Semgroup Corporation (SEMG) Q3 2018 Earnings Conference Call Transcript

SemGroup Corporation (SEMG)
Q3 2018 Earnings Conference Call
Nov. 8, 2018, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to SemGroup's Third Quarter 2018 Earnings Conference Call. As a reminder, this call is being recorded. Should you need assistance, please signal a conference specialist by pressing the * key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press * and then 1 on your touchtone phone. If you withdraw your question, please press * and then 2.

I would like to turn the call over to SemGroup's Head of Investor Relations, Alisa Perkins. Please go ahead.

Alisa Perkins -- Head of Investor Relations

Thank you, Chris. Good morning, everyone. Before we begin, I would like to remind you that our earnings release and presentation for today's call include projections, forward-looking statements, and certain non-GAAP financial measures. We encourage you to read our full disclosures and our latest press release, slide presentation, and SEC filings for a discussion of those items, including reconciliations to GAAP financial measures.

Hosting the call today is Carlin Conner, our CEO; and Bob Fitzgerald, our CFO. With that, let me turn the call over to Carlin.

Carlin Conner -- Chief Executive Officer

Thank you, Alisa, and good morning, everyone. We are glad to be here today to review SemGroup's financial performance for the third quarter and provide an update on our activities. I'm very pleased with the continued progress in executing our strategy by increasing the quality of our cash flows while organically growing in our core areas. Three of our segments reported a solid third quarter; however total adjusted EBITDA came in slightly lower than expected, largely driven by inventory timing issues, and supply and logistics, coupled with unplanned start-up costs associated with the new HFOTCO tanks. Bob will provide more segment performance details in a few moments.

During the third quarter, the crude expansion project at HFOTCO came online. If you recall, this expansion is fully supported with a 10-year take-or-pay commitment with a large Houston ship channel refiner. Our previously announced Wapiti plant, which we expect to be fully contracted by yearend, is scheduled to come online during the second quarter of 2019. This plant will provide another step up in our total cash flow while expanding our region to the Montigny. These projects are examples of how we continue to secure cash flow while contributing to the growth of our transformed portfolio. In all, nearly 60% of our gross margin is supported by take-or-pay contracts, underpinning our strong 1.4x dividend coverage ratio.

We continue to maintain a sharp focus on our balance sheet, and have been very active executing our capital raise. Selling noncore assets while executing on key JV concepts and a very efficient corporate press has raised over $1 billion at an attractive cost of capital. We recently closed the sale of an interest in Maurepas Pipeline, which we have a five-year option to buy back at a 1% per annum premium, which is, again, very attractive terms.

And we're not done yet. We're continuing to evaluate creative ways to raise incremental capital. In terms of future asset sales or joint ventures, we remain very intentional in keeping as many options open as possible. Our execution to date has been consistent with our objectives, and we will continue to be thoughtful, diligent, and opportunistic as we fund future growth and maintain balance sheet strength. Project execution and asset utilization remains a priority across our key operating areas. Generally, volumes remain strong across our systems. In the past few weeks, we have seen crude loading start to climb, which supports out view that crude exports will continue to grow through our system. To facilitate this growth, we are moving forward with the Moore Road Pipeline connectivity project at HFOTCO, which will improve our access to various long-haul inbound delivery systems, while adding outbound pipeline connectivity. Our deep-water docks, incremental waterfront opportunities, last-model crude distribution system, and additional real estate for significant tank capacity expansion positions us well to capture incremental volumes driven by regional markets and exports.

In addition, contracting of heated tanks at HFOTCO continues as planned, and we are proactively hydrating customers and contracts. IMO 2020 will drive the need for product segregation, blending, and development of new high sulfur fuel oil markets. Our position as a heated product hub with by far the most liquidity in the market will continue to provide logistical solutions for heated products. For instance, we are utilizing heated tankage for products such as VGO, an intermediate refinery feedstock. This creative and efficient service offering leverages our crude pipeline refinery connectivity, as well as our heating infrastructure. Adding more refinery customers underscores the asset dependence that HFOTCO has created on the Houston Ship Channel.

