Sempra (SRE) — Q2 2016 Earnings Call Transcript

Thanks, Rick, and thanks to all of you who were able to make it to our Analyst Conference a few weeks ago. We couldn't have asked for better attendance and enjoy being able to talk to you in person and listen to your feedback. Based on our year-to-date results, I will start by reaffirming our 2016 adjusted EPS guidance range of $4.60 per share to $5 per share. Joe will review the details of this quarter's results. But first let me take some time to address the strategic goals we have for the Natural Gas business. We previously disclosed the sale of our interest in REX which negatively impacted our quarterly results. We also expect losses in this segment in 2016 and 2017, which are incorporated into our adjusted guidance. Our decision to sell REX reflects the implementation of our strategy for the Natural Gas business to focus our investments around our anchor LNG assets where we have competitive advantages. We also decided to sell our Southeast utilities and TdM and redeploy the capital on assets that better align with our strategy and provide stronger long-term growth. I'd like to spend a minute reiterating the value proposition that we believe is top tier among our utility industry peers and that is a result of Sempra's long-term strategy. First, our strategy continues to provide the building blocks for high total shareholder return. Our base plan projections resulted in an approximate 12% adjusted earnings per share compound growth rate through 2020. Second, we plan to grow the dividend 8% to 9% annually. Third, we have a healthy balance sheet with significant projected credit capacity in the latter years of the plan, which gives us several options to return value to our shareholders. Four, our businesses have great development platforms with a long runway of opportunities. Finally, with those development opportunities, we are committed to our strategy of long-term contracted infrastructure and utility earnings, which moderates risk and provides less volatility in varying market environments. Now, I will turn it over to Joe to review the quarterly financial results. Please turn to slide 5.

Thanks, Debbie. Earlier this morning, we reported second quarter earnings of $16 million or $0.06 per share. We also reported second quarter adjusted earnings of $200 million or $0.79 per share compared to second quarter adjusted earnings in 2015 of $259 million or $1.03 per share. Quarter-over-quarter, adjusted earnings were impacted by the following items: at U.S. Gas & Power, we had losses of $19 million in the second quarter of 2016 compared with gains of $5 million in the second quarter of 2015, both related to movements of natural gas prices on inventory that we sold forward. We expect the majority of this quarter's losses to reverse by year end, as we sell the natural gas held in inventory. Our goal is to operate this part of the business to lower our economic exposure to commodity price swings. Also at U.S. Gas & Power, we had $8 million of lower equity earnings due to the sale of our interest in REX. At SoCalGas, we had a $13 million impairment as a result of the CPUC decision related to the North-South pipeline. We are now working on ways to recover all or a portion of these expenses, and more importantly, develop alternative solutions for the reliability needs in Southern California that this pipeline was designed to address. Last year, SoCalGas had a $13 million retroactive earnings benefit from higher CPUC rate base approved in the second quarter of 2015. You can find the individual financial results for our businesses in the Business Unit Earnings section. Please turn to the next slide. As Debbie mentioned, we took actions in the first half of this year to continue to align our assets with our long-term strategy. And at our California utilities, we received the final general rate case decision. As a result, we made several after-tax adjustments to arrive at adjusted earnings this quarter. The significant adjustments are: first, a loss of $123 million for the permanent releases of pipeline capacity that Sempra Natural Gas held with REX and others; second, $80 million in charges as a result of the final GRC decision for the reallocation to rate payers of certain benefits from tax repairs deductions, and third, also related to the GRC decision, earnings benefits of $21 million for the retroactive GRC effect related to the first quarter of 2016. Additionally, I want to remind you that we expect to report significant gains that will be excluded from adjusted earnings for two transactions when they close, both of which may happen in the third quarter. First, we expect the after-tax gain for the sale of our Southeast utilities to be approximately $70 million. We also expect to record a significant after-tax gain from the re-measurement of IEnova's investment in the shared joint venture with PEMEX upon its acquisition of PEMEX's interest. Regarding this acquisition, we have made progress recently, and we expect to close this year, subject to regulatory approvals. The transaction was restructured earlier in July, and a new price for the seven assets was finalized at approximately $1.1 billion. The sale by PEMEX will be submitted to the regulators for final approval. I'd also like to address Aliso Canyon. We have increased the cost estimate to $717 million, and we have begun collecting under the insurance policies and to date have received approximately $34 million. On July 25, the individual and business plaintiffs filed an updated and consolidated complaint as required under the case management order. In addition, the County of Los Angeles filed a separate complaint against SoCalGas, a primary component of which seeks new safety measures. Please see our Aliso Canyon status update slide in the appendix, which describes the costs included and excluded from our estimate. And please refer to our 2015 10-K and second quarter 10-Q for more detail on these costs and our insurance coverage. Finally, as Debbie mentioned, we are reaffirming our 2016 adjusted EPS guidance of $4.60 per share to $5 per share. With that, we will conclude our prepared remarks and stop to take your questions.

