have in the past 15 years. Currently natural gas has up to a 60% price advantage over electricity and oil for home heating in our service territory. And this price advantage coupled with the environmental benefits of natural gas continue to boost our competitive position. Let me comment now on two other developments during the quarter. First, in September the Oregon commission adopted an all party settlement that determines how we would recover cost associated with seven wells we drilled under our amended gas reserves agreement. This $10 million additional investment, like our original investment with Encana, provides a long-term price protection for Oregon utility customers. Under the order, this investment will be recovered at a rate of about $0.47 per therm. We are pleased with this collaborative settlement and the positive conclusion to the dock. Going forward, we are working with the commission and other gas utilities in Oregon on a policy docket that will explore commodity hedging, including what world gas reserve should play. Finally this morning, I’m proud to report in September we learned that for that sixth time in nine years, we ranked first in the Annual J.D. Power Residential Customer Satisfaction Study for natural gas utilities in the west. In addition, we have strengths among the top two highest scoring utilities in the nation eight out of the last 10 years. These results reflect our continued commitment to operate reliably, safely, and with high quality customer service in the communities we serve. With that, let me turn it over to Greg to cover the financial details. Greg Hazelton Thank you, Gregg, and good morning everyone. Turning to our results for the third quarter we reported improved performance with a consolidated net loss of $6.7 million or $0.24 per share versus a loss of $8.7 million or $0.32 per share for the same period last year. As a reminder, a majority of our business was seasonal in nature. And the third quarter typically realized the loss due to decreased heating requirements impacting customer usage. Year-to-date earnings through September were $0.88 per share on net income of $24 million compared to $1.11 per share in net income of $30.2 million for the same period last year. As previously discussed in the first quarter, the company recorded a $15 million pretax or $9.1 million after tax environmental disallowance related to the February OPUC Order. This charge is included in O&M expense. Excluding the charge, year-to-date consolidated earnings were $1.21 per share or $33.1 million. This reflects a $2.9 million increase in net income from last year primarily driven by higher utility margins and an increase in other income. At our utility, we reported a net loss of $7.5 million for the quarter, an improvement of $1.3 million from the prior year. Results were driven by higher utility margin, lower O&M expense, and decreased interest expense. For the nine months period, utility net income was $23.1 million or a decrease of $6.4 million from last year, mainly due to the environmental charge. Excluding the disallowance, utility net income increased $2.7 million year-over-year. Positive year-to-date drivers included higher utility margins and increase in other income, lower interest expense; these were partially offset by an increase in O&M expense. Utility margin for the quarter increased $1.5 million driven by customer growth and gains from gas cost incentive sharing. And as you may recall, utility margin for the year-to-date period was impacted by warm weather in our service territory during our peak heating season in the first quarter. Overall average temperatures for the first nine months of the year were 15% warmer than 2014, and 22% warmer than normal. Total gas deliveries decreased almost 10% and gross revenues were down 4% during the year-to-date period. Although our utility margin is generally protected from the weather, we do have about 11% of our customers in Washington who do not have weather normalization, and 7% of our Oregon customers are left out of the weather normalization program. In spite of the weather driven decline in volumes and gross revenues, net margins increased $2.7 million mainly due to continued customer growth and gains from gas cost, incentive sharing mechanism, as we took the advantage of lower gas prices to achieve savings for our customers. Moving to our gas storage segment, net income for the quarter increased approximately $800,000 compared to the prior year. The increase was driven by higher operating revenues from slightly higher contract prices for the 2015/2016 gas storage year and a reduction in operating expenses at our Gill Ranch facility. For the first nine months, net income for gas storage was over $800,000, an increase of nearly $400,000 from the prior year. Results included a reduction in operating expenses and interest expense, partially offset by a decrease in operating revenues due to lower contract prices during the first quarter of 2015 at Gill Ranch. As Gregg mentioned earlier with regards to consolidated O&M, as a result of our cost control initiatives undertaken to partially offset the environmental