Sempra (SRE) Q2 2011 Earnings Report, Transcript and Summary

Good day, and welcome to the Sempra Energy Second Quarter 2011 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Steve Davis. Please go ahead, sir.

Good morning, and thank you for joining us. I’m Steve Davis, Vice President of Investor Relations. This morning, we'll be discussing Sempra Energy's second quarter 2011 financial results. A live webcast of this teleconference and slide presentation is available on our website under the Investors section. With us today in San Diego are several members of our management team, including Don Felsinger, Executive Chairman; Debbie Reed, Chief Executive Officer; Neal Schmale, President and Chief Operating Officer; Mark Snell, Executive Vice President and Chief Financial Officer; and Joe Householder, Senior Vice President and Controller. You'll note that Slide 2 contains our Safe Harbor statement. Please remember that this call contains forward-looking statements that are not historical fact and constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of performance. As you know, they involve risks, uncertainties and assumptions, so future results may differ materially from those expressed on our call. These risks, uncertainties and assumptions are described at the bottom of today’s press release and are further discussed in the company’s reports filed with the Securities and Exchange Commission. It's important to note that all of the earnings per share amounts in our presentation are shown on a diluted basis. With that, I'll turn it over to Don.

Thanks, Steve, and thank you all for joining us. I'd like to begin today's call by commenting on our recent CEO succession process. We'll then review our second quarter financial results and then provide an operational update on our businesses. In light of Neal Schmale's retirement later this year and my retirement next year, our board engaged in a thoughtful year-long process to ensure a smooth leadership succession. That process culminated in the election of Debbie Reed as CEO and as a Sempra board member. As many of you know, Debbie has a broad understanding of the energy industry and has excelled in her 30-year career with the Sempra companies. She has demonstrated outstanding leadership at every level of responsibility. She is also well respected by key stakeholders that we interface with, including customers, regulators, elected officials community leaders and our employees. Given this, we decided that she was the right person to lead the company going forward. Once the decision was reached that Debbie would succeed me as CEO, we decided to make that transition effective immediately. This timing provides Debbie with the opportunity to focus on Sempra's annual strategic review of our business. Additionally, this timing allows Neal and me to provide support and guidance to Debbie and the rest of the organization during this transition until our retirements. We have an excellent management team in place to take the company forward. The board and I are confident that Debbie, Mark, the business unit presidents and the rest of the management team will continue our excellent track record of creating shareholder value and delivering great service to our customers. Now I'd like to hand the call over to Debbie.

Thanks, Don. I'm pleased to join you all in my new role today. Before I review our second quarter results with you, I would like to address the question some of you have asked concerning my strategic vision for Sempra. I want to start by reiterating that our strategy has been and will continue to be focused on regulated utilities and contracted energy infrastructure. It is a space within our sector where we have demonstrated success and one in which we have deep competency. As Don mentioned, we have just begun our annual strategic review at Sempra in which we update our 5-year business plan. This year, I have 3 objectives that we will complete as part of this process. First, we will conduct a thorough market assessment of the short- and long-term business environment in which we operate. We will be analyzing market trends to identify opportunities and risks. As an example, environmental regulations are prompting retirements of coal plant, at the same time that nuclear plant development has been substantially slowed. This trend is likely to create opportunities for natural gas-fired generation and the development of new gas infrastructure, including storage. Secondly, we will be reviewing the current and expected performance of our asset portfolio considering market cycles and focusing on getting the greatest value from these assets. We will develop specific strategies for assets not meeting our return expectation in this market environment. Lastly, we will put in place the organization and leadership to execute and deliver on our plan. I feel fortunate to have Don, Neal, Mark and the rest of the management team available to draw upon and support me in this process as I transition into my new role. As always, we will update you on any developments on our quarterly earnings call and…

Thanks, Debbie. At San Diego Gas & Electric, earnings for the second quarter of 2011 were $71 million compared with earnings of $75 million in the year-ago quarter. The small variance was due to higher AFUDC earnings, which were more than offset by higher litigation expense and insurance premiums. For the 6 months of 2011, SDG&E's earnings were $160 million, which is in line with the $158 million of earnings last year. At Southern California Gas Co., second quarter 2011 earnings were $59 million compared with $69 million in the second quarter of 2010. The second quarter of this year was impacted by $5 million from lower storage revenues and higher expenses net of higher CPUC authorized margin and a $4 million adjustment to prior year employee benefit costs. For the 6 months of 2011, SoCalGas' earnings were $127 million compared with $134 million of earnings last year. Now let's go to Slide 5. Sempra Pipelines & Storage recorded earnings of $337 million in the second quarter of 2011 compared with earnings of $39 million in the same quarter of 2010. Excluding the impact of the $277 million gain, earnings were $60 million for the quarter, and the quarter benefited from $14 million of higher earnings from our increased ownership stake in the utilities in Chile and Peru and also from $5 million of higher earnings from the pipeline assets in Mexico, which were acquired in the second quarter of 2010. For the first half of 2011, Sempra Pipelines & Storage had earnings of $391 million. Excluding the impact of the $277 million gain this year, earnings were $114 million for the first half of 2011 compared with $77 million last year. The increase was mainly due to $20 million higher earnings from Chile and Peru and $13 million higher…

