Northland Power Inc

TSX:NPI

Earnings Call Transcript 2018-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to this Northland Power conference call to discuss the 2018 fourth quarter and annual results. [Operator Instructions] As a reminder, this conference is being recorded Friday, February 22, 2019, at 10 a.m. Conducting this call for Northland Power are Mike Crawley, President and Chief Executive Officer; Paul Bradley, Chief Financial Officer; and Wassem Khalil, Senior Director of Investor Relations and Strategy. Before we begin, Northland's management has asked me to remind listeners that all figures presented are in Canadian dollars and to caution that certain information presented and responses to questions may contain forward-looking statements that include assumptions and are subject to various risks. Actual results may differ materially from management's expected or forecasted results. Please read the forward-looking statements section in yesterday's news release announcing Northland's results and may be guided by its contents in making investment decisions or recommendations. The release is available at northlandpower.com. I will now turn the call over to Mike Crawley. Please go ahead, sir.

[Mike Crawley, CEO & President]

Thank you, operator, and good morning, everyone. Thank you for joining us today as we review our 2018 results. We will provide an update on the business and provide guidance for our 2019 adjusted EBITDA and free cash flow per share.2018 was a very good year for Northland. The year unfolded largely as planned, with significant achievements of our 2018 growth and financial objectives. Paul will take a deeper dive into our financial results shortly, but first I'll provide you an overview of the highlights.Our operating facilities performed well, and most importantly, safely over the year. Excellence in operations is a key focus for Northland, as the predictability of the performance of our operating assets enables us to both comfortably pay our dividend to shareholders and provide funds for our growth activities.In 2018, we achieved adjusted EBITDA of CAD 891 million and free cash flow per share of CAD 1.90 compared to CAD 765 million of adjusted EBITDA and free cash flow per share of CAD 1.46 in 2017. A significant contributor to this growth was our North Sea 1 project, which was completed in late 2017 and contributed a full year's results to Northland in 2018. With both Gemini and North Sea 1 complete and contributing to our financial results, we turned our attention to our third offshore wind project, Deutsche Bucht. In September 2018, in-water construction officially commenced on Deutsche Bucht. By early January 2019, all 31 steel monopile foundations were in place. Construction activities are expected to be complete by the end of December 2019, with the project contributing to Northland's financial results through all of 2020, adding 269 megawatts of offshore wind power to our portfolio in that year.To enhance the long-term value of our operating assets overseas, we have established a European division, Northland Power Europe, which is based out of Hamburg. This European division will operate as a center for operations and management of our offshore windfarms initially by taking over the management of many ongoing functions that we previously outsourced. We expect to significantly improve our margins and our knowledge base.We also continue to advance our Hai Long projects in Taiwan. As you are aware, in April Hai Long was awarded 300 megawatts of capacity in the great allocation Feed-in-Tariff or FIT phase plus an additional 744 megawatts in the June competitive price auction. The 3 projects made significant progress on their permitting in the fourth quarter, with the 300-megawatt FIT project now having all required permits. We anticipate signing all 3 PPAs in 2019, with the 300-megawatt FIT project being the first to sign. Hai Long project economics and financing details will be finalized as development progresses.Our success in offshore wind speaks for itself, having demonstrated our ability to deliver major projects on time and on budget. Moving forward, we continue to pursue additional development opportunities in key markets and feel positive about our ability to achieve our growth and financial objectives.I will now turn the call over to Paul, who will provide additional detail on our financial results.

[Paul J. Bradley, Chief Financial Officer]

