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ITC Holdings’ (ITC) CEO Joseph Welch on Q1 2016 Results – Earnings Call Transcript

ITC Holdings Corp. (NYSE: ITC ) Q1 2016 Earnings Conference Call April 28, 2016 10:00 ET Executives Stephanie Amaimo – Director, IR Joseph Welch – Chairman, President & CEO Rejji Hayes – SVP & CFO Analysts Julien Dumoulin-Smith – UBS Caroline Bone – Deutsche Bank Praful Mehta – Citigroup Operator Good day, ladies and gentlemen, and welcome to the ITC Holdings Corp First Quarter Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, Ms. Stephanie Amaimo. Ma’am, you may begin. Stephanie Amaimo Good morning, everyone and thank you for joining us for ITC’s 2016 first quarter earnings conference call. Joining me on today’s call are Joseph Welch, Chairman, President and CEO of ITC; and Rejji Hayes, our Senior Vice President and CFO. This morning we issued a press release summarizing our results for the first quarter ended March 31, 2016. We expect to file our Form 10-Q with the Securities and Exchange Commission today. Before we begin, I would like to make everyone aware of the cautionary language contained in the Safe Harbor statement. Certain statements made during today’s call that are not historical facts such as those regarding our future plans, objectives, and expected performance reflect forward-looking statements under federal securities laws. While we believe these statements are reasonable, they are subject to various risks and uncertainties and actual results may differ materially from our projections and expectations. These risks and uncertainties are disclosed in our reports filed with the SEC such as our periodic reports on forms 10-K and 10-Q and our other SEC filings. You should consider these risk factors when evaluating our forward-looking statements. Our forward-looking statements represent our outlook only as of today and we disclaim any obligation to update these statements except as may be required by law. A reconciliation of the non-GAAP financial measures discussed on today’s call is available on the Investor Relations page of our website. I will now turn the call over to Joe Welch. Joseph Welch Thank you, Stephanie and good morning everyone. I’m pleased to report that we’re off to a solid start in 2016. We continue to deliver operational excellence to our customers and superior growth to our shareholders while concurrently focusing on the Fortis acquisition of ITC. On the operational front, system performance for the first quarter of 2016 aligned with our historical track record with good performance across the operating companies and minimal impacts to the system despite several spring storms in March. In addition, our capital projects and maintenance programs were off to a good start for the year. Many reliability, system capacity and customer interconnection projects are in process across all of our operating companies and progressing on schedule. One notable project in Detroit that we work to complete it in February is our portion of the new Temple substation which will support the load requirements for the new Red Wings Stadium. With respect to our development efforts, we continue to advance the new Covert project, which is scheduled to go into service later this year along with preparations and certifications to operate in PJM. We are also continuing to negotiate bilateral contracts with shippers on the Lake Erie Connector project. As we highlighted on our last call, the MISO Transmission owners filed their updated testimony on January 29, in the second base ROE complaint and have since held various hearings and briefings during the last several months as part of their most recent procedural schedule. And initial decision in the second base ROE complaint is expected from the Administrative Law Judge by the end of June. While final decisions from the FERC Commission aren’t expected until late 2016 and the first half of 2017 for the first and second complaints respectively, we remain confident that FERC will continue to support their historical policies given the significant investment requirements necessary to modernize the electrical infrastructure in the U.S. As for other regulatory matters, on March 11, FERC issued two orders concerning ITC Midwest. In summary, in its orders on the final and the formal challenge of ITC Midwest 2015 formula rates in its orders conditionally accepting the Bent Tree facility service agreement, FERC concluded that ITC Midwest’s decision to elect out of bonus depreciation wasn’t prudent. As a result, FERC has required ITC Midwest to simulate the effects of bonus depreciation that is to calculate generally applicable transmission rates and its charges under a specific agreement as though the company actually had taken bonus depreciation for facilities placed into service in 2015. In response to FERC’s order, on April 11, ITC Midwest filed request for rehearing on both orders, essentially asking FERC to reconsider and reverse its decisions. To the extent that FERC decided not to reverse its orders on the formal challenge, ITC Midwest also asked FERC to modify the date for implementation of the order on the formal challenge so that ITC Midwest is able to maintain compliance with the new tax law requirements. As we wait FERC’s response to our request for rehearing, we’ve taken steps to comply with these orders and have recorded the applicable bonus depreciation impacts during the first quarter as well as the necessary compliance filings on the Bent Tree facility service agreement. Subsequently, we’ve since received a similar challenges at METC from CMS, and are in the process of evaluating the next steps. That said, although we expect these proceedings to take some time to be resolved, we plan to elect bonus depreciation across all our companies for the 2015 and 2016 tax years. With respect to the Fortis transaction, Fortis and ITC have worked diligently to advance the transaction. The most material news since our last call – last week’s announcement of Fortis entering into a definitive agreement with GIC to acquire 19.9% equity interest in ITC for over $1.2 billion in cash upon closing the transaction. Needless to say, we are delighted with this outcome, as well as a well-respected long-term investor with over $100 billion in assets under management and strong track record of investing in North America infrastructure, GIC will be a great investment partner for Fortis and co-owners of ITC. With the minority investor secured, we can now proceed with other key milestones in the transaction, including the remaining State and Federal regulatory filings and the shareholder votes for both Fortis at ITC. Overall, the transaction continues to progress as planned, and we expect to close in the late 2016. Although it’s been a busy start to the year, we look forward to another strong year both operationally to the benefits of our customers, and financially by creating long-term value for the shareholders. I will now turn the call over to Rejji to elaborate on our first quarter 2016 financial results. Rejji Hayes Thank you, Joe, and good morning, everyone. For the three months ended March 31, 2016, ITC reported net income of $64.2 million or $0.42 per diluted share as compared to reported net income of $67.1 million or $0.43 per diluted share for the first quarter of 2015. Operating earnings for the first quarter of 2016 were $84.5 million or $0.55 per diluted share compared to $73.1 million or $0.47 per diluted share for the first quarter of 2015. Operating earnings are reported on a basis consistent with how we have provided our guidance for the year and exclude the following items. First, they exclude