Thanks, Mark. Now let me update you on activities at our California utilities. Last month, SDG&E and SoCalGas filed updates to their general rate case applications, which reflect the impact of bonus depreciation. The updates were consistent with what we had included in the guidance provided you in March. The CPUC schedule for the rate cases call for intervener testimony in September, hearings late in the year and a final CPUC decision around March of 2012. The CPUC has already approved making the new rates established by these rate cases retroactive to January 1, 2012. Another important regulatory proceeding is the CPUC's examination of what changes should be made to natural gas pipelines following the tragedy in San Bruno. As we talked about on our last call, the CPUC requested records supporting maximum allowable operating pressures for 1,600 miles out of 4,000 miles of Department of Transportation defined transmission pipelines that SoCalGas and SDG&E operate. We conducted an extensive review, which renewed our confidence that the maximum pressures on our systems have been appropriately set in accordance with current regulation, and that we operate our systems safely. The CPUC has also directed the natural gas utilities in California to file implementation plans to comply with new requirements to test or replace all transmission pipelines that have not been pressure tested. We will submit our plan to the CPUC by August 26. We believe that complying with these new requirements has the potential of increasing capital spending at our utilities, particularly at SoCalGas, by several hundred million dollars per year over a 10-year period. But it will ultimately be the commission's decision to set the appropriate level of spending going forward. Both SoCalGas and SDG&E expect full recovery for all incremental costs related to complying with the new requirement. Please go…

[Operator Instructions] We'll take our first question from Faisel Khan of Citi.

On the power generation contract I believe you guys signed at Sempra Generation, about the 25-year contract for 240 megawatts beginning in 2015, can you guys talk about that a little bit more in terms of what the pricing outlook is for that? I know we have the contract falling off at the end of the year. What does -- what is that contract exactly -- how this is structured?

I would just say that we're not going to disclose the commercial terms. But we feel that this is a really good starting point for hedging our fleet and we feel very positive about the contract. We think it's good for the customer and very good for our business as well.

Okay, fair enough. And then if you could give us a little update on what -- how you guys are thinking about some of your gas infrastructure assets within the U.S., particularly your equity investment in REX and your storage assets and your LNG assets, are you guys still thinking about or do you ever look at the MLP structure and how that could enhance the value of Sempra stock or how that might help you guys grow that business a little bit further?

Well, Faisal, I will start and then I'll ask Mark to add anything to that. As was mentioned, we're engaged right now in our strategy works that we do every year around this time. And those are the kinds of questions that we're looking at as part of the strategy work. We're looking at every asset we have and what's the best structure for that asset. Is it an asset that we can add assets to and increase the value and what is the best way to maximize the value of our existing investment? And certainly, we will look at structures like MLPs as part of that. Mark do you want to add anything?

Yes, I would just say, we've looked at it in the past and I think we're focused on it now and I would expect that we would -- I don't know that we'll go exactly the MLP route but I do think that we'll do something to maximize the value of our assets. But that's certainly an option that's open and we're exploring it in the current market.

Okay. And then, have you guys also looked at the liquefaction option at your Cameron facility? Is that still a possibility or do you -- how are you guys thinking about that?

I would say that, that is a possibility if we can get long-term contracts from a credit worthy counterparty for that. I think Don has stated before and I would reaffirm that my view is we're not going to do that unless we can have long-term contracts in place. But certainly, that's something that we're looking at with other parties.

We'll go to Paul Patterson of Glenrock Associates.

The tax rate for the second quarter seemed a bit low and I was wondering if you could sort of describe what's going on there and if there's been any change in the tax rate outlook for this year and others?

I'm going to ask Joe Householder to answer that.

This is Joe. Our tax rate is right in line with what Mark presented at the analyst conference, roughly about 30% for 2011. The low rate you're seeing in the statement of operations is simply due to the noncash book gain we had on the step-up of our basis of the preexisting Chile/Peru equity investment, so that's why it's 17% and 25% or so. But we're really at the 30% rate if you take that gain out.

Okay, great. And then, you guys have thought about a buyback and with the falloff in the share price and what have you, I was wondering if you guys might want to sort of talk about what your current thinking on that might be or how you're looking at that in relation to some of the activity we've seen in the market in your stock?