Thank you, Mike, and good morning, everyone. Last night Northland Power released its 2018 annual report and our annual information form. These documents are available on our website as well as on SEDAR. Starting with our full year 2018 results, Northland generated CAD 891 million of adjusted EBITDA in 2018, which represents a 17% increase over 2017 and was at the upper end of our guidance range. These favorable results were primarily due to a full year of contributions from North Sea 1 in 2018, whereas the project was still under construction in 2017. Also contributing to these results were higher wholesale market prices at Gemini and higher production at Thorold and North Battleford. Free cash flow increased by 32% to a total of CAD 338 million for the year. This was primarily a result of contributions from North Sea 1 and partially offset by higher scheduled principal debt repayments. On a per-share basis, free cash flow of CAD 1.90 increased 30% over last year. This was also at the upper end of our most recent guidance range of CAD 1.75 to CAD 1.95 per share.GAAP net income of CAD 406 million in 2018 represents an increase of 47% from 2017, and this was primarily due to an increase in gross profit and other income as well as noncash fair value gains on derivative contracts.Turning to our fourth quarter results, Northland generated CAD 221 million of adjusted EBITDA, which was CAD 17 million lower than the same period in 2017. The significant factors leading to the decrease in adjusted EBITDA in the quarter included higher operating costs at North Sea 1 compared to 2017 when it was under construction as well as lower sales in 2018 due to periods of negative power pricing, during which North Sea 1 did not receive its subsidy, and higher corporate G&A costs, primarily due to the timing of expenditures related to project development activities and higher personnel costs. Partially offsetting these was higher operating results in North Battleford, primarily due to favorable operating conditions and gas optimization activities.With respect to free cash flow, Northland generated a total of CAD 89 million in the fourth quarter, representing a 27% increase compared to the same period in 2017. On a per-share basis, free cash flow of CAD 0.50 increased 25% from CAD 0.40 in the fourth quarter of last year. The significant factors contributing to the higher free cash flow included an CAD 84 million increase in North Sea 1, which was under construction in 2017, offset by a CAD 37 million increase in scheduled principal repayments for Gemini and North Sea 1 debt and an CAD 11 million increase in taxes relating to North Sea 1. As of December 30, 2018, the rolling 4-quarter free cash flow payout ratio was 63%, calculated on a total dividend basis, compared to last year's payout ratio of 73%. The improvement in the free cash flow payout ratio from 2017 was primarily due to the contributions from North Sea 1.GAAP net income was CAD 65 million for the quarter, down from CAD 82 million in the same quarter in 2017. The decrease was due to factors previously discussed, partially offset by higher fair value gains on derivative contracts due to movements in the fair value of interest rate swaps and foreign exchange contracts.With respect to our financing activities, in December we completed the early redemption of our 5% Series B convertible debentures due June 2019. Of the CAD 77 million of principal outstanding, CAD 54 million worth of debentures were converted into 2.5 million shares, with the remaining CAD 23 million worth retained in cash.Also in December, we announced our intention to proceed with a normal course issuer bid, which would allow the company to purchase for cancellation up to 8 million common shares, representing approximately 4.5% of the company's issued and outstanding common shares. We believe that from time to time the market price of the common shares may not fully reflect their inherent value, and thus the acquisition of these shares could be a better utilization of available funds on hand.Turning to our adjusted EBITDA and free cash flow per share guidance for 2019, management expects the adjusted EBITDA to be in the range of CAD 920 million to just over CAD 1 billion, which includes the pre-completion earnings from Deutsche Bucht. Free cash flow per share is expected to be in a range of CAD 1.65 to CAD 1.95 per share, which includes the first full year of scheduled debt repayments at North Sea 1 and higher costs related to the timing and expanded scope of Northland's international development activities.Lastly, we would like to reiterate the expected 2020 adjusted EBITDA guidance for our Deutsche Bucht offshore wind project, which we estimate will be in the range of EUR 165 million to EUR 185 million when completed. As Mike mentioned earlier, Deutsche Bucht construction is expected to be completed by the end of 2019, with the project contributing to our 2020 financial results.I'll now turn the call back to Mike for concluding remarks.

[Mike Crawley, CEO & President]

Thank you, Paul. As I mentioned, 2018 was a significant year for Northland, achieving strong growth in free cash flow while continuing to expand our footprint into key markets and remain well positioned for continued growth. We witnessed our first 2 offshore windfarms, Gemini and North Sea 1, operating at their full potential, highlighting a successful pivot by Northland into a new growth sector, offshore wind. We continued to make good progress on construction of a third offshore wind project, Deutsche Bucht, which we expect to complete by the end of 2019. We've embarked on the multiyear development of the Hai Long project in Taiwan, which will open a new growth market for us. We've established regional development pods close to our target markets to allow us to identify and develop opportunities, including exploring alternative energy-related investment opportunities beyond power generation, such as transmission. Our LatAm and North American development pods are now fully established, with the Europe and Asia pods still adding some key talent.We remain committed to delivering excellent results from all perspectives: safety, financial, operational and as related to our growth initiatives. On that note, I'm pleased to share that we issued our inaugural sustainability report in the second half of 2018. The report, which is available on our website, demonstrates our commitment to transparency and provides some additional insight on how sustainability drives all our efforts at Northland.We look forward to keeping you apprised of our progress in the coming year. And in the meantime, we thank you for your continued confidence and interest in Northland. We would now be happy to take your questions.

