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Abengoa Yield’s (ABY) CEO Javier Garoz Discusses Q2 2015 Results – Earnings Call Transcript

Abengoa Yield plc (NASDAQ: ABY ) Q2 2015 Earnings Conference Call July 30, 2015 08:30 ET Executives Javier Garoz – Chief Executive Officer Eduard Soler – Executive Financial Officer and Chief Operations Officer Analysts Andrew Hughes – Bank of America Merrill Lynch Stephen Byrd – Morgan Stanley Andy Gupta – HITE Hedge Michael Morosi – Avondale Partners John Quealy – Canaccord Chris Malone – Palmerston Capital Javier Garoz Good morning and thank you for joining us in our Second Quarter Earnings Conference Call. Please proceed to Page 3. I will start with an overview of what has been achieved since our last call. It has been a quarter of solid execution and continuous growth. Regarding our solid execution, overall, we have reached strong levels of EBITDA and CAFD for the period. Our portfolio of assets has performed according to expectations. I am glad to announce the Board of Directors have approved a dividend of $0.40 per share meaning an 18% above the guidance of $0.34 we have provided for the second quarter. Thus, we are anticipating part of the $1.6 per share of dividend promise for 2015. In terms of executing previously announced transactions, we have closed the acquisition of all the assets, included in ROFO 3, which are Helios, Solnovas, the pending stake of Helioenergy and Kaxu. In addition, as per our commitments last fall, we have obtained the credit ratings from S&P and Moody’s, which have resulted in BB+ and Ba3 respectively. In relation to our ability to deliver continuous equity of growth, a few days ago we announced our fourth asset acquisition for a total price of approximately $370 million, generating $31 million of incremental CAFD before any related financial expenses. Firstly, the acquisition comprises the dropdown from Abengoa of Solaben 1 and 6. Two solar assets, very similar to the ones we already own. Secondly, after the project economics have improved significantly, we have closed the acquisition of Abengoa’s stake in ATN2, plus the stake of our financial investor, owning now 100% of this transmission line in Peru. And ultimately, we have reached an agreement to acquire a 13% of the stake owned by the Japanese firm, JGC in our asset Solacor, where we already own a 74%. These two last acquisitions are the first proof of a third-party acquisition. We expect to finance the three assets with the proceeds of the recently expanded revolving credit facility already signed with a syndicate of banks and cash on hand. We will continue pursuing third-party acquisitions through the end of the year within the target segments and geographies. Moving to Page #6, we will now review the quarterly results. In the first half of the year, our revenues and further adjusted EBITDA have reached $309 million and $265 million respectively, so a very significant growth in the range of 80% to 90% with respect to the same period of the previous year. In the six months period, we have also been able to generate $83 million of cash available for distribution. On Slide 7, you can see our revenues and further adjusted EBITDA breakdown by geography and business segment showing a strong performance across businesses and geographies quarter-after-quarter. We have experienced a very significant growth across all geographies, very much in line with our expectations. Looking at the results by business sector, in the renewable segment, we have had a very high growth, mainly driven by the assets we have acquired since our IPO and the entry into operations of Mojave. In the conventional segments, ACT in Mexico continues delivering excellent results. In the transmission segment, results have also been as expected. Moving to the next Slide #8, these results have been achieved due to a good operating performance of our overall portfolio. Within renewables, it is worth mentioning that Mojave has been reaching production levels well above 90% of its performance model, which reflects the production of what a fully optimized plant produces. This is an excellent result for a plant that has been in operation only since December and is now going through its first summer. Solana is also performing in line with its target having reached record daily productions above 4 gigawatt hour per day. Solar assets in Spain have been producing well above its target levels, with good radiation conditions throughout the period. On the other hand, wind assets in Uruguay have experienced a weak wind resource, particularly during the first quarter of the year. Similarly to what has happened in other areas of the Americas, but given it’s a small weight in the portfolio this did not have meaningful impact on us. Regarding our ability-based assets availability-based assets, which provide resilience to our portfolio. Performance has also been very solid. ACT our conventional power plant in Mexico continues showing excellent operating results. Our transmission assets have also show high availability numbers and the water assets have achieved availability levels in line with targets. I turn now to Eduard who will continue with our main financial figures. Eduard Soler Thank you, Javier. Going to Slide #9, regarding our cash flow generation, you consider we have achieved operating cash flow of around $79 million in the first half of the year and this is after deducting $151 million of interest payment, which includes a full semi-annual interest payment for the assets recently acquired. Our investing cash flow of $572 million corresponds mainly to the acquisitions completed during the period and the financing cash flow of $675 million corresponds mainly to the capital increase that we closed in May 2014 to finance those acquisitions. If we move to the next slide, regarding our financial position, we closed the first half of 2015 with around $155 million of cash at holdings level with a net corporate debt position of approximately $222 million corresponding to the Tranche A of our banking credit facility and to the 2019 bonds issuance. As Javier mentioned in the initial overview, we have increased our bank rate facility with a new Tranche B of up to $290 million to be used as a revolving credit facility to finance acquisitions. The numbers, as of June 2015 obviously do not reflect any amount of this Tranche B as it remained fully undrawn. We did levels of corporate leverage on considering our run rate CAFD before corporate interest, our corporate leverage is around 1.3 times, well below our target sailing of three times. If I move to the next slide, Slide 11, what you see there is net debt bridge where we show that our consolidated net debt position has gone from $3.8 billion to close to $5.1 million in December mainly driven by the acquisitions we have completed during the period. All the assets we have acquired come with its project finance in place. As a result, our project debt has increased by a total amount of close to $1.3 billion. It is worth noting that our corporate debt position has not increased during this period as we have financed our largest acquisitions with equity. And if we move to the Slide 12, as Javier also mentioned in the initial overview where you can see that the Board of Directors has approved a dividend of $0.40 per share for the second quarter, which is 18% above the initial guidance of $0.34 that we had provided for this second quarter. This way we are anticipating part of the $1.6 per share of dividend we have promised for the full year 2015. Javier Garoz Thank you, Eduard. We move now to Slide 14. In relation to acquisitions, we are going to start with an update on previously announced acquisitions. Specifically regarding ROFO 2, as you might recall, we have closed the drop down of Abengoa’s stake in Honaine and Skikda, two desalination plants in the north of Africa and the first 30% of Helioenergy. These three assets generate $9.4 million of cash available for distribution before acquisition financing, which represents an acquisition deal of around 10%. In addition, we have completed the acquisition of ATN2 as part of a much larger transaction we announced last Monday. The terms of this asset acquisition have changed with respect to what we announced in February. As revenue generation for the period has improved after the renegotiation with the off-taker and due to the acquisition of the stake in the project of our financial investor called Sigma, which was not previously part of the perimeter of this transaction. Regarding the dropdown of the 20% stake that Abengoa owns in Shams, the solar plant in Abu Dhabi, we have not secured all the necessary wavers at this point. Consequently, we have decided to put this acquisition on hold and considering it’s a small size, it has no impact on the guidance provided at all. Moving to the next slide regarding ROFO 3, all the assets part of a third drop-down from Abengoa have been already acquired. The remaining 70% is taking Helioenergy, the solar plants Helios and Solnovas and Kaxu in South Africa. This transaction has been closed at an acquisition deal of 9.4%. The CAFD generated by the euro denominated assets is hedged for five years by the currency swap at agreement signed with Abengoa that lock in CAFD at the exchange rate of the moment when