Tidewater Midstream and Infrastructure Ltd. (TWM) Earnings Call Transcript

Ladies and gentlemen, thank you for standing by, and welcome to the Tidewater Midstream and Infrastructure Ltd. Third Quarter 2020 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Chief Financial Officer, Joel Vorra. Thank you. Please go ahead, sir.

Thank you. Good morning, and good afternoon, everybody. On the call with me today as usual is Joel MacLeod, Tidewater's CEO. Before passing the call over to Joel to review the quarterly highlights, as usual, I'd like to remind you that some of the comments made today are forward-looking in nature and include expectations, estimates, judgments and projections. Forward-looking statements we may express or imply today are subject to risks and uncertainties, which can cause actual results to differ from expectations. For further information, please refer to our non-GAAP measures and further disclosure tidewatermidstream.com and on SEDAR. With that, I'll pass it over to Joel McLeod for an overview of the quarter and opening remarks.

Thanks, Joel. Good morning, everyone, and thanks for joining our Q3 2020 conference call. We delivered a record corporate adjusted EBITDA quarter in Q3, where we exceeded our previous record adjusted EBITDA in a quarter by 14% and delivered a record $47.6 million of adjusted EBITDA in Q3. This represents an 86% increase in adjusted EBITDA year-over-year. We continue to see growth into 2021 and are reiterating guidance of $175 million to $185 million of adjusted EBITDA for calendar year 2020. Our #1 priority remains deleveraging and free cash flow generation. And we are confident in our ability to achieve our target of 3 to 3.5x debt-to-EBITDA with the closing of the Pioneer Pipeline. We are also confident, we will be able to continue to grow per share distributable cash flow into 2021 as we continue to execute and grow a significant inventory of high rate of return small capital projects. We are nearing pre-COVID distributable cash flow levels, but the main drivers being our Prince George Refinery seeing cracks improve, high rate of return and optimization projects coming online, diesel demand continuing to outpace supply at Prince George and also our Pipestone Gas Plant having run times that continue to improve into year-end and 2021. Our business, although not untouched, has remained resilient and as a result of the contracted nature of our assets. Over 70% of our business remains under long-term contracts, and approximately 50% of our EBITDA is derived from investment-grade counterparties. We are not aware of another infrastructure company in Canada that delivered adjusted EBITDA per share growth of over 85% year-over-year. The amount of government outreach/stimulus and support we have seen in recent months is like nothing I have seen in my career, and we want to thank the various provincial and federal governments for all their support. Tidewater is positioned extremely well to benefit from renewable energy and clean fuel stimulus. Our canola coprocessing project, which was initiated over 18 months ago, continues to be a huge success and will come online in late 2021, where the B.C. government's support has been instrumental, and we do not expect material net incremental CapEx from Tidewater related to the project. With the support of the B.C. government, we are currently also evaluating a large renewable diesel project at the Prince George Refinery, which would also have a renewable hydrogen component. We are in a prime location at Prince George for potentially the first renewable diesel project in Canada, where B.C. is the only province with LCFS compliance cost/credits, and we also have the highest diesel prices in North America. We have had numerous parties approach us on hydrogen and various hydrogen opportunities, given we have 3 operating hydrogen assets in Prince George today. We also do have a material number of operating carbon capture assets that are likely to benefit from the growing hydrogen and renewable energy push that continues globally. Tidewater is in a strong strategic position with significant infrastructure to become a leader in clean fuels across Canada. We are also likely to continue to see significant government stimulus on intensive infrastructure capital deployment period over the next 12 to 24 months. And Tidewater is positioned very well to take advantage of this. This includes some of the largest capital projects in Canada and even North America in and around Prince George, including Site C Dam, Coastal GasLink, LNG Canada and TransMountain pipeline, all of which are multibillion dollar projects. We have seen activity ramp up materially on Coastal GasLink, which runs just north of Prince George, with the workforce now over 3,400 workers on the right of way. To see the majority of North American refineries have significant contraction in margins, while our margin at Prince George has held above $45 a barrel crack also emphasizes the strategic nature of our assets and infrastructure. We have seen numerous refineries announce reductions, shut-ins, closures and conversions to renewable diesel, including Phillips 66, Rodeo and Santa Maria. Marathon Idled Martinez and Gallup and also working on the conversion of the Dickinson Refinery. HollyFrontier converting their Cheyenne refinery to renewable diesel. Shell Convent recently announced idling shutting down their 240,000 barrel a day refinery. Come By Chance has been idle to -- from their 130,000 barrels. PBF Paulsboro on the East Coast also announced some