Atco Ltd

TSX:ACO.X

Earnings Call Transcript 2018-Q3

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the ATCO Ltd. Third Quarter 2018 Results Conference Call and Webcast. [Operator Instructions] The conference is being recorded. [Operator Instructions]I would now like to turn the conference over to Mr. Myles Dougan, Senior Manager, Investor Relations. Please go ahead, Mr. Dougan.

[Myles Dougan, Senior Manager of Investor Relations]

Thank you. Good morning, everyone. We're pleased you could join us for our Third Quarter 2018 Conference Call. With me today are Senior Vice President and Chief Financial Officer, Dennis DeChamplain; Vice President and Controller, Anthony Maher; and Vice President, Finance and Risk, Katie Patrick. Dennis will begin today with some opening comments on our financial results and recent company developments. Following his 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 & 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 Canadian securities regulators. And finally, I'd also like to point out that during this presentation, we may refer to certain non-GAAP measures, such as adjusted earnings, adjusted earnings per share, funds generated by operations 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 Dennis for his opening remarks.

[Dennis A. DeChamplain, Senior VP & CFO]

Thanks, Myles, and good morning, everyone, and thanks for joining us today on our Third Quarter 2018 Conference Call. ATCO recorded third quarter 2018 adjusted earnings of $87 million or $0.76 per share, which is $33 million or $0.29 per share higher than the third quarter of 2017. Higher earnings were recorded in all of our investments. Our Structures & Logistics business recorded $2 million in higher earnings mainly due to improved margins on fleet sales and fleet rentals as well as increased activity in Mexico and Chile. Canadian Utilities recorded $18 million in higher earnings. Its higher earnings were mainly due to the termination of the Battle River unit 5 power purchase arrangement by the balancing pool and the associated availability incentive and operating profit margins. Higher earnings in Canadian Utilities were also due to improved Alberta power market conditions for its independent power plants. You can find further information on Canadian Utilities' results on its website in the Events & Presentations section for its quarterly conference call and in the documents and filings section for the interim financial statements and MD&A. The website address is canadianutilities.com. In the third quarter, ATCO's corporate operations also recorded $12 million in higher earnings compared to 2017. This was mainly due to the sale of 4 Alberta properties in our commercial real estate portfolio. So overall, we had a very good earnings quarter in all of our investments. We were also active on the M&A front this quarter. Structures & Logistics acquired 264 space rental units in Mexico. This increases Modular Structures' rental fleet to 468 units in Mexico. These units are 100% utilized on existing rental contracts, including a contract for 166 units with the Ministry of Education for schools in the city of Monterrey in Northern Mexico. Perhaps the most interesting M&A development for our investors this quarter was our investment in Neltume Ports. On September 12, 2018, ATCO invested in a 40% interest of Neltume Ports for approximately $450 million. Neltume Ports is a leading port operator and developer in South America, with 16 port facilities and 3 stevedoring businesses primarily located in Chile and Uruguay. Neltume Ports' portfolio is highly diversified across cargo types and volume mix. You can find more information about Neltume Ports in the archived webcast in the Events & Presentations sector -- section on our atco.com website. Neltume Ports' contribution to ATCO's adjusted earnings in the third quarter was $1 million. This amount represents ATCO's share of adjusted earnings from the closing date of the investment on September 12, 2018, to September 30, 2018. Regarding our financial strength, in August, Dominion Bond Rating Service affirmed its A (low) rating and stable outlook for ATCO. In September, S&P affirmed its A- rating and stable outlook for ATCO. Credit ratings are important to our financing costs and ability to raise funds. We intend to maintain strong investment-grade credit ratings to provide efficient and cost-effective access to funds required for operations and for growth. That concludes my prepared remarks. Myles, over to you.

[Myles Dougan, Senior Manager of Investor Relations]

Thank you, Dennis. I'll now turn it over to the conference coordinator for questions.

[Operator]

[Operator Instructions] The first question comes from Linda Ezergailis with TD Securities.

[Linda Ezergailis, Research Analyst]

I'm wondering if you can give us a sense of your Structures & Logistics outlook, perhaps in the form of describing what your project lead list might look like, whether it be in British Columbia related to LNG or other major projects there as well as other jurisdictions. And maybe also as a follow-on, just a comment on how you see growth being driven, whether it be organic versus further acquisitions, potentially.

[Dennis A. DeChamplain, Senior VP & CFO]

Linda, do you mean growth in Structures & Logistics or growth at ATCO?

[Linda Ezergailis, Research Analyst]

Well, why don't we's start with Structures & Logistics?