regulatory charges of approximately $1.1 million or $0.01 per share for the first quarter of 2015. The 2015 charges relate to management’s decision to write-off abandoned costs associated with a project of ITC Transmission. Second, operating earnings exclude the estimated refund liability associated with the MISO base ROE, which totaled $11.5 million or $0.07 per diluted share for the first quarter of 2016 and $4.8 million or $0.03 per diluted share for the first quarter of 2015. It is possible that upon the ultimate resolution of this matter we may be required to pay refunds beyond what has been record to-date. We will continue to assess this matter and we’ll provide updates as necessary. Lastly, they exclude after tax expenses associated with the Fortis transaction of approximately $8.7 million or $0.06 per diluted share for the first quarter 2016. Operating earnings for the three months ended March 31, 2016 increased by approximately $11.4 million or $0.08 per diluted share of the comparable period in 2015, primarily due to higher income associated with increased rate base at our operating companies coupled with lower non-recoverable bonus payments associated with the V-Plan project in the first quarter of 2016 compared to the same period in 2015. These beneficial factors are partially offset by the impact of electing bonus depreciation, as Joe highlighted, at all of our operating subsidiaries. For the three months ended March 31, 2016, we invested $176.6 million in capital projects at our operating companies, including $41.1 million at ITC Transmission, $47 million of METC, $74.8 million at ITC Midwest and $13.7 million at ITC Great Plains. With respect to our financing liquidity initiatives on April 26, 2016, we executed a 30-year debt issuance at METC, the $200 million of senior secured notes were priced at 3.9% and the proceeds will be used to refinance an unsecured three-year term loan at METC. As we’ve underscored in the past, management remains committed to sustaining our strong financial position and solid investment grade credit ratings. As such, we are pleased to report that on April 15, Moody’s affirmed the issue ratings in outlook of ITC and its regulated operating subsidiaries. From a liquidity perspective, as of March 31, 2016, we have readily available liquidity of approximately $775 million, which consists of roughly $8 million of cash on hand and $767 million of net undrawn capacity on our revolving credit facilities. For the three months ended March 31, 2016, we reported operating cash flows of approximately $88 million, which reflects an increase of approximately $21 million from the first quarter 2015. It’s also worth noting that on April 7, 2016, we successfully amended all of our revolving credit facilities with unanimous support from our syndicate of lenders to allow for consummation of the transactions. As a result, we will be able to maintain the revolving credit facilities and the amounts under the revolving credit facilities close. In closing, we are well positioned to execute on our plans in 2016, including the Fortis acquisition of ITC, to benefit the customers and shareholders. Our continued solid performance in the first quarter serves as an important foundation for these efforts. At this time, we’d like to open the call to address questions from the investment community. Question-and-Answer Session Operator [Operator Instructions] And our first question comes from Julien Dumoulin-Smith from UBS. Your line is now open. Julien Dumoulin-Smith Hi, good morning. Joseph Welch Good morning, Julien. Julien Dumoulin-Smith So quick question here on the independent side. Obviously, we’ve got the GIC involved now as a JV partner. Would you expect to be able to keep that on a prospective basis here? Joseph Welch I think that’s a question you ought to ask GIC. The thing is that, as far as we’re concerned, this is – Fortis’ and GIC’s filing and you ITC and its shareholders were held harmless to that decision. Julien Dumoulin-Smith Got it. And then subsequently, you’ve commented in the past on FERC Order 1000, I’d be curious to get your latest thoughts on the SPP process. Obviously that had certain issues about allocations of points on the technical basis. I’d be curious to get your reaction and any broader implication? Joseph Welch No, I think that the SPP’s decision probably fits into the same line as the decisions that’s taken place in PJM, for instance that they awarded the points, I find it interesting that – from my standpoint, they’ve eliminated a lot of people based on conductor size and conductor design and we feel strongly, in our case, that our conductor sizing and design was 110% appropriate. But I could tell you this that on the whole process of a line that size and the amount of magnitude from an investment perspective, there was more money spent on bidding on it and more money spent on evaluating it than the whole line was worth. Julien Dumoulin-Smith Intriguing data point itself. And lastly, just turning back to bonus depreciation with the CMS complaint out there, I’d be curious how do you intend to treat results for this year given METC and actually potentially for the balance of the portfolio? Rejji Hayes Yes, Julien this is Rejji. Joe and I highlighted, we have assumed the election of bonus depreciation, both for the 2015 tax year as well as the 2016 tax year. And so as our Q is filed later today, you’ll see the details around that. It is flowing through the financials you see in the earnings release that hit the tape this morning and the estimate on a pre-tax basis for Q1 is about $5.4 million after-tax, about $3.2 million. And you can assume over the course of 2016, you’re probably just under $10 million and that’s for the full estimate for 2016 across all of the operating companies. So we are erring on the side of conservatism in our financials, but needless to say, we obviously requested a rehearing with the FERC on the IP&L matter. So we’ll see where we go from there. Julien Dumoulin-Smith Okay, great. Thank you. Rejji Hayes Thank you. Operator And our next question comes from Caroline Bone from Deutsche Bank. Your line is now open. Caroline Bone Good morning. Just a follow-up on that bonus depreciation question. Thank you so much for the details on the impacts for the quarter and the full year, but I was just wondering if you could comment a little bit about how this might impact your more long-term growth expectations? Joseph Welch It really, when I look at growth, I don’t look at growth quite the same way you do, we’re going to be growing at the same rate that we’ve always grown, when you look at the earnings and the bonus depreciation, but the fact of the matter is that the bonus depreciation, if you elect it and generates a lot of cash and that gives us the ability to start to invest in other areas. Rejji Hayes Yes, exactly right. The only thing I would add to that, Caroline, is it clearly you’re going to have a financial impact on your net earnings, we talked of the 2016 impact and as I’m sure you well know and which the election works, it flows through our tariff as an increase in deferred tax liabilities that reduces rate base and you basically have to wear that financial impact for about 15 years. And so you do work for some time, but as Joe highlighted, clearly we’re still going to be investing in the system and trying to obviously improve the system to the benefit of customers. Caroline Bone All right. So I guess, I mean in terms of the cash benefit that you guys will see from bonus depreciation, did you get a lot of that in Q1 or should there be kind of a similar level of – just looking at the line, the deferred taxes