Atco Ltd

TSX:ACO.X

Earnings Call Analysis

ATCO Q2 2022 Earnings: Pressures and Strategies

ATCO reported Q2 2022 results, feeling pressures primarily from rebasing in their Alberta-based distribution utilities and diminishing earnings in the Australian natural gas distribution business. Despite expecting the trend to continue in Q3 2023, the pressure should ease by Q4 with seasonal benefits and growth in nonregulated businesses. They value the stability of their regulated utilities earnings and consider it vital for their portfolio. Major strategic considerations include exploring opportunities in ATCOenergy Systems and EnPower and potential M&A in niche port opportunities via Neltume, avoiding heavily contested assets. Despite challenging market valuations, ATCO remains strategic with their investments, focusing on synergies and complementary acquisitions like Triple M, while maintaining modest leverage with room for growth through prudent capital allocation.

Overview and Performance

In the second quarter, ATCO achieved adjusted earnings of $87 million, or $0.77 per share, marking a slight decline from the previous year. Despite challenges, the company highlighted the robust performance of its investments outside of Canadian Utilities, which helped to alleviate some earnings pressures by approximately $15 million. ATCO Structures & Logistics boasted an increase in adjusted earnings to $26 million, up by $7 million from the same period last year.

Growth Across Segments

ATCO's space rentals business and the newly acquired Triple M Housing division delivered exceptional results, with fleet size growing by 13% and rental rates by 14%, alongside an average utilization rate of 75%. The U.S. market has been identified as a strong and repeatable growth platform, demonstrated by an additional contract award for 31 units in Texas. The steady performance of Neltume Ports has contributed to stable earnings, with ATCO increasing its ownership in certain port facilities from 40% to 50%.

Challenges and Pressure Points

Canadian Utilities saw a decline in adjusted earnings by approximately $19 million largely due to rebasing in Alberta's distribution utilities and softened earnings from the Australian natural gas distribution business as inflation began to recede. ATCO anticipates continued earnings pressure through the third quarter due to similar factors, though expectations are for this pressure to ease in the fourth quarter for Canadian Utilities.

Strategic Positioning and Future Expectations

ATCO is committed to a stable earnings model, intending to maintain a long-term portfolio split of approximately 80-20 between its utility and non-utility investments. The company is exploring funding options for its energy transition growth, with equity raises at the Canadian Utilities level considered viable. ATCO's strong balance sheet and access to liquidity place it in a favorable position to fund future initiatives. With a significant cash reserve of over $100 million on Neltume's balance sheet, ATCO is well-positioned to seize growth opportunities.

Capacity and Market Optimism

Despite substantial growth in fleet size, ATCO can continue to expand its earnings and business presence without needing to significantly increase fleet capacity at present. They expect a strong performance to continue through the year, supported by both their base business and a pipeline of potential opportunities. While considering strategic options, including the potential spin-out of certain segments, ATCO's primary focus remains on capital allocation that maximizes shareholder value.

Portfolio Diversification Strategies

ATCO is nurturing a robust pipeline of opportunities, with a strategic angle on niches within the port sector rather than competing for large container ports that command higher infrastructure premiums. This tailored approach to diversification allows ATCO to potentially enhance value while avoiding the more intense competition for mainstream infrastructure assets.

Earnings Call Transcript 2023-Q2

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the ATCO Limited Second Quarter 2023 Results Conference Call and Webcast. [Operator Instructions].

I would now like to turn the conference over to Mr. Colin Jackson, Senior Vice President, Finance, Treasury and Sustainability. Please go ahead, Mr. Jackson.

[Colin Jackson, SVP, Finance, Treasury, Risk & Sustainability]

Thank you. Good morning, everyone. We're pleased you could join us for ATCO's Second Quarter 2023 Conference Call. With me today is Executive Vice President and Chief Financial and Investment Officer, Katie Patrick.

Before we move into our formal agenda, I would like to take a moment to acknowledge the numerous traditional territories and homelands on which our global facilities are located. Today, we're speaking to you from our ATCO Park head office in Calgary, which is located in the Treaty 7 region. This is the ancestral territory of the Blackfoot Confederacy comprised of the Siksika, Kainai, and Piikani nations. The Tsuut'ina Nation and the Stoney Nakoda Nations, that include the Chiniki, Bearspaw and Goodstoney First Nations. The city of Calgary is also home to the Métis nation of Alberta Region 3. We honor and respect the diverse history, languages, ceremonies and culture of the indigenous people who call these areas home.

