South Bow Corporation (SOBO) Q2 2025 Earnings Report, Transcript and Summary

Good day, and thank you for standing by. Welcome to the South Bow Quarter 2 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to Martha, your first speaker for today. Please go ahead.

Thank you, Brianna, and welcome, everyone, to South Bow's Second Quarter 2025 Earnings Call. With me today are Bevin Wirzba, President and Chief Executive Officer; Van Dafoe, Senior Vice President and Chief Financial Officer; and Richard Prior, Senior Vice President and Chief Operating Officer. We also have additional members of our leadership team in the room to help with the question- and-answer session. Before I turn it over to Bevin, I'd like to remind listeners that today's remarks will include forward-looking information and statements, which are subject to the risks and uncertainties addressed in our public disclosure documents available under South Bow's SEDAR+ profile and in South Bow’s filings with the SEC. Today's discussion will also include non-GAAP financial measures and ratios, which may not be comparable to measures presented by other entities. With that, I'll turn it over to Bevin.

Thanks, Martha, and good morning, everyone. We appreciate you joining us today. South Bow's second quarter financial results once again exemplified the resilience of our business with our strong commercial underpinnings protecting our cash flows from the market volatility and operational downtime. We generated $250 million of normalized EBITDA in the period and for the second consecutive quarter, successfully maintained our debt metrics as we prioritize strengthening our financial position. We also demonstrated our execution abilities by advancing our Blackrod Connection Project and continuing to establish South Bow's capabilities as we transition from a large rate-regulated entity to a more commercially focused and entrepreneurial organization. Now that we are using our own ERP system and are close to substantially exiting our transition service agreements within a year of spinning, we are optimizing our workflows to ensure South Bow's long-term competitiveness and success. Now regarding Milepost 171, we expect to have the root cause failure analysis findings by the end of the third quarter. Richard will share more on that later. While we don't have all the answers yet, what I can share is that South Bow's agility as a stand-alone company has allowed us to respond, repair, recover and remediate quicker than before. This gives me the confidence that we are developing and executing a remedial action plan that will address the findings of the independent investigations and ensure the continued safe and reliable operations of our pipeline, all while maintaining our solid financial outlook for 2025. While this year has had its fair share of challenges, I'm incredibly proud of the way our team continues prioritizing the safety of our operations and surrounding communities, while remaining focused on the future as we work to enhance our value proposition of providing customers with the optimal path to the strongest demand markets. I will now ask Richard and Van to provide some additional details on our operational and financial outlooks. Richard?

Thank you, Bevin, and good morning. Today, I'll provide updates on the progress we've made responding to Milepost 171 and next steps as we address PHMSA's corrective action order and an independent third party continues the root cause failure assessment. The most important points to be made today are that, one, the pipeline is safe to operate. Two, we are confident the independent third-party investigation will identify causal and contributing factors to the incident and remedial steps will be taken that address these findings. And three, while we comply with the corrective action order, we are able to continue delivering on our contractual commitments of 585,000 barrels per day. Our operations and remediation crews completed the cleanup and reclamation of the site in early June. We estimate the total cost for the incident, inclusive of the response, repair and cleanup will be approximately $60 million, owing to the rapid and well-orchestrated initial response, which mitigated the environmental impacts of the incident. Our insurance policies are expected to cover most of these costs. As Bevin mentioned, the third-party root cause failure analysis is ongoing, and we anticipate the results will be completed in the September time frame. We can confirm that the mechanical and metallurgical testing completed to date concluded that the pipe and welds met industry standards for design, materials and mechanical properties. The testing determined the source of the failure was an axial crack that initiated on the long-seam weld, which propagated during operations until the failure occurred. The root cause investigation is a dynamic process, and we will continue to learn more as it unfolds. In parallel, our engineering and pipeline integrity teams have worked closely with our integrity providers, and we've begun implementing remedial actions. We have already completed 4 in-line inspection runs since April with the preliminary finding of these tool runs indicating no injurious issues. We've also completed 8 integrity digs in the vicinity of the failure location, again, with no notable issues to report. Additional in-line inspection tool runs and further integrity digs will be completed through the balance of 2025 and into 2026. As we conduct these activities, all findings will be reported to PHMSA as well as incorporated into our programs to strengthen our confidence in the integrity and reliability of the system, keeping our assets safely operating. Through this process, we will maintain transparency with our regulators, customers and industry peers. So with that brief operational update, I'll pass it over to Van to discuss South Bow’s financial outlook for the remainder of the year.

