Polaris Infrastructure Inc

TSX:PIF

Earnings Call Transcript 2018-Q3

[Operator]

Good morning. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Polaris Infrastructure 2018 Third Quarter Results Conference Call. [Operator Instructions] Mr. Downey, you may begin your conference.

[Shane Downey, Chief Financial Officer]

Thank you, Cheryl. Good morning, ladies and gentlemen, and welcome to the 2018 Third Quarter Earnings Call for Polaris Infrastructure. In addition to the press release issued yesterday on November 6, 2018, you can find our financial statements and MD&A on both SEDAR and our website, at polarisinfrastructure.com. Unless noted otherwise, all dollar amounts referred to are denominated in US Dollars. I'd like to remind you that comments made during this call may include forward-looking statements within the meaning of applicable Canadian Securities Legislation regarding the future performance of Polaris Infrastructure Inc. and its subsidiaries. These statements are current expectations and as such are subject to a variety of risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties include the factors discussed in the company's Annual Information Form for the year ended December 31, 2017. Certain measures referenced in this call do not have any standardized meaning as prescribed by International Financial Reporting Standards, and therefore, are considered non-GAAP measures. In the company's earnings releases, consolidated financial statements and MD&A, unless otherwise noted, all financial information is prepared in accordance with IFRS. EBITDA is a non-GAAP metric used by many investors to compare companies on the basis of ability to generate cash from operations. The company uses adjusted EBITDA to assess its operating performance without the effects of, as applicable, current and deferred tax expense, finance costs, interest income, other gains and losses, impairment loss, depreciation and amortization of plant assets, share-based compensation and other non-recurring items. The company adjusts for these factors as they may be noncash, unusual in nature and are not factors used by management for evaluating the performance of the company. The company believes the presentation of this measure will enhance an investor's understanding of its operating performance. I'm joined this morning by Marc Murnaghan, Chief Executive Officer of Polaris Infrastructure. At this time, I will walk through our Q3 2018 Financial Results, and comment on our recently announced quarterly dividend. After which I'll turn the call over to Marc for additional commentary with respect to San Jacinto operations, and of course, our recently announced acquisition of hydro assets in Peru as well as to accept any questions. As mentioned previously, I refer our listeners to the company's recently filed financial statements and MD&A for the quarter ended September 30, 2018, for a more complete presentation and discussion of the company's financial position and results of operations. And a quick point of emphasis, the acquisition of Union Energy Group closed subsequent to the September 30, 2018, quarterly reporting date. So results of operations of the acquired businesses are not included in our reporting for the third quarter of 2018. During the third quarter of 2018, San Jacinto operations delivered 144 gigawatt hours, an average of 65.4 megawatts net, versus delivery of 125 gigawatt hours in the prior year. This improved level of production reflects sustained incremental contribution from the recently drilled production wells, which is being facilitated by the removal of separating capacity constraints that occurred when HPS3 was commissioned in late April 2018. Accordingly, the third quarter of 2018 is the first fiscal quarter to include the impact all wells being connected throughout the entire quarter, or effectively, the second quarter included 2 out of 3 months with these additional steam flows. Marc will comment in greater detail on San Jacinto operations, and specifically, how we view current production levels relative to theoretical capacity. On year-to-date basis, the San Jacinto plant has generated 400 gigawatt hours, up from 363 gigawatt hours in the prior year. Given these levels of generation, we recognized $8.2 million in revenue during the third quarter of 2018 -- sorry, $18.2 million, up from $15.3 million in the prior year period. The 19% quarter-over-quarter increase in revenue was driven by the combination of the increase in generation as well as the 3% annual increase in tariff under the PPA. On a year-to-date basis, we recognized revenue of $50.5 million versus $44.5 million in year-to-date Q3 2017. Given revenue growth combined with ongoing cost containment, the company generated adjusted EBITDA in Q3 2018 of $15.5 million versus $12.9 million in the prior-year period. And on a year-to-date basis, $43 million versus $37.4 million in the prior year. The company reported net earnings for Q3 of $4 million versus $890,000 in the prior year, and $8.4 million for the year-to-date period in 2018 versus $911,000 in the prior year. Net earnings during the third quarter of 2018, were again, impacted by the revaluation of the share-based compensation liability, which is a noncash item and reportedly not reflected within adjusted EBITDA. We do, in any event, anticipate that 2018 will be the company's second consecutive fiscal year with positive net earnings. As of September 30, 2018, the company had a cash balance of $39.9 million of which $12.4 million was held in debt service reserve accounts related to the San Jacinto project. And before turning over to Marc, some comments on our latest quarterly dividend, which was declared by the board on November 6, and will be paid on November 26, 2018, to shareholders of record on November 14. The USD 0.15 dividend reflects a 32% payout ratio based on Q3 2018 results. And on a year-to-date basis, payout ratio comes in at 38%. We have always envisioned dividend growth to come from growth in cash flow generation, and secondly, from a possible increase in payout ratio. In light of the recent closing of the Peru hydro acquisition, we anticipate capital investment focused on construction of the Generación Andina projects, which once completed in late 2019, is expected to result in a further step change in cash flow available for distribution. We will at that time evaluate the appropriateness of the further dividend increases. And with that, I will turn things over to Marc.