[Dennis A. DeChamplain, Senior VP & CFO]

Okay. I'll keep it to S&L. In relation to our lead list, we've seen a -- not an explosion, but a huge increase year-over-year from last year, call it first quarter to now, that's probably almost a tripling of the amounts that we see. We segregate it by type and by region. And if you take a look at our lead list, probably half of it is associated with the natural resource sector, maybe 1/3 in military and government contracts and the remainder in education housing and our other new markets that we're entering. If you were to look at it by region, it's, I'm going to say, fairly evenly split between Alberta, British Columbia and the rest of Canada. That will -- that takes up probably 80% of it. And the remaining 20% was split between the U.S. and other international locations. That's kind of where we're at with lead list. And BC is in there, and that would include any potential work coming from LNG Canada. In terms of growth at Structures & Logistics, while we're still ready to capitalize on the large workforce housing contracts, growth in that business, is instead of the one-offs from the workforce housing, kind of commodity-driven projects that we've experienced the huge spikes in earnings in the past, we're really going to building a base business in our sales and rental fleet also through expansion into permanent modular construction, being able to supply different sectors, like the education and housing sectors that I referred to earlier.

[Linda Ezergailis, Research Analyst]

That's helpful. And do you see additional acquisitions similar to what you've done in Mexico recently?

[Dennis A. DeChamplain, Senior VP & CFO]

Yes. We've gone along about with structures, the nature of the industries with further kind of tuck-in acquisitions in markets where there's demand, where we feel that we could increase the service for those markets. And Mexico is included with the area for further expansion, United States as well for potential bolt-on acquisitions.

[Linda Ezergailis, Research Analyst]

And my second question relates to Neltume. And it's a relatively low-risk way to get into a new business platform through partnering with an established operator. But I'm wondering at what point ATCO might invest directly in ports outside of Neltume and in what geographies. And what would need to be in place for you to be comfortable to do that?

[Dennis A. DeChamplain, Senior VP & CFO]

You're bang on with that low-risk entry with an experienced operator like Neltume and provided by the Ultramar ownership. For now, I think we will defer to their port expertise and learn as we go. So it depends on where we go on that learning curve. We -- our partnership with Ultramar through the ATCO-Sabinco investment that we've done, we are very much aligned in our views. So we would -- for right now and foreseeable future, we are with Ultramar and Neltume for port expansions. I can't see us going off on our own in that respect for the foreseeable future.

[Operator]

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

[Mark Thomas Jarvi, Director of Institutional Equity Research]

Continuing on with Neltume, I just wondered if you guys could give us an update in terms of expectations and time lines for completing the permanent financing.

[Dennis A. DeChamplain, Senior VP & CFO]

In our Investor Day back in mid-September, we said that we were planning to take out some of the credit facilities. We're looking to do that in Q4 this year, market conditions allowable, and still with a hybrid instrument.

[Mark Thomas Jarvi, Director of Institutional Equity Research]

And then just you talked about the strategic review for the power assets. If you're thinking -- if there wasn't a third-party buyer, what's the openness of sort of ATCO Ltd. to sort of take those assets out from CU, transfer those assets inside the corporate structure. Is that something you guys would consider?

[Dennis A. DeChamplain, Senior VP & CFO]

Unlikely. I mean, Canadian Utilities, our 52% ownership in that, they are dedicated to energy infrastructure-type investments. And ATCO as a holding company, probably not take a direct investment in there, transfer those assets, that's not envisaged right now.

[Operator]

Our next question comes from Patrick Kenny with National Bank Financial.

[Patrick Kenny, Research Analyst]

Just as it relates to the recent FID by LNG Canada. Wondering if you can give us a sense as to what the scope of any workforce housing opportunities ATCO might be pursuing out in Kitimat, or perhaps elsewhere along the coast, if other LNG projects were sanctioned at some point over the next year or 2.

[Dennis A. DeChamplain, Senior VP & CFO]

Yes. There's several workforce housing projects associated with that, LNG Canada, both upstream on the pipeline route and downstream near the site itself. We have been actively involved in the proposal process, but we'll have to see what happens in the near future. So for now, I think all I can -- I'll recommend is that you stay tuned.

[Patrick Kenny, Research Analyst]

Got it. And then just on the tuck-in acquisition in Mexico, wondering if you could provide some color on the duration of the contracts tied to the space rental units. And maybe, if possible, what sort of transaction multiple we should be assuming here, either on an earnings or an EBITDA basis.

[Dennis A. DeChamplain, Senior VP & CFO]

Yes. The contract, the initial term for the contract is for a year, and then it's kind of month-to-month extensions after that. So that's the nature of those Mexican contracts. In terms of multiples and investments, I mean, that's kind of our initial very low-cost acquisition entry into that marketplace. A little bit of a one-off. I don't think it would be fair indicative with respect to multiples. So it's just a minor investment in Mexico. What it does show is that we are looking afield, and we are looking to -- or we are expanding into further markets, like the housing market and school market that we have those contracts for.

[Patrick Kenny, Research Analyst]

Okay, great. And then one last quick one if I could. Just any update on how you're thinking about the hybrid market over the near term. Are you still looking to tap that market here before year end? Or is that being pushed into the new year?

[Dennis A. DeChamplain, Senior VP & CFO]

That would be in relation to the Neltume investment. And yes, we're still looking for the hybrid instrument. And market-dependent, we're looking to close on that in the fourth quarter this year.

