Altius Renewable Royalties Corp

TSX:ARR

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the ARR Q3 2022 conference call and webcast. [Operator Instructions] This call is being recorded on Tuesday, November 8, 2022.

I would now like to turn the conference over to Flora Wood. Please go ahead.

[Flora Wood, executive]

Thank you, Laura. Good morning, everyone, and welcome to our Q3 2022 results call. Our press release and filings were released yesterday after the close -- well after the close and are available on our website. This event is being webcast live and you'll be able to access a replay along with the presentation slides that are on our website at arr.energy.

Brian Dalton, CEO of ARR; and Frank Getman, CEO of GBR, will both be speakers on the call. And in the Q&A, we also have Ben Lewis, CFO of ARR for questions.

The forward-looking statement is on Slide 2 of the presentation. It applies to everything we say both in our formal remarks and during the Q&A.

And with that, I will turn over to Brian.

[Brian Dalton, executive]

Good morning, everyone. It was another busy quarter for ARR with most of the activity concentrated around the developer side of the barbell approach to growth investing that Frank has discussed in recent periods. We followed up on the investment made with Bluestar that was announced in the first half, with a $40 million royalty funding agreement with Hodson Energy. The capital is helping Hodson advance and grow the portfolio of solar and storage related projects.

The deal also demonstrates that high-quality development groups continue to be attracted to the benefits of our royalty financing. They are increasingly recognizing and appreciating our ability to provide them with the partner like flexibility to simultaneously advance multiple opportunities, without having to take on restrictive debt covenants and perhaps more importantly, without having to dilute their corporate equity value.

Preserving the equity capital structure is becoming more important than ever to these developers as they are seeing increased interest from larger players to acquire portfolios rather than single projects. This was further evidenced during the quarter when the first developer that we backed, TGE, was acquired by Enbridge. This followed TGE's incredible portfolio growth trajectory over the past few years, for which Frank and the team at GBR can rightly claim a very strong supporting role.

The acquisition also has important direct implications for us as it effectively resulted in the sale of all of the projects in TGE's portfolio. This, in turn, made each project subject to our royalty and with a very strong new counterparty in Enbridge. We now expect the number and value of royalties to be received from our investment in TGE to significantly overshoot our original investment case and minimum return threshold.

Frank will have more to say on these events in his remarks, but suffice it for me to say that it is a strong proof positive that our structures are working and adding value to our partners, which we are confident, is being noticed by the rest of the developer community and will allow us to back more groups such as TGE, Hodson and Bluestar as we move forward.

While the announced progress in Q3 was distinctly developer-focused, this by no means describe the extent of activity. There are strong market -- there's a strong market evolution underway relating to later-stage development and operating stage projects that is keeping the team busy as well. Perhaps most notable here is the continuing strong shift we are seeing from these sponsors to preserve a component of merchant marketed price exposure in their projects.

This combined with rising interest rates and lender risk aversion is reducing the amount of debt that projects are being financed with, opening a hole in capital structures that our royalty capital is well suited to fill. Busy and fun times.

Over to you, Frank.

[Frank Getman, executive]

Thank you, Brian. We continue to make great progress in building our company. I wanted to share some highlights and observations in a few important areas. First, I'm going to touch on our accelerating revenue growth and positive cash flow at Great Bay. Then I'd like to make a few comments about the recently announced acquisition of TGE by Enbridge and its impact on our business. And finally, a few comments on the current state of the renewables industry in the U.S. and the outlook for Great Bay in our royalty financing.

First on revenue growth. We continued positive cash flow at Great Bay. Q3 was another strong quarter of accelerating positive cash flow. It was our third consecutive quarter of positive cash flow, all well ahead of our forecast at the time of the ARR IPO.

Merchant prices were strong in Q3, particularly in ERCOT, which positively impacts our Cotton Plains portfolio, which is approximately 70% merchant and our Prospero 2 royalty, which is about 30% merchant. Attributable revenue of $1.6 million in Q3 as compared to a negligible amount a year ago and $600,000 in Q2.