[Marc Murnaghan, CEO & Director]

Thanks, Shane. So in terms of San Jacinto, we put 12-5 online, which was the main well from the last campaign that we did. We put that online, call it -- just say March 1. And anytime we put big wells on, it does take a little bit of time to know where that's going to settle out and where the fields are going to settle out. And I think we have had a reasonable amount of time now with that being online. And we put a range of, call it, 70 to 72 gross in the press release. That's sort of where we are today. We do -- we have a small well closed right now, but it's a cycling well. So I think this sort of 65.4 net that we delivered in Q3, looks like that's where we have settled in here. And we are a snick lower, q-to-date with 64.8. We always have had 9-3, the well that always does cycle. And it's unpredictable, its cycle is a little bit more in October than in Q3. And so that does feel like where we're at, not just in terms of, call it, ability in terms of a capacity, but just deliverability on megawatt hours. Also small events in terms of downtime, or unplanned downtime reasonably small, but that always taken maybe, call it, 0.5 a megawatt in a quarter of deliverability. So 1% will be 0.7, so seems like that's an appropriate level with the recent wells coming online, and where it's all settled out. And at that, while we're not at, call it, full capacity, which the other thing I would say was learned is -- I think saying 77 gross capacity is very hard. I would say the most we can be running at is probably 75. Just because the way that we do turbine maintenance is we do one of the turbines every other year. And we do a maintenance on one turbine every other year, but that means you're always having, call it, one turbine at least 1 year out of maintenance. And so, it will just not -- it will not be able to reach its nameplate capacity. So I think 75 is realistically the gross capacity limit. And we're not at that, but we're not far off. And -- but I think, given the amount of cash flow we're generating, given how close we are, we don't feel a strong need to push it to that level where you start to get to diminishing returns. And so what we will do is update a numerical model based on all the new wells that we not just put online for this past year campaign, but the one before that. That's about a 2 to 3-month process that we're doing with our technical consultants to see where we're at in terms of the overall level of generation sustainability. And that will give us a sense as to whether we do want to push it more or we want to just call it harvest. So I would see 2019 being quite a low level of CapEx. In the project, the typical -- sustaining CapEx, which is about $2 million. And then, there may be some small -- we have a few ideas, and are potentially doing a little work over here and there at some of the wells, but these are small dollar spends. So we have been talking about that, but again, I think we're going to let it sit here for a little bit and see how the field does, and then focus on Peru at least for the next 12 months. And on that, we obviously made a press release about that. I think it would be better to open that up to the question period, but the, call it, mobilization has already started. We have spent, call it, $600,000 already. So our -- the cash balance that we have is not a huge difference, but that is, call it, $600,000 lower because of the spend that we have put forward in Peru. Once we get comfortable with it, that we will be moving ahead with it. So in terms of, obviously, there's legal, but there's also design work from engineering firms in terms of redesigning a couple of the things. There's -- so sending some teams to site for some of the construction plans, et cetera, that's all started. So we're now, call it, mobilizing and things are moving ahead as we speak. So we will be providing further updates on that as we go through the process. The small plant, Canchayllo, that will be -- again, that is a small producer. But we will have a very small little bump from that in terms of revenue and EBITDA that will end in Q4. And we will have the comments on that when we release Q4. And in terms of -- I will make a quick comment on the dividend, although we would just reiterate it, is that given the cash on hand we have and the cash we're generating, we're comfortable that we can execute on the investment in Peru in terms of the investment size, which we probably said we think is $35 million. That will enable us to get those projects up and running. We will plan to keep the dividend flat throughout the piece. And then as Shane says, assess increases at that time. So that's at least the plan of this moment. And I did mention in the press release, the fact that -- which we don't really do, but the fact that we do continue to pay down debt. So I think -- what I think shareholders are going to get in the next 12 months is still a very healthy level of dividend relative to share price. Debt reduction, which does go to the equity account, in my view. And then small production from a 5-megawatt plant in Peru, and then the bringing online 2 meaningful and material projects to the company that are in different jurisdictions, that are in a different asset class. And so that's what we aim to deliver to shareholders in the next 12 months. So with that, I will turn it over for questions.