[Operator]

[Operator Instructions] The first question comes from the line of Sean Steuart with TD Securities.

[Sean Steuart, Research Analyst]

A few questions. The 2019 EBITDA guidance. Paul, you mentioned it included the pre-completion revenue at Deutsche Bucht. Is CAD 70 million or thereabouts the right number for that pre-completion revenue in that guidance?

[Paul J. Bradley, Chief Financial Officer]

As things look right now, Sean, that's probably, we'd say, kind of at the higher end of the range that we've got in the numbers, but probably we'll know more as the year and the schedule unfolds. Just a reminder that you've got a number of things that create pre-completion revenues. One is how quickly the turbines come in, but also how good the wind is once those turbines are in. And to just remind everybody that if the wind is too good, you slow down your scheduled installation because you can't install when the wind's above a certain speed. So it is a very interesting dynamic to see how these PCRs do come out.

[Sean Steuart, Research Analyst]

Okay, understood. And Mike, wondering with respect to the Mexico prospective pipeline, can you give us any context around scale and timing of those potential developments as you move that pipeline forward?

[Mike Crawley, CEO & President]

Sure. So the team, as we've updated you on previous calls, the team in Mexico has been greenfielding a number of sites -- solar, wind and thermal sites in Mexico. We are looking in terms of revenue for those projects, revenue sources, looking at contracting through qualified suppliers with load directly as opposed to participating in government-run auctions and looking at our portfolio now to try and reconfigure it and adjust and focus on the projects that are in nodes that are most favorable to that revised strategy in terms of how we're looking at the Mexican market.I would think that a number of these projects, or at least 1 of these projects, would be in a position within 2019 to possibly move to construction, depending on where permitting and where other activities come out. So more to come on that, but certainly, from a development standpoint and from a permitting standpoint, it's moving along well. We do have a bit more work to do on the commercial side of it.

[Sean Steuart, Research Analyst]

Okay. And any context on what the scale of that 1 project might look like in terms of megawatts?

[Mike Crawley, CEO & President]

I would not expect -- it would not be on the scale of anything that we're doing in Europe in terms of a project size. We'd be looking at kind of doing a more scaled entry into Mexico if indeed we do proceed with an investment there.

[Paul J. Bradley, Chief Financial Officer]

This is more in our singles and doubles category.

[Mike Crawley, CEO & President]

That's the best way to put it.

[Operator]

Your next question comes from the line of David Quezada with Raymond James.

[David Quezada, Equity Analyst]

My first question here, just on the wholesale power prices at Gemini. It sounds like they were better in the quarter. Any commentary you could provide on what's driving that and how sustainable that stronger price might be?

[Paul J. Bradley, Chief Financial Officer]

Yes, basically there's just a wholesale market in Europe that gets driven by a number of things, including on the downside if there's too much production, largely from the collective renewables and prices may be lower. Nuclear plant outages and things of that nature might drive them higher. Certainly transmission constraints, any system issues that are there for the long term may create it. It's also a function of the economy to a large degree and demand for power overall, but generally, those are the macro factors. And there's a lot of micro factors that factor in, but it's hard to say how that migrates going forward. Most of our contracts are largely protected from the market price movements. But I think, as you know, there's a very small, small percentage of the Gemini overall revenues that do rely on the market price.

[David Quezada, Equity Analyst]

Okay, great, thanks for that. That's good color. And then maybe just a follow-up question on the guidance. Is it fair to say that progress at Deutsche Bucht and the pre-completion revenue there is the biggest kind of variable within that range that you provided, or are there any other sizable parts that we should be thinking about?

