Canadian Utilities Limited

Thank you for standing by. This is the conference operator. Welcome to the second quarter 2023 results conference call for Canadian Utilities Limited. As a reminder, all participants are in listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Mr. Colin Jackson, Senior Vice President, Finance, Treasury, and Sustainability. Please go ahead, Mr. Jackson.

Thank you. Good morning, everyone. We're pleased you could join us for Canadian Utilities' second quarter 2023 conference call. With me today is Executive Vice President and Chief Financial Officer Brian Skrobot. Before we move into our formal agenda, I'd like to take a moment to acknowledge the numerous traditional territories and homelands on which our global facilities are located. Today, we're speaking to you from our Akko Park head office in Calgary, which is located in the Treaty 7 region. This is the ancestral territory of the Blackfoot Confederacy comprised of the Siksika, Kainai, and Magani Nations, the Tsitsinu Nation and the Stony Nakota Nations that include the Chukniki, Berespa, and Good Stony Second Nations. The City of Calgary is also home to the Métis Nation of Alberta, Region 3. We honour and respect the diverse history, languages, ceremonies, and culture of the Indigenous people who call these areas home. Brian will begin today with some opening comments on recent company developments, our financial results, and key trends and expectations for our businesses in 2023. Following these prepared marks, we will take questions from the investment community. Please note that a replay of the conference call and a transcript will be available on our website at canadianutilities.com and can be found in the Investors section under the heading Events and Presentations. I'd like to remind you that our remarks today will include forward-looking statements. which are subject to important risks and uncertainties. For more information on these risks and uncertainties, please see the reports filed by Canadian utilities with the Canadian securities regulators. And finally, I'd also like to point out that during this presentation, we may refer to certain non-GAAP and other financial measures, such as total of segments measures, adjusted earnings, adjusted earnings per share, and capital investment. These measures do not have any standardized meaning under IFRS, And as a result, they may not be comparable to similar measures presented in other entities. And now I'll turn the call over to Brian for his opening remarks.

Thanks, Colin. And good morning, everyone. Thank you all very much for joining us today for our second quarter 2023 conference call. Canadian utilities achieved adjusted earnings of 100 million or 37 cents per share in the second quarter of this year. compared to $136 million in the second quarter of last year. As expected, the impact of our Alberta distribution utilities rebasing following our second successful performance-based regulation cycle resulted in lower year-over-year earnings in the second quarter. On its own, this rebasing contributed to a year-over-year decline in earnings of approximately $25 million. While significant, this is certainly not unexpected in a rebasing year, especially with the phenomenal outperformance we achieved last year, the final year of PBR2. Looking ahead to the rest of the year, we expect to see the earnings pressure associated with this rebasing peak in the third quarter. And in the fourth quarter, we expect seasonality benefits and our annual spending profile to create potential opportunities for year-over-year growth. Overall, despite the earnings pressure from rebasing, we still believe that our full-year performance for these businesses will be in line with the expectations that we've shared previously. More specifically, we continue to believe that we will be successful in achieving outperformance largely in line with our long-term historical performance. This will limit the single-year earnings decline for this year to levels largely consistent with what we experienced back in 2018 following PBR1. Moving to our natural gas distribution business in Australia, we continue to see strong growth in key operating metrics, such as new connections and system volumes. The in-country inflation trend within Australia continues to contribute to our year-over-earnings pressure. As we discussed on our first quarter conference call, 2022 saw us enter the year with a full year annual inflation expectation of 3% in Australia. By the time the year had ended, however, full year inflation had reached almost 8%. This surge in inflation resulted in strong earnings last year, but more importantly, an earnings profile that built beginning in Q2 of 2022 and rapidly progressed throughout the year. As a result of this trend in the prior year, our second quarter 2022 earnings were exceptionally strong, creating a comparable that is difficult to compete with as 2023 inflation levels begin to moderate. This trend resulted in us reporting a year-over-year decline of $5 million for this business in the quarter. Similar to what we saw in our second quarter results, we expect to see continued pressure in Q3 and Q4 related to the CPI trend and for it to push full-year results lower than last year. For added color, when we spoke following our first quarter call, in-country estimates were suggesting full-year inflation in Australia to be between 4% to 5%. Now, we continue to believe that this is an appropriate expectation but do see signs to suggest that inflation may trend closer to the 5% end of this range and be slower to recede than previously expected. Moving on to our electric generation business, we continue to see strong earnings contributions from our existing assets and those that we've acquired earlier this year. Along with our 40-mile wind in Adelaide assets performing in line with expectations operationally, We also saw earnings benefit from the strong Alberta merchant power pricing. This pricing strength helped offset lower than normal wind levels in Alberta during the quarter. As a reminder, our long-term power purchase agreement for 40-mile wind did not come in effect until July 1st of this year, which allowed us to capture these strong merchant market trends in the quarter. Now, before diving into our capital investments, I just want to touch on the recent wildfire activity in Alberta. Despite significant wildfire activity this year, our businesses have been successful in limiting customer outages and avoiding any safety incidents related to these events. My sincere appreciation goes out to all our employees who work so tirelessly to restore service and to support first responders. With wildfire activity in Alberta slowing significantly since its peak earlier in the second quarter, our teams continue to remain focused on restoration efforts. And we do not expect to see any negative impact to earnings as a result of these events. Moving on to capital, I just want to briefly touch on the capital investments we made in the second quarter. The second quarter saw us invest $336 million in our business, with $287 million of this spending being within our existing utilities. These ongoing utility investments ensure the continued generation of stable earnings and reliable cash flows, while also driving rate-based growth. The remaining capital was primarily related to our ongoing renewable generation initiatives, And the second quarter saw us achieve full commercial operation at our Barlow solar generation facility. We continue to push closer to completion of our previously announced Deerfoot and Ampersolar developments and expect commercial operation of these facilities this year. And we've also seen great progress in advancing numerous projects within our acquired renewables development pipeline and expect the upgrading of our 40-mile wind asset to be completed by year-end. Overall, the second quarter was a key inflection point in this rebasing year. The earnings pressures we expected related to rebasing and Australian inflation became more pronounced than they were in the first quarter as offsetting seasonality and timing impacts faded. That being said, rebasing is something we've dealt with before, and it's a key part of the PBR framework. We remain focused on driving exceptional results for our shareholders and position our business to maximize growth and earnings as we exit this key regulatory transition period. I look forward to providing further updates on the progress of our numerous growth initiatives as the year progresses. That concludes my prepared remarks. Now I'll turn the call back to Colin.

