SEMG Q3 2018 Earnings Call
Operator: Good morning, ladies and gentlemen, and welcome to the SemGroup’s Third Quarter 2018 Earnings Conference Call. As a reminder, this call is being recorded. [Operator Instructions] I would now like to turn the call over to SemGroup’s Head of Investor Relations, Alisa Perkins. Please, go ahead.
Alisa Perkins: Thank you, Carl. Good morning, everyone. Before we begin, I would like to remind you that our earnings release and presentation for today’s call include projections, forward-looking statements and certain non-GAAP financial measures. We encourage you to read our full disclosures in our latest press release, slide presentation, and SEC filings for a discussion of those items, including reconciliations to GAAP financial measures. Hosting the call today is Carlin Conner, our CEO; and Bob Fitzgerald, our CFO. With that, let me turn the call over to Carlin.
Carlin Conner: Thank you, Alisa, and good morning, everyone. We are glad to be here today to review SemGroup’s financial performance for the third quarter and provide an update on our activities. I’m very pleased with the continued progress in executing our strategy by increasing the quality of our cash flows while organically growing our core areas. Three of our segments reported a solid third quarter, however, total adjusted EBITDA came in slightly lower than expected, largely driven by inventory timing issues in Supply and Logistics, coupled with unplanned startup costs associated with the new HFOTCO tanks. Bob will provide more segment performance details in a few moments. During the third quarter, the crude expansion project at HFOTCO came online. If you recall, this expansion is fully supported with a 10 year take-or-pay commitment with a large Houston ship channel refiner. Our previously announced Wapiti plant which we expect to be fully contracted by year-end is scheduled to come online during the second quarter of 2019. This plant will provide another step-up in our total cash flow, while expanding our reach into the Montney. These projects are examples of how we continue to deliver secure cash flow, while contributing to the growth of our transformed portfolio. In all, nearly 60% of our gross margin is supported by take-or-pay contracts, underpinning our strong 1.4 times dividend coverage ratio. We continue to maintain a sharp focus on our balance sheet and have been very active executing our capital raise. Selling noncore assets, while executing on key JV concepts and a very efficient corporate pref has raised over $1 billion at an attractive cost of capital. We recently closed the sale of an interest in Maurepas Pipeline, which we have a five-year option to buy back at a 1% per annum premium, which is again very attractive terms. And we are not done yet. We’re continuing to evaluate creative ways to raise incremental capital. In terms of future asset sales or joint ventures, we remain very intentional in keeping as many options open as possible. Our execution to date has been consistent with our objectives, and we will continue to be thoughtful, diligent and opportunistic as we fund future growth and maintain balance sheet strength. Project execution and asset utilization remains a priority across our key operating areas. Generally, volumes remained strong across our systems. In the past few weeks, we have seen crude loading start decline which supports our view that crude exports will continue to grow through our system. To facilitate this growth, we’re moving forward with the Moore Road Pipeline connectivity project at HFOTCO, which will improve our access to various long-haul, inbound delivery systems while adding outbound pipeline connectivity. Our deep water docks, incremental waterfront opportunities, last mile crude distribution system and additional real estate for significant tank capacity expansion positions us well to capture incremental volumes driven by regional markets and exports. In addition, contracting of heated tanks at HFOTCO continues as planned, and we are proactively high-grading customers in contracts. IMO 2020 will drive the need for product segregation, blending and development of new high sulfur fuel oil markets. Our position as a heated product hub with by far the most liquidity in the market will continue to provide logistical solutions for heated products. For instance, we are utilizing heated tankage for products such as VGO, an intermediate refinery feedstock. This creative and efficient service offering leverages our crude pipeline refinery connectivity as well as our heating infrastructure. Adding more refinery customers underscores the asset dependence that HFOTCO has created on the Houston ship channel. Moving north to Cushing. The recent market shift from backwardation to contango is driving increased interest in recontracting Cushing tanks. White Cliffs Pipeline, thanks to our incentive tariff strategy, continues to outperform our volume metric projections. Growing production in the DJ Basin coupled with the redeployment of one of our 12-inch crude pipes to NGL service should help mitigate future contract renewal risk. As we continue to develop our crude footprint across the Mid-Continent and the Gulf Coast, we are identifying potential incremental projects that will provide integrated solutions by leveraging and connecting our assets. For instance, we are pursuing projects that can offer customers seamless connectivity from the Rockies through Cushing all the way to the Houston ship channel. These projects contemplate leveraging existing assets which will allow us to offer attractive tariffs while also preserving crude quality. In Canada, we took another step in the Montney region by starting construction on our Pipestone pipeline system. The pipeline is fully committed with a 15-year take-or-pay agreement and will deliver gas to our Wapiti gas plant for processing. It will also enable operational flexibility to connect to our proposed new sour gas plant in the Pipestone area, which the Alberta Energy Regulator recently approved. Having this license in hand, which can take up to two years to obtain provides us with an option to commence construction on an accelerated time line if commercial arrangements support an investment decision. In addition, the Smoke Lake plant will be coming online in late 2019 with the majority of CapEx contracted. With respect to the open season for the Montney to market liquids pipeline project, we continued to have commercial interest, and we hope to make a final investment decision in the near future. We’ve had an active quarter on the execution and commercial fronts. For a closer look at our financial results, I will now hand the call over to Bob.