[Operator]

Our next question comes from Robert Kwan with RBC Capital Markets.

[Robert Michael Kwan, Analyst]

Just in terms of the commercial real estate, starting with that. You had the $13 million of gains. How much was actually the gross amount on the sale?

[Myles Dougan, Senior Manager of Investor Relations]

We had 2 transactions, Robert. It's Myles here. The gross amount on the first one was $14.5 million for net earnings of just over $10 million, I believe. And we had a second smaller transaction as well. I don't have that gross amount at my fingertips, but it would be the similar kind of tax-affected impact. So we had total impact of $13 million. So gross up another $3 million-ish, call it maybe just under $5 million, would be my guess.

[Dennis A. DeChamplain, Senior VP & CFO]

A lot of -- sorry. Robert, a lot of the properties in the ATCO Investments were transferred over the years through the utility operations, and those were assets that were no longer required for utility purposes, generally older. So you'll see that at a relatively smaller book value.

[Robert Michael Kwan, Analyst]

Understood. I guess, what I'm kind of wondering is recognizing, look, that not all real estate's homogenous. But how do those properties kind of compare to what's in the rest of the portfolio? I don't know if there's kind of -- you can use like a percentage. But the other thing I'm wondering, too, is just how much of what's in the commercial real estate portfolio is actually leased back to ATCO entities?

[Dennis A. DeChamplain, Senior VP & CFO]

Well, we've got -- if you take a look at the rest of that commercial real estate portfolio. There's about 16 other properties that are in there. There's not much that's leased to ATCO entities. I'm trying to think off the top of my head, it's always dangerous. There's some in downtown Calgary that's leased to Canadian Utilities. But apart from that, not much.

[Robert Michael Kwan, Analyst]

Okay. I'm just wondering -- so because you put out some stats at the Investor Day. I think it was 417,000 square feet of saleable, leasable office space; 90,000 for industrial. In terms of what you sold here in what -- can you give a sense as to the percentage on, say, square footage?

[Dennis A. DeChamplain, Senior VP & CFO]

Those would be in the -- I don't know how much of the leasable office space would have been on the Calgary properties. Those kind of like old gas appliance -- or sorry, gas distribution warehousing. And in Edmonton, the properties were, my understanding, just bare land.

[Myles Dougan, Senior Manager of Investor Relations]

Don't have the square footage on the total assets sold at our fingertips here, Robert. But I'm -- that's -- there's no problem with sharing that. I can follow-up with you later.

[Robert Michael Kwan, Analyst]

Perfect. Maybe just then finish on financing. And after you get past the Neltume financing, what do you think your -- or how do you think about the amount of additional leverage you can add on your existing asset base in terms of where you'd be comfortable with, whether it's within the credit ratings or just where, generally, you'd like to be? Put differently, how much more could you raise to acquire things just by levering up the balance sheet?

[Dennis A. DeChamplain, Senior VP & CFO]

Yes. At ATCO, it would be -- kind of our guide is really maintaining the credit rating, so it would be minimal leverage at ATCO. I think at the Investor Day, as I said, up to 20%. We incur debt at the holdco very infrequent and judicious. So the plans right now aren't to lever up that balance sheet at ATCO.

[Operator]

[Operator Instructions] Our next question comes from Linda Ezergailis with TD Securities.

[Linda Ezergailis, Research Analyst]

Within the context of allocation of capital. Can you help us understand how you and your partner at Neltume are thinking of an appropriate dividend policy and payout frequency versus retaining free cash flows at the Neltume level to reinvest?

[Dennis A. DeChamplain, Senior VP & CFO]

The arrangement in Neltume that we have with Ultramar is that after CapEx requirements are looked after, dividend out all the free cash flow. So there isn't any amounts being held back beyond what is required for right now.

[Linda Ezergailis, Research Analyst]

Is that an annual exercise? Or quarterly? Or...

[Dennis A. DeChamplain, Senior VP & CFO]

That would be cleared up annually. It excludes the additional kind of growth CapEx that was -- that's being held by the -- by Neltume, a portion of our $450 million that is there to fund future growth. So absent that, the rest of the cash is dividend-ed out.

[Linda Ezergailis, Research Analyst]

That's helpful context. And maybe just as a follow-up to build on some of Robert's questions. Could I be so bold as to ask how I might think of a differential -- or the vintage of the book value of your real estate assets? Or how the book value might differ from the market value at this point.

[Myles Dougan, Senior Manager of Investor Relations]

That's a good question, Linda. And I've asked the same question of our real estate folks, but the challenge, of course, is that's providing a upper market value if we want to put that up for sale. So I think at this time, we'll probably want to just keep that one to ourselves.

[Linda Ezergailis, Research Analyst]

I can understand. I just felt that I could ask.

[Dennis A. DeChamplain, Senior VP & CFO]

Continue to be bold, Brenda -- Linda, sorry.

[Operator]

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

[Myles Dougan, Senior Manager of Investor Relations]

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

[Operator]

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