[Operator]

[Operator Instructions] And our first question comes from David Quezada, Raymond James.

[David Quezada, Equity Analyst]

My first question just on the Union acquisition, the development projects that you detailed that you acquired as a part of it. Wondering if you can provide any commentary on where they are in terms of -- how far advanced they are? What are the main hurdles? We'll start with that.

[Marc Murnaghan, CEO & Director]

So the first one I'm going to talk about is Karpa. That's the one that has the 20 megawatt contract, and the predecessor company had posted a 4.75 million U.S. bond that's sitting in a bank account. And that has to be done when you get a contract, you have to post a bond. And so with all -- so just like the 2 projects that are in construction, the issue with those was that they -- when you sign a contract, there's always a date in it that you have to commit to, to get the plans and operation by. And if you don't get into operation by that date, technically your contract is not valid. So those 2 that we're constructing. That date -- and definitely that date had lapsed and we had to get effectively a signed addendum from the Ministry of Energy that they would extend that date, which we got. And so that is a process that we are having to do with Karpa. And it's something that -- because the date has lapsed on that, we don't anticipate that to be a problem there. This Ministry of Energy, they want these projects. The prices are very good from their perspective. But we're going to have to go through a process with them in the next 3 months to agree on something, and try to come to an agreement. We have received early indicative proposals from other groups about possibly taking that project on or moving the contract, so that we can -- and even then, paying us back our bond or even rolling that bond into equity. So we're looking at all of those possibilities, and as we said in the press release, we'd hope to have something in terms of the plan clear by Q1 next year. But that would be the most advanced of all of them. The rest of them are earlier days and on various levels of development milestones ahead of it, but the biggest issue with those would be they don't have a contract. And what we are hearing is that there will likely be another auction for contracts at some point in 2019, likely later in the year. And so I think for those -- the next milestone -- we probably wouldn't do much on those really until such time as we bid 1 or 2 on that round, and to the extent that we're awarded something, I'm thinking that will be back half of next year. But that would be sort of the game plan on the rest of the pipeline.

[David Quezada, Equity Analyst]

Okay, great. And then, maybe just a follow-up. I guess, you mentioned the improving government, sounds like they're pretty eager for new power and there could be other round of PPAs? Is there generally a pretty pro-renewables stance there?

[Marc Murnaghan, CEO & Director]

Yes. They're right now at about 60% to 70% fossil fuels, and they've had a lot of natural gas. And they have a stated mandate to get -- to flip it to get renewables at sort of 60%. I would also just say though, so that's sort of, call it, a political mandate. But given they do have a lot of hydro, they can definitely have more hydro. And at the prices, that they're getting -- so these are sort of between $0.05 and $0.06 of kilowatt hour, which can work as long as you do the project properly, which the 2 that we're buying in construction, they definitely didn't. But that's a very good price for the buyer of power as well from my perspective. So I think they're keen to contract as much of that as they can.

[David Quezada, Equity Analyst]

Okay, great. That's helpful. And just one more if could. Just any last -- or any recent thoughts on the situation in Nicaragua. And if you've been down there recently, any color you can provide there.