Moving north to Cushing, the recent market shift from backwardation to contango is driving increased interest in recontracting Cushing tanks. White Cliffs Pipeline, thanks to our incentive tariff strategy, continues to outperform our volume metric projections. Growing projection in the VJ Basin, coupled with the redeployment of one of our 12-inch crude pipes to NGL services, should help mitigate future contract renewal risk. As we continue to develop our crude footprint across the Midcontinent and the Gulf Coast, we are identifying potential incremental projects that will provide integrated solutions by leveraging and connecting our assets. For instance, we are pursuing projects that can offer customers seamless connectivity from the Rockies, through Cushing, all the way to the Houston Ship Channel. These projects contemplate leveraging existing assets, which will allow us to offer attractive tariffs while also preserving crude quality.

In Canada, we took another step in the Montigny region by starting construction on our Pipestone Pipeline system. The pipeline is fully committed, with a 15-year take-or-pay agreement, and will deliver gas to our Wapiti gas plant for processing. It will also enable operational flexibility to connect to our proposed new Sour gas plant in the Pipestone area, which the Alberta energy regulator recently approved. Having this license in hand, which can take up to two years to obtain, provides us with an option to commence construction on an accelerated timeline if commercial arrangements support an investment decision. In addition, the Smoke Lake plant will be coming online in late 2019, with the majority of capex contracted.

With respect to the open season for the Montigny-to-market liquids pipeline project, we continue to have commercial interest, and we hope to make a final investment decision in the near future.

We've had an active quarter on the execution and commercial fronts. For a closer look at our financial results, I will now hand the call over to Bob.

Bob Fitzgerald -- Chief Financial Officer

Thanks, Carlin. Yesterday, SemGroup reported net income of $8.4 million for the third quarter, compared to net loss of $2.7 million in the prior quarter. Increase in net income is primarily due to an unrealized gain on commodities derivatives recognized during the third quarter. Third quarter adjusted EBITDA was nearly $97 million, compared to $99 million in the second quarter. While the third quarter benefited from the impact of higher gas volumes in the Midcontinent, as well as contributions from the recently completed expansion at HFOTCO, we reported lower margins in crude supply logistics, primarily due to inventory costs and counterpart timing.

As Carlin mentioned, we saw improved segment profit during the quarter in three of our segments. Crude transportation's third quarter segment profit was up slightly due to lower operating cost, partially offset by expected decrease in White Cliff's pipeline volumes, as a key producer moved a portion of uncommitted barrels to rail to capture greater basis differentials. We expect volumes to strengthen slightly during the fourth quarter, as production continues to ramp up and shippers seek low-cost transportation options.

Crude facilities reported third quarter profit of $8 million, down $1.5 million from the second quarter, as the prior quarter benefited from take-or-pay timing. In addition, the third quarter had a temporary drop in Cushing utilization, as we staged several tanks to a new counterpart. Although we continued to see a softening of Cushing storage rates, recent market dynamics, including new connectivity options and more favorable price curves, are supporting firmer rates in the future.

Crude supply and logistics recorded a $7 million segment loss during the third quarter. The segment was adversely impacted by inventory cost timing, which we respect to recover in the fourth quarter, due to the built-in inventory gain we had at the end of the third quarter, but not recognized in our financial results due to GAAP accounting rules. Additionally, we are still not fully recovering our cost related to our take-our-pay positions. However, due to the widening of the Bakken to newer lend price differentials, we are seeing improvement in that metric already in the fourth quarter, and expect that to continue in the near-term. At this point, we're forecasting this segment to come closer to break-even for the fourth quarter.

HFOTCO posted third quarter profit of $36 million, up slightly from the second quarter. While the completion of new projects contributed to increased earnings, this was somewhat offset by a few one-time items, including higher operating costs of $1.2 million related to the start-up of the new tanks. Also during the third quarter, HFOTCO experienced a decline in throughput volumes, driven by fewer export loadings. However, we've seen a shift back to expected volumes thus far in the fourth quarter.

Turning to SemGas, third quarter segment profit was nearly $20 million, up from $15 million in the previous quarter. This increase is driven by higher commodity prices, as well increase in volumes. Looking forward, we expect to see a drop in our stack volumes due to an incremental third party processing coming online in the stack in late fourth quarter or early first quarter 2019. SemCAMS results were down slightly as we saw a decrease in operating cost recovery during the quarter.