[Mike Crawley, CEO & President]

Well, as I was saying in the earlier question, the pre-completion revenues is also a function of wind production as well as construction schedule. Our biggest variances year-to-year going forward are always going to be just wind production generally, whether that's impacting operating or pre-completion revenues. And then the rest of the variations will kind of fall from there. So it's probably not necessarily the biggest, but it's -- because we don't expect it to be 0, we don't expect it's going to be, to Sean's number earlier, CAD 70 million. I sort of said that might be on the higher side. You're talking a range of 0 to CAD 100 million as part of our guidance, but overall wind production, entire fleet-wide, is going to have the biggest single variance on our potential results.

[David Quezada, Equity Analyst]

Got it. Thank you, that's great. And then just lastly, one more, if I could. On the installation of the monobucket foundations, is it too early to say how installation is going or has that been in line with your expectations?

[Mike Crawley, CEO & President]

It's so far in line. It's probably too early to make any definitive calls, but to date, the progress is reasonably on track, and we're not really expecting them until much later in the year.

[Operator]

Your next question comes from the line of Ben Pham with BMO.

[Benjamin Pham, Analyst]

I want to turn to Taiwan and wonder what were your thoughts on some of the Feed-in-Tariff pricing moves and if that impacted your expected returns on those projects.

[Paul J. Bradley, Chief Financial Officer]

Yes, thanks, Ben. We certainly, as you perhaps gathered, we're concerned with the initial announcement in the fall of the draft Feed-in-Tariff rates for 2019. We, along with the other developers, pressed hard to make the case to the government that it needed to be higher, and we were pleased to see the final Feed-in-Tariff confirmed at a higher rate, and also some of the structural changes that they had proposed largely removed or rolled back. So overall, we were generally happy with where it ended up. It is slightly lower than what the 2018 tariff is, and that will simply put a requirement on the project team and on our supply chain to find further optimizations to maintain the same return that we would have had otherwise.

[Benjamin Pham, Analyst]

Okay, it sounds like a lot of that supply chain is driven by some of your competitors pulling projects ahead of yours.

[Paul J. Bradley, Chief Financial Officer]

Well, that's what gives us some comfort, right? So we're not going to -- our grid availability is '24 and '25, as you're aware. We could wait until '25 or '26 to COD the projects, so there will be a number of large offshore wind projects that go ahead, ahead of ours in Taiwan, and the supply chain will be built out on the back of those projects. So we anticipate being able to actually realize some optimizations, hopefully, going forward.

[Benjamin Pham, Analyst]

Okay. And my second question on the payouts, you guys mentioned 6.60% sort of payouts. I'm just wondering. We've been getting increasing conversations around debt amortization, maybe looking at it from a useful asset life amortization rather than the contract life. And I'm just wondering you guys have any thoughts on that and if that makes your payout probably much lower than what it is today?

[Mike Crawley, CEO & President]

Well, I think the business kind of migrates on. As you know, we've got 3 uses of capital that we can put into new projects. We've got to spend money on development, which eats into our free cash flow per share if we want to grow. So we always look at the payout ratio as more of an output. I think we're enjoying the fruits of the growth from Gemini and North Sea 1. But as we mentioned in our guidance, we're also increasing the amount that we're spending on development in other areas, which if we follow the past patterns, should create larger cash flows in the future. But it's really not our style to manage the payout ratio in and of itself. It really sort of is a bit of an output. Obviously, we always keep an eye on it because it's 1 metric of many that might describe how the business is doing.

[Operator]

[Operator Instructions] The next question comes from the line of Rupert Merer with National Bank.

[Rupert M. Merer, Managing Director and Research Analyst]

There's a comment that you made about North Sea 1. You had lower sales because of extended periods of negative power pricing. Can you give more color on this? What's the impact of negative power pricing, how is it stipulated in your contract and what was the impact we actually saw in the quarter?