reduction in production and a few others. This is definitely positive for Prince George, as diesel and gasoline production on the West Coast will be reduced significantly. And Prince George remains advantaged with their Canadian crude supply. For a quick update on the Pioneer Pipeline, the Pioneer Pipeline continues to operate incredibly well from an operational standpoint. Tidewater and NGTL have agreed to terms and conditions to qualify Tidewater to receive interruptible storage services at Tidewater's Brazeau River Complex storage facilities. With IT-S Service, Tidewater will be able to attract new creditworthy storage customers at the storage facilities, creating expansion opportunities to increase storage capacities at the BRC storage facilities. The disposition of the Pioneer Pipeline continues to move forward, where Tidewater, AECO, TC Energy and TransAlta continue to work through the regulatory processes. Regulatory approval is anticipated in the first quarter of 2021, and Tidewater remains proactive in our efforts to accelerate this time line. In regards to Prince George, during -- our Prince George Refinery, during the third quarter of 2020, PGR achieved over 95% utilization. We have seen significant success on debottlenecking, optimization, blending operations where butane blending commenced in Q3 2020 and has exceeded our expectations. With our blending operations, we are now producing over 11,000 barrels a day of diesel and gasoline. Tidewater is encouraged by the resilience of the PGR asset in an unprecedented time with crack spreads, holding steady at approximately $50 a barrel. This demonstrates the refinery's long-term value in servicing the markets where -- in which it operates. And of note, a $5 barrel per moving crack spread would provide over $15 million of incremental free cash flow over a 12-month period. Demand for diesel continues to exceed our production as a result of the large infrastructure projects that I previously mentioned. The first offtake contract here with Husky ended on November 1, 2020, with Husky meeting its offtake obligations to Tidewater. The corporation has received confirmation from Husky that the force majeure notice under the offtake agreement that was initiated by Husky in April has been withdrawn. Tidewater looks forward to continuing to work with Husky as regional demand remains strong. We feel the merger between Cenovus and Husky will only strengthen the combined entity's balance sheet, and we look forward to continuing to grow our partnership with the combined team and want to thank the Husky team for all their efforts as they have been an absolute pleasure to work with. On the Pipestone, Tidewater, we processed an average of 72 million cubic feet a day in the third quarter of 2020. Facility availability for the quarter averaged 78% due to a constraint in early July. This was offset by record throughput in September of 86 million cubic feet a day and over 90% availability. The Pipestone Gas Plant is fully contracted with over 80% committed on take-or-pay arrangements. As for our gas storage assets, they've performed well in Q3, as volatility in gas prices increased materially. Our Pipestone Gas Storage Facility is fully contracted, with take-or-pay contracts spanning up to 8 years with multiple investment-grade counterparties. The facility represents a significant step forward in our fee-for-service gas storage business and offers producers at Pipestone significant optionality where the plant has 3 egress solutions, including connections to TC and Alliance in addition to gas storage. We continue to be committed to our ESG performance by investing in infrastructure to increase energy and natural resource efficiency, reduce emissions and enhance environmental performance. We have recently updated our Tidewater website for significant incremental ESG disclosure. As mentioned earlier, we do feel Tidewater is positioned tremendously well to be a leader, including fuels, within Canada. To reiterate, after enduring what is likely the largest shock to the global economy and the oil and gas industry, we do feel the worst is behind us and we are well positioned for what is likely to be one of the largest economic stimulus and infrastructure build-out periods in our lifetime. We also feel we are positioned tremendously well to be a leader in clean fuels across Canada. Our business remains resilient as a result of the location, of the contracted nature of our infrastructure assets accompanied with our strong defensive assets. We are confident in our ability to deliver $175 million to $185 million of adjusted EBITDA in 2020, with debt-to-EBITDA being 3 to 3.5x at the closing of the Pioneer Pipeline sale. Our focus remains free cash flow generation and debt reduction. And we do feel strongly that we can continue to show material debt-adjusted distributable cash flow per share growth for years to come. Capital expenditures are currently planned to be minimal as we close out 2020 as we focus on deleveraging, but do want shareholders to be aware that we do have a significant growing inventory of projects with 2- to 3-year payouts. I do want to thank our staff, Board, shareholders, credit syndicate partners and all stakeholders for all your support. We look forward to continuing to delivering strong results into Q4 and into 2021 and remain confident in our ability to deliver debt-adjusted per share free cash flow growth into the future. I'll pass it back to Mr. Vorra, and he can walk you through some of the details around the financial components of our Q3.