line, in terms of the benefit for the rest of the quarters? Joseph Welch Yes. So technically, we have not received the cash benefit. So you probably noticed the income tax receivable in current assets of about $140 million, technically we’d be receiving that when we file our tax return for the 2015 tax year around mid-year. I think that’s the earliest time we can get that done. So we’re expecting that true cash inflow around mid-year, it is approximately $140 million for 2016. Caroline Bone All right, thanks so much. Joseph Welch Thank you. Operator [Operator Instructions] Our next question comes from Praful Mehta from Citigroup. Your line is now open. Praful Mehta Thank you. Hi guys, just quickly on that bonus depreciation again and I truly appreciate the point on the cash that you have now freed up. I guess if you do have this cash freed up in the long-term, as long as you can reinvest that cash at an accretive way in terms accretive asset or bid it out of CapEx, would that support – is that your thesis on why the growth rates remain the same? And secondly, does that change, now that you’re part of Fortis, if they could use that excess cash to grow some other part of the, I guess the combined platform, does that kind of change your perspective on how you think about bonus depreciation longer term, I guess? Joseph Welch It doesn’t change our perspective on how we view that at all. Rejji Hayes Yes, I think, Praful, the only thing I would add to that is from a capital deployment perspective, we’ll see what the options are at the time we receive the cash and clearly, assuming we get the transaction of the finish line post-closing, it will be discussion we have with the owners of the business, both Fortis and GIC as to what the most efficient use of that cash is, but needless to say it’s not going to be sitting in a money market account, earning 5 basis points. Praful Mehta And then just in terms of FERC 1000 and growth and development CapEx and the projects there, can you just briefly give us an update on how that is going and do you see any updates in terms of the growth projects more longer-term? Joseph Welch With regards to Order 1000? I think you could regard Order 1000 as a complete failure for the whole marketplace. In our case and you must not have been listening when we had some of our earnings calls in the past because I’ve directly highlighted that we’re not very focused on Order 1000 for the facts that I’ve just outlined. We have of Lake Erie Connector that we’re really focused on, we’ve announced that we’re doing work in Puerto Rico and Mexico. We continue to stay involved in Order 1000, but I think it’s a tree that doesn’t bear much fruit for anyone. Rejji Hayes And then Praful, this is Rejji, so the non-traditional development side, as we highlighted in our initial comments, we continue to make progress in the new Covert line which we should have in service this year and clearly the other opportunities, Lake Erie and some of the other non-traditional development opportunities as they continue to progress and we should have visibility on Lake Erie project in the latter half of this year. So continuing to push forward on that as well. Praful Mehta And I do pay attention, I do listen guys, it’s always just good to get a refresh, although I appreciate it. Joseph Welch You just wanted it refreshed? Praful Mehta Yes, always good to get your perspective again on FERC 1000, I guess. Joseph Welch Okay. Praful Mehta Thank you. Operator I’m showing no further questions. I will now like to turn the call back to Stephanie Amaimo for any further remarks. Stephanie Amaimo This concludes our call. Anyone wishing to hear the conference call, replay available through May 3, can access it by dialing 855-859-2056 toll free or 404-537-3406, passcode 83086632. This webcast to this event will also be archived on ITC website at itc-holdings.com. Thank you, everyone and have a great day. Operator Ladies and gentlemen, thank you for participating in today’s conference. 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.) 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The Ultimate Guide To Risk Parity And Rising Interest Rates

Click to enlarge Risk Parity has had a phenomenal year-to-date. One popular provider of the strategy for retail clients is up nearly 9% while the S&P is up a little over 3%. This is primarily due to big rallies in both the bond and commodity markets, as the Fed has continued to ease off on interest rates while the global outlook has stabilized. YTD Performance of Major Asset Classes vs. Risk Parity (labeled “You”) Source: Yahoo Finance, Federal Reserve , WSJ , Hedgewise Despite this strong outperformance, the bond rally has raised a familiar worry: what happens when interest rates rise? Given the strategy has a heavier bond allocation than most traditional portfolios, does it continue to be a viable option? Fortunately, we have decades of historical data that show that rising interest rates are not a cause for great concern. In times of high inflationary pressure, like the 1970s, the strategy is protected by assets like commodities and inflation-protected bonds. While higher short-term rates do reduce the benefits of using leverage, our backtested model still performed at least as well as the S&P 500 throughout the 70s. The absolute “worst case” scenario is one in which rates are being driven up by continuously strong real growth, such as the post-WWII economy from 1950 to 1970. In this situation, both bonds and real assets like gold will tend to perform poorly while the stock market rockets ahead. Though Risk Parity will probably underperform the S&P 500 over such a stretch, you will still make solid returns ; they simply won’t be as high compared to a portfolio of 100% equities. In exchange for this possibility, you avoid the risk that the next 2008 may be right around the corner. While rising interest rates may seem like a foregone conclusion, recent history in Germany and Japan demonstrates that rates may be just as likely to fall. In short, it only makes sense to move away from Risk Parity if you are absolutely sure we will experience a booming, robust economy over the next 20 years and you can afford a few 40% downturns along the way. If you have this conviction, by all means, move to 100% equities. If you aren’t sure, though, recall that Risk Parity is a long term investment strategy that has consistently produced reasonable returns without the need to predict the future. Modeling Performance in the 1970s: Inflation Protection Works From 1970 to 1983, the Federal Funds rate rose from 4% to nearly 20%, or a whopping 1600 basis points. The US was facing a vicious combination of rising prices and falling economic activity, also known as “stagflation”. This provided an excellent environment to pressure test the Risk Parity framework, which you might expect to do terribly given its heavy bond allocation. However, just the opposite occurred: our model outperformed equities nearly the entire time . To create the historical model, we had to make a few key assumptions: We are using a modified form of our proprietary risk management framework, as there was not nearly the amount of market data available in the 70s as there is today. Our belief is that this is a handicap, and we expect our framework would perform even better than is shown here if we had the same data available. We limited the portfolio to nominal bonds (NYSEARCA: IEF ), equities (NYSEARCA: SPY ), and gold (NYSEARCA: GLD ) because inflation-protected bonds (NYSEARCA: TIP ) did not yet exist, nor did reliable data on the price of commodities like oil and copper. The assets that we had to exclude