Thank you, Brian. In the interest of time, we ask you to limit yourself to two questions. If you have additional questions, you are welcome to rejoin the queue. As most of you know, the ATCO Q2 call immediately follows this, and I'd like to just note that Katie Patrick, Executive Vice President, Chief Financial Officer, and Investment Officer has joined us in the room. I will turn it back to the conference operator now for questions.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw from the question queue, please press star then 2. Once again, anyone on the conference call who wishes to ask a question may press star 1 at this time. Our first question comes from Linda Ezergales with TD Securities. Please go ahead.

Thank you. I'm just wondering in terms of your PBR re-opener that was triggered for 2022 for your electrical and natural gas distribution utilities. I'm wondering what the process for resolving it, what is the range of possible outcomes, and what informs management's confidence that you don't expect any adjustment?

Hi, Linda. Thanks for your question. Yeah, I guess maybe just to start off, on June 30th of this year, the AC initiated a proceeding for both our electric distribution and our natural gas. business as a re-opener clause was triggered for both our utilities in the final year of the PBR program. And that just kind of highlights the exceptional outperformance that we were able to generate throughout the PBR term, but more significantly in the last year. So in this proceeding, the AUC would determine whether a reopening or potential adjustment to our 2018 and 22 plans are required. And really at the heart of this assessment is whether the outperformance achieved was due to a malfunction or a design error in the PBR framework, as opposed to the strong management of the underlying utilities. And so this is not new for us. We experienced the same re-opening or proceeding at the end of the first PBR term and And we view that we'll be successful given, you know, that we truly believe and we can demonstrate that it's really response of management actions and not a design flaw in the plan. And part of that is that you can look at all the other utilities. We're all under the same program and same plan, and none of them have reopened. So we fully expect as we go throughout this proceeding, we'll be able to demonstrate that and don't expect any changes I guess, negative impact or adjustment as a result of that proceeding.

Thank you. That's very helpful context. And maybe just as a follow-up in terms of more broadly your utilities framework, a recent mandate letter for Alberta's Minister of Affordability and Utilities contained a bullet about lowering transmission and distribution costs and some other elements that could potentially impact your company. How do you think the government might achieve this? And what might be the financial impact, if any, on your utilities? And if you have any other perspectives on this mandate letter, we'd appreciate it.

