Sea Limited (SE) Q4 2009 Earnings Report, Transcript and Summary

Good morning. My name is Trinity and I will be your conference operator today. At this time I would like to welcome everyone to the Spectra Energy 2009 Year-end Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a Question-and-Answer Session. (Operator Instructions). Thank you. Mr. Arensdorf, you may begin your conference.

Thanks Trinity and good morning, everyone. I am John Arensdorf, Chief Communications Officer for Spectra Energy, and I would like to thank you for joining us today. As you know we were with many of you recently in New York providing an overview of our 2010 business and financial plan, and we're pleased to share with you today our 2009 fourth quarter and year-end results. Leading our discussion today will be Greg Ebel, President and CEO, and Pat Reddy, Chief Financial Officer. Greg is going to begin by sharing his perspective on our 2009 performance and Pat will provide detail and context around our fourth quarter and year-end financial results. We'll move quickly through our presentation to allow ample time for your questions. In addition to the slides we'll cover with you today you will find in the materials our website an appendix of information that we think you will find helpful. As you know, some of what we'll discuss today concerning future company performance will be forward-looking information within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements and you should refer to the additional information contained in Spectra Energy's form 10-K and other filings made with the SEC concerning factor that is could cause those results to differ from those contemplated in today's discussion. In addition, today's discussion will include certain non-GAAP financial measures as defined under SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our website at spectraenergy.com. With that let me turn things over to Greg.

Thank you, John. Good morning, everyone. We appreciate you joining us today and I am pleased that we've got good results to share with you. 2009 was indeed a good year for Spectra Energy and our investors. As you have seen, we reported ongoing fourth quarter net income of $217 million compared with a $197 million in 2008, about a 10% increase. And for all of 2009 we earned $1.18 per share beating our original forecast of $1.15 per share, even in light of other NGL prices and an equity offering early in the year. The composition of our 2009 earnings under lines the power and resiliency of our diversified portfolio. Our investors benefited from ten projects we placed into service in 2009, projects that earning returns above our targeted level both today and I expect for the longer-term. We began seeing improved commodity prices during the fourth quarter for Western Canada in Field Services and we're pleased that that momentum is continuing into 2010. We also took steps during 2009 to position our company for continued success over the longer-term. Earlier in the year we bolstered our financial flexibility and we have consistently maintained adequate liquidity to fund all of our activities. We're achieving good growth, sustainable growth, from our core businesses. And we financed strategic acquisitions through our MLPs, Spectra Energy partners and DCP Midstream partners. So, 2009 was a good year in and of itself and an even better year in terms of positive positioning it provided for consistent earnings growth. During a year of uncertainty and economic downturn, Spectra Energy was able to rely upon its core strengths, a resilient forward-looking business model, financial strength and flexibility, diversity of robust sector leading businesses, and operational excellence. Consider the almost $3 billion in capital projects we signed…

Thanks, Greg, and it is a pleasure to be with you this morning and to report on our fourth quarter results and our overall 2009 performance. As Greg told you, it has been a good year for us, a year of hard work, significant challenges, and attractive returns. Let's take a look. As you seen in our earnings release Spectra Energy reported fourth quarter net income of $219 million or $0.34 per diluted share after moving the effective discontinued operations our ongoing earnings were $217 million or $0.33 per share. For the year we delivered ongoing earnings of $758 million or $1.18 per share. The annual results reflect solid performance from our fee-based businesses. The Company benefited from expansion projects placed into service in both 2008 and 2009, and while commodity price it is didn't meet the level included in our $1.15 per share guidance for the year, they did recover nicely toward the end of year and as Greg mentioned that momentum gives us a positive start to 2010. Let's review the results for each business segment in a little more detail beginning with our U.S. transmission operations. U.S. transmission reported fourth quarter 2009 EBIT of $204 million compared with $161 million in the fourth quarter of 2008. The 2008 period included a $44 million special item for an impairment of the Islander East project. Ongoing EBIT for fourth quarter 2009 was $204 million, essentially flat with the prior year's quarter. The segment benefited by $34 million from EBIT on expansion projects like our J-2 expansion, [Stekman Rich], Moss Bluff and Egan, returning to offset by timing of O&M expenses including pipeline integrity and lower capitalized costs as well as a favorable customer settlement in the fourth quarter of 2008 related to our Maritimes & Northeast Phase V project.…

