Talen Energy Corp

NASDAQ:TLN

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon and welcome to the Talen Energy's First Quarter 2023 Earnings Conference Call. Please note today's event has been pre-recorded and we will not be conducting a question-and-answer session at the end of the call.

I'd now like to turn the conference over to Rajat Prakash, Vice President and Treasurer. Please go ahead.

[Rajat Prakash, VP and Treasurer]

Thank you and good afternoon. Welcome to Talen Energy's conference call to discuss our first quarter 2023 financial and operating results, updates on our key value drivers, our restructuring and recent excess financing activities and our imminent emergence. Joining me on the call today is John Chesser, Chief Financial Officer.

Today's presentation is being webcast on the Investor section of our website. We have provided the first quarter 2023 earnings presentation. This presentation contains financial information and has been prepared by and is the responsibility of Talen management. Our quarterly financial statements are now also available on the Financials and Investor Presentation page on our investor website.

Given the proximity to the completion of our structure, we will not be hosting a live Q&A session at the end of today's call. Please note that this presentation contains forward-looking statements. We encourage you to review the disclosures in the earnings presentation and in our financial statements to learn more about the significant business risks that could cause actual results to differ from these forward-looking statements.

I'll now turn the call over to John.

[John Chesser, Chief Financial Officer]

Thank you, Rajat. Good afternoon, everyone. Thank you for joining and your interest in Talen. Talen is preparing to emerge from its restructuring this week, but we have not been idle during the past 12 months having accomplished several milestones as part of its strategic transformation and recapitalization of our company.

Today and in the coming weeks, we look forward to reintroducing Talen, a company with strong cash flow generation from a diverse fleet. One of the best nuclear facilities in the country backed by the up to $15 per megawatt hour nuclear PTC, carving the leveraging of its wholly owned co-generation portfolio nearly complete and one of the world's first direct connect zero-carbon data center campuses ready to take flight.

I would also like to welcome Matt McFarland and Talen's incoming Chief Executive Officer who will be joining at emergence [ph]. Matt brings more than 30 years of experience in the energy sector, and will help deliver on our key objectives, maximizing values from our core generation business and allocating capital and access cash flow on a discipline basis.

Turning now to slide forward to begin, 2023 is off to a very strong start with Q1 delivering $660 million of adjusted EBITDA and $497 million of adjusted free cash flow for the quarter. Importantly, almost two thirds of our generation for the quarter was from zero carbon sources.

This cash flow performance was a result of a high-free cash flow per megawatt hour delivered from reliable operational performance of our generation facilities, combined with the results of our commercial hedging program, which protected cash flows during mild Q1 winter weather and operating territories. These results are due to a discipline focused on the basics, the blocking and tackling that management is executing on our power plants every day.

Talking about the plants, I'd like to give you a brief overview. Talen owns and operates high quality geographically diverse power infrastructure in North America. We have a fleet size of over 12 gigawatts with 15 generation assets across four markets with multiple fuel capabilities, primarily nuclear and natural gas.

The fleet is led by our carbon-free base load Susquehanna in a nuclear power plant in PGM, in which we hold a 90% undivided interest with 2.2 gigawatts of own capacity. Susquehanna currently provides stable cash flows through a combination of hedged generation and PGM capacity revenues.

Starting in 2024, the facility also expects to benefit from the Inflation Reduction Act signed last year, specifically, the nuclear Production Tax Credit or PTC. The PTC will provide up to $15 per megawatt hour of support, basing up and down with Susquehanna's generation revenues of between $25 and $43.75 per megawatt hour.

Essentially, Susquehanna expects to receive PTC support when nuclear generation revenues fall below $43.75 per megawatt hour. This will give additional downside protection and predictability for a large part of our cash flows while maintaining upside optionality in a rising pricey vibe. Furthermore, the PTC benefit and price spans rise with inflation, providing us with structural inflation risk protection. Combining this with Susquehanna's $22 per megawatt hour all in cost of operations yields a cash generation engine.

As for the rest of our fleet, we have nearly completed and paid for our conversions from coal, extending the lives of over 3.2 gigawatts of our PGM assets and lowering the carbon intensity of our portfolio. The coal to gas conversion of Montour is scheduled for completion in mid-2023, and the H.A. Wagner conversion by yearend 2023.

Bruner Island was converted to run on natural gas already and has switching capability to coal. As a result of these changes, we will preserve these assets and their associated PGM capacity revenues. In addition to these 3.2 gigawatts of conversions, we have 3.2 gigawatts of existing gas and peaking capacity in PGM and 1.7 gigawatts of gas capacity in ERCOT for a total of over 8 gigawatts. These assets are capable of monetizing energy volatility for the foreseeable future. Importantly, this geographic diversity also gives us the ability to benefit from potential regulatory reforms in either market, such as the proposed new ORDC Rules in ERCOT.

In addition to our core fleet, we have multiple growth options through our digital infrastructure, renewables, battery storage, and other potential growth options such as green hydrogen production. Each of these options are based on leveraging our core generation and legacy sites. While many of these growth options have tremendous potential, we will only pursue them where we can be targeted returns that exceed our cost of capital.