Bob Fitzgerald: Thanks, Carlin. Yesterday, SemGroup reported net income of $8.4 million for the third quarter compared to a net loss of $2.7 million in the prior quarter. The increase in net income is primarily due to an unrealized gain on commodity derivatives recognized during the third quarter. Third quarter adjusted EBITDA was nearly $97 million compared to $99 million in the second quarter. While the third quarter benefited from the impact of higher gas volumes in the Mid-Continent as well as contributions from the recently completed expansion at HFOTCO, we reported lower margins in Crude Supply and Logistics primarily due to inventory cost accounting timing. As Carlin mentioned, we saw improved segment profit during the quarter in three of our segments. Crude Transportation’s third quarter segment profit was up slightly due to lower operating cost, partially offset by expected decrease in White Cliffs Pipeline volumes as a key producer moved a portion of uncommitted barrels to rail to capture greater basis differentials. We expect volumes to strengthen slightly during the fourth quarter as production continues to ramp up and shippers seek low-cost transportation options. Crude Facilities reported third quarter profit of $8 million, down $1.5 million from the second quarter as the prior quarter benefited from take-or-pay timing. In addition, the third quarter had a temporary drop in Cushing utilization, as we staged several tanks to a new counterparty. Although, we continue to see a softening of Cushing storage rates, recent market dynamics including new connectivity options and more favorable price curves are supporting firmer rates in the future. Crude Supply and Logistics recorded a $7 million segment loss during the third quarter. The segment was adversely impacted by inventory cost timings, which we expect to recover in the fourth quarter due to the built-in inventory gain we had at the end of the third quarter but not recognized in our financial results due to GAAP accounting rules. Additionally, we are still not fully recovering our cost related to our take-or-pay positions. However, due to the widening of the Bakken to Nederland price differentials, we’re seeing improvement in that metric already in the fourth quarter and expect that to continue in the near term. At this point, we’re forecasting this segment to come closer to breakeven for the fourth quarter. HFOTCO posted third quarter profit of $36 million, up slightly from the second quarter. While the completion of new projects contributed to increased earnings, this was somewhat offset by a few onetime items, including higher operating costs at $1.2 million related to the startup of the new tanks. Also during the third quarter, HFOTCO experienced the decline in throughput volumes driven by fewer export loadings. However, we’ve seen a shift back to expected volumes thus far in the fourth quarter. Turning to SemGas. Third quarter segment profit was nearly $20 million, up from $15 million in the previous quarter. This increase is driven by higher commodity prices as well as increase in volumes. Looking forward, we expect to see a drop in our stack volumes due to an incremental third-party processing coming online in the stack in late fourth quarter or early first quarter 2019. SemCAMS' results were down slightly, as we saw a decrease in operating cost recoveries during the quarter. Moving next to our 2018 guidance. We are updating our full-year adjusted EBITDA guidance to $385 million to $400 million, reflecting a midpoint change of just under 2% or $7.5 million from previous guidance. This update is driven primarily by the impact of onetime items during the year. As a reminder, during the first quarter, HFOTCO posted a $4.2 million insurance claim write-off that was not factored into our original guidance, and we had a onetime charge – startup charge of $1.2 million this quarter. In addition, lower-than-expected margins in Crude Supply and Logistics contributed to our updated guidance range. Regarding the HFOTCO insurance claim, we believe we are entitled to recover cost and are currently pursuing recovery with the underwriter. I should point out that we’ll continue to consolidate 100% of Maurepas Pipeline results following the partial sale in October. Our adjusted EBITDA results will reflected the full value of Maurepas, thus not impacting comparability between quarters. However, we will adjust our leverage and cash available for dividends calculations to only reflect the cash distributions received in computing our future metrics. Looking at full year capital expenditures, we increased our 2018 CapEx guidance by $10 million or 3% to reflect the expected current year spending on the Pipestone Pipeline project. The total cost of that project is $40 million, with the remainder of that spending to occur in 2019. We also added the Moore Road pipeline project to our capital project inventory as noted on Slide 8. That project is estimated to cost $65 million to build with most of the capital spending during 2019. We currently plan to issue 2019 guidance as part of our year-end earnings report. But I want to highlight that 2019 will not only benefit from a full year of the HFOTCO expansion project but also reflect approximately three quarters of the first year’s earnings from the Wapiti gas plant. These projects along with increasing fixed fee revenues and improving supply and logistics margins will drive higher earnings in 2019. We’ll provide more details on 2019 capital plan and earnings expectations during our February Investor Call. Turning to SemGroup’s leverage and liquidity. On October 22, we closed the sale of a 49% interest in Maurepas Pipeline for $350 million. On a pro forma basis, including the proceeds from the sale, we ended the quarter with a total consolidated net leverage ratio of 5.4 times and consolidated available liquidity of $932 million. To date, we raised approximately $1.15 billion in capital, and remain focused on reducing consolidated leverage to under five times by the end of 2019. I will now turn the call back over to Carlin for closing comments.