Thanks a lot, Pat. I think you can see our confidence in our 2010 plan and our outlook going forward and here is really what makes Spectra Energy such a compelling investment opportunity. We have an unbeatable track record of delivering results in a strong growth outlook. We all know that 2009 was a challenging year, yet Spectra Energy is starting 2010 with much better growth prospects than we had at the beginning of 2008. That's right, not 2009 but 2008. That positioning and the ability to excel and grow across market and economic cycles, is fundamental to our success. We have the advantage of the most strategically situated natural gas infrastructure assets in North America. We serve four of the five fastest growing demand markets in North America, and we're located in the midst of both expanding shale plays and conventional supply. Can't bet beat that positioning, and you definitely couldn't build it today. We have an abundance of expansion opportunities. Over the next several years we'll invest at least $1 billion annually in new growth projects that are manageable in size and align with our execution strength. And we'll deliver those projects with returns above our 10% to 12% range. We see low risk steady growth momentum from our core fee-based businesses. On January 22nd you heard directly from two of those growth businesses, our Northeast U.S. and Western Canadian operations, so you know we have excellent longstanding and productive relationships with our customers, relationship that have resulted in firm contracts and exceptionally high renewal rates. This core business with profitable steady growth which produces stable cash flow enables us to pay an attractive dividend which we expect to grow over time with earnings. We're well-positioned financially, too, with strong cash flow and investment grade balance sheet, ample liquidity and excellent access to capital. Investors are also poised to reap the rewards of further commodity strengthening we see on the horizon. And I will remind you again the improving commodity prices at DCP Midstream bolsters an already reliable source of cash to help fund Spectra Energy's growth prospects. Finally, natural gas is uniquely positioned to help address North America's energy and environmental challenges. It is clean, abundant, reliable and domestically available and it will be vital to the improvement in North America's carbon footprint and the economy overall. Bottom line, we're executing on our plan, and we will continue to deliver the operational and financial targets we have committed to achieve. When considering Spectra Energy, investors can reasonably expect to earn an annual total shareholder return in the 12% to 14% range from a company with almost 80% of its EBIT coming from low risk fee-based businesses. That's good value. With that I will turn things back over to John so we can talk with you.

Okay Trinity, we're ready for the Q&A session. So if you could give the instructions on how to ask a question one more time.

(Operators Instructions). Your first question is from Lasan Johong.

Thank you. Nice quarter. Wanted to ask you about kind of a little bit more, big picture stuff. You said 65% drilling rig increase in DCP areas. Going forward in 2010, what kind of an increase or what kind of change are you predicting for drilling rig counts and activity in your sectors for 2010?

Maybe the way to look at it, and thanks for your comments, is really kind of volume increase because obviously that's where we make our money, and I think versus '09 Tom's business would see volumes increased by about 2% from '09. That will be probably more back end loaded because even as you saw in 2009 the result of big drop in the rig counts, you really didn't see any volume impact towards the last half of the year and then as things started to come back on with rigs it will take a little while for that to impact. So think about 2% kind of growth from '09 to '10 with respect to volume comparisons.

I was trying to get at a productivity number or productivity measure for rigs, 1,600 rigs to 600 and I think it is back up to around 825. Wondering what you would need to sustain kind of level production going forward.

I am not sure I could answer that question for you. I think given the changes in rigs and going from vertical to much more horizontal, I think we're still going to have to see how that shapes out. It seems to me getting back up into that range where we are now is going to for us is going to give us a couple of percent, but not sure I can help you.