[Marc Murnaghan, CEO & Director]

Yes. I guess, I didn't bring that up. I was there about 6 weeks ago in September. It was very quiet. Operations not affected. Things continue to happen almost -- it's more quiet now than it was at the beginning when there was the protest and demonstrations. Now there hasn't been really much of that. And so -- really the only comment I would make is that our understanding is that the powers that be at Nicaragua are -- we think they're having conversations with groups -- with some of the development banks that loaned money to the country, like IFC, like IBB in Washington and others, about coming to some resolution in terms of how to move forward and continue to -- for these banks to either restart or continue to -- for them to lend money to the country, which we think the country needs. And they know they need that. So they're in the middle of conversations. I guess, we're sort of, fingers crossed, that some agreement is reached sooner rather than later. I would -- my guess is we won't see anything before the end of the year, realistically, for 6 months of next year as well.

[Operator]

[Operator Instructions] Our next question comes from Ian Clark, from Dichotomy Capital.

[Ian Clark]

Just curious, if we could talk about the 8 and 20 megawatt project. Obviously, they've got some issues getting to the finish line. Just kind of curious, what halted that, and what prevented them from getting there? Was it your funding, or the construction, and then -- how do you guys see the next 6 to 12 months as far as completing the construction? What sort of hurdles are there?

[Marc Murnaghan, CEO & Director]

So it was a combination of both. They were constructing, and the rainy season in Peru is effectively now, it's sort of between, call it, October, November to March, April. And there are certain things you don't want to do during that season. And so what we try to do is get a lot of -- some key works done in the dry season. And they didn't quite have it all done, and there were people saying, "We got to stop and the rainy season is coming." And some people didn't listen and so they pushed it. And so there were landslides actually at both of them, which is not uncommon in this area. These -- it's like, these are mountains, but it's jungle. And so the rain falls quite high, which is good for projects once they're up and running. And so they ran into construction problems. And at the time that they did, they already owed the contractor money because they were sort of tapped out financially themselves, and they were looking to bring in new investors. And so once that happened, they tried to find some more money, but by the time they were -- that can take time to bring in new investors, particularly, to projects that have stopped construction. So -- and by that time, the contractor was already out of money. They had to start demobilizing. And from there, it kind of just ground to a halt. We did our -- we obviously had technical people go in and there was nothing from a -- these are not specially challenging projects whatsoever. And combined with that, the view was that the fixes -- first of all, the damages didn't have to happen. It would have been pretty easy to have made the decision to not push on. But that also -- the fixes, they are not in any way technically challenged. We just need to take care of. And some of them we can do during this rainy season, and some of them will have to wait until, probably April or May to do some of the work. And some of that work is -- some of it is actually finishing some stuff, like just finishing the concrete at the intakes on both of them because they weren't totally finished. And then for one of them, there was some damage to the penstock. And we can actually go in and do that, because it's a tunnel, in the rainy season. And so we've got designs done where they have the things, it's just -- and we actually changed the contractors. The previous contractor was a huge company, we've chosen -- that actually have never done hydro projects in Peru before, these were the first ones. So we've chosen somebody of the local contractors that -- whose focus is in 20-megawatt hydro projects in the region. And combined with the hire of the owner's engineer to work with us, that had constructed hydro projects, and that was also something that didn't exist with the owner's engineer that really watched over the work that the contractor's doing. So we're also going take to the approaches differently. The turbines and the turbine house, that basically all done there, it's all there. We might -- we do need to connect some of the turbines and generators, but that's very easy work to do. Turbine houses are done. So a lot of this is already there. It's just finishing bits and pieces. The term, 78% done construction, is probably pretty close actually.

[Ian Clark]

Got you. So if I'm thinking through the $35 million spend, I'm talking probably, call it, 3 quarters of that is going to be around civil works, and making sure it head take, penstock and all that, whereas the interconnection and, I guess, the nitty gritty on the actual turbine side is going to be more de minimis overall?

[Marc Murnaghan, CEO & Director]

Yes, that's correct. I would also say that we didn't provide a full breakdown of $35 million. But a portion of that, call it, almost $10 million, is actually just paying off the former contractor. So the actual civil works and the turbine works, all of that included is probably in the $20 million to $25 million range.

