Sea Limited (SE) Q2 2010 Earnings Report, Transcript and Summary

Good morning, my name is Jasper and I will be your conference operator today. At this time I would like to welcome everyone to the Spectra Energy Quarterly 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. I would now like to turn the call over to Mr. John Arensdorf. You may begin, sir.

Thanks, Jasper, and good morning, everyone. Welcome to Spectra Energy's second quarter 2010 earnings review. We're glad you joined us this morning. Leading our discussion today as usual, will be Greg Ebel, our President and Chief Executive Officer and Pat Reddy, our Chief Financial Officer. Both Greg and Pat will discuss our quarterly results, the progress and growth we have achieved year-to-date, as well as strategic opportunities we see on the horizon and of course we're going to leave plenty of time for your questions. Before we begin, let me take a moment to remind you that some of the things we'll discuss today concern future company performance and include forward-looking statements within the meanings of the securities laws. Actual results may materially differ from those discussed in these forward-looking statements. So you should refer to the additional information contained in Spectra Energy's Form 10-K and in our other SEC filings concerning factors that could cause these results to be different from those contemplated in today's discussion. And in addition, today's discussion includes certain non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of those measures to the most directly comparable GAAP measures is available on our Investor Relations website at SpectraEnergy.com. With that I'll turn the call over to Greg.

Thanks very much, John, and good morning everybody. As you have seen from our earnings release this morning, Spectra Energy delivered ongoing second quarter results of $174 million dollars or $0.27 per share. As you know, we only provide annual EPS guidance but I can tell you that our second quarter performance exceeded our expectations and we're nicely ahead of where we thought we would be at this point in the year. We feel positive about the remainder of 2010, particularly with our typically strong fourth quarter yet to come. In addition to meeting our earnings targets, we have been busy executing on future growth plans and delivering value. Key drivers for the quarter included, first, our core fee-based businesses, U.S. Transmission and Storage, Distribution, and Canadian Gathering and Processing performed well, up more than 10% from last year's second quarter. You will hear the details from Pat shortly but the businesses are experiencing steady, profitable growth from expansion projects. You'll also recall that the vast majority of our 2010 EBIT will come from these fee-based businesses which support our dividend. Second, commodity prices have improved significantly from the lows we saw in the second quarter of 2009, and our Field Services segment benefited from that improvement with earnings up significantly. Third, during the quarter we continued to actively execute on our growth plan through a strategic acquisition, project expansions at our fee-based businesses as well as growing the footprint at DCP Midstream. I'll provide more detail on these in a moment, but will point out here that in sum they affirm the compelling earnings potential and strength of our portfolio of businesses. Spectra Energy continues to be ideally positioned in terms of expansion opportunities and we're realizing substantial growth. I'd like to talk about one of those opportunities in…

Thank you, Greg, and good morning everyone. As we announced earlier today, Spectra Energy reported second quarter 2010 ongoing earnings of $174 million or $0.27 per share compared with 141 million or $0.22 per share in the second quarter of 2009. And as Greg told you, this year-over-year increase of more than 20% reflects the solid progress we have made on executing our growth projects, a more favorable Canadian exchange rate and improved commodity prices this year as compared to last year. We're very pleased with this progress in the first six months of 2010. While we benefited from macro factors like higher commodity prices and a stronger Canadian dollar, we also continue to focus on factors that we can influence. For example, we continue to see increases in EBIT from projects previously placed into service and we expect to place six projects totaling 900 million of investment in full or partial service by year end generating ROCE's greater than 12%. We've controlled our operating and maintenance expenses to levels consistent with our previous guidance and we've been opportunistic in financing the business by timing our debt issuances to capture historically low interest rates. Our core fee-based businesses performed in line with our expectations and we expanded our gathering and processing contracted volumes in Western Canada. At the same time we maintained our balance sheet strength and improved our debt coverage ratios since the end of 2009. These accomplishments helped us to buffer certain headwinds in the first six months and position us to meet or slightly exceed our expectations for the full year. We know many of you focus on EBITDA. So the next slide provides this information by business segment. Ongoing EBITDA for the quarter was $657 million, compared with 579 million in the second quarter of 2009.…

(Operator Instructions). Your first question comes from the line of Anthony Crowdell.