Katie will begin today with some opening comments on recent company developments and our financial results. Following these prepared remarks, we will take questions from the investment community. Please note that a replay of the conference call and the transcript will be available on our website at atco.com and can be found in the Investors Section under the heading Events and Presentations.

I'd like to remind you all that our remarks today will include forward-looking statements that are subject to important risks and uncertainties. For more information on these risks and uncertainties, please see the reports filed by ATCO with the Canadian Securities regulators.

And finally, I'd like to point out that during this presentation, we may refer to certain non-GAAP and other financial measures such as total of segment measures, adjusted earnings, adjusted earnings per share and capital investment. These measures do not have any standardized meaning under IFRS, and as a result, they may not be comparable to similar measures presented in other entities.

And now I'll turn the call over to Katie for her opening remarks.

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Thanks, Colin, and good morning, everyone. Thank you all very much for joining us today for our second quarter 2023 conference call. ATCO achieved adjusted earnings of $87 million or $0.77 per share in the second quarter of this year. While this is slightly down on a year-over-year basis, these results really highlight the benefits of our diversified portfolio of investments. This diversification allowed us to partially offset the downward earnings pressure associated with the Alberta distribution utilities rebasing where the phenomenal outperformance in recent years is being shared with our customers.

When we look more specifically of where these offsetting earnings came from, we see that our results were driven by exceptional growth from our Structures & Logistics business, combined with great performance across our broader portfolio of investments. Collectively, the performance of our investments outside of Canadian Utilities serves to offset approximately $15 million of earnings pressure for the quarter. At ATCO Structures & Logistics, we delivered adjusted earnings of $26 million in the quarter, $7 million higher than the same period last year.

Continuing the trend from previous quarters, a key driver of our earnings growth in the second quarter was the strong performance of our base businesses. Both our space rentals business and our newly acquired Triple M Housing division, delivered exceptional results in the period. Compared to the second quarter of 2022, we grew our space rental fleet size by 13% and our average rental rate by 14%. All while achieving an average utilization rate of 75%.

Moving on to Triple M. The business continued its strong positive earnings momentum from the first quarter into the second and is integrating well into our existing structures business. We continue to believe this integration will allow for opportunities to incorporate various manufacturing process efficiencies as well as unlocking potential customer synergies across our businesses. During the quarter, we also reached substantial completion of the Bechtel Pluto Train II project. This project was a significant driver of project-based earnings for us over the last year and highlights our continued ability to successfully execute large-scale multifaceted workforce housing projects globally.

I'm also very proud to say that this project was completed approximately 4 months ahead of schedule, an amazing feat given the current economic and supply chain environment. Our plan to grow our base business globally continues to take form, and we have had success securing new contracts as well as supplemental additions to existing contracts. This included the previously announced 116-unit project in Texas with TIC where we were recently awarded a contract for an additional 31 units by the company. The U.S. market represents a strong, repeatable growth platform, and we look forward to increasing our presence in this jurisdiction.

As I've mentioned in the past, our base business typically accounts for 2/3 to 3/4 stake of our segment earnings. The strong performance from these base earnings at Structures offset the project-based earnings pressure we experienced at Frontec in the quarter. The team at Frontec continues to be active in pursuing new contracts to support earnings moving forward. Particularly, we see opportunities in the defense and government spaces where our deep indigenous relationships can be leveraged alongside our core remote services expertise.

At Neltume Ports, the business continued to deliver stable and dependable earnings. During the quarter, the business increased its ownership at Puerto Angamos and Terminal Graneles del Norte from 40% to 50%, helping to expand our earnings base moving forward. Favorable foreign exchange impacts also served to push second quarter adjusted earnings higher when compared to 2022.

As expected, our Canadian Utilities investment saw adjusted earnings decline by approximately $19 million when compared to the second quarter of 2022. This decline was primarily due to the impact of rebasing at Alberta -- at our Alberta-based distribution utilities, which I previously had mentioned. This rebasing pressure was compounded by year-over-year earnings pressure in the Australian natural gas distribution business as inflation levels began to recede from 2022 highs.