Thanks, Joel. I'll walk through some of the high-level quarter-over-quarter and year-over-year changes. And then we can open it up for questions. Revenue increased significantly quarter-over-quarter, primarily related to a recovery in commodity prices and refined products revenue. In Q3, it was $273 million, representing a 53% increase from the second quarter of 2020 and a 70% increase from the same period in 2019. The year-over-year change would be primarily related to the addition of the Prince George Refinery and the Pipestone Gas Plant. Gross operating margins after adjusting for realized hedging gains was approximately 17%, which is consistent with prior quarters, excluding Q2 where we had deferred certain operating and maintenance costs as a result of COVID, which had slightly increased margins in Q2. Downstream margins increased slightly from 15% closer to 20%. Midstream margins remained relatively consistent around 15% for the quarter. Adjusted EBITDA for the third quarter was $47.6 million, as Joel mentioned, with EBITDA margin approximately 17%, which again would be consistent with prior quarters, excluding Q2. EBITDA increase quarter-over-quarter was approximately $42 million up to $47.6 million, mainly related to a recovery in demand at the Prince George Refinery. Something we watch very closely, payout ratio and distributable cash flow. Distributable cash flow was approximately $10.6 million for the quarter compared to $12 million in the prior year and approximately the same distributable cash flow in Q2. The main reasons -- the main drivers for the decrease year-over-year would be a deferral of some operating costs and maintenance capital in Q2 as we dealt with COVID that were incurred in Q3 and also about $2 million of onetime costs related to a provision for doubtful AR accounts and a onetime payment on some new leased equipment. So we do expect that distributable cash flow number to start to step up into the end of the year and into 2021 and definitely something that we monitor closely, if not the most closely, and watching its impact on net debt as well. Definitely looking at ways and focused on increasing that distributable cash flow number. Obviously, carrying costs related to our leverage are projected to come down with the closing of the Pioneer Pipeline, which will save on our interest costs and start to bring that down after we've completed our capital projects. Obviously, increased run times at the plants now that we've moved out of some of the impacts we saw in Q2 related to cover will also help that number. But also watching those developments closely. Net debt quarter-over-quarter moved down approximately $8 million. We expect that to continue to move down into 2021. And again, I think as everyone is aware, upon closing of the Pioneer Pipeline disposition, decrease in carrying costs, leverage costs and even some other higher cost debt instruments in our capital structure, focusing on those to bring those costs down. So with that, I think those are the main drivers for the quarter. And happy to open it up for questions.

[Operator Instructions] Your first question comes from the line of Patrick Kenny from National Bank.

Just on the tie-in of additional volumes at BRC, just curious if you're also starting to have discussions with customers looking for incremental capacity at Pipestone? Or are we still a ways away from seeing discussions around the Phase 2 expansion, no matter what AECO trades at, just given maybe there's some underutilized facilities in the area?