Good morning. Some questions on the NGL pricing for field services. Is there any concern with all of the shale plays or more production you're seeing in gas, therefore more production in liquids that we're going to keep seeing further downward pressure on the NGL prices going forward?

Well I think we remain pretty positive on NGL prices from a long-term perspective. Obviously we've come back a long way from the last year. I think in the second quarter you're contrasting against what was a very strong first quarter and I think there were some factors that may have pushed it down. Obviously people were more concerned about the economy. People weren't sure where autos, et cetera, were going. We had a number of the steam crackers that had outages that lasted longer which allowed for a build up in inventories which kept prices down. But I see things like increases in auto sales up 5%. That's important for plastics. That's good for NGLs. Obviously we're going to head into the winter and crop drying and exports. So I think we feel very comfortable about our $0.95 overall forecast for the year. Longer term I think the big driver is how the economy moves forward, frankly and what I see is the chance of a double dip probably declining. It's still out there. I would suggest that bodes well for liquids prices even with the new supplies coming on.

Just for forecasting purposes, is it more accurate to use, say, Conway pricing for Field Services or should we use like Belvieu pricing or just a blend of the two?

It is really a blend of the two. Tom is on the line. I don't know, Tom, if you want to comment on that. Generally we've got so many contracts and obviously impacted by both pieces.

Thanks, Greg. I think generally what you can use is a blend of the two and somewhere -- roughly 50/50 to 55 Belvieu, 45 Conway would probably be a fair combination.

Great. Thank you for your help, guys.

Thank you.

And your next question comes from the line of Lasan Johong.

Hey Lasan

How are you?

Good.

Excellent. The storage levels for natural gas is getting kind of peaky. Are you starting to see strains or feel the strains and how is this having any -- is this having any positive pricing action on your side going forward?

Well I haven't seen a ton of pricing action at this point in time. I think you got a couple of unique things going on. One, you've got what I'm told is a kind of three sigma move in weather obviously, and that's really making the current prices higher than what you'd typically see vis-à-vis the fall or even the Oct.-Jan. type spreads and that's hurting storage prices right now. But I think the long-term focus for us, and we contract as such, we do some short-term contracts, some long-term contracts, some medium term contracts, is really the overall fundamentals of the storage market. And that we see continuing to be positive from a gas perspective. But yeah look, I think once the weather settles down, I think you'll see a more typical fundamental type structure around gas prices and hence around storage.

So even though NAT gas storage levels are close to record highs, this is not having an effect because the current weather is hot and people are selling into the current weather?

Right, that's exactly what's happening. So, then you end up, you have the current month and the front month actually high, people are going to sell that gas as opposed to put it into storage and as such you continue to see storage high. And then you go back once the summer ends, and it will end, you will go back to a typical, I would suggest, where you will find the back end of the curve higher as you look at the Oct - Jan. type of pricing.

Generally speaking, are you continuing to see drilling ramp in shale areas and backing away from conventional areas?

Yes, we are. Particularly in places like the Eagleford and the Permian. Again, Tom is on the line and he could probably give you some good insights on that. So, Tom, do you want to throw in on that?

Sure, yes. I think what we're continuing to see is a growth in rig counts primarily focused on our footprint around the liquids rich plays. If you were to parse our drilling, we have seen a recovery but not as quick a recovery in places like the Mid-continent. And then you look at places like the DJ and Denver where rig counts have effectively doubled this year. Activity in the Permian is up very significantly this year and since the trough of last year. And then of course the rig count continues to grow in the Eagleford as we move through the year, and I think people expect that to continue. So, for us it's primarily liquid centric, more conventional areas, drier gas areas, rig counts have recovered but not quite as quickly as the liquids rich areas.

The other positive thing about that, Lasan, is obviously in the liquids rich areas that's obviously a higher margin business for us than the dry gas areas.

Of course, one last question for me. Industrial activity, are you starting to see some pickup in that area vis-à-vis more demand or as the latest volume increases more driven by weather?