write-off and record warm weather, we achieved a decrease of over $900,000 in O&M expense versus last year. For the nine months period, however excluding the regulatory disallowance, O&M expense increased $3.4 million. The increase was primarily due to utility payroll and benefit increases which included a new Union labor contract that was effective June 1, 2014. Partially offsetting the increase in payroll costs were lower repair and power cost at our Gill Ranch facility. For the first nine months, other income increased $4.9 million compared to last year, primarily due to the recognition of $5.3 million of equity earnings on deferred environmental expenditures as a result of the February environmental order. Over the last 12 months, the utility redeemed $40 million of debentures without reissuance using environmental insurance proceeds to pay down the maturing long-term debt balances and defer new issuances of long-term debt. Consequently interest expense decreased nearly $700,000 for the quarter and $3 million for the first nine months of the year. Cash flow from operating activities for the first nine months of 2015 was $173 million compared to $215 million a year ago. Last year’s cash flow was significantly enhanced by $102 million of insurance recoveries partially offset by other working capital changes. Finally, today the company has reaffirmed its 2015 guidance for reported earnings in the range of $1.77 to $1.97 per share which includes the $15 million pretax charge. Our adjusted guidance for 2015 excluding the charge remains unchanged at $2.10 per share to $2.30 per share. The company’s guidance assumes continued customer growth from our utility segment, average weather conditions going forward, slow recovery of the gas storage market, and no significant changes in prevailing legislative and regulatory policies or outcomes. With that, I will turn it back over to Gregg for his concluding remarks. Gregg Kantor Thanks, Greg. At this point in the year, our focus is two-fold. First, we will be moving toward a decision on our open environmental compliance proceedings. And at the same time, we will continue to work necessary to advance our growth initiatives. As you know, in the first quarter, we received the Commission’s decision on our environmental cost recovery mechanism and the application of an earnings test to environmental expenditures. As part of the decision, the OPUC required a compliance filing that describes how we would implement their order. We submitted a revised compliance filing at the end of September and we’re currently working through the review process with OPUC staff and other parties. We believe the two main issues in question are whether the company is required to forego recovery of interest on the original regulatory disallowance and on how certain costs are allocated between Oregon and Washington. The filing will be subject to final commission approval which we expect early in 2016. On our growth initiatives, we’ve been working with the Oregon Commission and parties on a Carbon Solutions Program under Oregon’s greenhouse gas reduction legislation. As we’ve discussed before, Senate Bill 844 allows the OPUC to incent natural gas utilities to undertake projects that will reduce greenhouse gas emissions. Our first proposal was submitted in June and is designed to further the use of combined heat and power in Oregon, a goal that the state has had for a number of years. Under our CHP proposal, industrial and commercial customers in the market could submit CHP projects for consideration. In our view, this is an important effort that could provide a significant carbon reduction benefit for our customers and for Oregon. The OPUC has set a schedule for review of our CHP filing that calls for a decision early in 2016. And we’re currently working with parties on a number of items including the proper level of incentives and how to measure the carbon emissions. Now let me give you a quick update on the potential expansion projects at our underground storage facility in Mist, Oregon. As you know, last December, we received approval from Portland General Electric to move forward with the permitting and land acquisition work required for the expansion project. The project would require no notice storage services to PGE’s — I’m sorry to provide no notice storage service to PGE’s natural gas fired generating plants at Fort Westwood. It would include a new reservoir, providing up to 25 billion cubic feet of available storage, an additional compressor station, and a new pipeline. In April, we submitted an application to the Oregon Energy Facility Siting Council for an amendment to our existing Mist site certificate, a step required to support the expansion. And in early October, we held a public open house with the local community near the expansion site and received positive feedback from attendees. The next step in the process will occur when the Department of Energy and Siting Council publish a proposed order later this year. Between now and the issuance of that proposed order, we will continue to work with both organizations to address any questions about our filing. And our team