As a result, using the midpoints of our guidance, even though there's just 1 quarter remaining, we've increased our 2022 revenue guidance for Great Bay, approximately 35% from $4.5 million to $5.5 million, to $6.5 million to $7 million. It's also important to note that we currently have 3 new projects totaling approximately 975 megawatts under construction, which have royalties in favor of Great Bay, which are expected to reach commercial operations in the next few months.

Continued strong growth in revenue and cash flow built into the business for the foreseeable future based on our existing investments to date is already built into the business.

A few comments about the acquisition of Tri Global by Enbridge. On September 29, we announced that our development partner, Tri Global, had been acquired by Enbridge. This deal represents a true win-win-win for everyone involved. For TGE and its shareholders, the strong price they received was a validation of the great development team that they've assembled and recognition of the value of their approximately 6 gigawatt pipeline of high-quality renewable energy projects across the U.S. It's important to note that the vast majority of that 6-gigawatt pipeline was developed using royalty capital from Great Bay.

For Enbridge, acquiring TGE makes them -- gives them the renewables projects pipeline and development team that they need to grow and accelerate their North American renewables business. It brings in-house for Enbridge key renewables development expertise, which they did not have. For Great Bay, this deal essentially represents an acceleration of the sale of TGE's entire gigawatt, 6 gigawatt pipeline, which is now subject to a Great Bay royalty.

As the projects continues through the development process and achieve commercial operation, Great Bay will continue to receive royalty contracts until we hit our threshold return on the $46.5 million we've invested in TGE. After Great Bay has received enough royalties to achieve its threshold return, we'll have the option to acquire royalties on any future projects from that 6 gigawatt pipeline that achieved commercial operation based upon an agreed-upon valuation that uses a similar return profile as the royalties received by Great Bay prior to the threshold return being achieved.

Using current development timeline projections, we estimate that it will take approximately 2.5 gigawatts to 3 gigawatts of projects for Great Bay to achieve its threshold return, leaving approximately 3 gigawatts to 3.5 gigawatts of projects potentially subject to Great Bay's purchase option.

If there are delays in getting projects to commercial operation, our capital is accruing and it will take royalties on more of the 6 gigawatts for us to achieve our threshold return, leaving fewer projects subject to our purchase option. Obviously if our project is canceled or never achieves commercial operation, it would not be subject to Great Bay's purchase option.

Bottom line, this provides much greater certainty that we'll receive enough royalties to hit our base threshold return with a terrific counterparty in Enbridge and gives us the option to acquire royalties on another 3-plus gigawatts of projects at an attractive price.

As I mentioned earlier, we believe this deal represents a true win-win-win for everyone involved. It also represents a second major developer backed by Great Bay to be acquired, first Apex then TGE, and shows the direct impact a royalty financing can have to create significant value for our development partners. This point has not been lost on the developer market and it's fantastic for our business development efforts. It's also why we have tried to include equity ownership or warrants as part of our more recent developer deals, namely our Hodson and Bluestar deals.

Lastly, a few comments on the current state of the renewables market in the U.S. The big recent news in the industry was the passage of the Inflation Reduction Act. It provided a huge boost to the entire renewables complex. Probably the largest impact was the extension and resetting of the PTC and ITC. Many projects that, because of the passage of time, had been 80% or 60% PTC projects have now been reset as 100% projects.

Also included -- the IRA also included the ability for the direct sale of tax credits in some situations. This sounds great, but it remains unclear how big of an impact it will have. I don't think this means the end of tax equity by any means. For example, the direct sale of tax credits does not include the benefits from accelerated depreciation, which is included with tax equity and represents a large source of tax benefits, especially for utility scale, wind and solar.

So tax equity will likely remain a big part of the market, but you may see the use of the direct sale of tax credits for less established earlier-stage technologies, which could mean a real shot in the arm for hydrogen and other earlier-stage technologies.