As Brian spoke about Canadian Utilities in detail on this morning's CU earnings call, I won't go into those details again here. I would, however, highlight how the expected performance for CU will impact the remainder of 2023 for ATCO. Looking ahead to the second half of 2023. We still expect to see year-over-year earnings pressure at ATCO in the third quarter, driven by the same rebasing forces we are seeing this quarter. By the fourth quarter, however, we expect this pressure to ease for CU.

Seasonal benefits and growth within our nonregulated businesses at CU, combined with growth at our remaining portfolio of investments should provide opportunities for continued growth year-over-year. Overall, ATCO delivered a second quarter that was in line with our expectations and highlighted the strength of our diversified portfolio. Our non-CU investments delivered strong results that helped soften the earnings impact of rebasing and a downward trending Australian inflation. Although these headwinds are expected to continue through the remainder of the year, we continue to be proactive across our portfolio, to deliver long-term shareowner value during this key transition year at our largest investment, Canadian Utilities.

That concludes my prepared remarks. I will now turn the call back to Colin.

[Colin Jackson, SVP, Finance, Treasury, Risk & Sustainability]

Thank you, Katie. In the interest of time, we ask that you limit yourself to 2 questions. If you have additional questions, you are welcome to rejoin the queue. I will turn it over to the conference coordinator now for questions.

[Operator]

[Operator Instructions]. The first question comes from Maurice Choy with RBC Capital Markets.

[Maurice Choy, RBC Capital Markets]

My first question is just a follow-up on the themes from a CU call, specifically the potential ATCO and Power separation. And a comment that was made that CU is open to selling assets, and it sounds like that doesn't preclude selling regular utility assets. From ATCO's portfolio standpoint and your position as a controlling shareholder, how should we view your guardrails with regards to regulated utility and nonregulated earnings?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Thanks, Maurice. That's a great question. Thanks for that question. ATCO really values the stability of the earnings and the cash flows that we receive from our regulated utilities business. And going forward, that is something that will continue to be a very significant portion of our portfolio. So as we think about, I think Brian mentioned sort of the consideration that at the CU level, we would expect maybe earnings to grow to 20% from the nonregulated side. But as I said, I think we continue to value the stability of those utilities. And when we do talk about capital recycling alternatives, those would be probably more at the margin rather than a significant recycling opportunity within the utilities.

[Maurice Choy, RBC Capital Markets]

And just to be clear, those recycling opportunities at the margin, does that include utility assets?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Sorry, could you repeat that part of that question.

[Maurice Choy, RBC Capital Markets]

You mentioned that any capital recycling that you do is on margin. Just to be clear, does that include selling utility assets?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. As Brian mentioned, we're still -- we're exploring all options at this point. But I would say, like, as I said before, ATCO as a shareholder, really values the stability of the earnings and cash flows from the utilities. So long term, I don't expect our portfolio to deviate meaningfully from that 80-20 split that Brian had mentioned.

[Maurice Choy, RBC Capital Markets]

Got it. And then just staying with the theme of funding, obviously, CU seeking funding options to fund its energy transition growth. And intuitively, I would think that equity rates at the CU level remains on the table. Can you speak to ATCO's range of options to raise funds to support CU, including of these options? What is your pecking order?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Sure. No, I mean we will -- we have been a long-term shareholder in CU, we intend to maintain a similar ownership stake as a meaningful owner of CU. ATCO has ample access to liquidity through the debt capital markets through various different financing alternatives at the ATCO level. So as we look forward, we probably will look at the comparison between the cost of capital of all of our alternatives. But we maintain a very strong balance sheet at a stand-alone basis at the ATCO level, including cash and access to the debt capital markets. So I think we'll look to use the balance of those to fund initiatives as well as we mentioned, to help finance some of these options for ATCO EnPower and ATCOenergy Systems. We look externally as well for those entities to be able to access capital.

[Maurice Choy, RBC Capital Markets]

If I could just do a quick cleanup question on the asset -- the stakes that Neltume acquired. Can you just discuss how much is spent and how much cash does Neltume still have on its balance sheet?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Oh, sorry, Neltume. Yes, the -- there's still a significant amount of cash on the balance sheet. We still have over $100 million on the balance sheet at Neltume. And that 10% stake, we took out a minority partner that was in those investments. So the -- we actually finance that not with directly cash on the balance sheet at the corporate level. So there still remains a substantial amount of liquidity remaining at the corporate level at Neltume.

[Operator]

The next question comes from Robert Hope with Scotiabank.