Okay. On the commodities front, I am assuming that the company has limited ability to influence where its margins come from and it is more driven by self selection on natural selection by the producer who is choose to either drill more gas associated with liquids or just pure gas, correct?

Yeah, that's correct. We have, we've got 40,000 contracts or so, let's call it maybe 50,000 contracts at DCP and they all have different types of terms and you have minimums in certain areas, but the contracts are determine whether they're fee-based, POP or key hole. But you're right the producers have to beyond that producers have to actually put the capital to work to bring the volume to us.

And so the only way Spectra and DCP can influence that mix is by choosing to go into a particular basin that has a particular bend to that drilling program, correct?

I think that's correct, and I think one of the powers of a company like DCP, for example, is that you have 58 plants in multiple basins, so if you look at 2010, again, going back to those volumes where you might see say a decline in places like the Mid-Continent where you will see increases in the north Gulf Coast and the Permian type region which have more oily plays to them which people are interested in the production in that regard as well.

So the question becomes do you have a preference or choice on where you want to grow more going forward?

Well, liquids rich, is obviously a place where we like to be. Obviously when you're getting a percent of proceeds, that's where you would like to be. I think we're in those regions. Of course obviously paying attention not only to the shale areas we're already in but new place, so if we can get activity going on in (inaudible) and I know we've looked at a variety of times at places like Marcellus.

But Marcellus is not exactly liquids rich, is it?

No, that's right, so that's the issue. Can you achieve the same type of business model in the Marcellus, and it depends which side of the Marcellus you're in.

Your next question is from Steve Maresca.

My question, you talked about in your Investor Day a lot of your opportunities in the Northeast with TEMAX and Time III and Team 2012 and the New Jersey, New York expansions. Can you talk about what percent of capacity you talked about is contracted and spoken for already?

Virtually everything we have spoken about is contracted, so TEMAX, obviously long-term contracts, Conoco being the big off taker there. If you look at New Jersey, New York completely contracted with conEd, Chesapeake and Statoil. Team range would be the big contracted party there, so we don't put pipe in the ground until it is fully contracted, and I guess that's the point we were making. We haven't just announced projects. We've actually signed long-term commitments as you know and that's where the value is created all kinds of opens seasons and announcements get made but can you actually bring the customers in and can you provide them with a service that will allow them to commit to long-term contracts?

Okay. Thank you. And on switching topics quickly, Pat, you had mentioned potentially the debt markets this year for SE of about $1.6 billion if I remember correctly, correct me if I'm wrong. Is there something in terms of timetable you want to get that done and is that something you would do all at once?

We're kind of evaluating that, Steven. We have got $800 million worth of debt maturities that kind of come throughout the year with about $300 million at Texas Eastern at the back end of the year in the fourth quarter. We're thinking about doing prefunding given how attractive rates are today, but looking at forward starting swaps and some alternatives, and we haven't decided that yet.

Okay. My final question and we'll switch back to you, Greg. You seem to have a lot of opportunities right now for the foreseeable future for Spectra. You have mentioned in the past that you thought SE has a better cost of capital than SEP. I guess how do you think about cost of capital one versus the other and is it something that you would consider using that MLP as a way for you guys to raise capital others have done that as well? Maybe you could discuss that.

