AQN 2024Q2

Hello, and welcome to the Algonquin Power & Utilities Corp. Second Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I will now turn the conference over to Mr. Brian Chin, Vice President of Investor Relations. Please go ahead.

Thanks and good morning, everyone. Thank you for joining us for our second quarter 2024 earnings conference call. Speaking on the call today will be Chris Huskilson, Chief Executive Officer; Darren Myers, Chief Financial Officer; Jeff Norman, President of Renewables; and Sarah MacDonald, Chief Transformation Officer. To accompany today's earnings call, we have a supplemental webcast presentation available on our website, algonquinpower.com. Our financial statements and management discussion analysis are also available on the website as well as on SEDAR+ and EDGAR. We would like to remind you that our discussion during the call will include certain forward-looking information and non-GAAP measures. Actual results could differ materially from any forecast or projection contained in such forward-looking information. Certain material factors and assumptions were applied in making the forecasts and projections reflected in such forward-looking information. Please note and review the related disclaimers located on Slide 2 of our earnings call presentation at the Investor Relations section of our website at algonquinpower.com. Please also refer to our most recent MD&A filed on SEDAR+ and EDGAR and available on our website for additional important information on these items, including the material factors that could cause actual results to differ materially and the factors and assumptions applied in making such forecasts and projections. On the call this morning, Chris will provide an update surrounding the renewable sales agreement, which was press released this morning, and on the company's ongoing strategic transition to a pure-play regulated utility. Then, Darren will review key highlights pertaining to our regulated and renewables business groups and our second quarter financial results. Darren will also provide some color on the financial outlook following the expected sale of the renewables business, and then Chris will close with some final remarks. We will then open the lines for the question-and-answer period. We ask that you kindly restrict your questions to two, then requeue if you have any additional questions to allow others the opportunity to participate. With that, I'll turn it over to Chris.

Thank you, Brian, and good morning, everyone. After being in the CEO role for a year, I'm more convinced than ever that our current path towards a pure-play regulated utility supports our goals to create long-term value, increase our quality of earnings, and bring increased focus to improving our execution. A year ago, I set three priority goals: to sell the renewables business, to optimize the value of AY, and to get the regulated business up and running. Today, I'm pleased to announce the successful sale of our renewables business at a valuation of $2.5 billion. As we set out to accomplish in our 2023 strategic review, we've achieved a deal at a compelling value for our platform business with strong assets and scale. This agreement between Algonquin and LS Power for the company's non-hydro renewable energy business consists of $2.28 billion in cash proceeds and $220 million in an earn-out agreement relating to certain wind assets. I just want to take this moment to thank the team from across Algonquin for the tireless efforts that they put in. Great job team. Thank you very much. This major milestone, coupled with our previously announced support agreement to sell our Atlantica shares, delivers on our plan to transform Algonquin into a pure-play regulated utility, optimize our regulated business activities, strengthen our balance sheet, and enhance our quality of earnings. As Darren will touch on shortly, we expect to use the proceeds upon close in late 2024 or early 2025 to recapitalize our balance sheet and position ourselves for future growth. We're also making progress on our goal to get the regulated business up and running. We reorganized along commodity lines to improve operational efficiency. We recently completed the implementation of our Customer First enterprise platform, which promises to deliver value to our customers and substantial efficiencies. We added three new experienced board members with extensive infrastructure and regulated utility experience. We're implementing fundamental changes to how we operate the company with increased accountability. This is the beginning of a multi-year journey to unlock the value of our regulated business. In addition, we're making changes at the executive level. Yesterday, the company appointed Sarah MacDonald as Chief Transformation Officer. In her new role, Sarah will assume responsibility for utility operations and customer service. She has a broad background having worked in the utility sector for more than 20 years, including roles in utility construction as President and CEO of Emera Caribbean and as President of TECO Services. As part of this announcement, Chief Operating Officer, Johnny Johnston has left the company. I'd like to personally thank Johnny for his dedication and service. As we look forward, we're focused on delivering value to our shareholders in a more self-sufficient manner. We see tremendous value in our business from investments we've made for our customers that are not yet in rates. We need to improve our recoveries, reduce our regulatory lag, and absorb our growth. As a result, we will be reducing our regulated CapEx for 2025. Also, as part of our objectives to be more self-sufficient, the Board has decided to right-size the dividend, so we're not chasing a high payout ratio and excessive equity raises. These are necessary steps that we expect will unlock more value in the long term for our shareholders. Now, let me provide more details on the business, starting with the investments not yet in rates. We currently estimate over $1 billion in assets are not yet authorized in rates or receiving optimized regulatory treatment. This represents a rare capital-light path to earnings growth. An example of this is our Sarival wastewater treatment plant in Arizona. The plant is an important and currently operating asset, enabling the local community to grow but is not yet in customer rates. Another example is our Customer First SAP program, which just completed its final implementation. Our investment in the platform has been approved in six of our smaller jurisdictions but is not yet reflected in customer rates for the majority of our utilities. It's worth calling out that we are now in the typical post-conversion adjustment period for these types of systems. Our system implementation, combined with our most active rate case calendar in our history, is causing some delays in our rate case filings, which we're working through. In terms of our rate case filings, I want to discuss expected changes to our regulatory calendar in a few jurisdictions, namely Missouri, New Hampshire, and California. We expect delays of one to two quarters, which will shift the beginning of our recoveries closer to 2026. These delays will obviously impact short-term earnings. While we face some challenges in the short term, the substantial value here is a disciplined, capital-light trajectory to improve returns. With that, I'll turn it over to Darren.