we close the acquisition. This swap also covers all the euro-denominated assets in our portfolio. The acquisition of this group of assets has been financed as you all know with the proceeds of a capital increase closed in May. Going to the Slide #16, as mentioned earlier and continuing delivering on growth, we announced on Monday our fourth acquisition, which includes for the first time two acquisitions from third parties other than Abengoa. This fourth acquisition consist of, Abengoa’s stake in Solana 1 and Solana 6, a 100 megawatt solar complex collocated with Solana 2 and Solana 3 plants already owned by us what will generate important synergies in operation. The 100% of ATN2, I already mentioned, which is a transaction that is larger and more attractive than initially announced due to two main reasons. Higher revenues negotiated with the client and the acquisition of the stake owned by Sigma, our financial investor in the project, which was not originally foreseen. And finally, the agreement to buy an additional 13% stake in Solacor 1 and Solacor 2 from a Japanese firm JGC, where as you may recall we currently own 74%. Total consideration for these acquisitions will be $370 million, generating a run rate CAFD of $31.4 million, before acquisition financing expenses representing an acquisition deal of 8.3%. CAFD from Solaben 1 and Solaben 6 will also be covered by the currency swap agreements signed with Abengoa. We will fully finance this acquisition with our revolving credit facility, recently expanded, plus cash on hand. Then, when market conditions might be favorable, we will refinance the revolving credit facility most probably with long-term debt. It is clear that at current share prices we will not raise equity. We will update our 2016 dividend per share guidance as a result of this acquisition later in the year once we have closed the long-term financing to repay the revolving credit facility. Going to a Slide #17, with this fourth acquisition since our IPO, we have acquired $1.5 billion worth of equity in assets, mostly from Abengoa. Increasing our run rate CAFD before corporate interest by 85%, up to close to $290 million. Our acquisitions have been agreed at an average acquisition deal before the impact of any leverage of around 9%, which we consider is above industry average. In addition, we have performed all the acquisitions in industries and geographies where we have extensive experience over many years of operations and business. We continue growing being loyal to our DNA, disclosed at the IPO, counting with long-term contracts with credit worthy customers and a portfolio mostly denominated in dollars, having always project finance with non-recourse to the corporate level to isolate risk, while having a conservative leverage policy at a corporate level. All these together with the fact that we don’t have IDRs in our structure, positions ABY to continue delivering accretive growth to our shareholders as we become a larger company. In Slide 18, you can see an update of our pipeline of assets coming from Abengoa’s portfolio. As we acquire assets Abengoa has incorporated new assets under development that are all under our ROFO agreement and will be candidates for acquisitions, when they reach operation date. Since our last earning call, Abengoa has publicly disclosed that it has won new conventional power plant in Mexico and a transmission line in the United States. Sustaining the $350 million of cash available for distribution, that will be available for dropdown in the future. Going to our guidance in Page 20, today we reaffirm our guidance of $1.6 per share for 2015 and $2.10, $2.15 per share for 2016, what provides 30% growth year-over-year. This guidance will be updated after securing long-term financing for ROFO 4. Based on the visibility we have of the current pipeline of assets under operation construction or development by Abengoa, we also reaffirm our DPS growth target for 12% to 15% after 2016. We feel comfortable with what we consider a very conservative target and expect overachieving it in the future as we have done since the IPO. We will move now to Slide #21. And to finish this earnings call, I share with you a few remarkable points that makes Abengoa Yield notoriously different in this market and in my opinion a very attractive investment opportunity. First, positive economic results and cash flows have already been proved, over-delivering since the IPO. The strong performance of all our assets is the result of many years of expertise and a very committed team. Second, our existing portfolio will continue delivering strong cash flows in the future what provides Abengoa Yield with a very solid underlying value well above current stock prices. This fact makes Abengoa Yield a very attractive investment at this point in time. Third, in addition, the geographical diversification into countries with good track record of economic growth and political stability together with the nature of our contracted assets plays in our favor, contributing to the resilience of our business. Fourth, the number of ROFO assets brings significant visibility on growth, making cash flow generation highly predictable without the need to compete aggressively in the market and thus reducing the risk of overpaying for assets. Fifth, we have been strengthening our portfolio with continues dropdowns from Abengoa at a solid 9% acquisition deal above industry average. Six, driving with high beams into the future for the clear benefit of our shareholders, we have set a conservative policy around leverage with non-recourse debt at the project level and a moderate corporate leverage below three times cash available for distribution. With all these, I conclude the presentation of our second quarter results and leave the call open for questions. Let me suggest to make one concrete question at a time to facilitate adequate answers on our side. Thank you so much for your attention. And operator, we are ready for the Q&A. Question-and-Answer Session Operator The Q&A session starts now. [Operator Instructions] Our first question comes from the line of Andrew Hughes from Bank of America Merrill Lynch. Please go ahead. Andrew Hughes Good morning guys. Thanks for the question. Curious you mentioned looking potentially at third party acquisitions for the rest of the year, wondering what pro forma liquidity position is to go out and tackle that and how you would think about financing additional acquisitions going forward if there are some third parties? Javier Garoz Okay, thank you for your question. Well, at this point we are just exploring different market opportunities in line with our geographies and business segments. There is nothing to be close in the following weeks and therefore we don’t need additional liquidity, what we have today to conclude the acquisitions that we have announced. So, by the time, we could have any tangible acquisition to be closed, we would record again to the market to get the right financing or if we have already refinanced on the long-term basis, the acquisition of Solaben 1 and 6, we will come with the flexibility that the revolving credit facility allow us in terms of the capital in the acquisition on the financing timing in the market. Andrew Hughes Great, thank you. And then just a clarification on ROFO 2, the $9.4 million in incremental cash flow, that does not include contributions from ATN2, right, because that’s now included in ROFO 4? Javier Garoz No, exactly. The number has been done with the remaining assets on the ROFO 2 and ATN2 has been included in ROFO 4. Andrew Hughes Great. And then just one last one, in terms of Shams and the waiver issue there, is that a complication between you and Abengoa or something to do with the asset in particular? And just noticing the return profile over the last three acquisitions ROFO 2, 3, and 4 has compressed as your cost of capital has not necessarily declined, so thoughts there and if that’s anything to be concerned about in terms of relationship with Abengoa? Javier Garoz No, it’s not because of Abengoa, neither because of the asset, it’s just the shareholders, the other shareholders, which are not willing to, let’s say move on and facilitate this acquisition. That’s it. Eduard Soler Next question? Operator Our next question comes from the line of Stephen Byrd from Morgan Stanley. Please go ahead. Stephen Byrd Good morning. Good afternoon. I wanted to just make sure that I understood the leverage position from here in terms of your targeted debt level? And this is following up on the last question, in terms of additional acquisitions, how should we think about additional leverage versus equity? Would you imagine for future acquisitions that it would be a mixture of debt and equity or do you feel that even for future acquisitions even after the ones that you announced, that’s all debt – do you think you could potentially finance one or two additional acquisitions all with debt or how should we think about cap structure for future acquisitions from here? Eduard Soler Yes. With the existing leverage that we have, which is very [indiscernible] and you know that our target is go up to three. So, we thought with just that we could raise $500 million of debt easily without further acquisitions. And obviously that’s more than enough to refinance