[Paul J. Bradley, Chief Financial Officer]

I think it was about a CAD 3 million-ish impact for the year, I believe it was. This is something that it's not uncommon, but it's part of the Renewable Energy Act, that after a certain number -- in this case, I think it's 5 hours of negative pricing; sorry, 6 hours of negative pricing -- that they can ask us to -- well, they just basically don't pay us our subsidy on the contract. And we saw that a few times in December, and that just is what it is. But that's typically -- we include that in our estimates of what our guidance range should be. I think we could all agree that that would be impossible for anyone to predict. But it is something that we've got our eyes on as a variance that's going to be with us while we own the project in the subsidy mode.

[Rupert M. Merer, Managing Director and Research Analyst]

So it's impossible to predict. But looking forward, how would you predict this could manifest itself? Do you think with increased offshore winds in Germany, that you could see more events like this in the future?

[Paul J. Bradley, Chief Financial Officer]

Well, some of it also just depends on when it happens. I think what we saw was there was bank holidays in Europe right after a weekend and there was just -- the demand was just artificially low. It wasn't so much anything else.One of the things you could look at is as more supply comes on, is there going to be more of that online? But again, it's impossible to predict. But the market dynamics in Germany are relatively healthy. Do we expect that there's going to be more and more blocks of 6 hours that then translate into 7 hours or 8 hours where we're going to start losing? And if you think about it, you only start losing it after that 6 goes by, so how long would that last? Typically during the day or during any period other than middle of the night or a holiday, there's enough electricity demand that should absorb into positive pricing territory as we look at it. So we don't see it as sort of a runaway syndrome at this point, but it's going to happen from time to time.

[Mike Crawley, CEO & President]

This year, it was almost exacerbated by the convergence of the Christmas holidays or the December holidays during a month that typically has high production of wind, right?

[Paul J. Bradley, Chief Financial Officer]

Right, yes.

[Rupert M. Merer, Managing Director and Research Analyst]

All right, great. Switching gears onto thermal, you had a couple of announcements here, a new contract or contract extension -- North Battleford and you're revving up your energy marketing group. So we've seen a few plants mothballed in Ontario recently. And how do you see that dynamic changing over the next few years? And with that, what's the outlook for the Kingston plant and maybe for Iroquois Falls? Do you see any potential changes in the market before its contract expiring?

[Paul J. Bradley, Chief Financial Officer]

So there's -- we're actively engaged both with the system operator in Ontario, as they have certainly signaled a need for capacity in the next decade to understand to what extent they are looking to leverage assets like Kingston, like Iroquois Falls, going forward to secure capacity. So those discussions are ongoing, and there certainly is interest within the system operator in understanding availability of those assets going forward. We're also looking at other opportunities, other revenue streams for those assets going forward. So it's an active pursuit right now to find new revenue sources for those contracts -- those assets for Kingston currently and for Iroquois Falls once its current contract falls off.

[Rupert M. Merer, Managing Director and Research Analyst]

So looking in your crystal ball over the next 3 years, do you see an improving market dynamic there? Do you see more demand for capacity?

[Mike Crawley, CEO & President]

Well, in Ontario, as you know, a lot of it's tied to nuclear refurbishment over the next decade, so there's an active and aggressive nuclear refurbishment program going on. To the extent that that moves on schedule, there has been identified a need for capacity in the next decade. To the extent that it falls behind schedule, the expectation is that there would be an even greater need for capacity. So yes, so I think we -- our view is that there is opportunities for those assets going forward, and there's also been interest, as you know, from data centers and cannabis operations, for example, to find dedicated generation as well. So all of those opportunities are being considered.

[Operator]

Your next question comes from the line of Mark Jarvi with CIBC Capital Markets.

[Mark Thomas Jarvi, Director of Institutional Equity Research]

I wanted to go back to Taiwan and just -- I know you guys think you've got more flexibility and can benefit from the later coming online and taking advantage of maturation of the supply chain. But can you remind us again, obligations in terms of finalizing local content and when you guys have to sign some of those agreements?

[Mike Crawley, CEO & President]

Yes, for sure. So there's a -- in November we have to submit a local content plan in Taiwan, so there will be -- a lot of the work in 2019 will be preparing that local content plan, both directly ourselves with our direct, a very key contractor and the turbine supplier that we select, but also working with them through their supply chain to make sure that they can present an acceptable local content plan to the Taiwanese authorities. So that's the next milestone. It's November for the submission of that report.