Moving next to our 2018 guidance, we are updating our full-year adjusted EBITDA guidance to $385 to $400 million, reflecting a midpoint change of just under 2%, or $7.5 million from previous guidance. This update is driven primarily by the impact of one-time items during the year. As a reminder, during the first quarter, HFOTCO posted a $4.2 million insurance claim write-off that was not factored into our original guidance, and we had a one-time start-up charge of $1.2 million this quarter. In addition, lower than expected margins in crude supply and logistics contributed to our updated guidance range.

Regarding the HFOTCO insurance claim, we believe we are entitled to recover costs, and are currently pursuing recovery with the underwriter. I should point out that we will continue to consolidate 100% of Maurepas Pipeline results following the partial sale in October. Our adjusted EBITDA results will reflect the full value of Maurepas, thus not impacting comparability between quarters. However, we will adjust our leverage and cash available for dividends calculations to only reflect the cash distributions received in computing our future metrics.

Looking at full-year capital expenditures, we increased out 2018 capex guidance by $10 million, or 3%, to reflect the expected current-year spending on the Pipestone Pipeline project. The total cost of that project is $40, with the remainder of that spending to occur in 2019. We also added the Moore Road Pipeline project to our capital project inventory, as noted on slide eight. That project is estimated to cost $65 million to build, with most of the capital spending during 2019. We currently plan to issue 2019 guidance as part of our yearend earnings report, but I want to highlight that 2019 will not only benefit from a full year of the HFOTCO expansion project, but also reflect approximately three quarters of the first year's earnings from the Wapiti gas plant. These projects, along with increasing fixed fee revenues and improving supply and logistics margins, will drive higher earnings in 2019. We will provide more details on 2019 capital plan and earnings expectations during our February investor call.

Turning to SemGroup's leverage and liquidity, on October 22nd, we closed the sale of a 49% interest in Maurepas Pipeline for $350 million. On a pro forma basis, including the proceeds from the sale, we ended the quarter with a total consolidated net leverage ratio of 5.4x, and consolidated available liquidity of $932 million. To date, we have raised approximately $1.15 billion in capital, and remain focused on reducing consolidated leverage to under 5x by the end of 2019.

I will now turn the call back over to Carlin for closing comments.

Carlin Conner -- Chief Executive Officer

Thanks, Bob. 2018 has been a very active year. We have furthered the transformation of our portfolio and continue to execute on strategic opportunities. Our assets are positioned for growth at favorable multiples, and are supported by stable cash flows. As we explore options to better serve our customers, we commit to always do so in a safe and responsible manner. We believe our focus and persistence on existing our well-defined strategy while operating efficiently will ultimately deliver long-term shareholder value.

With that, I'd like to thank you for your time this morning, and now turn the call over for questions. Operator?

Questions and Answers:

Operator

Thank you very much, sir. Ladies and gentlemen, we will now begin the question and answer session. To ask a question, you may press * and then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing it. If at any time your question has been addressed and you would like to withdraw your question, please press * and then 2.

Our first question is from Tristan Richardson of SunTrust.

Bronson Fleig -- SunTrust -- Analyst

Good morning. This is actually Bronson Fleig filling in for Tristan. We appreciate the color on the dynamics behind the narrowing of the 2018 guidance. I guess specifically as it relates to S&L, it looks like some of the loss will be recovered in the fourth quarter. We're just curious on the outlook for the balance of the year for the S&L business.

Bob Fitzgerald -- Chief Financial Officer

Yeah, Bronson, this is Bob. I'll take that. As we said -- I think it was back in our February earnings call, we gave a little bit of color on our guidance for that segment -- we initially expected $10 to $15 million segment loss. At this point, given that we're looking at about a breakeven or so fourth quarter, we expect to be somewhere in the $16 million segment loss for the year. And some of that's gonna be dependent upon what happens at the end of the year with our inventory costing and GAAP accounting as well. That tends to create a little volatility quarter-to-quarter, obviously, as we saw in this third quarter. But right now, we're looking at it from where we're at operationally to be about that, give or take, $16 million loss on a segment profit basis.