A great question. Joel here. So Brazeau, I would say those volumes are more tied to gas price, given a little dryer gas, and most of it will be Mannville-related production with a little bit of Rock Creek and a little bit of Cardium. But great to see activity, and you'll see from public data kind of who's drilling around us, one of our existing large customer and then a new customer. So a great job by our commercial team to get those volumes locked up. And you will see a bump in processed volumes here into the next 6 and 12 months, which is great to see. As for Pipestone, I still feel that's more of a WTI oil-type driven place. Definitely, gas prices have helped. But to your point, you'll -- you can see the press releases of the operators in the areas. There's definitely activity there, but it's not like it was. So we would say there's interest, there's discussion, but it's not significant. And today, probability of an expansion would be sub-50%. But we all know that can change. And I think if WTI got back to $45 million to $50 million, then there likely would be -- probably we'd go above 50% probability. But for now, for us, focusing Pipestone on getting operational -- operations run times up to 95% and prove what we can do. The plant is running well, but we can always do better and want to be the best performing facility up there. And we have a little bit of work to do to get there.

Great. And I know your priority for next year is debt reduction. So maybe that timing lines up for you. And then at PGR, you mentioned large renewable diesel opportunities. So maybe you could just provide bookends on CapEx and timing, again, given the debt reduction priority? And also, with respect to renewable diesel capacity, would this production just simply replace your existing diesel production? And if so, how should we be thinking about the potential EBITDA accretion on top of the obvious ESG accretion?

Yes, Pat, it's early days, but see how supportive the B.C. government has been. It has been absolutely phenomenal. We need a little more time. Are we committed? Are we FID? No, but we're definitely very interested, especially when the federal government is also kind of reaching in and/or asking how they can be supportive. So definitely more work to be done. Everyone knows our balance sheet, where we sit. We won't be stepping into a massive capital project that's not contracted and wouldn't have a fairly high rate of return. But when we have government support, it's getting quite interesting, especially with Prince George having the highest diesel price in North America and also being the only province with LCFS-compliance costs. So if you could put a spot on a map where it would make sense to have a renewable diesel project, B.C. with X would mark the spot. So a little more work to do. Size-wise, again, we don't want to scare the market, our shareholders. Today, it's in that $150 million of cap, and we have some work to do. And I have lots of inbounds from various parties that would be happy to help fund that if Tidewater didn't want to commit a material check to the project. But we are excited about the project, and I think we'll update the market here over the next month or so.

Okay. That's great. And then just lastly from me, guys, on the liquidity front. Obviously, waiting for Pioneer to close. But maybe could you just comment on the repayment or refinancing plans for both the second lien loan as well as the high-yield notes? I know you still have some time, but just curious if there's a chance to take advantage of any opportunities in the market.

Yes. Good question, Pat. It's definitely on the forefront. We've got those maturities coming up in 2022. So we're likely looking sometime in '21 to address those. A few catalysts, obviously, that are coming up. We've had the refinery now for 12 months. I think we can point and communicate to the market that we saw one of what we're hoping is the worst shocks to commodity prices and demand, and we can show how that asset performed. And then, obviously, on the liquidity front, bringing in the Pioneer proceeds is going to help the story. So I think being able to put a couple of quarters behind us, Q4 looking good as well is going to help, obviously, our ability to get the best cost of capital. And we have seen, not a ton, but we have seen, as you would know, some deals in the market. So it's definitely on the forefront. We're evaluating where our highest costs of capital are and definitely addressing those first. But yes, to answer your question, that's something we'll be looking at in 2021 to consolidate, refinance those pieces. Credit syndicate has been very, very supportive to date. So yes, to answer your question, that's on the forefront, something that we're looking at very closely and is likely coming up here in the next 6 to 12 months.

Your next question comes from the line of Rob Hope from Scotiabank.

Want to follow up on some conversations that you had in your prepared remarks. Just taking a look at the gain in adjusted EBITDA through the year, we haven't seen the distributable cash tick up year-to-date. So can you just give us a sense of kind of what headwinds you've been seeing so far year-to-date on DCF? And I guess, specifically, how much of a magnitude do you think that has held back cash flow this year and kind of the implications for 2021?