Overall the insatiable demand for shovel-ready renewables projects continues as everyone and virtually every industry seeks to reduce their carbon footprint. PPA prices are moving up as overall energy prices increase, and there remains continued strong demand from commercial and industrial buyers of renewable energy as everyone is trying to achieve their own ESG goals and mandates.

However, the IRA didn't provide any immediate relief to address some of the ongoing headwinds the industry currently faces. Interconnection backlogs are probably the single biggest issue facing the industry. It's really a two-pronged issue. Both one, delays in processing of applications; and secondly, the interconnection costs are coming in higher than anticipated.

There's also supply chain constraints, physically getting access to solar panels and batteries. The IRA does provide some domestic content incentives to hopefully stimulate U.S. production of equipment. It's designed to help address these supply chain issues, but it will take some time for that to really have an impact.

Finally, the general outlook for Great Bay and the adoption of our royalty financing. The future has never looked brighter for Great Bay, and our permanent, non-dilutive, flexible, partner-like royalty financing.

With recent weakness in equity markets and higher debt costs, the market is looking for alternatives. We see significant opportunities for our royalty financing both in earlier-stage developer deals like our Bluestar and Hodson deals as well as for the operating stage, immediately cash flow in royalties like our Longroad and Northleaf deals. The market is definitely moving in our direction.

Ray Faust, Josh Levine and Bill Rogers continue to do a fantastic job in identifying, negotiating, completing due diligence and closing new opportunities as well as monitoring the progress of our growing portfolio of royalties. It's a major effort, and I'm so proud of the execution and professionalism of our team. We recently added 2 new hires, Peter Leahey from Goldman Sachs and Zach Farrar from GE, have joined us and their plates are full already.

This is an exciting time for Great Bay, and we believe we are still in the early innings of what is a tremendous market opportunity for the foreseeable future.

That's it for my update. I'll turn it back to you, Brian.

[Brian Dalton, executive]

And with that, I guess, we'll take any questions. Operator, can you open the floor for questions, please?

[Operator]

[Operator Instructions] Your first question comes from the line of David Quezada from Raymond James.

[David Quezada, analyst]

Congrats on the quarter. My first question here, just on the TGE sell to Enbridge. And I guess, the royalty purchase option on the latter sort of 3 gigawatts, Frank, you outlined there. Just curious what the decision-making process is going to be on whether or not you exercise that option? Like is there actually a scenario given the contract structure you have there that you would not move forward? I'm just curious how to think about that, those additional opportunities?

[Frank Getman, executive]

I think the way to think about it is that we're using the valuation metrics that we use for the developer stage royalties. And we know because we're active in the market of acquiring operating stage royalties. So we know that they're in the money today, so to speak. But obviously, if interest rates were to spike really high -- it is a fixed valuation metric. So if there was a dramatic move in interest rates higher, they may not be economic, but something would have to change pretty dramatically for them not to be valuable for us to acquire.

[David Quezada, analyst]

And then maybe just another one…

[Frank Getman, executive]

Just one more quick thing on that, as Brian just pointed out is that, we also -- we make that decision at the time, the 6 months post COD and it's project by project. So it's not -- it's like a -- it's not all in, all or nothing proposition. We can do it selectively project by project.

[David Quezada, analyst]

And then just a question on, I guess, on the topic of interconnection delays and obviously your investment in Hodson seems like an interesting one and kind of maybe, I guess, partly arises because of that issue. I'm just curious if -- is there a squeeze being created for certain development projects that's really more than anything creating an opportunity for you in that market, like projects, so that they maybe need some liquidity that are having to wait for the interconnection queue?

[Frank Getman, executive]

Yes, I think so. First off, on our Hodson deal, we factored in those delays because we had visibility into what the new proposals were from the ISO and PJM. So we factored those time -- that timing into our investment decision. But with other folks, time is money, and there is some pressure building.

I also think investors with a defined time horizon, private equity, like, if you're talking 3 or 4 years before a project even is going to get its interconnection application reviewed; that is creating some opportunity. For long-term capital like [indiscernible].