Thanks, Richard. South Bow's base business remains largely unaffected by tariffs and market volatility with 90% of our normalized EBITDA contracted. We are reaffirming our 2025 outlook for normalized EBITDA of $1.01 billion. South Bow expects to fulfill our committed throughput contracts for the remainder of the year, but we will have limited capacity to transport uncommitted or spot volumes on our Keystone System. We are revising our outlook for distributable cash flow to $590 million, up from $535 million to reflect a few items. First are the positive impacts from changes in U.S. tax legislation, which will contribute approximately $15 million of our run rate current tax savings. Second is our modified definition of the measure, which now includes interest income of about $30 million for 2025. The remainder is made up of small wins that came through the first half of the year. We are reducing our maintenance capital expenditures outlook by $10 million, bringing it down slightly to $55 million in 2025 as we focus on prioritizing the remedial actions related to Milepost 171 that Richard just spoke to. With our outlook for normalized EBITDA remaining unchanged, we expect to exit 2025 with a net debt to normalized EBITDA ratio of approximately 4.8x. Our deleveraging will begin as the cash flows associated with Blackrod start in the second half of 2026 and increase through 2027. Finally, our Board of Directors have approved a quarterly dividend of $0.50 per share payable on October 15 to shareholders of record on September 29. I will now hand it back to Bevin for his closing remarks.

Thanks, Van. As we approach our 1-year anniversary as a stand-alone company and look back at the priorities we initially set for our organization, I'm proud to say that the team is successfully delivering on our business objectives. First, financially, we are on track to meet our near-term deleveraging targets and our dividend underpinned by our highly contracted cash flows remains an important component of our total return proposition. Second, operationally, we are safely advancing our integrity and reliability work to achieve a timely resolution to the corrective actions from Milepost 171 while also making a significant progress on the Blackrod Connection Project. And finally, strategically, we are optimizing our business to enable future growth to support our customers by providing them solutions that leverage our existing infrastructure in North America's most strategic energy corridor. With that, I'll now ask the operator to open the line for questions.

[Operator Instructions] Our first question is from Maurice Choy of RBC Capital Markets.

Just wanted to have 2 questions. The first one is a big picture question about the headlines that we still see about building more energy infrastructure in Canada, including crude oil pipeline. With the assumption that we will indeed see higher crude oil production in the coming years through the end of the decade. Specific to South Bow, can you speak to what you may be working on, how the timing of such projects could line up to some of the contracts that are expiring later at the start of the next decade. Just thoughts on what it means specifically to South Bow.

Thank you, Maurice. It's Bevin. So our strategic corridor serves the strongest supply basin to the strongest demand markets for heavy oil. And as you've noticed, we anticipate to see that supply grow over the coming years. Quietly, over the last decade, we've seen heavy oil supply grow by 1 million barrels a day. And with the start-up of the TMX pipeline, that served that market. And so over the next couple of years, we anticipate that, that supply will continue to grow. And by the end of perhaps or by early 2027, we'll be in a position again where we may see, again, constraint in the egress out of the basin given the strong demand for that heavy product. For South Bow, we remain committed to leveraging our pre-invested capital that we have, not only in our Alberta systems and -- but also in our Gulf Coast section. And we're looking to work with customers to find solutions to provide incremental capacity solutions for them over the next number of years. Our initial focus, as we've highlighted in the earlier remarks was to leverage our Grand Rapids corridor to provide a solution for IPC to bring on that production in the near term. And we continue to see like opportunities, not only in Alberta, but throughout our system down through the Gulf Coast.

Understood. And if I could finish off with a question on the TSAs actually. Can you speak to what opportunities that may open up for you as you exit your final TSAs? And what, if anything, of that might be factored into the 2% to 3% EBITDA CAGR guidance that you have?

Yes. Maurice, getting off the TSAs is really allowing us to focus solely on our business. We accelerated moving on to our new ERP system that came with some extra manual processes, but now we're able to start rebuilding some of the workflows in our business. And so what I mean by that is we were having to operate under the processes of the previous systems until we switched over. So accelerating that just allows us to advance our business plans a little bit quicker. By the end of this quarter, we hope to be off the last of those major TSAs, and that's our SCADA systems. And that will likely get us then in a position that within 1 year since our spin date, we will be completely done with the TSAs and we'll have repositioned our business for that longer-term growth so that our teams can legitimately just focus on South Bow's business going forward as opposed to the spin activities. So it doesn't change our 2% to 3% CAGR growth outlook, but it allows our team to be much more focused just on our base business, which will then, in turn, I'm sure, find opportunities for us to continue to grow and optimize our solutions for our customers.