all tend to perform well in periods of high inflation, and would likely buoy performance within our full model. Risk Parity is typically available at multiple ‘risk levels’, the higher of which amplify expected returns through leverage. We ran an unleveraged “Low Risk” version of the model as well as a leveraged “High Risk” version. The portfolios are based on end-of-day index prices and do not account for live trading conditions. All dividends and coupon payments are included and assumed reinvested. Leverage is assumed to have a cost equal to the rate on one-year treasury bonds. The model does not include the cost of commissions or management fees. Performance of Risk Parity “Low Risk” and “High Risk” Models vs. S&P 500, 1970 to 1982 Click to enlarge Source: Hedgewise Analysis Despite one of the worst decades for bonds ever in history, both versions of the Risk Parity portfolio outperformed equities for nearly this entire stretch. This was possible for two reasons. First, ten-year bonds still achieved an annualized return of about 6% during this timeframe. Even though rising rates eroded the principal value of the bonds, this was counterbalanced by consistently higher yields. Second, assets that provide protection from inflation, like gold, performed incredibly well in this environment as the value of the US dollar plummeted. That said, it is interesting to note that based on total return over the entire timeframe, the “High Risk” portfolio failed to outperform the “Low Risk” portfolio even though it was far more volatile and leveraged. This makes sense when you realize that short-term interest rates were often higher than long-term rates during this period. In other words, you were often paying more in interest than you were making back. Does this mean that using leverage doesn’t make sense when interest rates are rising? Not necessarily. The “High Risk” portfolio actually was outperforming most of the time; the net result was highly influenced by the final period in which rates rose most rapidly. Still, it is accurate to say that leverage will be less useful compared to periods of flat or falling interest rates. Taken together, these facts lead to a few important takeaways. Even if you are relatively certain that inflation is about to pick up, Risk Parity would still be a great choice . In this kind of environment, higher risk level portfolios may occasionally fail to outperform the lower risk levels, though they would all generally perform well compared to the S&P 500. If you are absolutely convinced that we are heading for another period like the 70s, you might consider avoiding leverage, but it certainly wouldn’t make sense to abandon the strategy altogether. Before we move on, keep in mind that the decade of the 70s was the earliest period of rising rates in which we had enough data to do a proper simulation of our model. When studying the 50s and 60s, we must rely on a drastically more simplistic version. Still, this severely handicapped portfolio can effectively demonstrate some of the timeless concepts of the Risk Parity Framework. Modeling Performance in the 1950s and 1960s: The Boomer Years The Post-WWII economy in the US was incredibly robust. For nearly 20 years, we experienced strong real growth with relatively limited inflation and no major recessions. The S&P 500 grew by over 10% annually, while nominal bonds returned only 2% annually due to consistently rising real rates. You’d expect a portfolio of 60% bonds would make no sense; never mind adding leverage to the mix! However, such a portfolio still provided solid, steady returns with a lower risk of drawdowns . Using leverage also successfully increased returns, though not significantly. This was true even with no active risk management and during two of the worst performing decades for nominal bonds in history! To be clear, in hindsight, equities were the top performing asset class, and any mix besides 100% stocks probably underperformed. However, this fact misses the entire point of diversification: you just don’t know what is going to perform well next. Of course you will do better if you always switch into the asset class that is about to blow the others away, but you’ll often be wrong. Risk Parity allows you to consistently do well regardless of the environment. With that said, let’s take a look at the data from these decades. Here’s how we constructed the model this time: Since data was not available to implement active risk management, we assumed a static split of 40% stocks and 60% bonds for the Risk Parity portfolio. We took this same mix and added 75% leverage, for a final mix of 70% stocks and 105% bonds. This is a simple, static performance model that is limited to two assets. Performance of our full model in the same time period would likely have been better. Performance of 40% Stock / 60% Bond Mix and Leveraged 40/60 Mix vs. S&P 500, 1953 to 1970 Click to enlarge Source: Hedgewise Analysis As expected, the bond-heavy mix was unable to keep up with equities over this timeframe. However, both the unleveraged and the leveraged versions of the portfolio still performed reasonably well from an absolute standpoint. The unleveraged 40/60 mix averaged an annual return of 5.5% with less than half the volatility of the stock market and significantly smaller drawdowns. If your goal was capital preservation and moderate growth, this portfolio may have still been a better choice. While it’s easy to argue otherwise when you look over the 20 years, stocks experienced a number of significant declines during that timeframe that may have been unacceptable for someone close to retirement or with a shorter time horizon. For example, stocks lost as much as 31% during the dips in 1958, 1962, 1966, and 1968. If you needed to exit the market during these periods, or you were actively taking withdrawals out of your investments along the way, such losses could significantly damage your outlook. With our leveraged mix, we see a similar theme to what occurred during the 70s: you will still achieve higher returns using leverage, but not significantly so. Importantly, this dispels the myth that levering up a Risk Parity portfolio will be disastrous when bonds do poorly. The leverage is not harmful; it just isn’t as helpful compared to other times. Plus, remember that the modern day version of the portfolio would likely exhibit a much smaller performance gap compared to the one shown here. The key to this analysis is deciding what it means to you. First, consider how sure you are that stocks will be the top performing asset class over the next 20 years due to strong real growth and low inflation. If we experience any other kind of environment, Risk Parity will tend to outperform. Second, evaluate how damaging each worst-case scenario might be for you personally. If you moved to 100% equities at the peak of the dot-com bubble, it took you nearly a decade to recover your losses. If you utilized a simplistic version of Risk Parity during the Post-WWII era, you still made 6.6% instead of 10.4%. As with any kind of diversification, it only makes sense if you agree that the future is quite uncertain. As much as it may seem that bonds are about to enter a prolonged bear market, there’s a good deal of evidence that suggests quite the opposite. Where Have the Rising Interest Rates Gone? Supposedly, the bond bull market in the US has been on the verge of ending for about 4 years now. There was the so-called ‘taper tantrum’ in 2013, during which yields rocketed over 100bps when Bernanke announced the end of ‘Quantitative Easing’. Yet the US economy continued to sputter along slowly and global weakness brought yields back down. In late 2015, the Fed was expected to raise rates as many as 6 times in the near-future. Then, a global collapse in commodity prices and rapidly slowing growth in China caused them to back-off again. Meanwhile, ten-year bonds have continued to hover around 2%. 