[Ian Clark]

Got you. Okay, great. What are the turbines here, are these Pelton or Francis, or what type of turbine technology are we looking at for these 2 facilities?

[Marc Murnaghan, CEO & Director]

One is Pelton, one is Francis.

[Ian Clark]

Got you. Cool, nailed it.

[Marc Murnaghan, CEO & Director]

Andritz was the supplier, so they're sort a top company.

[Ian Clark]

Great. And then one other just final question. In the deck, you guys showed the capacity factor for Carmen and the number that you go through, it seems like 45 gigawatt hours per year would imply something like a 55% capacity factor versus the 25% listed. Just curious, what the discrepancy is there?

[Marc Murnaghan, CEO & Director]

That's a mistake, yes. At the higher numbers -- yes, the higher numbers. So thank you for pointing that out. But, yes, it's a higher number. We -- the one thing with these projects, it is an important point is the "capacity factors" are relatively high because they tend to size them a little bit smaller than you otherwise could. So both of the projects are going to run 2 turbines. And the way they do is instead of the rainy season, both of those are -- you're running almost at capacity. Both of them should be running full out. And then you've got maybe 2 or 3 months where they're both running lower, and then for another 2 or 3 months when it's the driest of the dry, you shut one of them down, and you run one of the turbines. And it might even be close to full capacity. So for -- some of them you're looking at even 70%, 75% capacity factors.

[Ian Clark]

That's great. And the guy who owns hydroelectric that has 50% capacity factors, I'd kill for 70%. So, great, appreciate it.

[Operator]

Our next question comes from Brent Buchanan, CIBC Wood Gundy.

[Brent Buchanan]

Marc, just a follow up on the question on Nicaragua. I'm curious on what's the trends you're seeing in power demand. Is it staying flat, going up, going down? And also payment of -- I know you're not getting payment from the consumers, but through your distributor. What are they seeing from that point of view?

[Marc Murnaghan, CEO & Director]

Yes. And so, interestingly, I'd looked again. We do track overall power demand. And it dropped, I'd say, 3% to 5% when this all started back in April, which you can read that as the tourism industry in my call, I don't know exactly. But when I looked this morning, it recovered all of that actually. So it has been, since over 2 months ago, starting to recover that. But it's basically back at where it was before. I would not read into to that the tourism industry is back to where it was, but it -- but I think, I would actually say there's more points of connection. There was something that has been going on for years that the electrification of the country has always been an issue. They have sort of the last mile to go here. And so they haven't stopped that. So I think, just the number of connection points is increasing. The total demand is now flat with where it was. And then in terms of payment, so those customers are paying. We mentioned in the last call that we are -- so we're paid up to date as of today, which is good. They are taking a little bit longer to pay. But that has effectively been the same for the last 3 or 4 months. So it's basically as they get paid, we get paid. And so they're paying a little bit slower because before they would sort of bridge that gap with sort of their own credit lines and et cetera. But our receivables have gone up a bit because we think that their credit lines have been tightened a little bit. And so there has been this bump up. And so as they get paid, they pay us. So that's all happening. And we think it's possible that some of the actual end-users are taking a teeny bit longer to pay for no real reason other than they are. But they can only push it so far because they do know that if they take, let's just say, longer than 30 days to pay their power bill, they can get cut off and will. And so power really is something that has not been cut back by anybody, which makes sense.

[Operator]

[Operator Instructions] Our next question comes from Mac Whale, Cormark Securities.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Just first on modeling here on seasonality. Just trying to get an idea the megawatts you provided for these various assets, those are-- you've given that full capacity of say 2 turbines that it would be [ in line with ]? Is that how it works? And then, so you expect that the rainy season like 80% capacity factors and then you -- then we should be modeling it as like half the megawatts and dry season at full. Is that how we should think about modeling it?