I'm going to ask Mark to address that. We've had a number of discussions, so.

Well, certainly, we think our stock is an excellent investment right now. But I do think -- we are still looking at where we come out at SoCalGas with the increased capital spending that we fully expect to have to pay or to have to invest for the next couple of years, and as we've said, it's probably to the tune of several hundred millions of dollars a year for a multi-year period. And so once we know what those numbers are, then we can think about whether there's room to do any kind of buyback or anything like that.

So we're probably talking in terms of timing still a ways off, is that how we should think about it?

Yes, I would think we wouldn't make any decisions until the fourth quarter.

Okay. And then the pipeline analysis, it sounds like you guys have done a thorough analysis and you're okay with the pressure. Another company in California has had quite a few things come out, I guess, as part of their review in terms of past practices and other issues perhaps not directly related to pressure. Can you guys tell us if there's anything potentially like that, that you guys are seeing or any revelations that you guys have had about your -- with your safety review that might be noteworthy?

I will just say that we have had people doing thorough reviews because we've had the same reporting requirements to the CPUC as other companies in California have had, and that we have not found anything that concerns us in terms of our past practices or how we operate our pipelines. We operate our system very safely. We have looked at lessons learned from the San Bruno incident and are making modifications going forward that we think would improve our responsiveness if something like that occurred. But we have not found any deep concerns at all in terms of the way we've operated our system. And we just had a recent audit of this by the CPUC and they didn't find any concerns either that's significant.

We'll take our next question from Mark Barnett of Morningstar.

Couple of just real quick questions. With the tax equity investment alongside just the normal equity investment in -- was it Rock Rim, sorry, are you considering doing that maybe outside of just wind or I mean, is there like a sort of a targeted technology? I mean maybe you might be considering geothermal investments as well or perhaps solar?

What we've looked at thus far is most of the projects we focused in on have been on the wind side, but it wouldn't preclude doing other technologies. I would stress that this investment is being done within SDG&E, within the regulated company, and so the big issue there is ensuring that the entire structure is a benefit for customers as well. So if there was a competitive solar deal that could be structured in the same way and provide benefits to customers, we would certainly consider that.

Would you be considering kind of the same set up where the tax equity investment alongside the equity?

Yes, on the geothermal, I don't think that, that would -- we would be looking at that. But in this case, this was a regulatory structure that was negotiated as part of a settlement. And that the CPUC basically had the structure approved where we would have the rate based investment and then we would have a shareholder investment alongside of that. So my sense is that, that would be the type of structure that they would want us to have going forward.

Mark, this is Mark Snell. The one thing on that would be is the tax equity helped us get a lower cost to customers because it lowered the financing cost for the developer and any of those. And that would be -- that same structure could work very well with a solar development, as well as wind. Anything that has a high tax component to it, we think it could be effective and literally -- I mean, it is one of the few times where it is sort of a win-win for everybody. We get lower pricing for customers, the developer gets -- has lower cost and we get a tax benefit at the utility that's shared with the shareholders. So all of that kind of works out well.

Okay. And then just one more quick question on the PEMEX assets, has there been any further discussion around those remaining kind of assets in the JV? Or is it just going to sit pat for now?

Well, as far as the PEMEX assets, right now, we're working with PEMEX on some potential growth projects. There has been no additional movement in terms of them exiting the partnership. But as long as we remain in the partnership, we believe that there will be a number of growth projects that we could do jointly. So that's where that stands at this time.

We'll take our next question from Ashar Khan of Visium.

Just wanted to check in, where do we stand on distributions from the sale of the commodity business, could you just help us where we are in that? Have you gotten everything or just still -- how much more is there to go?

Well, we've gotten about -- we expect to get between $1.8 billion and $1.9 billion. We've gotten a little over $1.4 billion, and we would expect to get the remaining $400 million to $450 million by the first quarter of next year. And we did get about $320 million in April of this year as a distribution.

Yes, and we're kind of on a quarterly distribution schedule. We should get another $100 million here in a week or so.

And Debbie, as you guys go through the strategic review, I guess, one thing as we've gone through the sale of the commodity business to make it more simple and all that, it's still -- I don't know we're still not getting the multiple, and I don't know, is there some way you're thinking how to simplify it to the investor base, so the I guess, the different components of the businesses get their multiples reflected into the price? I'm trying to see which way you are thinking about strategically as you think over the fall.

Yes, I would say that, that is one thing that we will be looking at. We'll be looking at all of our businesses and the long-term value of those businesses in our portfolio. We will also be looking at how do we focus on increasing some of our domestic earnings growth. And so those will be things that will be part of the strategy work. And since -- and I've just been in this job a month, I can't tell you much more than that, but we will be doing that work over the next few months.