Okay. Hey, good morning, good afternoon. Hey. So, first question, a little bit more strategic, again, going a little bit back to the Analyst Day commentary. But what's the latest thinking, perhaps, if – could you elaborate on IEnova and the decision to participate or not to participate both in the sort of an immediate sense and over time, in the equity offerings and maintain your ownership level. Just – can you elaborate a little bit more on that?

Sure. Let me talk a little bit about, first, the investment opportunities that are there. And we have a lot of things that are coming together now. First of which, we won the Marine pipeline bid in conjunction with TransCanada. Our investment there is about $840 million for that project. Then it appears that the transaction with PEMEX is going to move forward, as we had indicated, and hopefully close by the end of the third quarter, and that's about $1.1 billion. In addition to that, we're looking at some M&A activity; there are some renewables, the second auction is coming up for bid, and we have some projects that we're looking at bidding into that second auction. If you kind of look at all of these, we have several billion dollars' worth of new projects that we're going to be working on over the next few years that we've already secured and several other billion dollars' worth of other projects between the renewables and then the transmission bids that are going to be coming up that are additional opportunities for us. We're starting to do some things with the assets we have, like we just built a lateral or got an agreement to build a lateral. We have some others under negotiation off the existing pipelines, so we're looking at how we keep taking the assets that we have and growing those assets. We're really excited about the IEnova opportunities. Going specific to your question, then. What we're going to do, and I can't tell you what position we're going to take on the equity, but we're going to look at all of that, and we're going to look at all of the capital needs. We have a couple of hundred million dollars available in Mexico right now. So, we will have to look at the total capital needs that we would expect over the next year or so and then look at what's the right position for us to be in relative to that. We've told you that we're not repatriating because we wanted to take a position in the equity offering, assuming that the equity offering occurs, and we would expect it to occur. There's really not a definitive percentage ownership that we've ascribed to. What we'd love to do is have the pie keep getting bigger. We don't have to keep our same position in the pie. We don't have to own 80% of the pie. We'd like the pie to be bigger and own a significant position in that pie.

Got it. But is there kind of a point at which, let's say, Cameron IV does or does not move forward that that would potentially evolve as you think about capital allocation, or do you kind of think about it separately and distinctly as what is the return proposition in Mexico not necessarily what happens with the Cameron?

We're not looking at – because we think all these projects are really good and they're financeable. So I wouldn't say that's the consideration; however, we have some things going on in Peru right now that are very exciting. Potentially, we have the projects in Mexico and then we have Cameron IV. From a capital allocation standpoint, as we've looked at it that we set up IEnova so that we could issue equity through IEnova. We have the opportunity through our Peruvian company to issue equity, it already has, it's in the market, and we own like 83% of it, so if we needed capital for that, we could issue equity in Luz del Sur. For Cameron IV, we can issue equity at Sempra for that. We have different ways to finance these things. We showed you at the Analyst meeting that our balance sheet strengthens over the five-year period of time. We put a plug of $1.5 billion of stock buyback in there. We would hope to invest that money in good projects, and I think we're going to be able to do that.