[Marc Murnaghan, CEO & Director]

Yes. I think what I'll have to do -- it's a good point. We do have specific month-by-month for these assets. And this is where you get into the capacity numbers which everybody likes to quote. There's going to be a bigger difference between that and your megawatt hours delivering than, let's say, geothermal. But the way that they run, Mac, is so for the rainy season, we should be running 2 turbines and they should be running close to capacity for at least 4 months, okay? And then in the low season, you're running 1 turbine, and it will be close to its capacity. So for 8 de Agosto has gone to technically 9.5 megawatts turbines. But we will make -- they should be running at 9.5 megawatts to shut one down. So it's 8 de Agosto capacity factors is higher than El Carmen. And in a way, you could almost think of it as for the 6 rainy months, it's running close to 100%, and for the 6 dry months, it's running around 50%. And that will blend to 75%. Carmen is worse than that. But we'll work -- I just don't have it in front of me, but you'll get a little bit more granularity on that for sure.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Okay, okay, that's good.

[Marc Murnaghan, CEO & Director]

But if you were -- before we do that, if you were to take that megawatt hour numbers we have, which has all of that baked into it, and sort of put, call it, 2/3 in the rainy season and 1/3 in the dry season, the start we'd be getting reasonably close to more granular analysis.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

And you remind me, thinking rain. What are those months?

[Marc Murnaghan, CEO & Director]

I'm thinking October to March.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Yes, okay. So in general, when you're looking -- can you give us some idea of like, when you're looking at a new project now, if you're looking at this pipeline, what sort of IRR you're targeting? Or is there some other metric that you might be targeting? Could you sort of reveal that to us and give an idea for what the leverage would look like and sort of your cost of capital?

[Marc Murnaghan, CEO & Director]

Right. So the next thing with those 2, we basically targeted that 15%. We think we'll get a little bit more because between carbon credits, transmission revenue, that we think that we can get more. So call that a 16%, 17%. I think that's high, especially when these are very far along in the construction. So I don't think we'll be able to get that. Let's look at Karpa, so greenfield, and it's ours now, and so there's no extra restructuring. You're probably looking at, let's say, 12%, 12.5%, which sounds low. But the reason why people sort of do that here is that there is a very -- so that's like a 20-year IRR, okay. But there is a very healthy -- so I'm already getting approached by -- there is a very healthy insurance market, interestingly locally. And they try to get exposure to hydro assets because they like the long life. But they want them constructed. Once they're constructed, they'll sort of cap these things at like at 8% cap rate. So your IRR on your equity is obviously higher than the 12% because you can take back a bunch of your equity, and probably get a 10% to 12% IRR on what you leave in for the 20 years of the project. But then you can take back a lot of your equity. So your actual, call it, 2 to 3 year IRR is more like 25%, 30%, if you look at it on a short-term basis.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Right. Now to do that though, I guess, you kind of -- it'd be nice to have a big line of credit or something of that nature that you could leverage to do the spend on development. Like is that -- how do you look at financing?

[Marc Murnaghan, CEO & Director]

It's possible. What I would say is, so one of the benefits of having the 5-megawatt project, quite frankly, it's just -- is that exactly, which is that for us to get to sort of local line of credits when you've got, let's say, 3 projects up and running as opposed to just the 2, it's actually in a different area. People, the banks there, they will do that. But it's good for them to see like a mini portfolio. That's all.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Yes, yes. So it's not very long until your next...

[Marc Murnaghan, CEO & Director]

No. And I think the other thing that puts it in perspective, what I'm saying to people in the pipeline, there's -- let's just say, Karpa or a greenfield project in the pipeline. I do think that what we will hope to add to that in Peru is something that can't be exactly like what we're doing as of today at 8 de Agosto. But there are some projects that have actually contracts that are -- so further along than a true greenfield development. So there's just a brownfield, they've got a contract, they may have spent $5 million to $ 10 million, but they haven't completely lost the contractor, but they need help. So I would think that there's going to be one more of those added to the mix at some point next year. And that package is quite something where you can get a line of credit. You can go to the insurance market and get the super-cheap and long-term capital to kind of recycle some of your equity.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Okay, so it doesn't look like you really need to go out to World Bank, or really external sources? You really are hopeful that you can get it in country?

[Marc Murnaghan, CEO & Director]

Yes. That is one thing that's different. There's clearly a market in country for that. And I believe we have seen people out country in a similar financial investor provider. So there's both that are looking at the asset class and at the country.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Okay. And then, can you take us through if there's anything noteworthy in the environmental process, like in permitting in Peru. Is it kind of easy what's the local -- how do they get involved in local side of things?