Thank you, Chris, and good morning, everyone. I'll start with the regulated services group. During the second quarter of 2024, we received a final order for our BELCO utility in Bermuda, authorizing a revenue increase totaling $33.6 million over two years. New rates became effective on August 1, 2024. In New York, we filed a joint proposal with the New York Department of Public Services staff resolving all contested issues, and a final order is expected sometime in the third quarter. The Regulated Services Group currently has pending 14 rate reviews totaling $131 million as of quarter-end. Turning now to a brief update on our Renewables Energy Group. Our construction trajectory for renewables remains on track. Our construction loan balance has fallen to $405 million, due to the buyout of the new market solar and Shady Oaks II projects. By year-end, we expect that loan balance to round trip back up to similar levels where we started the year due to the completion of construction at Carvers Creek and Clearview. I'll now turn to our financial results. Our second quarter financial performance delivered growth in each of our key financial metrics, EBITDA, adjusted net earnings, and adjusted net earnings per share, with double-digit increases compared to the same period last year. Operating profit growth for both the regulated and renewables businesses were largely as expected, with regulated growing 7% and renewables growing 31%. Adjusted EBITDA was $311 million, up 12% from the same period last year. Adjusted net earnings were $65.2 million, an increase of 16%. On a per-share level, our second quarter adjusted net earnings per share was $0.09, a 13% increase from the second quarter of last year. First, weather returned to a more normalized level, contributing approximately $0.03 to the upside year-over-year. Second, our regulated business operating profit grew organically by $0.02, primarily due to new rate implementations at several of the company's electric, gas, and water utilities. However, this was offset by a negative $0.02 year-over-year due to last year's benefit of a one-time retroactive rate order in California. Renewables also organically grew by $0.02, driven by contributions from new wind facilities, Deerfield II and Sandy Ridge 2 brought online last year. This was offset by a negative $0.01 due to development cost expenses, in part as a result of the simplification of our JV entity as discussed in prior quarters. Depreciation contributed negative $0.02, and interest expense contributed a negative $0.01, excluding the impacts of our empire bond securitization. And lastly, tax credits were a little better this year than we had projected, being flat year-over-year. Turning now to key financing activities. During the quarter, the company settled the purchase contracts from its green equity units as expected, issuing approximately 76.9 million common shares for proceeds of $1.15 billion. These proceeds were used to reduce existing indebtedness and for general corporate purposes. We ended the quarter with approximately 767 million shares issued and outstanding. With the conclusion of the equity unit remarketing, as of June 30, 2024, we have refinanced approximately $2.5 billion of our borrowings over the trailing 12 months and simplified our capital structure. As Chris mentioned earlier, we are pleased to announce the sale of our renewables business. The transaction proceeds and valuation are compelling. We expect to close the sale in late 2024 or early 2025 and receive net cash proceeds of approximately $1.6 billion after repaying construction, financing, and other customary adjustments. Proceeds from the renewable sale plus our Atlantica shares will leave us with a very strong balance sheet. In addition, as we look forward, we are making changes to be more self-sufficient. We are looking at spending capital at a level just above requisite maintenance, safety, and environmental requirements, in order for the company to digest the impacts of investments already made on behalf of our customers. Once we improve our returns to a more appropriate level, we will have the opportunity to increase our capital spending in a disciplined way. With regards to our newly reduced dividend, we see our revised payout as roughly 60% to 70% of our optimized core regulated earnings power on our current assets. And although we are not providing guidance at this time, as described earlier, 2025 earnings will be impacted by rate case timing. With that, I'll hand it back to Chris for some closing remarks.