[Robert Hope, Scotiabank]

I just want to turn the attention to the base business of the structures business. Just taking a look at the global space rental income this quarter, both on a quarter-over-quarter basis as more so on a year-over-year basis, we're seeing strong growth with 14% the average rental rate. Can you maybe speak to what's driving this rental rate? And do you see this stabilizing at this level? Or could we even see it softening depending on how mix works.

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. Thanks for the question. It's -- structures, as you saw, had an exceptional quarter. And there, we've been able to benefit from overall rising demand in that sector, which saw the rental rates increase. I would say I can't point to any 1 area. I would say that we are executing on our strategy to grow that business globally. And you will see that particularly in the U.S., we've had some success in growing our fleet there. But also our core markets in Canada and Australia continued to perform very well.

Going forward, I think we've -- there's been significant growth in our fleet size, you can probably see the level of that growth tempering a bit because we probably have a significant -- we have enough capacity right now in some of our existing fleet that we probably can continue to grow the business and our earnings through deploying some of those assets. I hope that answers your question a bit.

[Robert Hope, Scotiabank]

Yes, that's helpful. So I guess, continued strong results in the base business. And then as you take a look at the back half of the year, you have some larger contracts rolling off or have already rolled off. What have conversations been with for some of the larger projects out there to help backfill what we'll call it, the large project backlog.

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. No, I think we're still very optimistic for the back half of the year. I think we'll continue to see a lot of the same strong performance that we saw in the start of the year through the year. As you noted, there are some projects, some of the larger projects that have come off, normally the Bechtel Pluto project in Australia that has come to substantial completion. But we do have a strong pipeline of additional potential opportunities as well as the resilience of that base business that I mentioned to carry us through the year.

[Operator]

The next question comes from Mark Jarvi with CIBC Capital Markets.

[Mark Jarvi, CIBC]

I want to come back to the discussion of EnPower and the discussion on the CU call in terms of range of options. If they did spin it out as a stand-alone entity, any commentary in terms of what ATCO's ownership levels could be? I mean, obviously, relative to where you are now or willingness to even maybe increase your position around that business, depending on the range of, I guess, solutions or financing options put out there?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. As Brian mentioned, we're still very early in exploring the options. As we noted in the press release, the spin-out is one of many options under consideration. And it would be too early to speculate exactly where ATCO would see ourselves long term in that. Obviously, as opportunities arise in both ATCOenergy Systems and EnPower, ATCO would consider its options for capital allocation between the 2 based on the best use of funds to maximize shareholder value at that time.

[Mark Jarvi, CIBC]

Okay. There's been a handful of, I guess, different M&A deals and things that I've seen across different trade magazines and news articles on the port space. On prior calls, you guys indicated you'd look at a number of range of opportunities there. How would you say the deal flow looks right now in terms of, I guess, level of interest, competition, pricing, just in terms of, I guess, whether or not economic outlook and/or the impact of higher rates, like how would you say asset values are trending right now?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. No. I mean it's a very interesting space. Obviously, there's been a lot of action with strikes in Canada and other events that highlight the benefit and the need for a diverse portfolio in terms of the ports and we are seeing a very strong pipeline there in terms of the range of opportunities. Neltume as I've discussed in the past, tends to target not necessarily the large heavily sought after container type opportunities as those continue to trade at the infrastructure premium type levels. And the Port of Vancouver in Washington state is a great example of kind of the type of opportunity that fits well within Neltume's sweet spot.

That's a bulk port. And there was obviously some competition, but we did manage to get that with an attractive profile going forward. So there's definitely a lot of interest in that space, but we continue to look for more of those niche opportunities where we can really add value is Neltume to the opportunity.

[Mark Jarvi, CIBC]

And then I guess maybe just how you would say the competitive environment to find those opportunities as it moderated at all in terms of where you're seeing activity or in terms of valuations and how you're seeing assets priced or evaluated?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

No. Generally not. I mean it's the same themes across the sector, right? I don't think that in the private markets, in the M&A environment, there has been a significant moderation in the multiples that are being paid, so we continue to see strong demand for most of those larger opportunities that I mentioned. But as I said, Neltume is looking in a slightly different field, which tends to have not as much interest from some of those infrastructure type players and the opportunities we look at.

[Operator]

And the next question comes from Linda Ezergailis with TD Securities.