[David Quezada, analyst]

And then maybe just one last one for me if I could. Just on the topic of strong power prices. Obviously that was a lift in the quarter. I'm just curious how were those being incorporated into any royalty agreements that you might be negotiating today? And does that mean that most likely we'll see more, I guess, kind of variable rate royalties if it was on an operational project? I guess, the question ultimately is, how much does the current high power price environment affects the negotiation process for a new operating stage asset royalty?

[Frank Getman, executive]

It's largely -- what's happening is that the sponsors are wanting -- the owners are wanting more exposure to some of the higher pricing than having a lower price fixed-price PPA. So there's a tension, right? Because tax equity and debt want everything lock down, but they feel like they're leaving money on the table. There's been a dramatic change in the market in the last 18, 24 months, of the way that historically owners maximize value of projects was to lock everything down and then put as much leverage -- low-cost debt and leverage on them as you could to increase your equity returns.

Now I think folks are treating these more like the resource assets that they are and saying, how can I maximize the value of the output from these projects? And what we're seeing now is a movement towards, I would say, 10%, 20%, maybe 30% merchant exposure for a brand-new project coming online.

But we're also seeing opportunities where folks may have a hedge in place that may -- even though it perhaps didn't blow up within a market that wasn't subject to a Storm Uri and the exposure they had in ERCOT, but they -- now it's brought to light some of the embedded risks and some of these hedges. And there is a movement to look at, maybe they can unwind some of those hedges and our capital is ideally suited to help do that.

[Brian Dalton, executive]

In terms of selection for like more or less merchant exposure, it's really not our call. But obviously if we're looking at an operating stage project, we'll look at what that sponsor has chosen and price and basically choose which projects we want to invest in accordingly.

And I think it's probably fair to say we like the way things are going and we like the blended mix we're getting right now. That's really just a function of what the market more broadly is -- how it's structuring itself. So you're starting to see it widely just more merchant exposure, but still a healthy component of fixed contracted prices. And I think it's fair to say our portfolio will evolve probably pretty much in line with that as it continues.

[Operator]

Your next question comes from the line of Rupert Merer from National Bank.

[Rupert Merer, analyst]

So your opportunities at this is growing. Where are you seeing most of the new demand for financing coming from? Is it more on the early stage end of the barbell or is it in the operating assets given the financial stress we're seeing in the market?

[Frank Getman, executive]

I think the near-term opportunities we're seeing are more on operating projects. The developer deals take a little bit longer to come together just because you're asking them to contribute their entire portfolio to the program. So there's a little bit of a give and take on both sides to get -- is it a team and a portfolio that we like, and are they open to because we're not going to do it. That's one of the key tenets of our developer stage investments is we don't do it on just a subset of their assets. We require them to -- their whole portfolio to be subject to the program.

So I would say some of the near-term opportunities will likely be more immediately cash flowing operating projects, but there is a healthy mix of both in the pipeline.

[Rupert Merer, analyst]

And then looking at the tax credits, it sounds like there are some puts and takes around the IRA. Just wondering if you can give a little more color on that. We are seeing an acceleration of potential growth in the market, so more developers coming forward, some need equity. But at the same time maybe a smaller hole in the capital structure for developers. Do you see it, overall as a positive, negative or maybe a wash?

[Frank Getman, executive]

Overall I think it's a positive, but I think your characterization is accurate. There is some things pulling and pushing in both directions. There's going to -- definitely it has accelerated the overall need for capital because a lot of projects that were either had -- because of the passage of time had become marginally or maybe even not economic are now back in the mix again and those folks are actively in the market looking for capital. And with the movement towards wanting a little more merchant exposure, that's an opportunity for us.

But like I mentioned, it didn't -- there's still an undercurrent of angst, I guess, I would call it in the industry with some of these interconnection delays and how are people going to fund through that. I mean, I don't -- I still believe we're on a trajectory of a massive growth overall for renewables. I just think it's part of the growing pains that you see.

