DTE Energy Company (DTE) — Q3 2017 Earnings Call Transcript

Thank you, Debby, and good morning, everyone. Before we get started, I would like to remind everyone to read the Safe Harbor statement on page two of the presentation, including the reference to forward-looking statements. Our presentation also includes references to operating earnings, which is a non-GAAP financial measure. Please refer to the reconciliation of GAAP net income to operating earnings provided in the appendix of today's presentation. With us this morning is Peter Oleksiak, Senior Vice President and CFO. We also have members of the management team to call on during the Q&A. And now, I'll turn it over to Peter.

Thanks, Barbara, and good morning to everyone and thank you for joining us today. First, no DTE earnings call would be complete without an update on my Detroit Tigers and Lions football. Here today, I am disappointed to say that for the second straight year, the Tigers did not make the postseason and traded away most of the veteran players. Actually, Justin Verlander is pitching tonight in the World Series, so I wish him luck. The good news is that for the Tigers, we do get the number one pick for the 2018 season, so every ending has a new beginning. And as always, I look forward to a greater season next year. Now, onto the update on DTE. Like last year, we’re keeping today's call focused on the quarter and our attention on the current year. The longer-term strategy and growth related questions will be deferred to the EEI Conference, which is only a couple of weeks away. At EEI, Gerry Anderson will provide our detailed business update. This update will include our 2018 early outlook, our long-term growth plans as well as details about each of our business segments. Now, I would like to start on slide three. Given our continued strong year-to-date results, we’re increasing the guidance midpoint by $0.12 to a range of $5.38 to $5.69 from a range of $5.26 to $5.57. The guidance increase is driven by our gas storage and pipeline and power industrial segments, which I'll discuss in more detail in a few minutes. Before I get into financials, I want to shift to another area where we are seeing great results, which is residential customer satisfaction. I'm particularly pleased to announce that we ranked second in the residential customer satisfaction at both DTE Electric and DTE Gas. Moving on to updates at our non-utility businesses. Since our last earnings call, our gas storage and pipeline business received FERC approval for both NEXUS and the CPP lateral projects. We are targeting 2018 in-service for both. We also have great news at our power industrial projects businesses. The agreement on the industrial energy services project we just closed on the last earnings call was finalized, and I can tell you now that the project is part of Ford Motor Company's campus upgrade. Powering Ford’s new research and engineering center, DTE will own and operate the new state-of-the-art energy center, using modern efficient and green energy. This facility is expected to begin operations in late 2019. We also have a great pipeline of projects in development to follow the ones we’ve announced this year, and we’ll continue to update you as they progress. At EEI, we’ll give you a more detailed description of the types of investments we are targeting. Now, I would like to go to the third-quarter earnings results on slide four. For the quarter, DTE Energy’s operating earnings were $264 million or $1.48 per share. For reference, our reported earnings were $1.51 per share, and you can find a reconciliation of the third quarter reported operating earnings in the appendix. For the quarter, our growth segment’s operating earnings were $274 million or $1.53 per share. Electric segment was lower by $63 million quarter-over-quarter. This quarter was considerably cooler than 2016, which was one of the warmest on record, driving much of the unfavorable results. DTE Gas was lower by $9 million quarter-over-quarter, primarily driven by the timing of the GAAP main renewal revenue and higher O&M expenses. As I mentioned on previous calls, with more of the gas made on renewal revenue and base rates, revenue was expected to be proportionally lower in the second and third quarters and higher in the first and fourth quarters and will not affect the full year earnings. For the gas storage and pipeline segment, third quarter earnings were higher by $8 million versus last year, driven by the linked acquisition and higher pipeline and gathering earnings. Our power industrial project segment was higher by $9 million quarter-over-quarter, primarily due to higher REF volumes and new sites coming online late 2016. Now, I'll talk more about this favorability when I discuss the guidance increases. Our corporate and other segment earnings were $14 million unfavorable versus last year, mainly due to the timing of taxes between the two years. Overall, the gross segment results for the quarter were $274 million or $1.53 per share. Energy trading loss was $10 million operating earnings at $3 million in economic net income for the quarter, and our trading is having a solid year and is on track to achieve its economic contribution target. Please refer to the appendix review of the energy trading standard reconciliation slide, which shows both economic and operating income performance. Overall, we had a strong quarter. Let's move on to slide five to discuss how this projection plays out in our full-year guidance. As I mentioned at the start of the call, our EPS guidance range for DTE Energy is now $5.38 to $5.69, up from a range of $5.26 to $5.57. We are increasing the midpoint of the 2017 EPS guidance by $0.12 from $5.42 per share to $5.54 per share based on the continued strength at our non-utility segments. For our GSP segment, we are seeing favorable results with the linked