[Marc Murnaghan, CEO & Director]

So there's 2 things I would say. So there is a magic to the 20-megawatt today. Anything under 20 megawatts, the permitting process is just simpler. Less cumbersome, I guess. And so that's why you see these bunch of 20 and under projects. But these are run-of-river. So these are not -- which is reasonably benign. This is not dam. And so the local communities are very supportive. The biggest industry in this country is mining. And so on a relative basis, we're light-years of difference between a mine and their permitting issues and their issues dealing with local communities. That being said, we're -- so we have somebody that's full-time in Nicaragua that deals with -- we have 2 people. One deals with community relations full-time, and so she'll be on-site in Peru as well. And transferring everything that we do there, which truly is best practice because we do work with World Bank. So these development banks we have in Nicaragua, they have very high standards for this. We are probably at the top of the list in terms of that. We're going to transfer that. Obviously we have somewhat of a smaller scale. So we'll transfer that. And then same thing on the permitting side. So we are going to be leveraging off of what we've done in Nicaragua to date, but also some of the people. And the conversations with locals already, they're very supportive of these projects.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Sorry, so many questions here. Just got 2 more. Construction, you touched on that in terms of the contractors. What's the quality like? Are they -- is it like dealing with -- or what is it like dealing with these outfits? Are they reliable? Build quality good? Can they keep their target? Like do you take risk on their mess-ups, or how does that work?

[Marc Murnaghan, CEO & Director]

So yes, I think, the previous contractor was -- they were doing the work on widening the Panama Canal. Huge company, good name for the banks. But they have never done this in Peru. So -- whereas the group we're dealing with, they're a Peruvian based company, but they actually have built about 12 to 15 of these in country. And I think, some in Chile. They actually own some stakes in some. So basically, all they do is run-of-river hydro. So they're not a big global name, but I'm very confident that they really know what they're doing. They know these projects very well because they were constructing one in the same river valley. And so they're -- I think they're as good as any as their risk to timelines, and which means more money, yes, there's risk to that. But I'm comfortable that we've also put some of that risk on the lenders, quite frankly. In terms of our financial at 15% preferred returns, so if we have to spend more money, we need to make more money before the lenders get more of their money back. But also we are hiring an owner's engineer. So even though this is the smaller company, that's the other thing. Dealing with multi-billion dollar companies, when you're a company like Polaris is tough. You don't want that sort of dynamic. And that did exist before. So this other company is more of a small-medium-sized company, which I think is good. So there, I will have a direct line into the CEO of that company, if there is anything. But also we are hiring an owner's engineer. The previous group didn't do that. And that's really important because no matter which contractor you deal with, you need to have knowledgeable people on the ground, basically making sure every single day, there's something to do every day. And whether it's done or not up to the standards and exactly to the designs, so that never happened. So that investment in my mind, which is in our numbers, let's call it like $1.5 million, let's say for that. I think you spend that money so that you don't have a $5 million cost overrun.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

Okay. So when -- and that's my last question actually was the about how should we think -- at developer, when you move into that space, developers can start adding up in the sort of the SG&A line, you start to see development that's not capitalized in expense and is that kind of that $1.5 million incremental increase, corporately. Or is this going to be residing inside Peru, and so we won't really see it? How do you -- what's your thought on that?

[Marc Murnaghan, CEO & Director]

Yes, the way it will work is -- because the deal we have with lenders is, whatever takes us to get these up and running, is going to go into the bucket. And we then multiply that by 15%, okay. And basically -- so that SG&A will go, before they're up and running, will go into that number. So that's how it is.

[MacMurray Davidson Whale, Analyst of Institutional Equity Research]

And so you're all capitalized really.

[Marc Murnaghan, CEO & Director]

And then once it's up and running, call it our G&A -- there's G&A cost in Canchayllo already. There will be -- there are G&A costs in the budget of those 2 plants as well. And the G&A cost that's embedded in those 3 plants, once those 2 are up and running, will be sufficient to have the G&A of Peru in it.

[Operator]

This concludes the questions in the queue at this time. I'll turn the call back to the presenters.

[Marc Murnaghan, CEO & Director]

That's it. We can terminate the call.

[Operator]

This concludes today's conference call. You may now disconnect.