Yes, I think it is more weather. I think probably a good indicator of industrial demand is job growth and as you know that's not exactly spectacular. One of the good insights we get out of places like Union Gas or LDC, we saw 16,000 new customers get attached. That's residential, but obviously that's an indicator better than what we would have expected and seen. So, I think what we're starting to realize, again, after what I think is a general and pretty robust first quarter, second quarter a little bit nervousness out there in the economy, that I think people are coming to realize that, look, this is a steady but a grind nonetheless up as opposed to a rocketing up. And I think that's probably what we're going to have, we're going to have a pretty slow grind up. The positive thing is it is a grind up now as opposed to a grind down.

Yes. And it puts less strain on future issues. Thank you very much. Appreciate your help.

Thanks Lasan.

And your next question comes from line of Monroe Helm.

Hey, Monroe.

Good quarter, just a quick question on your storage operation. It is a pretty significant investment for you. It's going to turn out to be $1 billion by 2015, yet the rate of return is at the low end of your targeted range. Does that have anything to say about other opportunities you're seeing now maybe not being as robust as the rates of return that you'd hope to see on some of these other opportunities?

No, I don't think so. The Bobcat acquisition is a bit of a hybrid. If obviously we went out and built it on our own and we took it from the start, you could have probably built it at, call it, 7 or 8 times EBITDA multiples. If you waited until it was fully built out, you look at acquisitions, people might be in the 10, 12 times multiple. We're buying it part way through, so it is a 9 or 10 times a multiple. I think we paid a fair value for it and we'll extract premium value for our investors. Versus other projects that we see, for example in Western Canada, we see very nice robust returns above our targeted 10% to 12%. So, then when you blend that with different projects, I think we feel very confident that on a portfolio basis we're still going to be very much at that 10% to 12% basis and for the next couple of years, frankly, we'll see returns much more in the even 12% to 14% range on the expansion projects as a portfolio.

Okay. Thanks.

Thank you.

And your next question comes from the line of Ted Durbin.

Hey,Ted.

Hi, there. Just talk a little bit about financing plans in more detail. With the acquisition of Bobcat you got the increased capital spending. Where do you see credit metrics? And if you think about the strong cost of capital down at your MLP, would you consider a dropdown there?

Ted, thanks for that. In January, when we gave our guidance, we mentioned that we do an internal three-year plan that goes out through 2012. And that plan showed that even with incremental growth CapEx each year of at least $1 billion that we wouldn't need to issue equity to preserve our credit metrics and our credit rating. And as we looked at the Bobcat acquisition, that really doesn't change. For a Company with $24 billion in assets and little bit about 9.8 billion in debt today, targeting around 11 billion of debt by year end, an acquisition in the $0.5 billion range really doesn't move the needle much on our FFO to debt or FFO to interest. And so we can, and expect to, finance the acquisition with a combination of internally generated cash and debt. And then the other 400 to 450 million for buildout CapEx comes over a period of four to five years, and it is something that we think we can absorb, again with debt, particularly as we're seeing such attractive interest rates. With respect to Spectra Energy Partners, it is always a possibility and it is something that we look at concerning the attractiveness of dropping down assets and using their currency. And then, frankly, taking those proceeds to reduce debt at Spectra Energy and to issue some equity at Spectra Energy Partners which improves our balance sheet overall. So, while we don't have anything to announce today or any immediate plans, that is part of what we'll look at between now and year end.

I think just to add to Pat's color, I think that's the real value of having multiple financing nodes. That's available to us today, and we'll utilize it. And I guess the key for us is what's the lowest cost of capital at any point in time let's utilize that and we continue to have basically all of those factors available. I think the other thing is Pat has been able, the Treasury team, to go out and raise debt this year at very favorable rates. Obviously that improves your coverage ratios as well, too, less interest per EBIT and FFO.

I think we mentioned that the fundamental reason that our credit metrics improved in our three-year plan is that we've got some very attractive investments in Western Canada, including Fort Nelson where the EBIT even though the CapEx is back-end loaded the EBIT begins to come on, even at the end of last year and building into this year. So, the returns from those projects are good and the cash flow is good, and that really isn't changed by Bobcat which, as Greg mentioned, really rolls out over a four to five-year period.