10-Year US Treasury Yields Since 2000 Click to enlarge The gut reaction to this graph is to think that we must be near the bottom. However, there is no reason that we can’t fall well below a 2% yield for decades. Japan, for example, has had ten-year yields under this level for almost 20 years. 10-Year Japanese Treasury Yields Since 1990 (2% yield emphasized) Click to enlarge Many are quick to point out that our economic history is quite a bit different than Japan’s. Instead, let’s take a look at Germany: 10-Year German Treasury Yields Since 2000 (2% yield emphasized) Click to enlarge The reality is that the entire world remains in a very fragile state. On a relative basis, yields in the US are actually still pretty high. In the EU, a number of countries have recently introduced negative interest rates to continue to combat recessionary pressure. The point is that we may be at the end of the bond bull market, but it’s also entirely possible that we are not. Conclusion: Rising Rates Are Not a Big Concern The evidence presented in this article helps clarify some extremely important concerns about Risk Parity. In the thirty-year stretch from the 1950s to the 1980s, adding leverage to a bond-heavy portfolio never resulted in disaster; it just had less of a positive effect on returns. During the most inflationary period in US history, our model outperformed the S&P 500 for a majority of the time. These facts boldly refute the idea that Risk Parity only ‘works’ during bond bull markets. As with any kind of diversification, there will always be periods when one asset is outperforming the others. In exchange for tolerating this, you get steadier, more reliable returns which do not depend on you predicting the future. You become less vulnerable to a crash in any given market. You’ll tend to make money even when interest rates are steadily rising, but you’ll make less than you could have if you had perfect foresight. Even if you do have a strong conviction that rates are about to rise, an unleveraged Risk Parity portfolio remains an excellent choice for investors with a shorter timeframe because of its significantly smaller drawdowns and steady historical returns. We would absolutely recommend such a portfolio over cash regardless of the market environment. For longer term investors, be wary about the likelihood that we are about to enter a period of growth similar to the post-WWII economy. As many countries in Europe and Asia have already demonstrated, another recession may be a far bigger risk. Finally, please keep in mind that this article focused on extreme scenarios, including the naïve construction of the model portfolios and the chosen start and end dates of the analysis. If the Risk Parity framework can hold up relatively well despite these handicaps, there’s little reason to keep worrying about the specter of rising interest rates. If you are interested in learning more about Risk Parity, check out this white paper overview . We’ll also be publishing the current construction of our “Low Risk” and “High Risk” portfolios early in May. Be sure to follow us if you’d like to receive it. Disclosure: I am/we are long SPY, IEF, TIPS, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This information does not constitute investment advice or an offer to invest or to provide management services and is subject to correction, completion and amendment without notice. Hedgewise makes no warranties and is not responsible for your use of this information or for any errors or inaccuracies resulting from your use. To the extent that any of the content published may be deemed to be investment advice or recommendations in connection with a particular security, such information is impersonal and not tailored to the investment needs of any specific person. Hedgewise may recommend some of the investments mentioned in this article for use in its clients’ portfolios. Past performance is no indicator or guarantee of future results. This document is for informational purposes only. Investing involves risk, including the risk of loss. Information in this document has been compiled from data considered to be reliable, however, the information is unaudited and is not independently verified. Performance data is based on publicly available index or asset price information and does not represent a live portfolio except where otherwise explicitly noted. All dividend or coupon payments are included and assumed to be reinvested monthly.

PNM Resources’ (PNM) CEO Patricia Collawn on Q1 2016 Results – Earnings Call Transcript

PNM Resources, Inc. (NYSE: PNM ) Q1 2016 Earnings Conference Call April 29, 2016 11:00 am ET Executives Jimmie Blotter – IR Patricia K. Collawn – Chairman, President and CEO Charles Eldred – EVP and CFO Analysts Ali Agha – SunTrust Robinson Humphrey Anthony Crowdell – Jefferies & Co. John Barta – KeyBanc Capital Markets Lasan Johong – Auvila Research Consulting Operator Good morning and welcome to the PNM Resources First Quarter Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jimmie Blotter, Director of Investor Relations. Please go ahead. Jimmie Blotter Thank you, Rocco, and thank you everyone for joining us this morning for the PNM Resources First Quarter 2016 Earnings Conference Call. Please note that the presentation for this conference call and other supporting documents are available on our Web-site at pnmresources.com. Joining me today are PNM Resources’ Chairman, President and CEO, Pat Vincent-Collawn, and Chuck Eldred, our Executive Vice President and Chief Financial Officer, as well as several other members of our executive management team. Before I turn the call over to Pat, I need to remind you that some of the information provided this morning should be considered forward-looking statements, pursuant to the Private Securities Litigation Reform Act of 1995. We caution you that all of the forward looking statements are based upon current expectations and estimates and that PNM Resources assumes no obligation to update this information. For a detailed discussion of factors affecting PNM Resources’ results, please refer to our current and future annual reports on Form 10-K, quarterly reports on Form 10-Q, as well as reports on Form 8-K, filed with the SEC. And with that, Pat, I will turn the call over to you. Patricia K. Collawn Thank you, Jimmie. Good morning, everyone, and happy Arbor Day. Thank you all for joining us this morning as we report on the Company’s first quarter performance and take a quick look ahead. I’ll start on Slide 4 with a look at the numbers and our achievements from the first quarter. First quarter earnings were lower than last year but consistent with our expectations. Consolidated ongoing earnings were $0.13 per diluted share, compared with $0.21 per diluted share in the first quarter of 2015. In addition, today we are reaffirming our 2016 consolidated ongoing earnings guidance of $1.55 to $1.76 per diluted share. At PNM, concerted efforts to create a more favorable customer experience continue to pay off despite the challenges associated with high-profile filings such as our current rate proposal. J.D. Power reported the overall Customer Satisfaction Index reached a high point for PNM. I’m particularly proud of our customer service results which came in among the highest in our benchmark peer group. This achievement is the result of the effort and dedication of our employees from departments all