Got it. And one more clarification on the thought process for IEnova, anything around the FIBRA-E structure in Mexico to think about here? Obviously, that's kind of maturing. What does that mean for you guys, one way or another? I mean, from your tax position in the country, probably, it doesn't mean much, does it?

I'm going to have Joe answer that. We talked a lot about that when we were in Mexico City last week. A lot of the agencies or PEMEX have been looking at FIBRA-E for some of their assets. I think it offers some opportunity for financing. Again, for us, a lot of it is as it was with the MLP, what's the best cost of capital? So Joe?

Sure. Thanks, Debbie. Hey, Julien. Yeah. We looked at this over a year ago when it first came out, and there were some issues with it, and we worked with the regulators around those. I think that's sorted out. It goes back to what Debbie said. What's going to be the best source of capital for us to grow the business? We were just down there. It makes us even more excited to own a large part of this business. How we decide to fund it with debt and equity, we will take that all into account because these are great projects and we really like the growth opportunity there. As to FIBRA-E specifically, we just look at that as one of the options we have to grow the business. PEMEX would love to try to do something, but they'd like to see the market kind of open up, and it just hasn't evolved yet. But we stay very close to it.

Great. Thank you.

Thank you, Julien.

Hey. How are you? So, looking at where you are for the first half of the year and then understanding that certain things are coming out of the numbers like we won't have REX in the second half, we expect the gas costs to reverse and other puts and takes. Given the line of sight you have right now, do you feel like you're right at the midpoint of the guidance range, a little bit behind, a little bit ahead? Can you give us a sense of how you think you're trending?

We're not going to pinpoint within the guidance range. That's why we use a range. The things that I think that you mentioned are the things that will take effect over the rest of the year. A few things to consider: usually SDG&E has its best quarter in the third quarter, but SoCalGas has its worst quarter because of the way that the revenues are and then has a good quarter in the fourth quarter. The earnings are not even throughout the year for the utilities. The hedged inventory that we talked about should reverse in the second half of the year. We had a North-South impairment at SoCalGas in the quarter of $13 million that hit SoCalGas. That's not something that is repeated again throughout the course of the year. The income tax tracking issue at SoCalGas came really retroactive to the beginning of the year. So that's not a quarterly issue, that's like double what it would be. Last year to this year, we were looking at putting renewables in service last year, where we had a higher ITC. The ITC levels that we're showing are more normalized. The earnings that we have are like half of the earnings that we have in our guidance range, and we would anticipate being in the range. We're in the range – there's a lot of moving parts. We feel really good about our business and what we're in this for is truly the long-term. When we start looking at the great opportunities that we have for growth in addition to what we've laid out in our five-year plan, we feel really good about our business, and that's what we're really focused on delivering.

No, that's fair. Okay. Can't hurt – can't harm me for trying. The second question is a little bit off the beaten path. As you are looking to work on the emissions offset and carbon reduction programs that you're putting in place both in the normal course of business and as a result of the Aliso Canyon incident, how significant are some of these programs for methane emission reductions? What are the big buckets of methane-emission reductions that you're going after? And do any of them actually require capital investment where you might look to put those types of programs into the rate base?

Sure. And some of them certainly do. Let me refer this to Dennis because he can address both the Aliso but more specifically the methane reductions. SoCalGas has been actively involved working with DOE on this whole methane-emission issue. The one thing that SoCalGas has very, very low relative emission levels to other kinds of pipeline systems or upstream systems. It's something that we've looked at, and we've looked at what investment would be required to really get it down significantly. So, Dennis?

Sure. Good morning, Greg. Let me start with what we're doing regarding Aliso, and I touched on this at our Analyst Conference. We've already signed some letters of intent with various dairy owners. Our strategy is consistent with what the Air Resources Board put out. Our strategy looks at the destruction of methane, and the biggest opportunities in California are with dairies and/or landfills. We're working with some of those owners. We're actually in the process of due diligence on a handful of dairies to see how we can most cost-effectively mitigate what resulted from Aliso. From a systems standpoint, as Debbie said, SoCalGas's emissions from our system itself are some of the lowest in the country. We don't see a huge number of opportunities to make improvements in the rate base. We're looking at new technologies from a monitoring standpoint that could be associated with our system; those types of things could be added into a rate base in the future. Technologies are continuing to evolve, and we're on the leading edge of working with those technology manufacturers and the gas industry.