That's very helpful. Thanks, if I could just ask one more. You said you're ahead of your plan for the year. You're halfway through. There are certain segments here where you're tracking above or below guidance and why would you be above or below?

Well I think obviously we have done better in the first half of the year than on NGLs, so that helps. I think the average for the year is around $1.03 year-to-date, and we'd expect $0.95 on a full year basis, so that's been beneficial. We have actually done well on the interest side. Currency has helped, as well and then the expansion projects, just having those delivered, some of them a little bit less than budget. Basically I would say, both from a things we can control and things we can't control, they're all running very much full out. So, it is a positive situation when you can develop projects, bring on new projects, and also have the factors you can't control like interest rates and the commodity go your way, as well. So, that, I think, bodes very well for the first half of the year. And the key, as you know, really is the fourth quarter. Let's have the winter coming. Let's get our projects in on time and on budget which we expect, and have commodity prices be in line with our expectations, and that bodes well.

And, Ted, as Greg said, we captured about 50 million of incremental EBIT from expansion projects year -to-date, about 30 million at U.S. Transmission and 20 million in Western Canada. And then on the cost front there is a good story there, as well, year- to-date. Our costs versus the costs that were embedded in our guidance are down about $38 million. So, those are things that we have some control over and while part of that is timing and we'll give a little of it back in the second half of the year, it will help us to offset the fact that our forecast had increasing commodity prices in the second half of the year. And obviously the opposite's happened. The first and second quarters were a little bit higher than maybe the balance of the year, but again we still see NGLs coming in around $0.95 on average. So, it really shows the beauty of the portfolio where one element may be down but we've got other levers to pull.

Okay. Great. Those are my questions. I appreciate it.

(Operator Instructions). The next question comes from the line of Matthew Akman.

Hey, Matt.

Hi, Greg. First quick question and then maybe a bigger picture one. The quick question I have is on Union Gas. You guys had a really good quarter there and attribute it to lower operating fuel costs. I am not actually sure I even know what that means. But I presume it means the costs were lower and under incentive regulation, it boosted earnings for the Company. But maybe you could expand on that?

Sure. Really it means we used less fuel than we thought and cheaper fuel than we thought in terms of pushing gas through the pipeline, so that was the real benefit there. It is not really an IR related item, and it was probably around $8 million or so.

Okay. Thanks for that. Maybe this one is for Tom if you are still on the line. But it really relates to potential opportunities in moving liquids out of Marcellus. We have seen a couple recent announcements on the Bakken and where ethane and other liquids might go, even some of that moving back to Alberta, which is interesting. Do you have any thoughts on where it might move and how it might move out of Marcellus? And are there pipelining opportunities maybe for Spectra in that regard?

Thank you, Matthew. I think right now, as you know, there is a number of proposals being kicked around, some bringing the liquids back to Belvieu. There is going to the East Coast and then shipping to Belvieu some going to Sarnia and then others going back further west. At this point we're in a mode more of evaluating on the front end what do we think the liquids production is going to be and the timing of the need for an NGL solution out of the Marcellus. I think it is early on that, and I think the opportunity is going to be there, I think the need is going to be there, but we're at this point trying to evaluate the timing vis-à-vis what the drilling expectations are, what the quality of the gas is, so what the overall need will be. And then we're at this point I think pretty flexible on where we think the ultimate solution is going to be. The good news is that there are several, or at least a few, opportunities which appear to be economic and realistic. And from our standpoint through our joint venture opportunity with EQT we expect to be handling a significant amount of liquids, so we think we can influence what ultimately gets done and at the end of the day would like to participate in the build-out of that solution.

I think Matt, the other thing you have is obviously if it is a major liquids line and large diameter, you end up having opportunities for Spectra as well. So, you get the nice complement between DCP and the processing side and Spectra on potential amount of liquids side. And the benefit, obviously, for folks like Equitable, EQT, they work with both those very closely, both important customers. So, I think the idea and what we're trying to do at DCP and Spectra is really try to offer full cycle solutions here.