acquisition and pipeline of gathering earnings. At P&I, we’re able to capture additional value from the REF business with two new high production sites. Longer-term, our 5% to 7% growth rate continues to support our original 2017 guidance, whether normalized as utilities and also normalized as the favorability of P&I from our REF facilities. Before I get into nuances of the earnings guidance change for our P&I segment, I would like to step back and discuss the overall value creation with the REF projects just to set the context. As you recall, the REF projects and facilities make additives with coal to produce fuel that reduces emissions from the coal-fired power plants. The REF projects included tax credit incentives that can be generated over the fine 10-year life. The initial products came online at the end of 2009, and when Congress extended the refined coal tax credit program, a second tranche of projects was developed and brought online at the end of 2011. Since that time, we saw ways to increase the value of the projects by entering into strategic transactions with utility and investor partners. These transactions are completed to increase REF production, optimize cash flow, and minimize operating risks. The timing of entering these transactions changes our earnings and cash profile. Tax credits generated are recognized immediately as earnings, which can then be utilized in the future to reduce federal income taxes. When transactions with investor partners are completed, they receive their earned portion of the projected tax credit allocation, which increases our near-term cash flow while decreasing earnings. Now, let's move back to the 2017 guidance update for the P&I segment, where we see some of this impact playing out. We see this guidance change is tied to additional REF projects we developed last year with both a relocation and acquisition, generating earnings for us and our shareholders. We're now in the process of looking for investor partners. We have done this already with many of our existing units, and when these partnerships are executed, they will be value and cash accretive to the enterprise and will reduce earnings. Until we find partners, we realize higher earnings in the near term on these projects. Finding these investor partners will maximize the NPV of these assets. The exact timing of when we enter these partnerships is driven by two factors; one is the cabinet units run for a period of time to maximize performance; and the second is finding the optimal partner to maximize cash values. Over the remaining lives of the projects, we will continue to maximize the value of the REF business line by performing potential relocations to higher volume sites or the acquisition of additional third-party units where we can create value. This business line has and will continue to deliver significant earnings and cash benefits to our bottom line. Now, let’s move to slide six to discuss cash and capital guidance. In addition to the solid earnings results, our cash flow and balance sheet remain strong and continue to support our long-term growth plan. Based on the year-to-date results, we're updating our cash flow and capital expenditure guidance with the change related to capital. Taking a closer look at the capital expenditures on the right side of the page, we show that the capital expenditures by business unit. We still expect to invest nearly $2 billion in our utility this year. This includes $1.5 billion at DTE Electric, driven by investments in our distribution system, and $400 million at DTE Gas, driven by investments in base infrastructure and main renewal. With the capital investments that have occurred over the past years at DTE Gas, we're likely to file our rate case by the end of this year. We have decreased our non-utility capital guidance by $500 million, which is due to the retiming of the construction of the NEXUS project. As I mentioned earlier, we're targeting a third quarter 2018 NEXUS in-service date. This brings our total capital expenditure to approximately $2.5 billion for the year. Now I'd like to wrap up on slide seven, then we can open the line for questions. We had another successful quarter, and we're in a great position to exceed our original EPS guidance this year, looking to extend our streak to 11 consecutive years of meeting or exceeding initial EPS guidance. We’re investing heavily in our utilities by upgrading our aging infrastructure and improving our customer experience. We're executing on growth opportunities at our non-utility businesses, most notably with Link and NEXUS at GSP and the recent industrial energy services project at P&I at the Ford complex. We continue to maintain a strong balance sheet, which sets us up nicely for future growth opportunities. During this period of significant investments, as we begin to transform our electric generation fleet and the strength of our utilities combined with the growth for our non-utilities gives me a lot of confidence that we’re continuing to deliver premium shareholder return. In closing, I would like to remind everyone that Gerry Anderson will be giving a presentation at the upcoming EEI conference on November 7th. This update and his update will include an early outlook for 2018 and an update on our long-term growth plan. There will be a webcast on our investor relations website, and we hope to see many of you there. Now, I would like to open it up for questions. As I mentioned at the beginning of the call, we would like to focus the questions on the current quarter and year. I also have members of the management team with me whom I may call upon to answer your questions. So Debby, you can open up the line for questions.

Maybe you could talk a little bit more about how far you are on track to P&I replacement of one-third of the expected $40 million for new projects that you have targeted for 2021?