A few other developments; Susquehanna Unit 2 completed its regularly planned refueling and has returned to service. This marks the sixth year, our Chief Nuclear Officer, Brad Berryman, and his team have completed Susquehanna refueling.

The conversion of our Montour plant from cold to gas operational capabilities continues to be on track, and this is a credit to Dale Lebsack, the leader of our thoughtful operations in its talented team.

As I will discuss in more detail, we have priced in largely completed the excess financing of our go-forward capital structure, which provides us with $875 million of starting liquidity and no near-term recourse debt maturity. Finally, we have substantially completed our one gigawatt flagship data center campus, and our first 48 megawatt data center power shell, located next to the Susquehanna facility. We are actively marketing this first building and seeking to find a high quality investment grade tenant.

Now, let's turn to Slide 5. The Agnes [ph] financing I just mentioned was the final step in our restructuring, and we are on track to merge this week, possibly as soon as tomorrow, May 17. Regulatory accruals have cleared, as we received our NRC in FERC approvals in March, and the HSR waiting period expired yesterday, May 15.

The Agnes financing establishes Talen upon emergence to be well-capitalized, with ample liquidity from its $700 million undrawn revolver capacity, and $175 million of unrestricted cash. Our recourse debt maturities are long dated with none until 2030. The confidence of these factors enables us to focus on cash flow generation and allocating capital and excess free cash flow on a discipline basis. We will discuss the capital structure in more detail shortly.

Now, turn to Slide 6, the high-light, significant drivers of values. With our emergence and Talen's return to the equity markets, I want to highlight significant drivers of values. First, is the meaningful contribution from zero carbon power to our results, driven by our Susquehanna nuclear plant, which generated approximately 18 million megawatt hours in 2022, net to our 90% share at a low cost of $22 per megawatt hour, which is top quartile among its peers.

Furthermore, as I mentioned, starting in 2024, Susquehanna expects to benefit from the up to $15 per megawatt hour nuclear PTC. This will provide support when nuclear power generation falls below $43.75 a megawatt hour, enabling us to earn up to $270 million of PTC benefits in a given year of power prices decline and this is before taking the inflation adjustment protection into account.

Second, is our over eight gigawatts gas and peaking fleet largely in PGM and ERCOT. These are reliable assets well positioned to capture upside from power price dynamics and the benefit from potential regulatory reforms, such as the proposed ORDC reforms in ERCOT. These assets are run by an experienced team led by Dale Lebsack and in PGM generate material amounts of annual capacity revenue.

Thirdly, we continue to maximize the lives of our fossil fleet through what we call carbon-deleveraging. This involves converting our coal fuel generation to natural gas or other fuels. We have 3.2 gigawatts of near complete conversions of our wholly owned coal facilities.

This not only reduces our CO2 emissions, but also extends the life of and maintains the capacity revenue these assets earned every year, while providing additional upside optionality. Altogether, this means that the significant cash flow contribution that we have seen from our generation portfolio in recent years has the potential to continue well into the future.

Fourth, is the development and operation of our up to one gigawatts data center campus directly connected to Susquehanna. Secular growth in US data computing is over three gigawatts annually and zero carbon power for data centers has become highly sought after by technology companies. This demand for zero carbon power is expected to give us the opportunity to sell power to high quality investment grade data center customers at prices that could be well above the PTC floor price but during long term, credit worthy contractual agreements.

Most of the expected capital expenditures for our data center campus infrastructure are first 48 megawatts data center power shell and our plant conversions are behind us as we emerge. This leaves our cash from operations to fall to the bottom line and allows us to allocate capital and access free cash flow in a disciplined way.

Turning to Slide 8, here we provide a performance summary of our generation fleet during the first quarter. Overall, the fleet delivered $729 million of realized energy margins through reliable operations combined with significant gains from hedges that protected cash flow.

Above average temperature is during January and February 2023 resulted in lower demand for heating needs of the PGM and ERCOT regions, and this was a contributor to the reduced power load during Q1 2023. PGM wet tub in ERCOT stop a day at peak average pricing for this quarter, 37% and 30% lower, respectively, than the same quarter in 2022.

Consequently, we ended the quarter with a capacity factor of 25% as compared to 36% in a prior year. Overall, the fleet generated 6.6 million megawatts this quarter. However, when our fleet was called upon, it ran consistently as our equivalent forced outage factor in the first quarter was 1.5%, which is one of the best performances of our fleet over the last five years. This is a testament to the strength of our operational teams led by Brad and Dale.

Importantly, the lower generation was offset by hedge gains of $586 million. Our PGM Q1 average realized energy margin was $119 per megawatt hour driven by our ability to protect cash flow by financially locking in these higher prices during the second half of 2022 ahead of winter.

To put this in perspective, the fleet was able to realize a total of $749 million of realized energy margin, while running fewer hours because we could earn margin financially when the market did not materialize and earned margin through generation when it did. Strong financial and physical execution remains our go forward focus.

Now, let's move to our financial summary results on Slide 9. The company achieved one of its best quarterly financial performances over the last five years, due to elevated real-life energy margin and prudent capital allocation across their fleet.