I think as you know one of the things at EQT, what interested EQT in DCP Midstream and as part of the Spectra enterprise is our liquids capability in terms of handling and getting good values for liquids. But also the financial capability of the enterprise and its ability to bring not only the technical expertise but the capital to what could be a fairly sizable NGL solution.

Okay. Thanks. That's what I was looking for. And my last question relates to dividends and the dividend policy. I guess and maybe I guess this is for Greg here. You talked about earnings likely being higher than guidance this year hopefully if the back half plays out. There is a big appetite for yield in the marketplace that we have seen play out in MLPs and your MLP products. How does that bear on the dividend then and for potential dividend growth into next year?

Obviously, as we start putting the plans together for next year and talking to the Board about that, I think both obviously management and the Board really recognize the value of dividends and how important that is to the value proposition. So, that's definitely something we'll be taking up, and obviously with the steady earnings growth like to be able to see us have an opportunity to consider that. So, definitely something on the radar screen, Matt.

Okay. Thanks, guys. Those are my questions.

Okay. Thanks.

Operator, do we have another question?

Your next question comes from the line of Faisel Khan.

Hi, Faisel.

Hi, how are you doing? Good morning.

Good.

Just a couple nits and nats, on the U.S. Transmission side, the operating and maintenance costs at $165 million, even if I add back the $24 million for last year, it still looks like O&M is fairly high compared to last year. Anything going on there in terms of development costs?

No, Faisel. There is some timing during the year for turnarounds, for integrity spending. And we're actually, as I mentioned a minute earlier, we're about $38 million at the corporate level under spent on O&M. But U.S. Transmission is basically right on budget.

Okay. Got you. And then on the distribution segment, I know you talked about the lower operating fuel costs. Was there any impact from this higher pipeline throughput that you guys had of roughly up 40% over last year? It looked pretty strong. I am wondering what's driving that despite lower heating degree days.

No, really not much. Remember that that's all contracted, so we would have volumes go through. Obviously it might have been a little bit of a weather impact. It didn't get hot until later on in the summer, but really doesn't have much of an earnings impact given the nature of the way we contract for those services.

Got you. On the Western Canadian side, the Empress inlet volumes, I know you talked about a 25-day turnaround for that facility. It still seems to be down 50% over last year, seems a little bit higher down time compared to the number of days you had that plant down for.

Yes. I think you found the overall volumes coming out of Western Canada, the border volumes were down from call it 5 Bcf a day to the 4 Bcf range. So, when you combine the two together, that actually was the impact. And obviously that meant we had to pay a little higher premiums to get gas through Empress which obviously had an impact. Very much in line with what we thought we would earn there this year, but you might have thought that with the higher frac spread you would actually even be doing better there but when you have to pay to get the gas coming through your plant that eats a little bit on the margins.

Okay that makes sense. And then on the Bobcat Storage assets, would there be any ancillary benefits to the asset as you connect those storage assets to your main line?

I think that's one of the key things. When we first bought MHP Storage, what you're able to do, again, is offer customers so much optionality and flexibility for them to use services, not only through the assets we have existing today, allowing access to the pipes but now Transco, Gulf South also giving customers access to those pipes. I think that's the real benefit and why we'll be able to realize premium values out of that asset as we build it up. So, when you think about all the power changes that will go on in the Southeast, you think about the gas flows, you think about the pipelines that now interconnect with what will be 100 Bcf of storage and I think we'll be able to make that asset hum quite nicely.

I guess that would be outside the $100 million that you talked about that Bobcat could earn in 2015?

We'll see how we contract the thing up as we go, but obviously I think we have been appropriately conservative with our assumptions there and the storage guys will get out there and hunt and do everything they can to add to that.

And last question on NGL supply growth. Over the last two quarters what part of the barrel have you seen the most supply growth in, meaning ethane, propane, butane, the different parts of the barrel? And what do you see the rest of this year?