[Rupert Merer, analyst]

And then as a follow-up, in Canada, we -- it looks like we may have our own tax credits coming soon. Are you seeing any opportunities developing in Canada or is that something you have on your radar screen?

[Frank Getman, executive]

We have it on our radar screen. We haven't -- we are -- there's so much opportunity right now in the U.S. We've had a few introductory calls with companies in Canada, but we haven't seen yet the same level of opportunity that we're seeing in the U.S.

[Operator]

Your next question comes from the line of John Mould from TD Securities.

[John Mould, analyst]

Maybe just starting with the Great Bay staffing updates. So you've added a couple of people. Can you just maybe talk about how this improves your bandwidth for deal flow, and for how long do you think this puts you at a steady state in terms of your personnel means at the JV?

[Frank Getman, executive]

Sure. I think the way to think about it is, and this is what I shared with the Board at the time when we were making decisions to grow and staff up a little bit, is that we have been, with the 4 of us, we would have been doing kind of like I would call batch processing, where we would find and identify opportunities, then it would literally take most if not all of our time to move those through the process to negotiate, document, do due diligence and then close those ultimately. And then we would be back to, okay, now let's go find the next best opportunity.

Zach Farrar at GE was on the sales side, on the origination side for the Wind Services division, Head of Global Wind Services for GE. And so he brings with him a deep and broad expertise in organizing ourselves on the front end, on the origination front. We had a very long Excel spreadsheet. He has now had us working with the CRM system. So we're able to slice and dice our leads and identify opportunities and organize them and high-grade them in a much better fashion.

And I think what we're already seeing -- that work is ongoing now. It doesn't stop while we're working to close other deals. And then -- so I think -- and then adding Peter is just -- the way that we kind of work is someone will take the lead, then everyone else supports and then someone else is lead on another deal, we're able to process multiple deals now at the same time.

I think we could, I think, deploy an awful lot of capital with the team that we have. We're turning to really a finely tuned machine. So I don't see the immediate need. Maybe on an analyst or something on the junior side we could use some additional support, but I feel like we're in pretty good shape for the foreseeable future to be able to process and close deals.

[John Mould, analyst]

And maybe just on that, on the question of funding. I mean, you've got -- when you layer in the TGE projects that Enbridge is looking to develop where you've got that royalty option, and granted there's a longer -- much longer-term runway there beyond 2024. But you've got a line of sight on projects that likely exceed your capital availability right now and also with Bluestar and Hodson, those are likely to get tranche out the door over the next 2 to 3 years.

How are you thinking -- maybe it's more of a question for Brian, but how are you thinking more about the midterm funding plan and keeping the door open for executing on maybe bigger opportunities on the operating side, just given that those tend to have larger tickets associated with them?

[Brian Dalton, executive]

It's Brian here. So there's somewhere around $50 million at the ARR level and then, of course, you've got the matching funding from Apollo. So Frank and the team have good liquidity for, I guess, what's on their plate right now.

The point I'd make as well with regards to like the future tranches under the Hodson and Bluestar agreements, like don't forget that there's pretty serious cash flow ramp up starting to happen in the business. So I'm not overly fussed about that -- those future tranches as we go forward. But, yes, I mean, our expectation is that we are going to need to continue to bring capital to the table to basically keep up with the deal flow that's happening.

Previously in different quarters, we talked about, are we getting to that point where we could start to introduce some leverage into our own structure to help support that. I'd say we're still on the early side for that. And then to be fully honest with you, the debt market isn't looking nearly as attractive today as it would even a couple of years ago.

So still thinking long terms -- longer term, I think, or not longer term, but medium term around front-ending equity as the main source of funding for the business going forward. Obviously markets are tough. Share price is by no means where we think it should be at the moment.

But don't forget as well that renewables is very strongly supportive. And in particular, Altius Minerals is also reaping very strong cash flows in this market and is highly committed to making sure that ARR does not run out of money to execute its growth.