the proceeds that the price that we will pay now for the assets of the fourth dropdown. So, we will have plenty of space with our existing portfolio, pro forma of the fourth drop down to raise even more debt to do acquisitions and obviously when you do acquisitions that one brings extra CAFD that you can de-lever. So, on top of that, we have – we will have the revolving credit facility. So, to your question, yes, we could finance further acquisitions only with that obviously in the long-term like any of the yieldcos we will balance both debt and equity as we execute our growth plan. Stephen Byrd Understood. And then just on the returns on the dropdowns, we have seen a trend down someone in returns, so I do take your point that on average your yields on dropdowns have been above the industry average. Can you just talk about the rationale for the targeted yield that you have had on recent acquisitions given it’s a challenging environment in terms of the implied cost of capital for yieldcos overall? How do you think about that appropriate dropdown sort of in the future? Should we expect this trend downwards to continue or will it be really case-by-case depending on the asset? How should we think about that? Javier Garoz Well, we feel comfortable with an average 9% deal in our portfolio. Of course, it’s a case-by-case and it will depend on market situation. It is clear that we will always do a treaty of acquisitions and therefore there must be on a spread between the acquisition deals and the cost of financing would be equity or would be or would be a debt. And it is clear also that for example at current levels of the share price, we will not do any capital increase. And as Eduard was saying before, we will record to any kind of debt at the right time and when the market might be up a bit for that. So, I think at this point in time, we feel comfortable with the average yield that we are having throughout all the acquisitions we have done. Stephen Byrd Understood. That makes sense. And just last question, just on the relationship with the parent, there certainly in some investor questions about the financial strength of the parent. In the event of financial distress at the parent, can you remind us of how from Abengoa Yield shareholder point of view we should think about protection and certainty that these assets that are eligible will in fact be sold to Abengoa Yield? Javier Garoz Well, first of all, I am not really familiar with exactly what’s going on with Abengoa. So, I don’t want to extend much on that. And with regards to the hypothetical situation of our financial distress, I think we should keep in mind different considerations. First of all, the assets under construction right now, they are mostly financed through the warehouse. They have set with another financial investor, APW1. So, I foresee that somehow the financing for those projects is somehow secure and available for them to get to a final conclusion. Then in the situation in which Abengoa minor continue providing the operation and maintenance service for our assets, we can always record to the market, find for someone else doing that or takeover the operations directly. And keep in mind that we have strong cash flows coming from 20 assets in our portfolio, which has pretty strong underlying value and therefore our growth might be slightly impact, I say slightly because we always can record to the market for third-party acquisitions, but I don’t foresee any major inconvenience or stress for the ABY shareholders. Stephen Byrd That’s great. Thank you very much. Javier Garoz Thank you. Operator [Operator Instructions] Our next question comes from the line of Andy Gupta from HITE Hedge. Please go ahead. Andy Gupta Hi. Good afternoon, guys and congratulations on the quarter. I just wanted to walkthrough a quick math with you. I am trying to understand the $1.60 guidance. Based on your CAFD for the first half of $83 million and I assume that will continue the second half. I get a total of $1.66 and then if I add the additional ROFO 3 and 4 that you have announced that’s another 45 and I subtract additional interest expense, I get about 207 of CAFD and if I apply a 90% payout ratio, I get to about a $1.82 for dividends. So, one I wanted to see if ballpark this is right and second why maintain $1.60 after having increased your second quarter distribution? Eduard Soler The $1.60 per share guidance implies a CAFD for the year of $178 million or $180 million, okay. So, we are very well on track to reach that. But, you know that summer is a very important season in our business and before increasing our commitment to the market, we want to make sure that the thing works out properly. And we will go through the summer season with results similar to the ones who have been delivering up until now. So, we will delay the seasonal and potential increase of the $1.6 for later in the year. Andy Gupta That makes sense, Eduard. What about – what could impact your summer? Is it above or below long-term average on the solar? Is that what is a sticking point here? Eduard Soler Yes. We don’t expect any impact at all at this point, but just we prefer to be conservative and go through the summer. You know there is a peak in solar generation in summer time and therefore we want to see how all the assets are performing, how do we get closer to the end of the year, so that’s why we want to be conservative at this point. Andy Gupta I understand. And the impact for Shams is about $2 million in EBITDA for the full year, is that about right? I know it was a very small amount. Eduard Soler On EBITDA, is actually zero because it was an – we will not, it’s a 20%, so you don’t consolidate that stake in any case. In CAFD, it’s a very small impact, more than compensated by the better ATN2 that we just closed. Andy Gupta Understood. And one last thing is I just want to confirm again on our previous answer that you could raise based on the financing, after financing of this acquisition for, you still have capacity to raise another $500 million of debt to fund further acquisitions and still be within your leverage levels? Eduard Soler If you do the quick math, you know that we are close to $290 million of CAFD debt service, once accounted for this transaction and our target level of leverage is to be below 3. So if you do the math that means that we could raise $500 million counting on this portfolio and respecting our policy. We need much less to execute these transactions in order to refinance the dropdown – sorry the revolving credit facility we will use for the dropdown and then of course we would do an acquisition with that money. And that acquisition would bring extra CAFD that could be levered three times. Andy Gupta Got it. Well, thank you again. Javier Garoz Thank you, Andy. Operator Our next question comes from the line of Michael Morosi from Avondale Partners. Please go ahead. Michael Morosi Hi, thanks for taking my question. First off, one of the pushback that I have received from investors has related to the performance of concentrating solar projects. So, maybe if you could just speak about how your assets have performed over the quarter and what you guys are doing operationally to maintain a high level of output? Javier Garoz Okay. Well, of course, CSP is much more difficult to manage than PV, that’s quite obvious, nothing new under the sun. Having said that, we have been operating CSP plants for the last 15 years, especially with parabolic trough, which we consider is very consolidated technology in the market, not only owned by our sponsor Abengoa, but also by other participants and competitors in this market. So, it is true that it is more difficult, but it doesn’t mean it’s an impossible mission. So, going through the summer time, our assets are performing pretty good at this point. Radiation has been higher in some parts than expected. And therefore, our European assets are above 100% of the expectation. When looking at the assets in the United States, I think as I mentioned before, we are pretty comfortable with the ramp up of Mojave, which has achieved about 95% performance over the last two months, which is pretty good. And Solana is starting to generate up to record levels of, as I said before, 4 gigawatt hour of production in the last days. So, I think in general, all our CSP portfolio is performing even above expectations. Michael Morosi Okay, thank you. And then as it relates to your third-party acquisition strategy and just looking at the evolution of your portfolio as you progressed through the ROFOs, it seems like conventional assets and transmission assets are going to take a larger percentage of your overall CAFD and portfolio. So, I would just like to see how that will in turn influence maybe the assets that you pursue in terms of the M&A and the different markets and the different segments that you are pursuing and what that could mean for – for transaction yields? Javier Garoz Well, I am not sure if viewers anticipating there will be a much higher weight of conventional generation and transmission line in our portfolio. It will depend on what speed Abengoa is dropping down those assets after completion and it is true that we are trying to find synergetic assets, which might be adjacent transmission lines to the ones we already own in Chile or Peru or