Yes, we have announced three projects this year. This quarter, we announced the details that we’ve been discussing regarding the Industrial Energy services project with the Ford complex. So this is a visible sign that we are currently one-third of the way there in terms of backfill. We are targeting at this point $40 million to backfill for 2020, which is a portion of the REF of earnings, based on short duration contracts. We have asked the Power and Industrial segment to backfill a portion of that with long-term contracted earnings. We also have a great pipeline of additional opportunities that we’re looking at, and at EEI, we’re actually going to go into more detail regarding the nature of these types of opportunities.

And for NEXUS, when do you expect to start construction and is there any remaining FERC rate issues that need to be dealt with?

Michael, we actually commenced construction on the 16th of October, so we’re underway. It’s primarily right-of-way work that we’re beginning with. We have a plan to do a number of HDDs working on the compressor stations, and that will play out over the course of the winter, with mainline pipeline construction commencing in the spring.

I'm table-ing the questions on Power and Industrial’s future outlook for EEI, since you requested that. When we look at the quarter, the underlying growth trends that you’re seeing in terms of economic outlook at DTE Electric, I know the weather has had a significant impact on earnings over the last few quarters. We’re seeing strong economic activity across the board here. My Chief Economist this morning just pointed out how strong the data looks, both in the U.S. and globally. Are you seeing any signs of accelerating growth from the auto industry or other big industrial segments in your service territory, and how would that impact your outlook?

We are seeing for us the best indication of the underlying economic growth as we take a look at customer accounts within the region. We are observing a steady increase over the last five or six years of about 0.5%. Overall, the Michigan economy has been diversifying over the years, and I think it’s solid. We continue to see solid performance. Regarding the automotives, they are currently at a pretty high level of 18 million units, and now they’re talking about 16 million units, which is still a good level for them to achieve some profitability. I would say it's more characterized as solid economic performance in Michigan.

So you’re not witnessing any change to the upside?

We’re still projecting relatively flat loads, probably underlying growth around 1%, but we continue to see energy efficiency occurring, and we have a robust energy efficiency program that’s delivering dividends for us. However, we’re planning for relatively flat financial performance.

A quick question on the P&I side: Does the additional projects have shifted the roll-off and timing of those credits at all by any meaningful amount? Or is that still the expectation that you laid out before?

The expectation is there will be a roll-off in 2020 and then 2022. These projects have been good for us, as you know—bringing in lots of earnings and cash. So these additional projects will provide more cash; we have significant investment programs ahead of us. But we are targeting right now, and you will hear at EEI, we’re really aiming for a non-REF state post-REF for each of the business lines, and we’ll give an update at EEI.

Can you talk a little bit about the change in the non-utility CapEx? There are moves in NEXUS, etc. but anything else we should be aware of?

No, it’s primarily related to NEXUS.

Regarding the utility, some of your peers are talking about green tariffs and offering those as another growth avenue at the electric utility side in Michigan. Is there any opportunity on your side that you guys are looking at?

We do have a green tariff and obviously we’ll continue to work; that’s definitely an area of focus for us with our commission and our customers.

Let me just, I know you're going to discuss this at EEI. But from your prepared comments, it seems like you’ve done a very good job of filling any gaps as the earnings stepped down. There doesn’t appear to be a concern that the additional incremental sites are contributing to an increasing earnings cliff. Could you discuss how you’re approaching this?

That is a good question. The REF units do provide more than we originally had, but it’s really cash that will help us in the near term. We are currently targeting a post-REF growth of about 5% to 7%. However, I wouldn’t characterize it as additional earnings, but rather additional cash. We will continue optimizing this business unit over the next year to continue delivering value and cash.

On NEXUS, do you plan on providing any update as far as any affirm commitments to connection agreements at EEI?

At EEI, we will definitely provide a more thorough update around NEXUS, and how we see it evolving. We’ll also likely provide a sense of where we are in terms of looking at potential opportunities related to contracts.

You mentioned filing a rate case, but is that planned for the end of this year?

Yes, the plan is to file for our gas utility at the end of this year.

Just to clarify, I think with Julian's question, these new sites at REF don’t change the timing of the wind-down, but rather are more cash producing?

Exactly, that is how to think about it.

NEXUS has slipped from late 2017 to 3Q 2018. Is it still negligible impact on earnings for 2018?

Yes, to think about it is that we do get the AFUDC accounting, as we’ve discussed. So it is a pretty minor impact for 2018.

On the guidance increase this year for the P&I segment, is that all due to REF or is there anything else going on behind the scenes?

It is all REF, and we’ve had two guidance changes. The first one was also related to REF, based on volume and capacity performing well at existing sites. This latest change pertains to new incremental units that we have.

So the rest of P&I is just unchanged, or has that actually shrunk while REF is growing more? What are the dynamics between the two?