Yeah, thanks for the question, Linda. Yeah, in terms of obviously affordability is top of mind of of all our customers and Albertans, and certainly it's top of mind for our company as we conduct ourselves. And in terms of the mandate letter, we fully expect to be in active conversations with the government, and we have been. And, you know, the first thing I'd note is, and the government has acknowledged this, we're the only utility in the province that actually saw a rate reduction in 2023, a meaningful rate reduction. And And that's the best thing that we can do is continue to operate our utilities as efficiently as possible and then pass on those savings to customers. We'll also be looking at, I know they're going to review the AUC and the ISO, and there's definitely, I guess, opportunities for savings to be had across the utility sector in terms of some of their capital deployment, some of the policies, investment criteria. So, you know, I think it's early days. We'll be active in those discussions, but we don't anticipate any negative impact to our business. The Alberta government and our regulator has been very firm on upholding the regulatory construct, which is a very positive thing, and we expect that to continue.

Thank you. We'll turn back to the queue.

The next question comes from Rob Hope with Scotiabank. Please go ahead.

Good morning, everyone. In the FD&A, there was some commentary on the newly rebranded Empower potentially reviewing financial alternatives that include a spin-out of the, I guess, the renewable power business. Can you maybe talk to some of the thinking behind the financial review here? Is the growth here too large to handle on the balance sheet? Or do you think it's not being properly valued inside of CEU?

Yeah, thanks, Rob. Well, first of all, I think it's important to emphasize that we certainly haven't made any definitive decisions and that we're simply just exploring, examining all options. As you've kind of heard us speak about previously, we continue to see significant opportunities for growth in connection with the energy transition. including existing and new opportunities in both our kind of newly branded aqua energy systems and aqua and power. So although we've kind of historically relied on whether it's cash from operations, recycling of capital, partnerships, and debt issues to fund our growth, and it certainly has served us well to date, but as we look ahead, however, we recognize that future growth is likely to require capital and financing beyond the traditional sources we utilize. So As a result of this and the attention of just being transparent within the market, we've announced our intention to explore all means of financing and including the potential creation of a separate entity. So our intent over the upcoming months is to gather feedback from investors, partners, and other stakeholders to help inform our planning going forward and ensure that we're making the best decisions. And once we've completed that assessment and review of the various options, we'll certainly disclose any material decisions. As with all of our decisions we make, we evaluate these opportunities through the lens of shareholder value creation and long-term growth and stability of our businesses. So, you know, for example, a separate entity, a transaction of this nature would only be pursued if we saw clear signs of it being financially accretive, beneficial to shareholders, and the best interests of all entities within our group. as we look to position our business for long-term growth and stability.

I appreciate that. And then just maybe in terms of the outlook for growth, I should take a look at the backlog of renewable power projects that you have. Can you maybe update us on which ones are percolating to the top and whether any progress has been made on the Alberta development projects or the Australia hydro facility?

Yeah, great. Thanks for the question, Rob. Yeah, in terms of we are, like I mentioned in my opening remarks, we're continuing to make some really good progress. We mentioned the Barlow coming fully commercial operational, and Deerfoot and Empress projects are progressing well, and that combined will have capacity of over 100 megawatts. We're also working on our upgrading of our 40-mile wind assets, and that will add an additional 20 megawatts. We expect that by the end of the year. And the next kind of item in the development pipeline that we're actively working on and making progress is our 40-mile solar project, which will – at an additional 220 megawatts of solar production. So I guess, long story short, is all our development pipeline is progressing well on all fronts. We're happy with the progress. We're being proactive with supply chain to make sure that materials are ready when we need it. And, yeah, it continues to be a healthy pipeline of growth there. Thank you. I'll hop back in with you.

The next question comes from Maurice Choi with RBC Capital Markets. Please go ahead.

Thanks, and good morning. Can I just follow up on the discussion about Go Empower and potentially separating that into a separate entity? You mentioned that any transaction needs to have clear signs of being financially accretive. I assume by this you mean EPS, and if so, can you also talk to how you might size this with respect to the mix between utilities and non-regulated cash flows or earnings? What are your guardrails over there?

Yeah, thanks, Maurice, for the question. And, you know, as I previously mentioned, certainly we're at the very early stages in just exploring all options, and so we haven't really defined it completely what that would look like. But generally, we would expect, just like our branding, we'd have non-regulated businesses in our new branded aqua and power, and then our regulator gas and electric utilities in our aqua energy business. systems. So, you know, I think it's just too preliminary at this stage. We're used to kind of get into that detail because we're at the very beginning stages. And when we get a little bit further down the path and come up with some of that analysis, we'll freely share that with you.

Understood. And I guess, you know, if you think about what, obviously this is a very early stage, but What have you ruled out in terms of options to finance this growth? Because obviously today you're announcing the NPower or the non-reg business. Contemplate it possibly taking a minority stake sale in your regulated business. Is that something you consider or maintaining a majority or 90% stake in utilities versus 10% non-reg? Is that an important part of your decision?