Thanks. So you're really going after the methane emissions from animal waste? That's the biggest potential offset?

That's correct. The biggest potential directly on methane is on dairies. We have quite a few dairies within our service territory especially in the Central Valley, and that's where we're starting to look.

I would say also a couple of things. We put the estimate of that in the $717 million for all the offset for the emissions from Aliso. The emissions have been measured now, and we're going after fulfilling that commitment of making those offsets. It's really quite cost-effective. So that is our focus, and we will fulfill that commitment.

Great. Thank you, guys.

Thank you.

Thank you. I, too, have kind of an off-beat question. By 2020, the rate base of the utilities looks like it's going to be about $17 billion, maybe $17.5 billion. Could you give me an estimate on what the non-utility investment total would look like in 2020?

Non-utility investment total. Okay. I have the utility projected rate base – while Joe looks up the non-utility piece, I have the utility piece. At SDG&E, we're looking at about $10.4 billion of rate base in 2020, and that's about 6 bps being about 4.4. For SoCalGas, the rate base that we're looking at for 2020 is about $7 billion, and about $5.1 billion of that is CPUC, about $1.9 billion of that is more special projects approved by the CPUC that's not part of the rate case.

Yeah, this is Joe. I think you're asking a question about something we typically don't give out, but it's probably information that's here, and we can catch up with you on the call after because you're asking about what's the total invested capital outside the utilities. We can do it offline. I don't have that information at our fingertips. We don't usually talk about our total invested capital outside. You can see it on the balance sheet pretty easily, but it's more complex.

Agreed.

The utility assets are much bigger than their rate base. There's a whole bunch of things in there. You have a nuclear decommissioning trust and all sorts of things. We need to parse it out for you; the information is there, but we could lead you to it.

Yeah. I mean, that's a really difficult comparison. Our strategy is based upon having a portfolio that has similar risk profiles between our utility and our non-utility business. We do that by doing long-term contracts. Our international businesses are either foreign utilities that have been under a regulatory framework for 30 years, or they are long-term contracted assets like our pipelines. We have 20-year to 25-year contracts on those. Most of those assets, once they go into service, they're more like a bond because you have a steady stream of earnings coming from those. The construction risk on those projects is not much different than the construction risk that was on building Sunrise. They're very similar, and that's our strategy, is to not go into extremely high-risk areas to create the growth but to have our risk profile be quite similar.

I'll just add on to that; you could look at the slides that we did at the conference and look at slide 7 in my deck. It talks about the investment grade credit ratings at all of our subsidiaries. These are all highly-rated, mostly A rated, including Cameron. While we don't have ratings on all project financing at renewables, as Debbie said, they're all contracted long-term with utilities. We spent time with all rating agencies explaining to them why our non-utility businesses were as strong or stronger than our utility businesses because we don't have three-year or four-year rate cases, we have long-term contracts. They like that very much and they understand our business well; it’s very strong.

Hey, guys. Just a little bit of question. I want to make sure I understand the trajectory of earnings within your 2016 guidance and even for 2017 just across the quarters. It strikes me that when you talked about this a little bit that there's going to be some significant movement around what to expect versus a typical or historical year at both of the utilities in third versus fourth quarters going forward.

Yeah. What – last year was the first year for SoCalGas. We had the new way of accounting for revenue. That gives you what percentage of the revenues come out each year. They're allocated on that basis. That should follow suit. We historically reported earnings based on the same methodology. If you look at last year, those are pretty regularized in terms of how the earnings are allocated by quarter. We can give you the precise percentages for SoCalGas if you want those. But this quarter, we had a lot of unique things because we had the REX transaction, capacity release, the change in rate case, and the impact of the taxes from the rate case decision. A lot occurred this quarter. Next quarter, we're going to have a lot of things occurring as well; we will close Mobile and Wilmut by the end of this year, most likely the PEMEX transaction will close. Both will have gains adjusted out of adjusted earnings. Hopefully, once we get through some of that, we hope to see more normalized earnings going forward. We've tried to cleanse our asset portfolio of things that don't add to our long-term growth. Hopefully, you'll see more stable earnings going forward.