Our next question is from Burke Sansiviero of Wolfe Research.

Just one for me today. It seems like there was a little bit of a delay on the third-party root cause analysis. Is there anything in particular to call out on the timing lag? And can you just walk through any early takeaways in more detail on how you think the process might go from here?

Yes. I don't think there's too much of a delay as I see it. It's a dynamic process. We were probably -- it took us a little bit longer than anticipated at the very front end, actually getting our root cause failure analysis third party selected and having PHMSA approve that. So that was maybe a very few weeks at the very front. But that process continues on. The lab has completed the majority of their work, although there's some follow-up things that they're working on with the RCFA provider. And I think that the way it's going to play out is we expect the analysis to be delivered in the September time frame. And then as I mentioned, in parallel, we've got a lot of activities on the remedial side already ongoing. We have completed 4 in-line inspection runs. We've got 2 more scheduled. We've completed 8 integrity digs. We've got 4 more scheduled. And so that work will take shape through September. And then once we have that RCFA, we'll work with PHMSA in developing a more detailed remedial work plan, and we'll have that approved and then we'll continue that scope. But it's a little too early until we see the results of the RCFA to define exactly what that remedial work plan is going to look like and what the duration of it is going to be.

Our next question is from Robert Hope with Scotiabank.

This is Jessica Hoyle on for Robert Hope. So just to start, regarding the comment in the MD&A that demand for uncommitted capacity is expected to remain low in the near term. With Enbridge's Mainline under apportionment, how do you envision uncommitted barrels returning to your system versus TMX?

Yes. Thank you, Jessica. When we set guidance for 2025, that was ahead of a couple of other headwinds that showed up. But for 2025, with the start-up of TMX, we anticipated that we'd have lower demand for our walk-up spot capacity. And just to remind folks, we have 94% of our Keystone System is fully contracted and flowing, and we have to reserve 6% for spot capacity. So for that spot capacity, we remain extremely competitive as we serve the highest demand market in the Gulf Coast. And so as additional barrels as supply starts to grow and exceed available capacity, we believe that we provide the most competitive route to the strongest market. And the most important thing that we manage is to improve the netback for our customers. And wherever the strongest netback is for those barrels is where those barrels will likely land. And so not only do we believe we provide the highest netback, we also are the only batch system, and we deliver the barrels faster than any other system to those strongest markets. So we haven't guided this year to anticipate much spot volumes coming on to our system. Obviously, we're under a derate moving all 585,000 barrels a day of our contracted volumes out of the basin. And we anticipate that as we address the next steps of our integrity program that once we see supply later in '26 and '27, our goal is to have our system ready to accept those walk-up barrels.

And then can you update us on your initiatives to add contracts to the southern end of Keystone?

Yes. On the market-linked portion of the system, sure. So that really is at this point, just an ongoing part of our business is we just recently ran another open season that closed successfully entirely within our expectations and our plans. I expect that we're going to continue to run open seasons throughout the year as we work with our customers on exactly what they're looking for, for terms that they'll move domestic barrels from Cushing down into the Gulf Coast. And as you'll notice in our release that we've been keeping that segment of the system quite full. It's actually moved more barrels in the second quarter than in the first.

Our next question is from Sam Burwell of Jefferies.

Just curious how you'd characterize the organic and maybe inorganic growth opportunities for South Bow as things stand today? And any color on whether you see more attractive opportunities on the Canadian side versus the U.S. side?

Yes, Sam, great question. Our focus as per our earlier remarks was to get through our first year, get off our TSAs, get in a position where we were lined out to be able to start pursuing that additional growth, both organically and inorganically. And so very happy that we've achieved our objectives on that front. When we initiated, though, it wasn't as if we were waiting to start building that hopper of opportunities. And on Richard's team, they've been maturing quite a large list of opportunities both organically and inorganically. But those take time to mature, and we intend to provide a bit more color at our Investor Day in November as to how those are progressing. What I would say is that we have noted a slight increase in balance of opportunities on the Canadian side of the border kind of balancing out now between the U.S. and Canada, where earlier in our journey, we probably articulated that we anticipated the balance to be more U.S. focused. And so that's great to see because we're here to serve our customers in both jurisdictions and find those solutions. So those -- I'm happy to say that are -- it takes -- you got to have a lot of irons in the fire to get certain ones to the finish line. And fortunately, for us, we're seeing that progress quite well.