I guess maybe just kind of I'll restate, Maurice, that we're exploring all options. We certainly have ample cash in our balance sheet, continue to have access to debt and equity markets, and we just kind of came out and just to continue to reiterate that we're exploring various alternatives like partnerships, asset sales, and even potentially the creation of a separate equity and power entity. So, you know, we continue to explore a variety of those options to support our growth and add value to shareholders. You know, in terms of kind of the growth, and we kind of gave some guidance in this in the past, we continue to believe that the non-rate portion of our growth could, at the end of the day, represent potentially a 20% portion of our business. So the structure and makeup of our businesses going forward, we don't expect to change from that guidance that we gave.

Got it. That makes sense. And maybe if I could ask about your growth CapEx expectations for your energy infrastructure business over the next three years. I know that at the start of the year, you had around $800 million of CapEx for 23 to 25. But it's unclear to me what projects are included in there. Maybe you could just speak to that.

Sure. Thanks, Maurice. So, yeah, in terms of our kind of a capital spend and, you know, we've kind of already talked about we're progressing a number of our solar initiatives, whether it's the Deerfoot, Barlow, Amherst projects. We also are progressing our 40 miles solar, which is that additional 220 megawatts. And then on top of that, we have that 1.5 gigawatt pipeline. There's, you know, continuing to be progress in that where we go to the 40-mile phase two. So those are kind of like the sanction projects that we got going now. Obviously, more in the pipeline. We've talked about hydrogen being potentially a significant investment area. That's kind of not in those base numbers, but obviously has the potential to be significant.

And just to clarify, I am going to assume that the Central West pump hydro is not in there, notwithstanding the LTESA results a couple months ago?

Yeah, I think in terms of the Central West project, you know, for that project, currently, since we did not get the LTESA, we're currently on hold right now. We continue to work with the government to gather support for that project, and we truly believe that, you know, you know, large-scale commercial green hydrogen facility or storage will be needed, and it makes a lot of sense for Australia. So, to date, we haven't been successful in getting the LTS up, but we will be other rounds, and we'll continue to explore with the government alternative funding arrangements. And we've been successful securing the $9 million grant funding for the New South Wales related to this project. So I guess we'll continue to give you updates as that progresses.

Great. Thank you very much.

And the next question comes from Ben Pham with BMO. Please go ahead.

Hi. Thanks. A more quick follow-up. The rebranding, is that just simply a rebranding, or is there some movement in legal structure, just how to use running those two businesses in terms of responsibilities and allocation?

Yeah, thanks, Ben, for the question. So, you know, in terms of rationales, we look to shape the future of Canadian utilities while continuing to deliver the long-term value for our customers and shareholders. We We recognize there's unique opportunities and dynamics between both our kind of non-regulated businesses and our kind of electric and gas utilities. So, you know, acknowledging this and the fact that each of these businesses are pursuing their own distinct growth strategies and excelling in their respective markets, we embarked on the creation of, you know, this brand of ACO Energy Systems and ACO Empower Brands to create market distinction for each segment. So we believe that this brand evolution will bring greater strategic focus to the two businesses, and we believe it creates greater organizational alignment to enable both Aqua Energy Systems and Empower to realize their exciting growth trajectory. So nothing more than that at this stage.

I got you. And it sounds like you'll have a decision for a market sometime later this year. I think that was my read from your commentary.

In terms of, are you referring, Ben, to the evaluation of various financial options? Is that what you're referring to?

Yeah, exactly. It sounds like it's more early stage now, revealing things, getting feedback. Do you have a sense of when this will be all done?

Yeah, I think we'll continue to complete the review for the rest of the year. And again, the decision might be nothing, continue the course. You know, I think we'd give updates as we go, and I'm sure you'll ask us the same question on our Q3 call, and we'll be happy to give you an update of where we're at.

Okay. Got it. And maybe the last thing on Australia with filing of the new access arrangement is there – I mean, I get the whole CPI situation and rebates, but how do we think about really just maybe – more broader, bigger changes into that access to the range from a rebasing and are we probably moving up to allowed ROE? Is it just as simple as a flow through? Is there more bigger impacts to consider?