Carlin Conner: Thanks, Bob. 2018 has been a very active year. We have furthered the transformation of our portfolio and continue to execute on strategic opportunities. Our assets are positioned for growth at favorable multiples and are supported by stable cash flows. As we explore options to better serve our customers, we commit to always do so in a safe and a responsible manner. We believe our focus and persistence on executing our well-defined strategy while operating efficiently will ultimately deliver long-term shareholder value. With that, I’d like to thank you for your time this morning, and now turning the call over for questions. Operator?
Operator: Thank you very much sir. [Operator Instructions] Our first question is from Tristan Richardson of SunTrust.
Bronson Fleig: Hi, good morning. This is actually Bronson Fleig filling in for Tristan. We appreciate the color on the dynamics behind the narrowing of the 2018 guidance. I guess specifically as it relates to S&L, looks like some of the loss will be recovered in the fourth quarter. We’re just curious on the outlook for the balance of the year for the ethanol business?
Bob Fitzgerald: Bronson, this is Bob. I’ll take that. As we said, I think it was back in our February earnings call, we gave a little bit of color on our guidance for that segment. We initially expected $10 million to $15 million segment loss. At this point, given that we’re looking at about a breakeven or so fourth quarter, we expect to be somewhere in that $16 million segment loss for the year. And it’s – some of that’s going to dependent upon what happens at the end of the year with our inventory costing and the GAAP accounting as well. That tends to create a little volatility quarter to quarter, obviously, as we saw in this third quarter. But right now, we’re looking at it from more operationally to be above that, give or take, $16 million loss on a segment profit basis.
Bronson Fleig: Okay, great. Thanks for that color. And then one more from us. Regarding the Moore Road Pipeline. In the supplemental materials, there’s a mention of a 4 to 8 times EBITDA multiple range. Just curious on the assumptions behind that? What would bring returns to the high end of the rate range? And is there any S&L component?
Carlin Conner: Yes, this is Carlin. Moore Road is a pipeline connection junction, let’s call it. It’s a 36-inch pipe that kind of provides the HFOTCO connectivity to several pipes that are in the Moore Road vicinity. The reason we have a range on the expected multiple is that there is – there are definitely incremental economics that are very direct associated with the delivery of crude on that line, but then there’s also we think, quite a bit of other opportunities that, that line will provide for us. So when you kind of look at overall value that’s created, you could assign some of the – some other EBITDA to that calculation. I would even go so far to say that it’s potentially even more valuable than the four times that we put on the low – on the high end of that range. It’s an essential part of the HFOTCO strategy. It really enhances our connectivity, and we feel really good about getting that project going. There are no S&L economics associated with that multiple. That is from an asset point of view. Anybody that’s marketing at HFOTCO will probably utilize that asset. So if we’re ever marketing at HFOTCO, our S&L Group will probably be utilizing that asset.
Bronson Fleig: Great, thanks for all the details Carlin, that’s it from us.
Operator: Thank you very much. [Operator Instructions] Sir, it would appear that we have no further questions. My apologies, we do have a question from Ryan Levine from Citi. Please go ahead.
Ryan Levine: Good morning. Just wanted to follow up on potential new White Cliff contracting given the recent election results in Colorado. Would – has there been any new strategy as to how you’d approach new customers? Or how – has that activity been – has been dead relatively over the last few weeks as a result of the pending election and is that likely to change?
Carlin Conner: Ryan, this is Carlin. Yes, you can imagine that probably anybody who was willing to put any commitments on the table, renegotiate any contracts with the 112 Prop coming to vote. So now that’s behind us. We definitely expect that commercial discussions around a myriad of options and projects that we’re working on, that we’ll start having some in earnest discussions and then trying to hopefully get to commercial agreements.