Okay. Great. And then sort of somewhat related to that, it looks like you're making great progress on the Blackrod project. But fair to say that the majority of that cash flow contribution in '26 and '27 goes towards deleveraging rather than growth CapEx?

So the way we think about growth CapEx, Sam, is our -- after covering off our interest and dividend obligations and tax, that leaves us roughly between USD 100 million and USD 130 million a year to allocate against growth. That kind of component stays consistent year-over-year and the projects that we've identified like Blackrod on average, to underwrite that 2% to 3% growth CAGR, we need to spend roughly that $100 million per year. Now how it gets spent, it's not going to be $100 million exactly every year. It's a bit lumpy. But we're just -- as we -- as those cash flows from Blackrod come on, the priority is to keep that consistent capitalization of the business and all the extra cash flow goes to our deleveraging targets to get to our -- within 4 years, get down to that 4x level.

Our next question is from Praneeth Satish of Wells Fargo.

Just on cash taxes. So I think you mentioned cash taxes come down $50 million in 2025. I guess that's from $100 million, so roughly from $100 million to $50 million because of the one big beautiful bill. I guess how should we think about the cash tax trajectory in 2026 and beyond? Because if you're -- is it going to be at that $50 million run rate going into '26 if we assume the current pace of CapEx persists? And then if so, that's quite a sizable reduction going from $100 million down to $50 million basically gives you $50 million of extra free cash flow. So does that all go towards debt paydown? Or could that put you in a position to maybe increase your CapEx budget a bit and sanction more bolt-on projects?

Thanks, Preet. It's Van here. I said $15 million, not $50 million. So yes, so it will be $15 million for the foreseeable future will be the reductions in current tax. And that's just a flip between current tax and deferred tax. And we'll use that. That's just additional distributable cash flow that we'll use either for growth capital or ultimately deleveraging.

Got you. Okay. Maybe I guess I misheard that. That makes sense. And then maybe just switching gears. So can you elaborate on kind of -- you mentioned you ran a metallurgical analysis or with a third party and what those findings revealed and whether just broadly, do those findings kind of suggest that the rupture was an isolated manufacturing or insulation issue rather than a systemic problem? And then just maybe broadly, like how does this study -- how does that metallurgical study differ from the third-party root cause analysis? And does that -- does the study -- does the metallurgical study kind of help narrow the scope of potential remedial actions that could arise from the RCFA?

Yes. I think simply the lab report and analysis, which was also completed by a third party that was approved by PHMSA that ended up becoming a component of the root cause failure analysis and investigation. I just think like that's all the scientific lab work that they did to study the pipe and examine exactly what occurred. And what it did determine is that it was an axial crack on the long-seam, which propagated during operations until the failure occurred. I think to provide much more detail than that, we're going to have to wait for the RCFA to be completed, which should be in the September time frame. But I would say that from everything that we've seen so far, we're not seeing evidence that this is a broad systemic issue that we're not going to be able to get our arms around through remedial actions that we're either completing now or that we add additionally once the RCFA is done or enhancements and additions that we make to our ongoing integrity program in the future.

Our next question is from Aaron MacNeil of TD Cowen.

This is [ Ali ] on for Aaron MacNeil. Bevin, the recent Alliance settlement is top of mind for investors and this got us thinking about if other Canadian pipeline assets may experience some sort of negative toll revisions in the future. I can appreciate you can't directly link Alliance with Keystone, but I'd like to get your perspective on the differences with contracting beyond the end of the decade, do you think there could be a resetting of revenue and cost assumptions in the future?

Yes. Thanks, Ali. With Keystone, we've negotiated market-driven contracts with renewal provisions and terms already approved by the CER and the FERC. So our market-driven approach which is really focused as per my earlier comments to provide the most competitive route to preserve the highest netback for our customers. And so we continue to see that our approach is actually quite a different circumstance than what some of our competitors' tolling mechanisms are. We feel quite confident that because we serve the strongest supply base and most directly to the strongest demand market, that we'll be in a very good position to renegotiate our contracts with our customers, really focused again, though, on providing that strong netback for them and a great return for our shareholders.

This now concludes the question-and-answer session. I would now like to turn it back to Bevin for closing remarks.

Well, thank you all for joining us today. We look forward to connecting with you in November when we report our third quarter earnings and host our first Investor Day. Thank you all.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.