Yeah, no, I think, great question. You know, in terms of the access arrangement, we've been active in that process for some time. And I think the biggest impact is we will get higher allowed ROEs under the AA6 than what we received under the AA5, which is obviously great in terms of earnings and from cash perspective. So that's probably the biggest impact. part of what to expect under the new access arrangements. And obviously, we put a lot of work to make sure that our decarbonization programs and various capital activity that we're doing to support our customers will get approved as part of this access arrangement. So, you know, that's kind of the key focus, making sure that the framework supports the treatment of our of our ESG goals, enabling hydrogen blending, and make sure that keeps long-term options to decarbonization trends available to us in part of that submission. So ROEs is probably, again, the biggest thing to expect from the outcome of this proceeding.

Okay. I got it. Thank you.

Once again, if you have a question, please press star, then 1. The next question comes from Mark Jarby with CIBC. Please go ahead.

Yeah, thanks. Good morning. I wanted to turn to the disclosure where it's in the MD&A about sudden core withdrawing from the hydrogen project. Maybe you can't speak for them, but what it kind of means for you guys, how much would you be willing to shoulder yourself? Would you need to bring another partner? And I guess, does that factor in at all in terms of what you're reviewing in terms of the end power options?

Yeah, thanks for the question. So, you know, as we kind of stated in the MD&A and I'll say today, you know, we remain committed to our hydrogen project and continue to move forward the development of that project going forward. And certainly the project has significant potential supply hydrogen to domestic and international markets, including Alberta gas grid, industrial, municipal, and commercial transportation users. So, You know, as we kind of noted in our MD&A that subsequent to our quarter that Suncor Energy had provided notice in the tension withdrawal. So, again, just to reiterate, this definitely has not changed our commitment to hydrogen project, nor is it to our ongoing Atlas carbon capture projects as well. So, you know, in terms of progress going forward in our commitment, you know, we're in discussions with other hydrogen off-takers, across the Valley chain and continue to believe that there's demand in the local market that exceeds the facility capacity, even without the previously contemplated offtake from Suncor. With the announcement, we are also in active discussions. I'll mention that we're in active discussions with other operating partners. We're also heavily involved in discussions with the governments, and even as late as last week, we've continued to receive some great support for the project. Overall, still progressing forward, very committed. In terms of the overall size trench, you know, we don't think that will be materially different. Obviously, if it goes to the volumes that we're expecting, partnerships will likely be expected. But, again, it's still going to be a meaningful project for, like, in terms of our stake. But, you know, obviously, we're working, continuing to work with government, opt-takers, trying to get the regulatory certainty and government certainty on some of the policies and decisions. So obviously still early days, but the progress on this project is definitely proceeding. We've completed the DBRM phase of the project and are now evaluating progress to the next phase, which is the feed. Hopefully that answers your question.

Yeah, just to clarify, Brian, you said bringing in operating partners, but you also said sizing it. So do you think those operating partners would be also – shoulder some of the CapEx and the equity investment as well, right? And so your total commitment wouldn't necessarily change relative to what you would have assumed six, 12 months ago?

That's correct. And, you know, when the dust settles, that's what we expect. Yeah, we expect our pretty partners to have an equity stake inside. and ensure that we have the right balance between all parties in our investment for what we're planning to take on. So, yeah, although there'll be some change in that overall partnerships, you know, we don't think that would be materially different than what we contemplated going in.

Got it. And in terms of the cost of capital proceedings 2024, it seems like maybe increasingly it's moving towards a formula, so updated views in terms of when we'll have clarity on that, and then What comes with that as well in terms of, I don't know, review of earnings sharing mechanisms, criteria for reopeners? Does that all fall in the same proceeding, or is there a separate sort of proceeding that has to kick off for any of those other elements?

Yeah, great question. And, yeah, in terms of kind of update, we've kind of completed our hearings where we're kind of waiting on the decision. Interesting enough, there was quite a bit of discussion about on a formula and the Commission came out and signaled they're definitely not set on having a formula. So I guess that's, I don't want to say that's a certainty. If anything, it's up in the air whether or not the Commission will go with the formula. They might instead arrive at a 2024 generic cost of capital parameters, but we'll need to weigh that against kind of regulatory burden of continuous kind of generic cost of capital proceedings. In terms of kind of the earnings sharing, that should come out as part of that decision as well. And I guess we'll wait the outcome of where the commission lands.

In terms of timeline, when do you think you'll have clarity?

Yeah, I think the decision is expected to be in October of this year. Okay, great.

Thanks. Once again, if you have a question, please press star, then one. As there are no additional questions, this concludes the question and answer session. I would like to turn the conference back over to Mr. Collin-Jackson for any closing remarks.

Thank you so much, Charisse. And thank you all for participating today. We appreciate your interest in Canadian utilities, and we will look forward to speaking with you again soon.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.