Ryan Levine: Okay. Is there any color as to the near-term priorities there? Or if you may take a different recontracting strategy in light of the more favorable decision?
Carlin Conner: Well, you may have picked up on the script, we believe that there are opportunities to fully integrate our position in the Rockies, and provide maybe integrated services all the way down to the Gulf Coast into our HFOTCO facility. We have some really interesting ideas utilizing existing assets coupled with some new construction, and these projects will now be able to be fully discussed and then hopefully commercialized. I can’t really add more to it. It’s a very competitive environment, but we expect to have some really interesting projects to talk about in the real near future.
Ryan Levine: Okay. I guess one follow-up on that. Those competitive projects, that was announced recently with the joint tariff down to Cushing. Would you – are you looking to do something similar? Or is there any resources that you could bring to bear to gain participation in similar to have a joint tariff?
Carlin Conner: Well, we’re responding to what customers are needing, and what we realized was customers want to have access and optionality. And being able to deliver crude that’s produced in a region that had limited market access and be able to connect markets and provide that customer with better clarity on the quality of crude oil being received at the very end of the system as well as at a tariff that’s very competitive. If you can deliver those two things then you’re going to be potentially a winner in that race. We think we have a project that’s going to be very competitive from a tariff point of view and then also from a quality point of view is going to be able to maintain the quality of the crude going all the way through the system, all the way towards the water. We think that’s probably pretty unique in this space right now.
Ryan Levine: Great. Thank you.
Operator: Thank you very much. The next question is from Elvira Scotto of RBC Capital Markets.
Elvira Scotto: Hi, good morning everyone. So can you just provide us – you touched on this a little bit, but maybe a little more around your Cushing storage recontracting efforts and your outlook on utilization going forward?
Carlin Conner: Yes, so I think we talked about this. Our guidance around Cushing is we were maintaining that 95% to 100% utilization. The – what we have seen over the last six months to nine months as you would expect with the backward-dated market, the conditions to recontract were not very favorable for us. We did plow through, and we renegotiated some contracts in that environment at lower rates than our average low 30s. We still feel fairly confident and optimistic that 2019 and 2020 will give us a little more pricing power, and as we continue to recontract going forward. As you know, we have a pretty heavy load of recontracting every year at Cushing. So – and we’re looking forward to the market conditions providing some support for hopefully getting some of the contracts done. So we continue to chop wood off our Cushing markets in a better place, but we still have some work to do.
Elvira Scotto: Got you. And then just a follow up on the potential to maybe move crude through your system and then potentially all the way down to the coast. So is that – are you – is this contemplating moving crude on White Cliff down to Cushing and then building a new pipe from Cushing down to the coast, partnering with one of these announced potential projects that talking about moving out of Cushing, or can you provide any more detail around that?
Carlin Conner: It’s premature to probably provide any more detail. I’m confident enough to say that we will be probably going to an open season very quickly. So you’ll learn more real soon. It is a project that will be utilizing some of our existing assets, and there’ll be some new assets that will be added to the system to allow for that move to happen. And again the key with that project is providing clarity to producers and oil traders. The clarity that they can see all the way from the DJ all the way towards the water and to the water and be able to preserve the quality of crude at a very attractive tariff.
Elvira Scotto: Got you. And – so we’ll look forward to seeing more on that on the open season. And then just the last one for me, just any potential for more or a faster deleveraging?
Bob Fitzgerald: Yes, as Carlin noted – Elvira, this is Bob. We’re continuing and are still in the process of looking at a lot of different options. We are very focused and committed to driving down that leverage through next year. If we could do it sooner, that would be something that we definitely want to do. The key is that we to be really smart and deliberate about how we do it. And so we constantly look at the cost of capital. We look at the implications to our strategy if it involves existing assets. And we’re going to be very careful about it. So we’re going to be focused on it. I can’t tell you right now. We’re going to try to accelerate it or not. We definitely have things that we’re looking at. And there’s still as there has been a lot of interest from private equity, private capital to go to work. And we think that bodes well for us to be creative.
Carlin Conner: And Elvira, I’ll add that the past execution around this point, I think has been really strong. When you look at the cost of capital, the projects that we’ve done are very, very efficient and effective. I would hope that as we move forward, we’ll continue to be that creative and diligent. And that’s the expectation. So we will definitely have more to share at some point, and we continue to work that problem.
Elvira Scotto: Great. Thanks, that’s all I had.
Operator: Thank you very much. Ladies and gentlemen, that concludes our question-and-answer session. I would now like to turn the conference back over to Carlin Conner for some closing remarks.
Carlin Conner: Thank you all very much for joining us today. We appreciate your continued interest and support. Have a good day.