[Mark Thomas Jarvi, Director of Institutional Equity Research]

But there's no definitive contracts and pricing set with those suppliers at that point?

[Mike Crawley, CEO & President]

There would be some form of agreement set with those suppliers at that point. We're working through with Taiwanese authorities just how explicit and how detailed those agreements have to be. We obviously would like to have as much flexibility as we can so that we can adjust and optimize going forward. But we do have to identify where we'd be sourcing the local supply for sure. The question is how explicit we have to be.

[Mark Thomas Jarvi, Director of Institutional Equity Research]

So at that point, would you guys think you'd be in a position to kind of provide rough CapEx budgets for those projects then?

[Mike Crawley, CEO & President]

No, no. We would be anticipating further optimization after that point. There are still too many variables from late 2019 until what would likely be late '22 financial close or FID on those projects, particularly in terms of just input costs to a lot of those suppliers won't be defined by then. So we won't be able to provide firm CapEx by that point.

[Mark Thomas Jarvi, Director of Institutional Equity Research]

Okay. And then just going back to the commentary about continuing to sort of expand and optimize your development capability, you guys talked about a potential incremental CAD 15 million to CAD 20 million in this year. So maybe you can just sort of outline where you think you want to put those incremental dollars to work. Is that just more bodies, more bidding on projects? Is it more focused on an expansion in Asia or just kind of a little bit of everywhere across where you're currently set up?

[Mike Crawley, CEO & President]

Well, so what's exciting is we've, as I said in my introductory remarks, we've got a LatAm office now, largely fully staffed up -- in fact, still fully staffed up. The Toronto office, which is focused on Canada and the U.S., is fully staffed up. We've got some key talent that will be added in London in the next few weeks, and then that office will be fully staffed. And then Asia, we've got 2 people installed, but we'll be adding some more people in the next 4 to 8 weeks. I would expect to augment that team there as well.So what we're seeing is some good opportunities starting to come out of the LatAm group. Our new European head has been identifying some early-stage opportunities, which we still have to vet more. But generally, the idea is that these pods will operate almost as mini-development companies, right? And they have all the requisite talent to identify and advance opportunities on their own, up to a certain point. And so in terms of kind of how we'd allocate budget, it will come down to which one of these pods surfaces the better opportunities.In some markets, like as we talked about earlier in LatAm with the Mexico opportunities, that is greenfield development, so there will be some funds that will go towards that. In other markets like Europe, it will likely be more diligence, funding for diligence and funding for acquisitions of platforms going forward, which is what we're looking at in that market. In Asia, as you know, we've talked about offshore wind in Korea and Japan. So we'd anticipate, if we were able to secure a partner or an involvement in one of those projects that we'd have to be funding, we'd be funding the development, co-funding the development cost of those projects, which for offshore wind, as you know, can be substantial. So that's roughly how we see the funds going forward. But it does -- you can see it's not yet fully defined and it will be determined by where the opportunities come from.

[Mark Thomas Jarvi, Director of Institutional Equity Research]

Understood. And maybe just to touch on one thing. You made a comment about potential acquisitions. I know you guys talked about it at the Investor Day. What are you guys thinking currently in terms of deal flow or opportunities you're seeing to accelerate development through acquisition, either platforms or projects?

[Mike Crawley, CEO & President]

We're, as I said, we're looking at -- in Europe, we're looking at renewable platforms, so onshore renewable developers in certain markets where we think that there are better returns than you're seeing, certainly, in Canada and the U.S. for onshore renewables. So that's one area where we're looking at opportunities. We're also -- the Latin American team has been looking at a couple of other smaller platforms that we may pursue. So it's probably more, in terms of platforms, it's more onshore renewables. And there's some initial analysis being done in terms of alternate types of assets that are 1 step away or 2 steps away from power. But those are at a fairly early stage.

[Operator]

[Operator Instructions] And with no further questions, Mr. Crawley, there are no questions at this time. I will now turn the call back to you.

[Mike Crawley, CEO & President]

Well, thank you for everyone for joining us today. We will hold our next call following the release of our first quarter results in May 2019.

[Operator]

Ladies and gentlemen, that does conclude the conference call for today. Thank you for participating and have a pleasant day.