For sure. So let me just clarify lower cost of capital. I think you are missing one word, long-term. So, today I would argue that, yeah, I think it is fair to say that SEP may have a lower cost of capital today given where it is in the splits, etcetera, but longer-term, and I think you see that across the MLP market that in fact you see a convergence of cost of capital. So we have set up SEP to be a financing node and just like any other financing element inside the company to utilize it to grow the overall company and I think you have seen that through some of our acquisitions and the organic growth there with what is that current time at lower cost of capital. Now, as we grow the comp of the overall SE, obviously we're going to be spending a lot of capital, and when you retain a lot of capital and you obviously not paying out all your cash flow, that's better to do that at a corporate level. We see that through 2014. Now, somewhere down the road and 2014 is a long ways away you didn't have any growth prospects and all you were going to do was generate cash which is not a bad thing, then you might think of structures at that point in time, but I would, both DPM, SEP are very complementary to SE overall. They're used in excellent news for good acquisition vehicles up to a size, remember there is only so much capital you can issue out of an MLP even a large MLPs have proven thaw can't go out and issue $1 billion dollars of equity out of a large MLP today and I think you could do that if you wanted to at a large C Corp. So I think they're complementary. I think it is a timing issue who has the best cost of capital at any point in time, and I can assure you we'll take a look at the best cost of capital inside the corporation each and every day.

Your next question is from Matthew Akman.

Thank you. A couple questions on the breakdown of segmented EBIT growth in slides 14 through 16. First on U.S. transmission in past years there was this processing revenue, and but in '09 there wasn't because of market conditions. Is it possible that we'll see that maybe bounce back to something positive going forward given maybe volume and your price improvements?

On U.S. transmission the volumes are fairly constant. It was really just in 2007 and 2008 as a result of hurricane that disabled another party's processing plant. We had unusually high volumes that were directed to us, and once that other plant came back online, those volumes reverted, and so our throughput is fairly constant and our processing revenues should run at about 80 million a year. It is kind of our run rate without a lot of fluctuation.

So the commodity price impact there wasn't significant, Pat?

It is really more fee-based income.

Okay. Thanks. My other question is on Western Canada, so your slide 16 pretty significant increase this year you're looking for over last year from fee-based EBIT and in fact when you look at the increase if you're looking at 12% kind of returns capital, that would have implied a $400 million to $500 million investment in that business, but I don't recall the company making that, so is it fair to assume that a lot of this is just from volume improvements on Fort Nelson?

It is a combination. Remember, we have spent a lot of money in the Montney so a lot of those West Doe projects have kicked in, but also let's remember that we're starting to see the front end of the Fort Nelson projects come in, and the front end has some reach start of existing assets, so obviously you see much better returns from the front end, and then as we move out to 2011 and 2012 and build the big new processing plant, those returns aren't quite as robust. So you kind of get a little bit of front end loading with respect to the results in Western Canada and you start to see that in 2010 which is great. More cash earlier is always good. I think you probably see close to $60 million of uptick just from expansion projects, and that’s some things that offset it. You will have a little bit like turn around and things like that, but really a big pickup just from the expansion projects, and the other thing is producers I think are being quite smart by contracting up volumes, and you even saw that in the fourth quarter. So as you know, it may not be fully utilized yet once they're contracted people are paying a reservation charge, and that's obviously very beneficial for us as opposed to just people picking up interrupt I believes, and I think that's a really strong indicator to us that in fact things in the Horn River are accelerating quite nicely.

Your next question is from Ted Durbin.

Hi just staying on slide 16 there, the drop off on the commodity base side of things, is that volume or I think your frac is pretty similar but maybe I missed something there?

The frac is down versus what we realized in 2009. Volumes pretty well hasn't changed too much.

Okay. So it is really just sort of see the similar volumes to what you saw in '09?

Right, there is a turn around we expect to see in 2010 as well, so that’s got some impact but the daily volume change is not a big one.

Okay. And just on the O&M side on U.S. transmission, a little higher this quarter. Is that do you see any kind of that coming back at all in '10? Anything one time you consider or is that kind of a good run rate going forward?

Yeah. I was going to say, Ted, I think the 2010 forecast is a better run rate going forward, and 2008 we had in the fourth quarter some adjust adjustments to our O&M that could have been done more ratably during the year, so really was just timing on the full year basis, so our run rate I think is good going forward.

Okay and then just small one. In terms of the, I think you said $7 million for weather and distribution. Is that kind of what's driving the pickup then at distribution? Is it just customer growth or is it more weather if we look at your 2010 outlook?