It's interesting. I mean, I guess, it's always the way. When the markets are tough, opportunities are greatest. So there's a little bit of push and pull. But anyway, long story short is the message to Frank from the shareholders, I think ARR and Apollo, is, "Make good deal, the money will be there." And that's full stop.

[Operator]

Your next question comes from the line of Nick Boychuk from Cormark Securities.

[Nicholas Boychuk, analyst]

Brian, coming back to your comment about how the debt markets aren't as attractive. Is the rising of the interest rates having any impact on the competitiveness of your royalty or alternatively, could you guys potentially see a scenario where your 8% to 12% targeted IRR actually has increased now, if you were to go with an earlier stage developer, for example?

[Brian Dalton, executive]

Yes. I mean, we'll keep an eye on those developments in the market. But we're, obviously, as a royalty player, you're competing with all other forms of capital. I think Frank would agree with this. More particularly, we feel like we compete with the equity cost of capital for players. And you just have to look at valuations for the IPPs to know that that hasn't gotten cheaper in the last little while either.

But I think in terms of more specifically on the debt side, it's not just the pricing. When you get in these kinds of environments when it used to be black swan events for things that happen every so often. I don't know if there are any white swans anymore. Everything is a black swan, it feels like. And it's not an environment where you'd find lenders to be overly constructive when you're trying to do creative and need things.

So I'd always look at not just the cost of debt, but also what comes with the debt and how restrictive it is around your business, but ultimately are the most opportune time. So there's a lot of push and pull.

I'll just go back. We're not actively involved with trying to bring capital into the debt markets at this time. I'm sure it comes, but right now, I think, it would be almost too much of a distraction to the growth trajectory and an unnecessary pain in the a***, too, quite frankly.

[Frank Getman, executive]

Nick, I would just add on the 8% to 12% range, it's like there's not -- nothing says that's fixed in stone forever and ever, and we're always looking to do the best deals we can. And it's not like there's a posted what's the market price of royalty capital and renewables. So we're always trying to test that and press that and see, is there opportunity for us to scooch up our returns. So I'd say on every single deal, we're looking to maximize our opportunity. So that's an ongoing process.

[Nicholas Boychuk, analyst]

And then coming back to the comment that you made about the attractiveness of the U.S. market, obviously, with more developers looking to get and more sponsors looking to get the merchant exposure. Is the opportunity set in Europe becoming more attractive? And could Bluestar start to maybe introduce you guys to some opportunities there or is the U.S. just so doubtful that there's no need to expand beyond the borders?

[Frank Getman, executive]

It's interesting. So I think that we recently had a board meeting at Bluestar. And I think that they're seeing there is opportunities for some M&A type opportunities from sub-developers for Bluestar in Europe. But in the U.S., the pricing is so high. I think they're very much focused on greenfield, and they have a very strong team they put together and continue to grow forth to build out that greenfield development in the U.S.

But I think there's no -- obviously, our royalty financing, we're -- they're obligated to provide us royalties in the U.S. under Nova Clean Energy and not in the European, although we have exposure through our Bluestar ownership, but there's an ongoing dialogue and the benefits of our capital are not lost on Declan. So we'll see how that moves forward, but nothing immediate.

[Brian Dalton, executive]

I think I might only add, like, the question would have come up a lot around the time of the IPO, where we focused. And what we said then is probably still mostly true. The key here is to get adoption in what we think is the most sophisticated capital market for renewables. That's obviously happening, awareness of the royalty financing for the sector is growing.

So international, I think, is still on our radar, and you're probably zoning in pretty right here that it's going to -- when it happens for us, it's probably going to happen in conjunction with some partner who is expert in the region, but not this month.

[Operator]

[Operator Instructions] Presenters, there are no further questions at this time. Please proceed.

[Flora Wood, executive]

Thank you, Laura. And I want to thank everybody for joining us on the call today, and we'll see you next quarter, year-end.

[Brian Dalton, executive]

Thanks, everyone.

[Frank Getman, executive]

Thank you.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.