And our next question will come from Michael Lapides of Goldman Sachs.

Your Latin American businesses, can you talk to us -- I think one of the times we were out there meeting with you guys, your -- George had discussed and I think in the follow-on, you all had about significant potential growth opportunities around your Peruvian and your business in Chile. Can you just talk about whether those growth opportunities are adding bolt-on distribution businesses or are they branching out in other things like hydro or electric transmission?

Yes, I'd be happy to talk about that. As I mentioned, I was down meeting with the new president, the energy minister and the prime minister, and they are very interested in seeing that more electric generation gets built. And in Peru, we are working right now on our first hydro project, that will be about 100-megawatt project to be completed over the next couple of years. That project will then give us an opportunity to do more. But I want to stress just in our basic distribution area, kind of our basic growth in our Chilean and Peruvian businesses so you get a good sense of that. If you look at the customer growth that we're seeing in those businesses, it's about 2.5% a year. If you look at the sales growth in those businesses, it's about 5.5% to 7% per year. And we are interested, and if there are some potential distribution companies that could be consolidated and we feel that they would be wise investments for us, we would certainly consider those investments as well. It does have a very high growth environment and have a very stable regulatory environment, which we believe will continue.

Got it. And one follow-up. Can you talk about the capitalization of the business and if growth opportunities don't emerge, whether there's a potential to recapitalize that business and eventually to bring back some incremental capital back to the U.S. or use it for like investment in Mexico or elsewhere?

Yes, there is some opportunities, and I'll have Mark go through the details of that.

Of course, all of the expansion projects and even the acquisitions that we could possibly do in South America would all be funded at the local level down there. We have additional borrowing capacity at that level, and we also have offshore cash that we could use to invest there. So we wouldn't anticipate funding from the U.S. to grow those businesses. We would anticipate doing that there locally. And then obviously, we, like a lot of other companies in the U.S., are lobbying and talking about some kind of change in the tax system that would allow U.S. companies to bring cash home and invest in opportunities here. And we certainly are poised and ready to take advantage of that if that should happen. But we have in our models also anticipated that even if it didn't happen, at some point in development we will have enough cash, we will have to bring some of it home. And of course, we have to pay the taxes on that. But we think the right answer right now is since we have good investment opportunities is to continue to invest that money offshore.

How sizable is that? Meaning like if you were to make the decision to bring back some of the capital today, what are we talking about?

Well, in our 5-year plan, we'd build up about $1 billion of offshore cash over the 5-year planning period.

[Operator Instructions] And we'll take a follow-up from Faisel Khan.

Sorry, guys, just a couple more questions. I think there's talk of this brass LNG project maybe moving forward, and I think you guys might have a small stake in that project. Are you still interested in participating in that project? Or is that something that you have to review?

I would say that we're looking at all opportunities in terms of that, and I'm going to ask Neal to put some color around it.

Yes, this is Neal Schmale. And we did have an interest in acquiring a small stake in that project, emphasize the word small, and the project like all of these takes a long time to get going. But I think the general idea is that to acquire molecules of LNG internationally will allow us to improve that business.

Okay, understood. And then on the SoCalGas side, you guys talked about kind of lower storage revenues. Can you highlight that a little bit more or go into that a little more? What causes those storage revenues to be lower? I thought that was mostly a regulated business, but I guess there's a little bit of industrial and power generation load that affects that number?

Yes, it is a regulated business and on the storage piece, so we have an incentive design that allows us to make some additional money by selling storage at a premium to some of the market pricing and packaging storage in creative ways. And we've earned incentive historically, earned some incentives this year for that, but the incentives were less this year than we've had in the prior year. That's all that's happening there. And there was a couple of million dollars on a pretax basis and nothing real significant.

Okay. And then just, is your Sunrise, when I look at the CapEx for the first 6 months and is it possible to break out kind of what Sunrise and the Smart Meter programs was, because these are very distinct projects that will -- that have come to a close or will come to a close in the near future, so that represents kind of a ramp down I guess CapEx although I think some of your other...

Yes, for Sunrise, the number was $347 million for the first 6 months of the year. And then for the Smart Meter CapEx, we were looking at a total this year of about $120 million for the entire year, and I don't have the number in front of me for the first 6 months. But it's pretty much -- it's in that range.

And at this time, there are no further questions. I'll turn it back over to Ms. Reed for closing remarks.

Well, thank you for all joining us today. We really appreciate you being with us this morning. And if you have any questions, please don't hesitate to call Steve Davis, Victor or Scott with any follow-up. Thank you again. Bye-bye.

Once again, ladies and gentlemen, that concludes our conference. Thank you all for your participation.