Customer growth and storage and transportation revenues that have continued to grow FX is also a help in assuming that the Canadian dollars $1.10 instead of $1.14 in 2009. That gives us some pickup as well.

Your next question is from Carl Kirst.

Thanks. Good morning, everybody. Just a few mop-up questions, maybe Pat's starting with the distribution which you were just on. Is it possible to say on that Canadian delta 2010 over 2009 how much is coming from the storage component and as well I didn't know if you happen to have this off the top of your head what the actual ROE realized for Union gas was in 2009 and what's baked into the 2010 assumption?

Our authorized return is 854, and we did earn about 300 basis points above that. We were into the sharing band at 9010 with our customers, and in terms of the return on equity for 2010, I don't have that handy, but it would be about the same level I believe on a budgeted basis in 2010 as 2009. Okay.

Okay. So that didn't necessarily revert to the base, you think it just going to be similar performance.

Yeah, long-term rate there deal there, right, Carl, so that's providing that opportunity, so the first 200 basis points goes to the investor, the next 100 basis points you split between customers and the investor.

FX next year helps us to the tune of about $20 million in on a budgeted basis.

And then with respect to the storage delta?

That helps us by about $6 million.

Okay. One other question if I could just switching to the U.S. pipes and appreciate the continued detail and breakout of the processing and development costs. Perhaps this really isn't very volatile but can you give us a sense of what the park and loan or optimization component was over the last two years and what's baked into the 915 expectation?

It is fairly small. It is not that significant a piece of their revenue.

(Operators Instructions). Your next question comes from Jonathan Lefebvre.

Just quickly on the tax rate for 2009, it looks like it ran a little below the guidance that you had given. What drove that and then just do you have that same type of flexibility going into 2010? Incompetent you're estimating about 30%.

That's correct. For the full year our effective tax rate was about 27.8%. When you take out the income from non-controlling interest, it is 29.5%, and very close to the 30% that we're we have budgeted for 2010, and you always have adjustments that take place, for example, you may have noticed that in the fourth quarter of 2008 the effective tax rate was only 19%, and that's because in 2008 we had some adjustments when is we filed the 2007 tax return. So you always have things that are kind of in and out as you fine tune your effective tax rate during the year.

I think Jonathan as you look forward the 30% is rate for modeling purposes. I think the benefit if it comes will be in Canada, and part of that depends on how the earnings break dawn because the Canadian corporate tax rates are much lower than they are in the United States, so I think that run rate that Pat gave you is right, but I think you've got Canadian corporate tax rates dropping from kind of the low 20s to the high teens if you will over the next couple of years. But exactly how that plays out, have you to figure out, A, does the Canadian government stick with that because they have deficits as well and, B, how exactly do our earnings break down. I would use the 30% going forward but we might be able to do a little better.

Makes sense. And then this morning you mentioned that potentially increasing the dividend may be possible either later this year or early 2011 which kind of jives with our numbers, but just trying to get a sense if you can maybe rank that dividend increases versus maybe some other shareholder friendly options as share repurchases or debt buybacks, things like that?

I don't see share repurchases in the outline right now, but definitely, look; this is something that I think boards always talk about on a regular occasion. I don't think we'll take this up with the board until middle of the year and then with effect of see how things shake out. As you know we've look to kind of be in the 60% - 65% payout range, so you obviously don't want to get too far ahead of that, but I think that's probably a discussion we'll have with the board later this year and figure out what to do. I don't think I said we would look at increasing the dividend this year. I think, again, that's something that the board will look at in the middle of the year and see where we are at that point in time.

(Operators Instructions). At this time we have no questions.

Okay. Well, thank you very much for joining us this morning. We really appreciate it. As always, if you have any additional questions, you can feel free to give Patrick or me a call, and with that, again, thanks for joining us.

Thank you for participating in today's teleconference. You may now disconnect.