across the Company who are focused on being responsive to and meeting the needs of our customers. Our Company has stayed the course, proactively communicating and sharing information that customers need the most. I’m proud of the work we have done. We know there is no silver bullet. It takes countless decisions being made every day on behalf of our customers. I’m confident our strategy is on target and we are doing the right things for our customers. I’m also pleased to say that TNMP has again been recognized by ENERGY STAR for the Company’s successful energy efficiency efforts. TNMP received the Partner of the Year Energy Efficiency Delivery Award for its high-performance Homes Program. The initiative promotes the construction of new ENERGY STAR certified homes and provides financial incentives and other assistance to homebuilders. This honor is on top of receiving ENERGY STAR’s Market Leader Award for the 11th consecutive year. So now let’s turn to Slide 5. Throughout the first quarter, we were preparing for the hearing of the New Mexico Public Regulation Commission regarding our $123 million general rate case. The hearing began on April 11 and after three full weeks of testimony it is scheduled to end today. As you all know, this filing is primarily driven by capital, the more than $650 million of investments we have made since our last rate increase to improve the electric service and better serve our customers. Our top priority is to achieve timely cost recovery to support strong credit metrics. I’m not going to speculate about the outcome. However, thanks to the knowledge and endless hours of preparation of our employees and our witnesses, we are confident that we presented a strong case. At this point, we anticipate a recommended decision by the Hearing Examiner in June with a final ruling by the Commission in July. We expect to implement new rates August 1. Part of our replacement power plant for BART includes adding a natural gas peaker on the San Juan site. On April 26, PNM filed an application for a CCN for an 87 million 80 MW facility. We hope to receive a procedural schedule in the next few weeks with the goal to have the facility online by June 2018 before the summer peak season. I’m also very pleased to say that on March 17, FERC issued an order approving the settlement in the PNM formula transmission rate case, which includes a 10% return on equity. On April 15, the Company made the final compliance filing for the rates that have already been in place. Going forward, rates will be updated annually on June 1, including this year. Over in Texas, on March 23, the PUCT approved TNMP’s most recent TCOS filing and new rates went into effect totaling $4.3 million annually. We plan to make our next TCOS filing in July with rates expected to go into effect in September. Now I’ll turn it over to our Chief Financial Officer, Chuck Eldred, for a more detailed look at the numbers. Charles Eldred Thank you, Pat, and good morning, everyone. I’d also like to say happy admin week for all the administrative assistance that help all of us in our daily work. So beginning on Slide 7, as Pat said earlier, we are reiterating our 2016 guidance of $1.55 to $1.76. As you know, this is a broader range than we typically provide because of our pending rate case at PNM. I want to remind you of the quarterly distribution of earnings that we provided to you when we issued the 2016 guidance. We have provided that information here for your reference. Because of the third quarter rate case implementation, we expect the second half of the year to have a higher percentage of our earnings than we normally see. With Q1 being 8% to 9% of our earnings for the year, our first quarter results of $0.13 is inside the guidance range for the quarter. Turning to Slide 8, let’s review the PNM’s load details. Load at PNM was down 1% compared to the first quarter of 2015. Residential was down but growth in the small commercial sector helps to offset that decrease. Industrial, although only a small portion of overall load, was down 7.2% between the periods. In this group, Intel is a large customer and they continued to show a decline on a year-over-year basis. As many of you are aware, they announced a major restructuring in their business during the first quarter earnings call. We are carefully monitoring the situation. We have received no communication from Intel that they plan to close this site. Our 2016 guidance range for the load of flat to down 2% considers sensitivities for changes to Intel’s load. We continue to see overall improved economic development efforts locally. This resulted in the Albuquerque Metro area having the best month for job creation in March on a year-over-year basis since May of 2007 at 1.6%. The bulk of that job growth was in private sector jobs. We anticipate that the increased focus on growing the private sector jobs will result in a more diverse and resilient economic base. We see some of the results of these efforts in our continued customer growth which is above forecast at 0.7%. Now moving to TNMP’s load on Slide 9, volumetric load for the first quarter of 2016 was down 1.6% compared to the first quarter of last year, but demand-based load was up 1.5% for the same period. Most of TNMP’s commercial and industrial customers are billed based on their peak demand, which is not reflected in the volumetric based load figures. This offsetting impact causes load in total to have a slightly positive financial impact for the quarter of about $0.005. Both volumetric and demand-based load were used to create a load forecast. We continue to expect load for the year to be at an increase of 2% to 3% compared to 2015. As you read in many publications, this has been a warmer and drier winter than normal in Texas. As a result, the quarter to quarter load comparison has likely been skewed by this, particularly in the residential customers as this group is more sensitive to weather. This has been more than an offset in our results by the demand-based customers which are much less sensitive to weather changes. Turning to Texas economy, as we talked about on our last earnings call, it continues to be strong due to its diversified base. While Houston is feeling the impact of the low oil and natural gas prices, the state overall is diversified and this helps to compensate for the weakness in the energy sector. The Permian Basin which TNMP serves a portion of continues to show the most strength in the oil market. We saw that Chevron made an announcement this week that it plans to invest more heavily in this area even though they’ll be cutting costs in other areas. Several other economic factors in the state also continue to show strength, including increases in building permits and existing home sales to name a couple. We see the impact of the strong economy by way of continued higher than forecasted customer growth at 1.6% for the first quarter 2016. Now Slide 10, let’s review the drivers for PNM. We purchased 64 MW of Palo Verde Unit 2 leases in January of this year. The savings from the lease purchase offset by the additional depreciation results in a $0.03 improvement to earnings in the quarter. Outage costs were $0.02 higher. While San Juan had outages in the first quarter 2015 for the SNCR installation, which were not experienced in the first quarter this year, Four Corners had an extensive outage this year. In addition to the planned outages at Four Corners, San Juan Unit 3 had a 12 day unplanned outage. We had higher depreciation and property tax expense of $0.02 due to increased investments. Lower market prices for Palo Verde Unit 3 sales caused results to be $0.02 lower this quarter and interest