any other type of generation assets that might generate some kind of synergy cost benefit or similar when operating with our existing assets. So it’s not easy. We feel we are not forced to do acquisitions at any price and we feel comfortable that we can deliver the growth and the DPS we promise with the existing portfolio and therefore we will be cautious when acquiring assets. We are looking at right now different alternatives in South and North America. Some other parts of Europe might be a target, not clear, because they have to be mostly in U.S. dollars. And there would be other opportunities in other markets in Africa as well, but it’s still unclear. Michael Morosi Alright. Thanks for the questions. Great quarter. Javier Garoz Thank you. Operator Our next question comes from the line of John Quealy from Canaccord. Please go ahead. John Quealy Hey, good afternoon folks. So, in terms of your plans and the Abengoa’s plans to dropdown assets, given some of the liquidity concerns that debtholders have had over that stock recently, what’s the likelihood that you could accelerate ROFOs, Javier, in the next couple of years and just if you walk us through some scenarios there? Thanks. Javier Garoz Well, I would like to accelerate ROFOs, but I don’t think it’s going to be up to us just exclusively, John. So, it will be mostly dependent on Abengoa and the speed at which they can execute the completion of the projects. From what it refers to our capability to acquire, of course it’s going to depend on how the stock is trading, of course, at the current prices is going to be difficult to make any capital increase and to do accretive acquisitions and how open the debt markets are going to be. So, I think it will depend mostly on the market to get the financing for acquiring the ROFO – sorry, the ROFO assets, but mostly it will depend on Abengoa to speed up the execution of those assets. John Quealy Alright, great. Thanks, folks. Javier Garoz Thank you, John. Operator Our next question comes from the line of Andrew Hughes from Bank of America Merrill Lynch. I am sorry. Our next question comes from the line of Chris Malone from Palmerston Capital. Please go ahead sir. Chris Malone Good morning guys. I was just wondering if you could give us some detail on the fees in relation to the service agreement on the Spanish assets in ROFO 3 and 4 given that we have so many Spanish assets now? Hello? Did you get that? Javier Garoz Yes, Chris. Yes. Chris Malone Okay, thanks. Javier Garoz We got it. Well, we got a service support agreement with Abengoa, because some let’s say commodity activities, let me call, are subcontracted to Abengoa and this is why we are paying a service report fee to Abengoa. I am talking about accounting and some kind of tax support and things like that, but apart from that, I am not aware of any other additional fee. I don’t know if you have something specific? Chris Malone No, no. Just I noticed at the time of the IPO that the service fees is payable to Abengoa on the non-Spanish assets is 1% and for the Spanish assets it was 2.5%. And specifically related to the assets that we are in ROFO 3, in your 6-K filing, it seems like there was a 15% of revenue fee paid to Abengoa. I was just wondering is that part of the old regime that’s going to be re-struck at a new level, just trying to get a sense from what… Eduard Soler Each asset is different in that regard. And you are correct some assets pay 1%, some of the initial Spanish assets that we had in our portfolio were paying closer to 2%, but that’s different in adjusted earnings. And in the new ones, it tends to be in the lower side. Chris Malone I am sorry, I missed that last bit it tends to be what? Sorry. Eduard Soler In the low side of that range. Chris Malone Okay, of the 1 to 2, great. Thanks very much. And maybe just one more question, the revolver that’s recently been upsized, is there a clean down provision in that? Eduard Soler You mean a period after where we could not redraw again only if after paying it down? Chris Malone Once annually, where you have to train it down, pay it off and before you can redraw it okay, right. Eduard Soler No, no. When we repay, we need to wait, I think its 10 business days to redraw again, but it’s a very minor thing. Chris Malone Okay. And maybe, if you don’t mind, one last one, the third-party transactions that you have just done, where they executed in relation to any tag along rights or put called structures or would you just go in unsolicited, okay? Javier Garoz No, it was an unsolicited proposal. Chris Malone Okay. Javier Garoz They affected and we closed the deal. Chris Malone Great, okay. Thanks very much. Javier Garoz Thank you, Chris. Operator Our current last question comes from the line of Andrew Hughes from Bank of America Merrill Lynch. Please go ahead. Andrew Hughes Hi, team. I just had a quick follow-up on one of the earlier questions about scenarios of consent financial distress at the parent and how that might impact their ability to complete projects going forward. If I look on Slide 18 and the list of sort of your replenished ROFO opportunity set, can you give us a sense for what in the 2016 to 2020 timeframe for assets coming online? What is being built within the warehouse, what is not? So, just we have a sense of what assets are sort of not sensitive to true financial distress at the parent. Thanks. Javier Garoz Yes. Well, I would love being able to answer that, but I think this is more a question for Abengoa I guess, because you are asking, which of those are part of the APW 1 or which ones will be part of any other warehouse that might be working on right now and this is an answer of that regretfully we don’t have. Andrew Hughes Alright, understood. Thanks. Javier Garoz Thank you. Operator [Operator Instructions] There are no further questions at this time. There are no further questions. Javier Garoz Thank you very much to everyone for the attention. And I will be looking forward to see you within three months.

Xcel Energy (XEL) Benjamin G. S. Fowke on Q2 2015 Results – Earnings Call Transcript

Xcel Energy, Inc. (NYSE: XEL ) Q2 2015 Earnings Call July 30, 2015 10:00 am ET Executives Paul A. Johnson – Vice President-Investor Relations Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Teresa S. Madden – Chief Financial Officer & Executive Vice President Analysts Michael Weinstein – UBS Securities LLC Travis Miller – Morningstar Research Paul T. Ridzon – KeyBanc Capital Markets, Inc. Anthony C. Crowdell – Jefferies LLC David A. Paz – Wolfe Research LLC Feliks Kerman – Visium Asset Management Operator Good day and welcome to the Xcel Energy’s Second Quarter 2015 Earnings Company Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Paul Johnson, Vice President of Investor Relations. Please go ahead. Paul A. Johnson – Vice President-Investor Relations Good morning, and welcome to Xcel Energy’s 2015 second quarter earnings release conference call. Joining me today are Ben Fowke, Chairman, President and Chief Executive Officer; and Teresa Madden, Executive Vice President and Chief Financial Officer. In addition, we have other members of the management team in the room to answer your questions. This morning, we will update you on recent legislative, regulatory, and business developments, review our 2015 second quarter results, and reaffirm our 2015 earnings guidance range. Slides that accompany today’s call are available on our webpage. Please note we have updated our slides to provide more information. In addition, we will post a video on our website of Teresa summarizing our financial results. As a reminder, some of the comments during today’s conference call may contain forward-looking information. Significant factors that could cause results to differ from those anticipated are described in our earnings release and our filings with the SEC. I will now turn the call over to Ben. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Thank you, Paul and good morning. Today I’m going to provide a business update and discuss our recent legislative efforts in Minnesota and Texas. Later, Teresa will provide more detail on some of our recent regulatory decisions and financial drivers. We reported $0.39 for the quarter, flat with last year. Overall, we’ve had a solid first half of 2015, with results generally in line with our expectations. While we’ve had some challenges from lower than expected sales, unfavorable weather and additional adjustments from the Monticello proceeding, we fully expect to deliver 2015 ongoing earnings within our guidance range of $2 to $2.15 per share. I want to start by saying how pleased I am with the company’s response to recent storms across our Minnesota and Wisconsin service territories. Two weekends ago, intense winds with speeds between 70 to 80 miles per hour knocked out service for 250,000 customers. Our employees in the field responded quickly and effectively, restoring 75% of our customers within 12 hours and 98% within 45 hours. All of our customers were restored to power within three days. This event is yet another reminder of the company’s top-tier storm restoration efforts and illustrates the value of building a resilient system. We also hit several additional operational milestones during the quarter that I wanted to share with you. Beginning with our