Bronson Fleig -- SunTrust -- Analyst

Okay, great. Thanks for that color. And then one more from us. Regarding the Moore Road Pipeline, in the supplemental materials, there's mention of a 4 to 8x EBITDA multiple range. Just curious on the assumptions behind that. What would bring returns to the high end of that range, and is there any S&L component?

Carlin Conner -- Chief Executive Officer

Yeah, this is Carlin. Moore Road is a pipeline connection junction, we'll just call it. It's a 36-inch pipe. It kind of provides the HFOTCO connectivity to several pipes that are in the Moore Road vicinity. The reason we have a range on the expected multiple is that there are definitely incremental economics that are very direct associated with the delivery of crude on that line. But then there's also, we think, quite a bit of other opportunities that that line will provide for us. So, when you kind of look at overall value that's created, you could assign some other EBITDA to that calculation. I would even go so far as to say that it's potentially even more valuable than the 4x that we put on the high end of that range. It's an essential part of the HFOTCO strategy. It really enhances our connectivity. And we feel really good about getting that project going.

There are no S&L economics associated with that multiple. That is from an asset point of view. Anybody that's marketing at HFOTCO will probably utilize that asset. So, if we're ever marketing at HFOTCO, our S&L group will probably be utilizing that asset.

Bronson Fleig -- SunTrust -- Analyst

Great. Thanks for all the details, Carlin. That's it from us.

Operator

Thank you very much. Ladies and gentlemen, again, if you wish to ask a question, please press * and then 1. We will pause a moment to see if we have any questions.

Sir, it would appear that we have no further questions. My apologies. We do have a question from Ryan Levine from Citi. Please go ahead.

Ryan Levine -- Citi -- Analyst

Good morning. I just wanted to follow up on potential new White Cliff contracting, given the recent election results in Colorado. Has there been any new strategy as to how you would approach new customers, or how -- has activity been dead relatively over the last few weeks as a result of the pending election, and is that likely to change?

Carlin Conner -- Chief Executive Officer

Hey, Ryan. This is Carlin. Yeah, you can imagine that hardly anybody was willing to put any commitments on the table, renegotiate any contracts with the 112 Prop coming to vote. So, now that's behind us, we definitely expect that commercial discussions around a myriad of options and projects that we're working on, that we'll start having some in earnest discussions and trying to hopefully get to commercial agreements.

Ryan Levine -- Citi -- Analyst

Okay. Is there any color as to near-term priorities there, or if you may take a different recontracting strategy in light of the market revote decision?

Carlin Conner -- Chief Executive Officer

Well, you may have picked up on the script. Now, we believe that there are opportunities to fully integrate our position in the Rockies and provide maybe integrated services all the way down into the Gulf Coast to our HFOTCO facility. We have some real interesting ideas utilizing existing assets coupled with some new construction. And these projects will now be able to be fully discussed and then hopefully commercialized. I can't really add more to it. It's a very competitive environment. But we expect to have some real interesting projects to talk about in the real near future.

Ryan Levine -- Citi -- Analyst

Okay. I guess one follow-up on that. There is a competitive project, though, that was announced recently that was a joint tariff down to Cushing. Are you looking to do something similar, or is there any resources that you could bring to bear to gain participation in some other type of joint tariff?

Carlin Conner -- Chief Executive Officer

Well, we're responding to what customers are needing. And what we realize is customers want to have access and optionality. And being able to deliver crude that's produced in a region that has limited market access, and be able to connect markets and provide that customer with better clarity on the quality of crude oil being received at the very end of the system, as well as at a tariff that's very competitive -- if you can deliver those two things, then you're gonna be potentially a winner in that race. We think we have a project that's gonna be very competitive from a tariff point of view, and also from a quality point of view, is gonna be able to maintain the quality of the crude going all the way through the system, all the way toward the water. We think that's probably pretty unique in this space right now.

Ryan Levine -- Citi -- Analyst

Great. Thank you.

Carlin Conner -- Chief Executive Officer

Thank you, Ryan.