expense also reduced earnings by $0.02 because of the additional long-term debt that PNM entered into in August of 2015. Load, AFUDC and Navopache FERC Generation contract, each caused results to be $0.01 lower than Q1 of 2015. We also recorded $0.01 in Q1 of 2015 for the cumulative reimbursement of prior year’s Palo Verde spent fuel storage cost that did not repeat in 2016. Now moving to Slide 11, we’ll review TNMP and Corporate drivers. At TNMP, rate relief in the TCOS filings was up $0.01 compared to the first quarter of 2015. Weather was down $0.01 and depreciation and property tax expenses were also higher by $0.01. At Corporate, we were up $0.02 compared to the first quarter of 2015. This change was driven by less interest expense because of the repayment of the 9.25% debt in May of last year and the incremental interest associated with a financing agreement with Westmoreland, offset by additional interest expense from higher short-term debt balances. On a side note, since Westmoreland took over the San Juan Mine on February 1, we have been very pleased with the operational performance of the mine. Thing are running smoothly and the transition has gone very well. Westmoreland taking over the mine has proven to be a great benefit to our customers as well and the associated cost savings helped to offset the rate request that we have before the Commission now. In conclusion, I want to reiterate that we are pleased with the progress so far in the rate case. As Pat indicated, we believe that we have presented a strong case during the hearings. We expect to receive the Hearing Examiner’s recommended decision in June and ultimately to implement new rates at PNM on August 1. As a result, we plan to update our current year guidance to potential earnings power schedules and capital spending forecast during our second quarter earnings call. This concludes my comments and I’ll turn it back over to Pat. Patricia K. Collawn Thanks, Chuck. We are pleased to say that the Company continues to perform well. Customer satisfaction is up. We are confident we presented a strong case to support our rate increase. We continue to execute our plan and manage our businesses effectively and responsibly, and at all times the focus is on our efforts to serve our customers with safe, reliable and environmentally sensitive energy at low prices. I’m also pleased to say that as Chairman of the New Mexico Economic Development Partnership, I’m in a position to see the fruits of all of the policy changes that Governor has made to make New Mexico a more business friendly state. Our pipeline is as robust as I’ve seen it in many years. Thank you for joining us today. Operator, let’s now open it up for questions. Question-and-Answer Session Operator [Operator Instructions] Our first question comes from Ali Agha of SunTrust. Please go ahead. Ali Agha As per the call, Chuck, you mentioned that in your guidance you’ve assumed that new rates go into effect August 1 of this year. Can you remind me, is there some flexibility for the Commission to delay that or push it back, and if so, remind me what the sensitivity is for every month in delay? Charles Eldred I don’t think we have provided that in the guidance of the sensitivity. While Jimmie is taking a look to see what the numbers are, legally they could delay the rate case, the Hearing Examiner or the Commission, up to October 1 of this year. But we’ve seen that the Hearing Examiner, although the one month of lag that you are aware of, has been very disciplined towards trying to stay to this current schedule. So if you looked at the sensitivities, the implementation on August 1, we dropped the earnings about $0.08, and then September 1 it drops down about $0.07, and then $0.06 in October of one implementation of those rates. So you can see that. Jimmie can lead you to the guidance information to give you more detail if you need to reference some of the previous slides that we’ve prepared on that. Ali Agha Right. And then secondly, so if this comes into effect August 1, I recall, I mean if the timeline is not that the San Juan retrofit rate increase should go into effect beginning in 2018, historically has there been any precedents when you’ve had two rate increases in New Mexico so close to each other and is that a concern from a regulatory approval process with two back-to-back rate increases? Patricia K. Collawn Ali, everybody understands that the next one on the primary drivers of that are the San Juan to BART settlement. And so that will have some normal capital spending into it. But I think everybody understands that these are special circumstances with the BART settlement here that state settle for regional haze and will help us with the clean power plant. So long answer, I don’t think it has any worries for us on that. Ali Agha Okay. And then last question, on the load trends, first in New Mexico, any sort of light at the end of the tunnel where we may reach an inflection point and start to see at least load flattening? There’s constant negative trends for the last several quarters, so let me start with that. Are you seeing anything that tells you we may have bottomed out here? Patricia K. Collawn I think I’ll kind of give you a high-level answer, Ali, and then I’ll let Chuck fill in. I think what we’re seeing is the economy is starting to turn around. Chuck mentioned we’ve seen the best job growth since 2007. And I think that you’re seeing most utilities are having negative usage per customer growth on the residential side. They just haven’t seen the customer growth. The job growth here is going to help us bring back the customer growth on that. And as I mentioned, our economic development pipeline looks very strong right now. So we are starting to see some of those turn around. Charles Eldred I mean the trends are beginning to reflect more of a flattening indication on load because what we are benefiting from in the small commercial and some of the growth is being offset by still some of the economic hardship in the area of Albuquerque. But again, we are beginning to see some flattening, hopefully not much of a decrease, but certainly even the sensitivities I mentioned with Intel are still within that zero to negative 2% guidance range that we gave you. Ali Agha Right. And Texas, I think it’s the first time, at least in the recent past, you’ve broken out this demand side and volumetric load trends, but you put them together and you come up to a negative number. I know you mentioned that weather normalization may have been a challenge here, but anything else that concerns you on Texas? I mean we haven’t seen a negative load number there forever I think as far as I can go. Charles Eldred A lot of it, and we mentioned a little bit about the weather being unusual that first quarter that we’re a little sensitive on the weather normalization in that calculation because it was a drier period in Texas, it created a little different kind of adjustment as you think about weather modernization, but we added the demand-based load because we consider that. We could see that with the AMI implementation, we’re getting more readings and shifting customers more to that demand based to be more reflective of the type of customers that they are and providing that tariff. So as we go forward, we’ll continue to incorporate the demand-based load and be more reflective of the expectations of the entire load projections with that consideration. But as I mentioned, the end result even this last quarter was about $0.5 million, so $500,000 benefit on an earnings basis as a result of the load in first quarter. Patricia K. Collawn Ali, I think a key number to look at on that Slide 