Monticello nuclear facility, we are very happy to report that this month we received NRC concurrence and reached 671 megawatts of generation. The facility is now fully in service, operating at designed capacity and meets all the requirements of the Minnesota commission to be considered used and useful. Finally, our Cherokee combined-cycle natural gas plant in Colorado successfully completed its first fire on gas and is on time and on budget. Last year we spoke to you about our refocused strategic plan with a key tenet being improving the performance of our utilities and reducing the ROE gap. Our approach was to target the jurisdiction where the gap was the greatest and seek legislation in those states to improve the timeliness and method of cost recovery. Beginning with Minnesota, last month the Governor signed into law a bill that contained several notable enhancements to the regulatory framework. The legislation expands the length of multi-year plans to up to five years, allows for a more formulaic approach to recovering capital investments, provides for the recovery of O&M expense based on an industry index, and allows rider recovery of distribution costs that facilitate grid monetization. We’re now considering how to include these improved mechanisms in our Minnesota rate case filing scheduled for later this year. In Texas, we, along with several other non-ERCOT utilities sponsored legislation that will reduce regulatory lag and provides for improved inclusion of post test year capital additions, more timely implementation of new rates, and greater flexibility and more timely recovery of new natural gas plant investments. The Governor signed the bill last month and while this does not eliminate all regulatory lag in Texas, it does represent an important incremental step towards improvement. We feel the legislation in both Minnesota and Texas strengthens the regulatory compact, helps to close the ROE gap and enhances our ability to meet our long-term earning growth objectives. Moving to Colorado, we anticipate that the Colorado Commission will be scheduling informational meetings to examine the long-term supply of natural gas and approaches to managing prices, including the rate basing of natural gas reserves. We continue to see the value of these types of investments for our customers, particularly when considering the current low-price commodity environment. After the information meetings are held, we plan to make a regulatory filing before year end that will establish a formal framework that incorporates feedback from the meetings. Following the commission’s decision on a preferred framework, we anticipate filing for the approval of potential investments during the second half of 2016. In Minnesota, we were pleased to see, the Minnesota Commission supported our settlement with smaller solar developers, which limits the size of proposed solar gardens to no more than 5 Megawatts. This important policy settlement ensures that Minnesota has one of the largest community solar gardens in the country rather, but also minimizes the impact of the program on our customers’ bills. Xcel Energy continues to be a major advocate of solar and we view it as an important and growing component of our resource mix. However, we want to ensure that it’s done at the most attractive price point for our customers. A couple of recent studies confirm that utility scale solar is far more cost-effective for consumers than smaller applications and we think it’s important that policy be based on these sound economics. So while solar gardens and rooftop solar have a place in our portfolio as an option for consumers, because they require heavy subsidization from non-participants, you will continue to see us advocate that the primary focus be on utility scale solar so that we can keep energy cost affordable for consumers as we move to cleaner energy sources. So I think we’ve made significant progress during the first half of the year. We look forward to implementing some of these new mechanisms and policies in the coming months. And with that, I’ll turn it over to Teresa. Teresa S. Madden – Chief Financial Officer & Executive Vice President Thanks, Ben and good morning. Today we reported ongoing earnings for the second quarter of $0.39 per share, flat with last year. The most significant drivers in the quarter were improved electric margin, which increased earnings by $0.06 per share, largely due to new rates and higher rider revenue driven by infrastructure investments that provide long-term value to our customers. These incremental revenues were partially offset by unfavorable weather and lower sales. Additionally, offsetting the higher electric margin was increased depreciation, higher property taxes, and lower AFUDC. Each of these items separately had a negative $0.02 per share impact on earnings. Turning to sales, our year-to-date weather-normalized electric sales were down four-tenths of a percent, driven primarily by declines in the residential class, partially offset by modest growth in the C&I class. Regardless, we continue to experience healthy economies in our service territories with an average unemployment rate of 4% compared to a national rate of 5.5%. Our customer additions remain solid at about 1%. The decline in residential sales is driven by lower customer usage. We believe this trend is due to a combination of factors including appliance efficiency, conservation efforts, and an increase in multi-unit dwellings. We have adjusted our annual electric sales guidance to reflect year-to-date results, which lowers our expected growth rate for 2015 to about 0.5%. We will continue to monitor sales and customer usage and will take appropriate management action if we determine this represents a long-term trend. It is important to note that we will be implementing de-coupling for the residential and small C&I class in Minnesota in 2016, which will offset any decline in customer usage trend. Next I will provide an update on several regulatory proceedings. Additional details are included in our earnings release. Earlier this month, we received decisions on several outstanding items under reconsideration in our Minnesota electric rate case and our Monticello prudence proceeding. The Commission allowed NSP Minnesota to recover its 2015 rate increase beginning in early March and determined that the Monticello extended power upgrade investment was not used and useful until certain NRC conditions were met. These conditions were met in early July. While we believe that the Commission should have concluded differently related to the in-service date of the Monticello project, we will review the written order to determine our next steps. In Colorado, last month we received intervenor testimony in our PSCo multi-year natural gas rate case. The staff recommended a rate decrease, while the Office of Consumer Council recommended a modest rate increase. Primary differences between the Company and other parties were driven by ROE, capital structure, and whether to use a historical test year in the establishment of base rates. The positions recommended by the staff in the OTC were consistent with past positions and we remain confident we will reach a constructive outcome in the case. Finally, I wanted to address our rate case in New Mexico. After another utility in the state had its case dismissed, the New Mexico Commission determined our filing also did not comply with their new interpretation of the statute regarding forward test years and the timing of rate case submissions. As a result, the Commission dismissed our case as well. We believe our filing was consistent with the requirements of the New Mexico legislation that allows for a forward test year and have appealed to the State Supreme Court. While the timing of resolution is uncertain, we plan to re-file the case later this year. This morning we are reaffirming our 2015 ongoing earnings guidance range of $2 to $2.15 per share. We are confident in our ability to deliver earnings in our guidance range due to the timing of O&M expenses and revenue recognition from the Minnesota rate case, both of which will provide for a more favorable comparison in the second half of the year. Our guidance range is based on several key assumptions as described in our earnings release. Please note that some of the assumptions have changed. With that, I will wrap up my comments. We are very pleased with the legislation that was passed in Minnesota and Texas during the quarter. The new legislation provides a framework that will allow us to reduce regulatory lag and streamline the regulatory process. As a result, we are confident that we will achieve our goal of reducing the ROE gap by 50 basis points by 2018. Growth projects like the Courtenay Wind Farm are on schedule. We remain on track to limit increases in O&M to 0% to 2% for 2015. The company is well positioned to deliver an attractive total return to our shareholders by growing earnings 4% to 6% annually and our dividend at 5% to 7%. And finally, we are reaffirming our 2015 ongoing earnings guidance range of $2 to $2.15 per share. So operator, we will now take questions. Question-and-Answer Session Operator Thank you. And we’ll take our first question from Michael Weinstein with UBS. Michael Weinstein – UBS Securities LLC Hi, good morning. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Good morning. Teresa S. Madden – Chief Financial Officer & Executive Vice President Good morning. Michael Weinstein – UBS Securities LLC Hi. Considering the legislation in Texas and the legislation in Minnesota and you are now very confident of increasing or reducing the regulatory lag by 50 bps by 2018, just wondering if, at what point would you consider increasing your long-term growth rate commensurate with the improvement in ROEs? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, I think that’s what we are focused on is closing that gap. And if we close that gap by 50 basis points that will get us on the upper end of that – those growth objectives. So you’d have to start to exceed that and see some other things before we would be comfortable doing that Michael. Michael Weinstein – UBS Securities LLC Would you say that would require a, I guess, wait and see after the results of a rate filing in Texas? Is that…? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer We need to implement it. We are working the plan. This is the legislation. While wasn’t essential to close that gap, it’s certainly helpful. And now we need to execute on that and let things play out. Michael Weinstein – UBS Securities LLC Okay. Thank you very much. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer You are welcome. Operator We’ll take our next question from Travis Miller with Morningstar. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Hey, Travis. Travis Miller – Morningstar Research Good morning. Teresa S. Madden – Chief Financial Officer & Executive Vice President Hi, Travis. Travis Miller – Morningstar Research Hi, thanks. On the Minnesota legislation, just wonder if you could lay out maybe a more detailed timeline in terms of – I know it’s obviously one of your lower spreads on – a wider spread between allowed and earned right now. How do you go about closing that, sort of taking advantage of the legislative items? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, you are absolutely right. We have been under-earning in Minnesota. If you are looking at the charts by the way that were attached, keep in mind that that’s a little bit distorted due to some revenue recognition. But you are right; it’s been in the mid-eighths and we need to improve that. Take a look at what we did in Colorado. When you get into a multi-year plan, I think you’ve got a much better shot at closing that ROE gap. You are getting all of your capital recovery; you are getting your O&M potentially recovered and I think Travis, the other thing that I think is so important about entering into these multi-year plans is it gives you an opportunity to communicate more frequently with your commissions around important policy decisions, resource plans decisions, where we want to go with our portfolio generation et cetera. So you don’t get disconnects. And I think if you look at why we’ve under-earned, we’ve had a lot of CapEx going through a funnel. We had to relicense our nuclear plants. We had some challenges there as everyone in the industry did. And we didn’t have a lot of forums to communicate some of those challenges. So it’s not only the mechanisms associated with the legislation in the multi-year plan; it’s kind of what that frees you up to do. And I am optimistic that we will make good progress next year and in the years to come. Travis Miller – Morningstar Research Okay, great. Do you think this is something you could do in one cycle for your multi-year plan or is this closing up the gap, would that take two rate cases or two cycles? Is this something that you can close quickly? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, the multi-year plan, as you know the legislation allows for up to five years and allows a number of other things. The regulatory team is busy right now assessing how we put those tools to work, what alternatives we want to present to the department and ultimately the commission and we’ll figure out – we’ll use the tools that we can and do it in a pragmatic approach. Now, depending on how you structure that, do you get it all in one year? – Not necessarily. But do you get it over the timeframe of the filing? – Yes. That would be the plan. Travis Miller – Morningstar Research Great, thanks so much. Appreciate it. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer You’re welcome. Operator We will take our next question from Paul Ridzon with KeyBanc. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Hi, Paul. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Good morning, Ben. Good morning, Teresa. Have you indicated when you are going to re-file in New Mexico? Teresa S. Madden – Chief Financial Officer & Executive Vice President We have just indicated that we will re-file before the end of the year. Paul T. Ridzon – KeyBanc Capital Markets, Inc. It seems as though the commission has kind of said we want a do-over with PNM. How does that play into the timing? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, I mean – are you talking about the appeal or – I mean right now the commission has taken the rule back and is trying to I guess maybe understand their own interpretation of the rules. So we recognize that there might be some time lag with that, Paul. So we will re-file a case that we think will meet their current interpretation of the rules by year end, so we can get to start it while we are trying to sort through what the future test year rule and legislation really means from a administrative standpoint. Teresa S. Madden – Chief Financial Officer & Executive Vice President Right. I mean, we obviously think that the legislation allows for the forward tester as we had previously interpreted and that’s why we are filed with the Supreme Court in terms of an appeal. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Thank you. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Did I answer your question Paul? Paul T. Ridzon – KeyBanc Capital Markets, Inc. Yes, you did. Thank you. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Okay. Paul T. Ridzon – KeyBanc Capital Markets, Inc. And where – you kind of walked down the growth numbers. Where are you seeing the most weakness? Teresa S. Madden – Chief Financial Officer & Executive Vice President Seeing the most what? Paul T. Ridzon – KeyBanc Capital Markets, Inc. Weakness. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, I mean – and Teresa, jump in here, but it’s really been on the residential side. And we are seeing good growth, Paul; we are seeing about 1% customer growth but what’s happening we believe is you’ve got energy efficiency – some of that we are driving of course. And you have – where we are thinking some of the growth is, is in more multi-unit dwellings which inherently use less electricity. So those two factors combined are putting – or offsetting growth with lower usage per household. Teresa S. Madden – Chief Financial Officer & Executive Vice President Right. I mean, just to supplement that in the multi-units, we think they use about 50% what a standard, stand-alone dwelling or whole module (19:14). So you get the customer growth, but just not at the same pace in terms of adding to our growth. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Have you seen efficiency start to plateau with I guess a lot of the light bulbs already been switched out and a lot of the appliances have been switched out? Where are we in that cycle? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Yes, that’s a really good question, Paul. I mean I think if you look at technology, it’s going to continue to get more efficient. Will the pace of that efficiency slow down? – I don’t know if I have a crisp answer for you at this point. But I wouldn’t think that it’s going to plateau and just level off. I think you’re going to continue to see more efficiencies; you’re going to continue to start to see – as we get to the, ultimately the Internet of Things, even more efficiency. I think we are a few years away from that. But the gas business has been a long-term efficiency cycle and I think we will see that on the electric side. And that’s not necessarily a bad thing. It does mean though, back to the earlier comment that we have to start rethinking rate design and what the 21st century regulatory compact and offerings to our consumers look like. That’s one of the reasons again, why we think it’s so important to have longer-term regulatory compact, so you can have these dialogues with new (20:34) policymakers. Paul T. Ridzon – KeyBanc Capital Markets, Inc. Thank you very much for your time. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Welcome. Operator We’ll take our next question from Anthony Crowdell with Jefferies. Anthony C. Crowdell – Jefferies LLC Hey, good morning. I just wanted to focus on Minnesota. You’re successful at getting a legislation for potentially a five-year deal, but I think previously I think you had the ability to file for three-year deals but I think maybe you filed for two. Is there reluctance on the regulator for granting a longer-term deal? Some states, you see regulators push back on longer-term deals. I wonder what’s your feeling or view of that in Minnesota. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, keep in mind that prior to this legislation, the multi-year compact was not really comprehensive. So when we filed, we were able to file for larger step-in type capital programs. This legislation was passed with input from a lot of important parties, including the Department and certainly the Governor’s office and it was passed and it was supported. That said, I think to your point, this could be transformative, it’s change, and I think our team has to work with the department and make sure that they’re comfortable with the pace of what we are doing. So that’s what we are trying to assess right now. So your question is a good one. I think the policymakers support it. I think there is a number of reasons why the business community would want this and it’s good for our customers and this could be tremendously more efficient than how we process rate cases today. So I am optimistic we are going to use the majority of those tools and come out with something far more comprehensive than we had prior to this legislation. Anthony C. Crowdell – Jefferies LLC And I guess on your next filing you would file, you would attempt to get the full five years? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Well, we’re going to incorporate a number of the tools. We’ll figure out – I mean, I would anticipate that we will look at the five years, figure out how that could be done, but I also anticipate that we’ll present the Commission with different alternatives. The key is, get something comprehensive, make use of the tools, and close that regulatory gap. So that is always the first and foremost in mind. And again, we want something that frees up space to have a timeframe that we can work with the Commission on other important policy decisions. Anthony C. Crowdell – Jefferies LLC Great. Thanks for taking my question. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer You’re welcome. Operator And we will take our next question from David Paz with Wolfe Research. David A. Paz – Wolfe Research LLC Hey, good morning. Teresa S. Madden – Chief Financial Officer & Executive Vice President Hey, David. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Hey, David. David A. Paz – Wolfe Research LLC Just on Minnesota filing, when would you expect a final decision? On the November filing. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer The pending case that we haven’t filed yet? David A. Paz – Wolfe Research LLC Yes. On the November filing. Teresa S. Madden – Chief Financial Officer & Executive Vice President It could take either late in 2016, it could – depending on the schedule, other cases that we know are going to be filed, we could go into 2017. But I think the key thing that’s important is we have interim rates and we are anticipating that those will start just as they always have. I mean, that’s still part of the new compact that we have starting in January 1, 2016. So I think that’s really the key thing to be focused on. David A. Paz – Wolfe Research LLC Great. Okay. And separately, did you update your capital plan for the Courtenay Wind Farm? Teresa S. Madden – Chief Financial Officer & Executive Vice President We haven’t updated it yet; we plan later this year. I mean, we’ll do a more comprehensive update. I mean, we have disclosed the cost is about $300 million and so – again, we’ll do a more comprehensive look later this year. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer And that project’s moving along very well, so… Teresa S. Madden – Chief Financial Officer & Executive Vice President Yes. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer David, we expect that the Commission is going to probably rule on – the Commission in North Dakota and in Minnesota will rule on that in August. Teresa S. Madden – Chief Financial Officer & Executive Vice President Right. David A. Paz – Wolfe Research LLC Okay, great. And then just last, I think your projected rate base growth over the period you’ve outlined is just shy of 5%. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Right. Teresa S. Madden – Chief Financial Officer & Executive Vice President That’s correct. David A. Paz – Wolfe Research LLC And so it looks like Courtenay will be added. Any other potential upside to that growth? I know it’s three stages (25:03), but you guys will do a new look soon. But anything we should think about? I mean you mentioned gas rate base, other type of renewable. Just anything else that we might be missing, particularly as carbon rules get at some point finalized? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer Yes, I mean, we’re going to look at all of those opportunities you mentioned. They are not included in the CapEx forecast right now. Maybe there’s more opportunities for Courtney Wind type projects, the Calpine projects that we have done in the past. We’ve got a great backyard and I think there is a number of opportunities that we think makes sense and are keeping with our low-risk profile that we’re going to pursue. We’re conservative; we’re not going to increase our forecast for things that aren’t – that you can’t touch. But we’re certainly going to go after all the opportunities that makes sense for us. And you hit on a couple of them. David A. Paz – Wolfe Research LLC Okay, great. Thank you. Teresa S. Madden – Chief Financial Officer & Executive Vice President Thanks. Operator We’ll take our next question from Feliks Kerman with Visium Asset Management. Feliks Kerman – Visium Asset Management Hi, thank you. Can you just remind us in which states you’ll have decoupling in, in 2016? Teresa S. Madden – Chief Financial Officer & Executive Vice President We will have it in Minnesota. There is an open docket in Colorado, but it has not been acted on for quite some time. But for sure, we will have it in Minnesota. Feliks Kerman – Visium Asset Management And is there expectation that we will achieve the decoupling in Colorado or no? Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer I would think – we’re under a multi-year plan there, so, no, we don’t anticipate that we’re going to have decoupling during this – the current multi-year plan that we have. That said, as you know that we’ve actually exceeded our authorized return in Colorado. So I think barring some major drop-off, there is no reason to really be concerned in Colorado. Teresa S. Madden – Chief Financial Officer & Executive Vice President I agree. Feliks Kerman – Visium Asset Management Okay. Thank you. Benjamin G. S. Fowke – Chairman, President & Chief Executive Officer You’re welcome. Operator And that does conclude our question-and-answer session. I’d like to turn the call back over to Teresa Madden, Chief Financial Officer, for any additional or closing remarks. Teresa S. Madden – Chief Financial Officer & Executive Vice President Well, thank you all for participating in our earnings call this morning and please contact Paul Johnson and the IR team with any follow-up questions. Thanks again. Paul A. Johnson – Vice President-Investor Relations Thank you, everyone. Operator And this does conclude today’s conference. Thank you for your participation.

Union Pacific: How To Trade Around A Core Position

Summary After researching and developing a clear investment thesis, I designated Union Pacific a “core” equity position. Disciplined trading around core positions permits an investor to harvest gains, then buy back shares during routine over/undervaluation cycles. Here’s a step-by-step “How To Do It” featuring Union Pacific stock; including concepts, specific process, and results. Union Pacific Corp. (NYSE: UNP ) is a core position in my portfolio. Here’s my definition of a core position : An investment security identified as a foundation holding; a position the portfolio owner believes meets fully his/her investment philosophy and objectives. The owner expects the investment thesis to be strong, long-term, and durable. Notably, even if a core position, I own no “buy and hold forever” stocks. I scale in and scale out of equity positions; accumulating shares when prices appear discounted, and distributing shares when prices are deemed expensive. Typically, a core position “base” remains in my portfolio for years. The accumulation/distribution process usually takes months. As an example, we will use Union Pacific common stock. UP is America’s largest Class I railroad, effectively covering the western two-thirds of the country. In addition, the company has six gateway interchanges with Mexico, and a busy west coast marine/rail intermodal business. Union Pacific Investment Thesis About 2 years ago, Seeking Alpha editors published my initial article about Union Pacific . I outlined an investment thesis, then reinforced it in a subsequent article . That thesis is outlined below: The railroad business is an oligopoly, or a “large moat” enterprise. Carriers enjoy good returns on capital, generate profits in cash, and have strong franchises…and thus enjoy a level of pricing freedom. Based upon multiple operational and financial measures, I believe Union Pacific is the best-of-breed U.S.