Yes. It's a good question, Rob. Obviously, we're not at the run rate on distributable cash flow that we would want. I think some of that is related to onetime items. Some of that is pushing a few pieces from Q2 that showed up into Q3. We had a couple of onetime pieces. I mentioned the provision for some AR that was in the $1 million range that would be coming off that number. There was another onetime payment on some leased equipment related to optimizing. One of our facilities that would come off that number that we don't expect again. There are some leases expiring in Q4 that will bring that lease -- cash lease number down into Q4. So I would say there's probably between $3 million and $4 million of -- in that number. Obviously, we're 10%, 10.5% or so for the quarter. When you look at a $3 million or $4 million move, it's 30% or 40% move to that number. So although it feels like relatively small dollars when you look at a run rate, I think we can see a vision to increasing that number, getting the payout ratio closer down to 20%, where we would have communicated prior to COVID. So there are some pieces going forward and then obviously increasing the cash portion of EBITDA, lowering our -- I sort of talked about the capital structure and some of our carrying costs. Even when you take the Pioneer proceeds and you apply that to our cost of debt, you get into the $6 million to $7 million even in interest costs a year, which will add to the bottom line cash flow. So I think there's a few pieces that came up in Q3 that we won't see going forward. There are some additional pieces in Q4 that are coming off. Our finance costs are obviously going to come down when we're able to close Pioneer. So I think you start to add all those up with some EBITDA growth and you very quickly start to see a material percentage increase in that distributable cash flow number.

All right. That's helpful. And then just in terms of growth CapEx, you spent a little bit of capital there in Q3. How are you balancing the balance sheet versus high-return projects? And kind of what projects do you think you'll move forward on these small-return projects over the next 6 months over the magnitude of such?

Yes. I think you'll see growth CapEx likely move down a bit into Q4 and into 2021. We feel the market will let us know when they're ready for growth projects. It's nice to have a few in the works. Butane blending at Prince George was a great example, where we're able to blend materially more butane into the gasoline stream than we anticipated and do feel we're going to achieve kind of a 12-month payout there. But Rob, very cognizant. Our Board is very cognizant of that. We want to show free cash flow generation and get debt down. So it's a fine balance. And you'll see that growth CapEx likely move down into 2021, barring a capital project that would have another means to finance. So I just want our shareholders and market to know we're very cautious and are grinding through all maintenance and growth CapEx, but are building a pretty significant inventory of high rate of return growth projects.

Your next question comes from the line of Robert Catellier from CIBC Capital Markets.

Just wanted to talk to you about the -- what you might envision from -- coming from the Cenovus-Husky merger and how that influences your long-term plan for PGR beyond the initial offtake period. It seems to me that you've been working pretty hard to expand your markets. Is that the ultimate strategy here to expand the markets beyond that customer?

Great question, Rob. Husky has been a great counterparty. And having that investment-grade offtake, I think, definitely helped us finance the entire acquisition with debt. But to your point, we have -- with COVID, we felt we have to have incremental markets. And the team has done a great job from product in Eastern Canada, into the U.S., et cetera. So at this point, Cenovus, we get along with them well. We're excited to work with their team members. And then the Husky team members that move over, have been great. They over-lifted on their first contract, and we continue to see big demand out at Prince George. So I would hate to say we are committed to pivot away from Husky-Cenovus, because that's not the case. I think I'd prefer to grow our relationship with them and work with them. But we have to make sure we can move product outside of the orbit should we need to do so. Today, there's way more demand than we can handle. But given COVID and the uncertainty, we want to make sure we do have a backup plan.

Okay. The second question then is also my last one. I just wanted to have a good understanding of where you feel you are with marketing plans, so the depths of the trough post-COVID? And how close are you to regain those volumes getting back to the levels that you were at pre-COVID?

As far as NGLs, Rob, we're on kind of the crude condensate side. We're also on the crude -- yes.