Looking at the table on the left, you can see these $749 million I talked about earlier, which represents real-life energy margin. This includes the $586 million of hedge gains previously mentioned. Our adjusted EBITDA for the quarter was $660 million, and adjusted free cash flow, which is calculated as adjusted EBITDA less CapEx interest payments, was $497 million. This CapEx excludes two non-recurring items.

First, approximately $33 million of total CapEx associated with a Montour and Wagner fuel conversions in Q1, with approximately $37 million of post-Q1 spend remaining. And second, approximately $32 million of CapEx primarily associated with the cumulative digital entities, which was pre-funded in late 2022.

Finally, interest for the period was $98 million, but this reflects our pre-emergence cap structure. Post-emergence, our pro-format quarterly interest payment, is estimated to be reduced to approximately $50 million. All in, the strong Q1 performance has materially contributed to our unrestricted cash balance of $1.4 billion as of March 31.

This cash will be used to pay down our pre-emergence debt, along with the proceeds from our equity rights offering and excess finance. Ultimately, this allows us to further deliver and emerge with 1.6 times recourse net leverage based on estimated recourse 2023 EBITDA and $175 million of unrestricted cash.

We will discuss post-emergence Talen next. Let's turn to Slide 11. This slide highlight our strategic recapitalization of the company's balance sheet, most notably, the 40% loan to planned value.

At emergence, the company will immediately reduce this gross recourse debt from over $4.4 billion to $1.9 billion. This will be accomplished through the full repayment of all secured creditors and cash and with the support of our unsecured note holders, who are converting their more than $1.4 billion of pre-petition debt into common equity, and providing additional equity, pursuant to a $1.4 billion dollar rights offer.

This is significant in that this is a restructuring where equity is being put into the business, which signals topics in the company's ability to execute on the core generation business, and allocate capital and access-free cash flow is disciplined way. The company's net recourse debt and emergence of approximately $1.7 billion, compared to the plan enterprise value of $4.5 billion, results in a loan to plan value of approximately 40%. Again, this demonstrates the meaningful equity layer in our post-emergence business.

Turning to Slide 12, as discussed earlier, our successful excess financing allows Talen to emerge with a lower cost of capital and favorable capital structure, including a long dated maturity tower, and at least $875 million of starting liquidity.

Starting on the upper left side, you can see where we have no significant funded recourse debt maturity until 2030. We are also particularly grateful for the expressions of confidence by the nine banks that make up our $700 million revolver and letter of credit syndicate, which don't mature until 2028.

Our recourse liquidity profile can be found at the bottom left of the slide. Company will emerge with an estimated $875 million of recourse liquidity from unrestricted cash and undrawn revolver capacity. In addition, the company secured approximately $545 million of LC and term loan fee facilities to support its ongoing letter of credit needs. These LC facilities help us maximize the available capacity under our new $700 million revolver, enhancing our go-forward financial flexibility.

In the upper right, we have a summary of our recent access financing, which we discussed in detail earlier. These facilities, together with cash on the balance sheet, will provide funding for the payment of claims in the plan, along with liquidity and working capital for the post-emergence business.

Lastly, on the bottom right, is a governance update on our emergence, which is expected to occur on May 17. Post-emergence, the company will be led by its new CEO, Matt McFarlane. Other key management team members are expected to remain unchanged.

Talen will be governed by a new board, including six independent directors and Matt. We will continue to be focused on our core business. That being the running of our power plants, belly power to the markets, protecting our cash margin, and allocating capital and excess free cash flow in a disciplined way.

Now let's turn to Slide 13 for a look at our funded debt terms and pro-formic capitalization. This page provides further details on our exit debt. And noted, our emergent cash structure will result in materially lowered interest expense, bolstering our free cash flow generation.

On the right side of the page, you can see our pro-forma capitalization table. This includes our $175 million of emergent cash, plus the $479.000 of term love C, which the proceeds have been placed in our balance sheet, to collateralized letters of credit, and are netted.

The funded debt is primarily our new $580 million secured term loan B, and $1.2 million secured notes. In addition, our existing non-recourse $281 million LVMC project financing, and $131 million of unsecured municipal bonds will carry through emergence and provide low cost financing. The non-recourse construction financing associated with our digital infrastructure project is excluded as we don't present it as a core part of our generation business.

All in, the total pro-forma recourse debt of our generation business is approximately $1.9 billion with the recourse net debt of approximately $1.7 billion. As we talked about at the beginning, this results in compelling pro-forma 2023 recourse net leverage of 1.6 times. This concludes our prepared remarks for this Q1 2023 financial and operating update. Thank you for your interest.

In the coming weeks, we look forward to continuing the reintroduction of Talen. A company with strong cash flow generation from a diverse fleet, one of the best nuclear facilities in the country, backed by the up to $15 per megawatt hour nuclear PTC, carbon-deleveraging of its wholly owned coal-generation portfolio of nearly complete, and one of the world's first direct-connect zero carbon data center campuses ready to take flight.

With that, I will now turn the call back to the operator.

[Operator]

This now concludes today's conference. Thank you for attending and have a pleasant day.