-based railroad. Its balance sheet is the strongest in the industry. The company operates primarily throughout the western two-thirds of the United States, offering superior span, scale, and future growth. Multiple west-coast and Mexican interchanges provide unique international opportunities. Union Pacific has experienced strong revenue growth via transportation of automobiles, industrial products, and chemicals. Historically, such freight lines do well in an expanding economy. UP expects these segments to continue to drive strong volumes and revenues. Coal volumes remain a concern for all major rail carriers. After a difficult 2013, coal shipments stabilized in 2014. In addition, UP has a heavy tilt to “oil” versus “coal.” While the long-term trend for U.S. coal consumption is at best uncertain, the trend for crude oil and related drilling materials (pipe, frac sand, etc.) is expected to be positive. UNP management is shareholder-friendly. The 5-year dividend growth rate is 27%. Since the end of 2006, share repurchase plans have reduced the number of diluted shares outstanding by more than 18%. The Initial Accumulation Phase Having developed an investment thesis, backed by fundamental due diligence, it was time to buy the stock. Here is an outline of my original UNP purchases. I bought shares in 3 transactions, beginning in early 2013. For illustrative purposes, I’ve denoted share quantities proportionally to round a sum total of “100” shares. Purchase prices are actual: Bought 40 shares @ $150 Bought 40 shares @ $153 Bought 20 shares @ $163 These 3 purchase events were spaced over 6 months. While I prefer to buy at lower and lower prices (yes, folks, I hope a stock goes DOWN after I begin to buy it), this time corporate performance and prices didn’t cooperate. I bought shares, waited, bought some more at just a little higher price, then waited several months before combining 2 related decisions: I thought it time to fill out the “100” share position I believed the stock was still trading significantly below fair value Note the last purchase was for a lesser amount of shares than the first two purchases. If the stock price had gone DOWN, instead of up, I would have bought even more shares. A Time to Wait Patiently After accumulating a “full” UNP position, I waited. Waiting isn’t idle time. All the while I monitored the investment and “did the homework.” This included reading and reviewing routine news releases, earnings reports, earnings conference call presentations/transcripts, investor presentations, and the SEC filings. Pleasantly, Union Pacific shares trended upward. By June 2014, prices topped $200 a share. I was faced with a high-grade problem: I deemed the shares overvalued. The Distribution Phase In June 2014, SA published another article I wrote about Union Pacific entitled, ” Premier Companies, But Overpriced Stocks – Part 1. ” At the time, I viewed UNP common shares to be trading too rich. Among the evidence, I offered the following F.A.S.T. graph: (click to enlarge) Notice how the black line (price) had become far upfield from operating earnings (the green shaded area). Shares were trading above expected full-year 2014 EPS and the year wasn’t half over yet. Note: In mid-2014, Union Pacific’s stock split 2-for-1. Post-split, I owned “200” shares each worth about ~$100. So, as aligned with my article, I began lightening up shares in June. Selling “40” post-split shares represented 20% of my original “100” share holding. The stock had appreciated ~38% from my first purchase. General Rule #1: When a stock is up more than 25%, sell about 25% of the original holding. “But Ray,” you may ask, “The stock was up more than 25% and you sold less than 25%! You didn’t follow your own rule!” Yes, you are correct. Indeed, I didn’t think the shares were overvalued until cracking $100; and when they breached that mark, the stock was running. Postponing the sale was buttressed additional rationale: the 1Q 2014 earnings report/forward guidance/ongoing fundamentals were outstanding, the technical charts were strong, and I tossed in a dash of intuition. Therein lies the beauty of being an Individual Investor . I don’t have to answer to anyone except myself. Yes, I have investment rules. But I can bend the rules. As an Individual Investor , I have the right to be delightfully inconsistent. After I sold shares at $104, I felt reasonably confident the price would hit a wall. I was wrong. The shares kept running up. So here’s another “rule” for consideration: General Rule #2: Never accumulate or distribute shares all at once, no matter how certain you are. Scale in and scale out in increments. To do otherwise is arrogant. While I bent my first rule, following the second one resulted in a lot of additional gains. Between June and the end of the year, I sold down as the stock went up: Sold 20 shares @ $121, and finally sold 40 shares @ 119. By the end of 2014, I had offloaded half my total UNP shares. Since Union Pacific was a core position, my plans were to sell not more than 50% of the original holding. I had a nice profit from the shares sold. Now it was time to wait again. Historically, the stock should revert to the mean and “come in” again; at such time, I would attempt to regain my old “100” share position. Why should I expect this? The stock was trading above fair value. I Hear the Train Coming! In late 2014 and early 2015, a confluence of news and events started to bang down railroad stocks. The price of oil plummeted, causing a perceived huge loss of crude-by-rail volumes, as well as oilfield materials. Coal shipments got soft. Striking longshoremen shut down Long Beach and LA container ports. Rail safety regulations were raised. Some investors fretted about the wider Panama Canal. Share prices began to fall. I agree some of the foregoing justified part of the decline. However, based upon historical P/E multiples, the shares were overpriced at $104. The stock ran up over $120. Did the business get much better to deserve that uplift? No. When shares went from $104 to $124.50 (the high), the underlying corporate fundamentals didn’t get better. The stock price and earnings just separated; and Union Pacific share price and earnings have a long history of following each other. General Rule #3: For the vast majority of stocks, price follows earnings and/or cash flow. Corollary: Sometimes stocks stay overvalued for a while. That’s ok. Don’t get greedy. Let’s look at an updated F.A.S.T. graph. It’s instructive: (click to enlarge) Despite all the media hoopla and brokerage house hand-wringing, we see that the price decline from $124 to 106 (a 15% correction) simply re-united Union Pacific stock price and earnings. UP 1Q 2015 Earnings: A Re-Calibration Opportunity During the 1Q 2015 earnings report, we found Union Pacific management wasn’t in a state of panic. Some facts: Operating earnings grew to $1.30 a share from $1.19 a year earlier A 64.8% operating ratio bested the full-year 2014 average Year-over-year net margins improved Operating cash flows were up YoY freight revenues were down 1%; volumes were down 2% During management’s earnings discussion and conference call, we learned that coal volumes are likely to remain soft throughout 2015. Energy transportation volumes are uncertain, but there’s no expectation of permanent impairment. Agriculture and automobile shipments are expected to be good. Intermodal transportation is forecast to recover in 2Q as west coast ports get back to business. Shares outstanding are down again on strong repurchase activity, and the first-quarter dividend was bumped up 10%. And while BNSF is rumbling to be get more competitive on some routes, Union Pacific expects 2015 “core pricing” to improve by 3.5%. Key Learning: The fundamental investment thesis outlined at the beginning of this article, set over 2 years ago…has not changed. Accumulating Shares To Rebuild The Position By March, the train arrived at the station. Share prices were “coming in,” falling below $110. Since March, here’s the action: Bought 20 shares @ $109 (a bit early, but refer to Rule #2!) Bought 20 shares @ $106 Bought 20 shares @ $104 Now, here’s one more general rule: General Rule: Don’t repurchase shares for more than you sold them. Never chase. Remember, I had distributed “60” shares at $119 and $121? Well, now I’ve bought these back at prices between $104 and $109. However, I “prematurely” sold the first “40” share block at $104. Therefore, I will not buy these last “40” shares back unless I can get them for AT LEAST a 7% discount. Otherwise, my net/net after tax could be a washout. I have placed a limit order and sold short puts, whereby I will not purchase additional long shares unless $97 or less. Conclusions Trading around a core position requires discipline and patience. Have a researched and complete investment thesis before buying any stock. Accumulate shares in increments. Determine at what price you believe this stock is overvalued. Distribute shares above your price. Sell down shares in increments. Never completely sell core positions, unless the ownership thesis has turned negative. When shares revert to fair value or less, you may begin to repurchase. Repurchase shares in increments. Only repurchase distributed shares at lower prices than those sold. Don’t chase. Union Pacific: Price, Volume and SMAs (2013-to-date) (click to enlarge) Courtesy of bigcharts.marketwatch.com Please do your own careful due diligence before making any investment. This article is not a recommendation to buy or sell any stock. Good luck with all your 2015 investments. Disclosure: The author is long UNP. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.