Operator

Thank you very much. Our next question is from Elvira Scotto of RBC Capital Markets. Go ahead.

Elvira Scotto -- RBC Capital Markets -- Analyst

Hey. Good morning, everyone. So, can you just provide us -- you touched on this a little bit, but maybe a little more around your Cushing storage recontracting efforts and your outlook on utilization going forward?

Carlin Conner -- Chief Executive Officer

Yeah. So, I think we talked about that our guidance around Cushing is -- we're maintaining that 95 to 100% utilization. What we have seen over the last six months to nine months is, as you would expect with the backwardation market, the conditions to recontract were not very favorable for us. We did plow through, and we renegotiated some contracts in that environment at lower rates than our average low-30s. We still feel fairly confident and optimistic that 2019 and 2020 will give us a little more pricing power, and as we continue to recontract going forward. As you know, we have a pretty heavy load of recontracting every year at Cushing, so -- and we're looking forward to the market conditions providing some support for hopefully getting some good contracts done. So, we continue to chop wood, Elvira, at Cushing. Market's in a better place, but we still have some work to do.

Elvira Scotto -- RBC Capital Markets -- Analyst

Gotcha. And then just to follow up on the potential to maybe move crude through your system and then potentially all the way down to the coast. So, is that -- is this contemplating moving crude on White Cliff down to Cushing, and then building a new pipe from Cushing down to the coast, partnering with one of these announced potential projects that -- talking about moving out of Cushing, or can you provide any more detail around that?

Carlin Conner -- Chief Executive Officer

It's premature to probably provide any more detail. I'm confident enough to say that we will be probably going to an open season very quickly, so you'll learn more real soon. It is a project that will be utilizing some of our existing assets, and there'll be some new assets that will be added to the system to allow for that move to happen. And again, the key with that project is providing clarity to producers and oil traders -- the clarity that they can see all the way from the DJ all the way toward the water, and to the water, and be able to preserve the quality of crude at a very attractive tariff.

Elvira Scotto -- RBC Capital Markets -- Analyst

Gotcha. And so, we'll look forward to seeing more on that on the open season. And then just the last one for me, do you have any potential for more or faster deleveraging?

Bob Fitzgerald -- Chief Financial Officer

Yeah. As Carlin noted, Elvira -- this is Bob -- we continued and are still in the process of looking at a lot of different options. We are very focused and committed to driving down that leverage through next year. If we could do it sooner, that would be something that we'd definitely want to do. The key is, is that we want to be really smart and deliberate about how we do it. And so, we constantly look at the cost of capital. We look at the implications to our strategies, if it involves existing assets. And we're gonna be very careful about it. So, we're gonna be focused on it. I can't tell you right now, are we gonna try to accelerate it or not. We definitely have things that we're looking at. And there's still, as there has been, a lot of interest from private equity, private capital to go to work. And we think that bodes well for us to be creative.

Carlin Conner -- Chief Executive Officer

And Elvira, I'll add that the past execution around this point, I think, has been really strong. When you look at the cost of capital, the projects that we've done, very, very efficient and effective. I would hope that as we move forward, we will continue to be that creative and diligent, and that's the expectation. So, we will definitely have more to share at some point, and we continue to work that problem.

Elvira Scotto -- RBC Capital Markets -- Analyst

Great. Thanks a lot. That's all I had.

Operator

Thank you very much. Ladies and gentlemen, that concludes our question and answer session. I would now like to turn the conference back over to Carlin Conner for some closing remarks.

Carlin Conner -- Chief Executive Officer

Thank you all very much for joining us today. We appreciate your continued interest and support. Have a good day.

Operator

Thank you very much, sir. Ladies and gentlemen, that concludes this conference call. Thank you for joining us, and you may disconnect your lines.

Duration: 28 minutes

Call participants:

Alisa Perkins -- Head of Investor Relations

Carlin Conner -- Chief Executive Officer

Bob Fitzgerald -- Chief Financial Officer

Bronson Fleig -- SunTrust -- Analyst

Ryan Levine -- Citi -- Analyst

Elvira Scotto -- RBC Capital Markets -- Analyst

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