It has really been a big growth on the ethane side and you see that across the board. And as you see more and more activity in liquids rich areas I would expect that's where you will see it. Tom, any comment on that either with respect to other parts of the barrel, propane, et cetera?

No. I think both propane and ethane have moved up and I think the expectation you're seeing with additional cryogenic facilities coming on over the next couple years is that those will continue. There is a fair amount of variability between formations and geographic locations, and I think we're all still trying to get our arms around that as some of the newer plays come online. But in general those two have moved up and that's simply, on the ethane side, a matter of the number of new cryo facilities coming on.

And do you see the fees you're charging for fractionation, are those fees moving up over time, do you think?

The fees on fractionation in general have moved up. I think, as you know, they're in some cases up very significantly. It is enough to support -- and we're encouraged by this quite honestly -- it is enough to support new fractionation facilities being contracted longer term, enough to support them getting built. There is a few that will come online here in the next six months or so and now folks are talking about additional frac facilities and additional expansions in the Gulf Coast that I am sure you are aware of. So the fees are there to support those, provide decent returns, and we're encouraged by that because we don't want to see a bottleneck at that point in the system.

Are you seeing some of those profits drop through to your bottom line at DCP?

Our frac facilities are fairly modest. We have the opportunity to participate in some expansions. The answer is yes, but in terms of the other aspects of our business, the most important contributions to our growth are going to be the things that Greg mentioned, our expansions in the Permian, our new facility in the DJ that's going to come on here in January, and our expectations for growth here in the near term in the Eagleford and the Marcellus.

Great. Thank you very much for your time. Appreciate it.

Thanks.

(Operator Instructions). Your next question comes from the line of Elvira Scotto.

Good morning.

Hi, good morning. A couple of questions to follow up on the Bobcat acquisition. Number one, can you talk a little bit about what kind of process this was? Was this a negotiated deal? Was there an option and if there was any bidding, how competitive it was?

I am probably limited in what I can say under various confidentiality agreements, but they had run a process. This is a group of folks that have actually developed storage a couple of times. In fact they developed our MHP asset when we bought it off of them. So it's private equity that had gone out and taken risks to develop this. There is always competition in assets, that's for sure. And then in the end it was obviously just a negotiated deal between ourselves and them.

Okay. Great. And then just bigger picture and longer term, when you think about storage and you have a couple of storage focused MLPs and you see a lot of expansion announcements, if you look out longer term, say five to ten years, what do you think the supply demand dynamics are going to be for storage? You touched on it a little bit, but maybe some additional thoughts on that, and thoughts on maybe where the storage is located and the type of storage.

I think you hit on a couple of them. If you go out 2015, maybe there is going to be about 5, maybe 5.1 Tcf of storage versus today what would be there about 4.9. So not a huge massive increase in storage. You hear about lots of announcements. Obviously two critical components. One is it's salt dome storage which is what this is that we bought that has high deliverability, high flexibility, injection and withdrawal rates which is so critical to gas fired generation which is going to be increasing. And then you have the other kind of storage which is reservoir storage which is what would be like our Union Gas storage which is obviously valuable, particularly given its location closer to the market typically. but very different dynamics, as well. I think what you'll continue to see, and the value proposition, you will continue to see volatility, season-to-season, basis-to-basis around natural gas and that's where the real value opportunity exists. On top of that you see an increasing amount of gas-fired generation which is going to demand that type of high deliverability type service. So if you look in the Gulf Coast region where the Bobcat asset is, call it five years out, a T-and-a- half of storage of which we'd make up, call it 75 Bcf, so we're still a pretty small component of the storage piece.

Okay. That's helpful. Thank you.

There are no further questions at this time.

All right. With that I would like to thank everyone for joining our call today. I will remind you that on Tuesday, August 17th we're going to be in Boston for breakfast and in New York for lunch. You should have received an invitation to that. If you haven't, let us know and we'll see to it that you do. If you would let us know whether you plan to attend, that would be great, and we'll look forward to seeing you then. As always, if you have any further questions, please feel free to either call Patti Fitzpatrick or me. With that, thanks for joining the call today.

And this does conclude today's conference call. You may now disconnect.