also continues to work on obtaining other required permits and property rights. Assuming successful and timely completion of those items, the current estimated cost of the expansion is approximately $125 million with a potential in-service date in the 2018/2019 winter season, again depending on the permitting process and the construction schedule. I will end my comments today by noting that in quarter, our Board approved a dividend increase making this the 60th consecutive year of increasing dividends paid. It is a record of which we are very proud. And with that thanks for joining us this morning and now I will open it up for questions. Question-and-Answer Session Operator We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Spencer Joyce of Hilliard Lyons. Please go ahead. Spencer Joyce Hi good morning guys. Great quarter here. Gregg Kantor Thank you. Thank you, good morning Spencer. Spencer Joyce Just a couple of real quick ones from me. First want to go back and talk about the $13 million of environmental cost that we’re going to be able to start recovering in Oregon, I guess beginning just a couple of days ago on November 1. I guess first question is this going to be strictly a cash flow statement item or will we see this flow also through the income statement part one there. And then part two, I guess this recovery subject to a final review. Are we pretty comfortable with the $13 million or can you kind of put odds on the likelihood we see some change to that number? Greg Hazelton Spencer, this is Greg Hazelton. I will take those questions in order. First of all the recovery of the $13 million, we will see an increase in revenue for that amount and you’ll see an offsetting increase in expense or amortization. As we have reported as an operating expense as we amortize the deferred balance. So the net-net would be it will be a positive cash flow perspective but net zero from an income or net income perspective. Spencer Joyce Okay, perfect. That’s what somewhat what I assume there. Greg Hazelton Sure. Now we’re collecting the $13 million which has been authorized this is not something that’s subject to refund, this is something that we’re collecting amortizing those balances any adjustments to collections on a — of deferred balances would be done on a perspective basis as we go through each calendar year. Gregg Kantor And once it gets put into the PGA, we’re collecting it has — those are dollars that have been approved for collection by the commission and there is no second look at it, right. Spencer Joyce Okay, perfect. I guess totally separately jumping up to the O&M lines, a real nice quarter here sounds like you’ve got a couple of cost tailwinds there. I would expect some of those to perhaps show up in Q4 and may be into early next year as well any color there, I know it’s somewhat baked into guidance. But I know previous quarters, we have talked a little bit about some increased cost or maintenance cost or some of the storage facilities, it seems like that may be unwinding a bit, but just any additional color to help us model that O&M over the next few quarters? Greg Hazelton Yes I think may be a couple of things would be helpful here. Gill Ranch, we had about $1.8 million recorded last year on the storage segment which increased Gill Ranch’s O&M which we wouldn’t expect to be repeated this year or something that would be recurring. As we think about O&M or generally, we have implemented cost controls to try to offset some of the impact for weather and the write-off, frankly coming off ’14, which was actually a pretty, we had a pretty low level of O&M expense that year based on FTEs and so forth. So we’re coming off a pretty low base. From a budgeting perspective, we actually expect it to be up fairly significantly year-over-year in the 7% area. In fact that we’ve held it to relatively close to flat year-over-year is acknowledgement of the effort that we’ve taken this year which are probably not sustainable next year. At some point, we have to have — we have to adjust staffing, we have to reflect increases in cost that are baked into third-party expenditures and other things. So I would say if you look at our — if you look year-over-year, if you think our O&M of $121 million which is reported year-to-date and we adjust out of that the about $16 million in write-off, environmental write-off and other adjustments. And then, if we look at some of the baked in increases that we had to offset which included bargaining unit labor increases and compensation increases. Again we’ve kept that flat relative to last year. So that in total that gets you somewhere in the $4 million plus area in terms of savings that we’ve been able to achieve which are baked into our forecast numbers. Spencer Joyce Okay, perfect, great color there. That’s all I had. Thanks guys. Operator [Operator Instructions]. Gregg Kantor Okay, doesn’t seem to be any additional questions. I want to end by thanking you all again for joining us this morning and for your interest in our company. We appreciate it. Take care. Greg Hazelton Thank you. Operator The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com . Thank you!