9 is, our customer growth forecast is 1% and we are at 1.6%. So our territories in Texas are still growing. We don’t see anything and a quarter does not a trend make, just as we kind of good quarter we don’t call it an upswing on the low growth for just one quarter, especially when it was a leap year normalized and a weather normalized and heaven only knows what else in there, it kind of tops out. We’re not changing our forecast on Texas. Ali Agha Understood. Thank you. Operator Our next question comes from Ben [Budis] [ph] of Jefferies. Please go ahead. Anthony Crowdell It’s Anthony Crowdell. I don’t know how it came in as Ben, but that’s okay. I’ve been called worse. On Slide 11 you have $0.01 benefit for the Westmoreland financing agreement for the quarter. Is that something we can annualize and make it $0.04 to $0.05? And when I compare it to the Slide 14, potential earnings power, shouldn’t that offset some of the Corporate and Other because that looks like it has not changed, it’s still at a $0.06 to $0.04 loss? Charles Eldred I think I’ve talked about it even on the last call. The Westmoreland would be about $0.04 benefit to eastern Corporate and Other. So that’s a good indication of what you can expect going forward. We haven’t updated potential earnings power slide to reflect any incorporation of the Westmoreland loan. So we are really intending to wait to the rate case that we have all the information necessary to update the slide. In that point in time, we’ll include the Westmoreland loan. So we just don’t want to put pieces of information out there. We really want to give you more of a comprehensive view based on the major driver, which is the rate case at PNM, to give you a better reflection of how we see all these additional earnings and the impacts of the rate case to be incorporated into the earnings power slide. Anthony Crowdell Great. Thank you so much. Operator Our next question comes from John Barta of KeyBanc. Please go ahead. John Barta So I guess if we go back maybe a month ago, it seemed like ROE, PV2 and the Balanced Draft Technology were probably the most contentious pieces of that rate case. Just after three weeks of hearings, do you have a better feel on any of those items just from talking with the staff, et cetera? Charles Eldred John, we really don’t want to bring any color to the results of the discussions going on, but I think you’ve certainly pointed out some of the areas the intervenors have questioned, but we look at this as a capital rate case. It’s being litigated with the idea that we think we can build the right record on our capital investments as being prudent and reasonable for the utility to maintain the reliability of the business itself. So there is a lot of different factors, so ROE, depreciation, some of the capital items that you’ve mentioned that intervenors had questioned, but again we felt like our testimony and the record that we’ve built was very solid and well justified the Company’s position to recover those costs. John Barta Okay. And then just in Texas on the load growth, so it sounds like the volumetric percentage is going to transition more to the demand-based load over the coming years. Charles Eldred You see the split-out. We really have taken that in consideration because it’s becoming more of a driver as the automated meter reading gives us a more accurate indication of the type of customers, commercial, industrial and the type of demand that they have on the system. It’s more reflective of that now going forward. So you’ll see us evolve into adding that additional component to our load forecast. Again, no concerns about TNMP’s continued guidance in growth of 2% to 3%. Just want to give you another variable how we’re driving towards those numbers. Patricia K. Collawn It’s easier for us to split it out now that we have the data from the automatic meter reading because that’s how it’s billed, and so it just provides another level of transparency. John Barta Okay, thanks. And then have you disclosed how many megawatts in total is? Patricia K. Collawn No. John Barta All right, thank you. Operator Our next question comes from Lasan Johong of Auvila Research Consultants. Please go ahead. Lasan Johong Question on kind of looking forward, in your presentations you put out 2017, 2018, 2019 outlook, have you taken into consideration the changes in Texas potential ORDC regulations, shutting down of the coal plants, build up of solar, more wind power probably as well, and how does that affect – I mean has that all been taken into consideration in your kind of outlook, how are you incorporating that into your outlook? Patricia K. Collawn The nice thing for us now is that since we’re a T&D utility, that really only impact it would have is if energy prices get extremely high over there, I think you would see customers starting to conserve, so our volumetric load might fall. Customers in Texas have been pretty inelastic to price sensitivity there. Their rates for example in Texas are higher than in New Mexico but their usage is a lot more. On the solar side, we’re seeing some solar penetration in Texas but not a lot. Texas does not have net energy metering, and so the solar potential or the solar penetration in Texas has been low, we’re seeing more of it, but so far all of the growth we have seen has been able to overcome that. So the trends we pay more attention to in Texas are sort of the overall economy and particularly our service territory since we’re sort of around Dallas. We’re south and east of Houston in a petrochemical manufacturing area, refining area, and then more over kind of in West Texas. So the thing that drives our numbers is more those general economic positions. And in the outlook we’ve put forward in terms of earnings potential, we haven’t really seen anything that drives us to believe we’ll see a lot of macro changes in the economy. Lasan Johong And based on [indiscernible], any kind of mass migration in customer usage or patterns of switching for example, as prices go up and down, do you think there’s vulnerability with bigger players, such as yourselves relatively speaking, versus smaller players who are more nimble and take more market risk shall we say, you don’t see shifts in customer or switching? Patricia K. Collawn No, we don’t really see that impacting our piece of the business right now. I think obviously the Texas market is in a little bit of flux right now in terms of where they are going to go with their regional haze plans and their clean power plants in terms of where the generation mix is, but we don’t see anything to incorporate into our numbers. Lasan Johong And lastly, Texas has experienced some really bad weather as of late, tornadoes, hurricanes, hailstorms and such. Any impact? Patricia K. Collawn No. The really bad weather that you saw kind of missed our service territories. It was more in the Houston Metro which is center point. So we’ve had some outages and some impacts but nothing major for us. Lasan Johong Great, that’s fantastic. Thank you very much for your time. Operator This concludes our question-and-answer session. I’d like to turn the conference back over to Pat Vincent-Collawn for any closing remarks. Patricia K. Collawn Thank you. And again, thank you all for joining us today. We hope you have a wonderful rest of your day and a wonderful spring and we look forward to talking to you again on the second quarter call. Have a great day. Operator And thank you. Today’s conference has now concluded and we thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful day. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. 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