[Linda Ezergailis, TD Securities]

Recognizing it's still early days, but I just wanted to step back big picture and understand how ATCO balances complexity and the potential for subordination of cash flows and any sort of restructuring, either at the CU level? Or can you confirm that this might not spill into any sort of optimization or initiatives at the ATCO level? Is that off the table? Or might that come subsequent to what you're doing at CU?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

I mean, as Brian mentioned, again, very early days in terms of EnPower, specifically exploring its financing alternatives. At the moment, this does not -- this doesn't impact ATCO in terms of how it's evaluating its current structure or its funding alternatives. So if anything, and as mentioned that it becomes a separate entity, I think we'll continue to evaluate what's in the best CU, will continue to evaluate what's in the best interest of getting utility shareowners, of which ATCO is one of those, obviously. So I don't see any potential spillover as you noted, for ATCO at the moment.

[Linda Ezergailis, TD Securities]

Okay. And just maybe looking back, I mean, at 1 point, ATCO kind of streamlined and simplified its kind of ownership and platforms. And I'm just wondering how both ATCO and CU consider not just best access to financing at a given point in time, but also considering some of the potential implications around potentially introducing complexity of structures and also the potential for subordination in the debt capital markets.

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. I mean we -- ATCO as we look to structure our investments are going to take a look at each individual portfolio company and look for what's the best way to finance that vehicle. So that the same would hold true for structures for Neltume for any 1 of our particular investments, we would look to see how the best way to maintain the ability for them to grow, combined with maximizing shareholder value for that, whatever that particular investment is. So in terms of me understand that we do have a different structure, but I think that we continue to operate that well, and it continues to serve us well in terms of accessing capital for the various entities.

[Operator]

[Operator Instructions]. The next question comes from Ben Pham with BMO.

[Benjamin Pham, BMO Capital Markets]

I wanted to follow up. I know you talked about the ports opportunity, and that could be M&A and organic. Can you talk what else your probably the most [indiscernible] in terms of M&A, whether it's Triple M structures-related businesses or even any other verticals that you have looked at in the past?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. I mean let me think about ATCO's growth. And I think I've said this a few times in the past, we look at both growth within our existing portfolio of investments so -- which obviously would be considering that if we can find areas where we can have synergies or clear value proposition. That's probably our most preferred route of growth. So Triple M was a great example of how we are able to add on a very complementary business with synergies and forward-looking pipeline to one of our existing businesses. But we also do look at growth outside of our existing verticals, and in our materials, we've mentioned interest in some of the other essential services such as water and agriculture. And we'll continue to explore opportunities within those to add on a new portfolio for ATCO.

[Benjamin Pham, BMO Capital Markets]

Okay. I think also in the past, you mentioned one of the constraints for maybe more M&A side with valuations and what you want to pay for valuations. Has that changed now? I think that's somewhat to an earlier question that was framed. And then can you also comment to, is this really a good environment for you to expand the opportunity of M&A, given where valuations are, there's really maybe no change in how you're looking...

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes, I think it's obviously very sector specific. I mean you'll hear from most people, I'm sure that we probably haven't seen the valuations and the premiums for M&A transactions, come down as much as you would expect, considering the public markets at the moment. But that is pretty specific to the sectors that you're talking about. I think, for example, our Triple M, we got a very attractive valuation. And I think in certain instances and different opportunities, we can still find areas where we can deploy capital and M&A at attractive valuations. But I'm sure as everyone is aware, the general theme of -- the current market is still a bit unstable, and we're continuing to watch for opportunities that present themselves to deploy capital.

[Benjamin Pham, BMO Capital Markets]

And maybe lastly, on your leverage, is there room for you to take on leverage or even perhaps and just thinking the news on the credit rating agencies. And may just remind us on the balance sheet on where you're at?

[Katherine-Jane Patrick, EVP & Chief Financial & Investment Officer]

Yes. No, we still have a pretty very modest level of holding company leverage at the ATCO level. So I still think we do have capacity to take on additional debt there. We've kind of set ourselves an internal target that we wouldn't go above around 30% debt to total cap, but we're far below that. So there still is pretty good room on a stand-alone basis that is at the ATCO level, pretty good room to fuel growth if we see an opportunity.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Colin Jackson for any closing remarks.

[Colin Jackson, SVP, Finance, Treasury, Risk & Sustainability]

Thank you, , and thank you all for participating today. We appreciate your interest in ATCO, and we look forward to speaking with you again soon.

[Operator]

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.