To think about this from a normalized perspective, go back to your original guidance for that segment; that’s the best way to understand it.

And all of the increases are related to REF?

Yes, that is correct.

Regarding these tax credits, has there been any discussion about them potentially being extended, given the administration's focus on coal and the initiatives that could be different from the past?

We do not anticipate any extensions at this point in time.

Is the Ford deal related to the large CHP deal you’ve been discussing since the beginning of the year?

That is correct, Jonathan. This is indeed a significant project we’re excited about.

Are the other two Landfill Gas transactions you announced a couple of quarters back related to this as well?

That is correct. We’ll provide more updates around the nature of these new opportunities and how we’re evaluating them in this segment.

Peter, regarding the Ford project, do you have an ongoing relationship with Ford? Is this just a one-off, or should we anticipate that Gerry will discuss what’s downstream with Ford regarding additional CHP projects?

This project is really significant. They’re going through a transformation, upgrading their campus. This research engineering center is one project among others they wish to develop. They wanted to have renewable and green power there and partnered with us. While this is a standalone project for now, we’re very excited working with Ford on this.

You have assembly plants, but are you providing similar service there or not? I don’t recall.

Yes, onsite energy. We provide onsite power and chilled water utility type of services at the assembly plants. However, this is specifically related to the new construction on their campus, particularly at their engineering center.

I want to clarify the REF situation. I'm not entirely clear on the business dynamics. You mentioned partnerships and I was wondering if you could elaborate more on the impact or what was missing in terms of clarity.

Absolutely, I’ll clarify. These projects generate tax credits; that’s where the value lies. These tax credits are paramount for us and we can utilize them in the future for tax relief. Looking at our cash position right now concerning our taxes makes it logical to enter into partnerships where we essentially sell a pro-rata piece of that partnership and the credits. In the meantime, we're experiencing strong earnings from these projects, but we’ll be establishing partnerships, leading to an earnings-to-cash trade-off. You’ll see this within the segment over the next year or two as we explore further relocations; you might see a temporary bump in earnings due to tax credits, but as we prioritize cash and value, earnings may be adjusted.

So this would be a temporary benefit seen through increased REF tax credits, which will decrease as you monetize them with partners. Is that the way to perceive it?

Exactly; that’s the right perspective to have.

Regarding the Ford deal, what’s the associated CapEx with that project?

We haven’t disclosed that amount as of yet. However, it is a great investment for us and part of our overall backfill strategy for our REF units.

Actually, all my questions have been asked. Just a follow-up on the Ford announcement. Is this a one-off, or there are no extension opportunities with that particular project?

This is a significant standalone project for us. However, we are looking at similar types of financial projects with different customers. For now, this particular one is unique, and we’re very excited to be collaborating with Ford on it.

At EEI, will we receive numbers regarding that project to gauge the opportunity for future similar projects, or will it be part of the overall guidance you've mentioned?

We will provide a description of this area and the nature of potential opportunities in this domain at EEI.

Regarding monetizing the REF credits moving forward, do you have a deferred balance that you would monetize, or is it just selling their earnings stream?

It's primarily about selling the earnings stream. We do have a deferred balance in our balance sheet, and that's an aspect we evaluate periodically, assessing the cash value against future tax benefits versus the merits of entering into partnerships.

How many REF projects are you currently managing?

At the moment, we have 11 projects.

In the original guidance from EEI last year, I believe the P&I segment was pegged at around $90 million to $100 million. What percentage or amount is REF included in that projection?

We do not provide that level of disclosure. However, I can inform you that this segment is predominantly supported by REF projects, which is why we’ve initiated a backfill strategy. We get a lot of short-term earnings from these arrangements, and part of that will transition into the P&I segment for backfilling. The straightforward answer is that most of our current earnings are derived from REF, which is why we are looking at new projects.

Does the original guidance indicate there were seven REF projects mentioned? So we are now up to 11?

The original guidance does indicate 11 currently. We have two new incremental projects, one involving relocation and one being an acquisition, which underlines the timeline for building partnerships. We’re timing these projects and realizing earnings from tax credits. When we engage these partnerships, we’ll start seeing cash flow improvements.

The growth rate of 5% to 7% is based on the original guidance, and that’s what we should utilize as a foundation for project progression through the years?

Yes, I would say that would be the best approach for the time being.

And what is the original guidance figure?

It was a midpoint of 5.31. We should aim for around 5% to 7% growth off the original guidance.

Thank you, everybody, for joining us this morning. I look forward to seeing many of you here at the EEI in a couple of weeks. I believe we have a solid message to convey, and we’ll provide updates as I mentioned earlier. Until then, have a great rest of the day.