No. That helps a ton. Real quick. As you think about the strategic positioning of existing assets, where does your Gulf Coast-related gas storage facilities fit into this?

As we look at those, one of the things we've started to see as some of the LNG facilities have come online is those storage assets will have more value over time. It makes sense to have storage run an LNG facility. We suspect that, once we develop those further, the need for storage adjacent to facilities will become a lot more apparent. We haven’t put any money into developing those yet but expect as LNG facilities come online in the Gulf that the need for robust infrastructure will increase.

When do you expect to economically benefit from higher storage pricing?

When we did our work this year, we looked a lot at that. We used outside firms and cut some of their forecasts when we did our projections this year; they projected that as LNG facilities come online and as you get more coal-to-gas conversion, you will start seeing some storage rate increases occurring. However, it’s been slower than projections. We took a conservative view in our plan but are starting to see some price movement upward from last year. We anticipate better storage rates as more load comes on.

Got it. Thank you, Debbie. Thank you, Joe.

Sure.

Yeah. Hi. Just a question on Aliso. Could you give us an update on your well testing? What are your latest thoughts on when some of the first wells could start coming back into operation?

Sure, Steve. I'm going to have Dennis address that because he's right in the middle of that now. So, Dennis?

Hey, Steve. As of right now, we've completed the first series of tests on all 114 wells. As of this morning, the Division of Oil, Gas, and Geothermal Resources has approved and reviewed 96 of those wells. Out of the 96, we've had an additional 17 wells that have gone through the next series of tests and they've passed and been reviewed by DOGGR. Out of the 114, 17 have been completely cleared by DOGGR. Once DOGGR and the Public Utilities Commission confirm that the entire field has met the requirements of the new law, we believe that by September, we'll be ready to start injection, subject to their approval, of somewhere between 20 to 25 wells. That’s our best estimate right now.

Okay. Thank you.

Yep.

Good morning.

Hi, Paul.

Just really quickly, on the permanent release impairment is there any longer-term impact to earnings associated with that? Any benefit from reduced cost or something like that?

Let me have Mark talk about the capacity release. Most of it was tied to the REX transaction.

Right. I think to understand your question, I don't think there's any significant reduction in expense going forward tied to that release. It's a pretty small team that was managing it. There won't be any ongoing P&L impact now that it's done. So, I think the answer to your question is no, there's really no ongoing effect.

Okay.

I would just add to that. The decision to do this was largely looking at what the value of that capacity was going to be over time and it was devaluing in comparison to what we had assumed it was going to be valued at. We wanted to get that behind us. We had some credit issues on REX that were there. There were some shaky credits in addition, and we just felt it was better to get, when we sold REX, to get all of that behind us and not have a tail risk associated with that pipeline.

Okay. And then, just to follow up on Aliso. You mentioned the $717 million update and the receivable, what have you. There were some things that that cost estimate excludes. Do we have any sense of the neighborhood of those cost estimates that may be excluded are and what the insurance coverage of that is?

What I am going to say is that we've included everything that’s estimable. The $717 million includes all of the well costs, it includes all the relocation costs, the cost for Blade Energy Partners to do the investigation. All the kinds of costs that are estimable. What's not estimable is what happens in litigation. We don't know what that would be. I would say, the good thing is that we've paid for relocation. We've offered people to be out of the area. We tried to do things to reduce damages; the Department of Health Services has come out repeatedly and said there were no long-term health effects from this. We can't estimate what will happen in litigation but we’ve managed the risk effectively. We believe that the insurance coverage is adequate for the damages.

Great. Thanks so much.

Yeah. Since there are no further questions then, I thank you all for joining us, and I thank you all for being at the Analyst Conference. It was great seeing you in person. If you have any follow-up questions, please contact our IR team. Have a really wonderful day. Thanks a lot.