Okay. Thank you, Darren. In summary, we've achieved several major milestones and are delivering on our plan to transform Algonquin into a pure-play regulated utility. We're reducing our capital spend and dividend to position the company for greater long-term value creation. As we look forward, we expect to have a solid balance sheet, a healthy payout ratio, a capital-light path towards earnings, and ultimately dividend growth, all under for the first time, a focused company with a singular business model. It's a tremendous story and we're excited for the future. With that, we'll open the lines for calls.

Our first question comes from the line of Rupert Merer from National Bank. The line is open.

Hi. Good morning, everyone. Congratulations on getting to the conclusion of that deal.

Thank you.

Thank you, Rupert.

So if I can start by asking about the net cash proceeds of $1.6 billion. What does the walk down look like from the sell price? How much of that difference is related to taxes, transaction fees versus construction debt repayment?

Yeah, I mean, Rupert, it's primarily the construction loans. There's very little tax friction on the deal, consistent with our original expectations. So, the majority of it will be construction loans. And then really just the transaction costs and some of the break fees on the APCo bonds would be included in that as well.

Okay, great. And that construction debt, is that debt that's currently off balance sheet or yet to be incurred on your development pipeline?

Yes. As I mentioned, the balance is lower as of the end of Q2, but we expect it to get back to similar levels that it was, around the $700 million mark, or just below that by the end of the year as we continue to build out Clearview and Carvers.

Great. And then on the transaction itself, can you walk us through your thoughts on the valuation? How much of this is for your development pipeline versus your operating assets? And what's your perspective on the multiple that you're getting on the deal?

Yeah, listen, we think it's an excellent multiple and a strong transaction. It's always hard to decipher what you're getting for the platform, but clearly we see this as, with the earn-out at 12.5 times type multiple of next year's EBITDA, like estimated EBITDA, and without the earn-out, more like close to 11.5 times. So really strong multiples. And so clearly there was value seen in what the team has built over 30 years, the strong development pipeline, and just the strength of the organization. So we're quite pleased with where that ended up.

Yeah. And, Rupert, I think we said all along that in order for us to get to a sale of this business, we had to see value for the development pipeline. So, we haven't tried to quantify that, but it's pretty clear to us that we did get paid for that.

Very good. I'll leave it there and get back in the queue. Thanks very much.

Great.

Thanks, Rupert.

Thank you. Your next question comes from the line of Sean Steuart from TD Cowen. The line is open.

Thanks. Good morning, everyone, and congrats on getting this over the line.

Thank you, Sean.

Chris, the 60% to 70% payout ratio on EPS, am I to take it that is from the starting point 2025 post this asset sale? Or is that relative to where you would expect EPS to get to as your rate cases normalize?

Yeah. Sean, it's Darren here. Let me just jump in. The target payout has been set based on our current regulated assets fully earning or earning closer to fully earning. Clearly, next year will be our first year as a pure-play regulated utility. We're in a multi-year journey. As Chris highlighted through his prepared remarks, we have the most active rate cases we've had in history, plus the implementation of a major system. So from a timing perspective, we do expect some delays in 2025 with improvements in 2026. But just for clarity, that dividend rate has been set based on the current assets, including $1 billion getting recovered in that $1 billion of investments we've already made that's not in rates.

Okay. And then the follow-on question there is, you've indicated constrained capital investment in the regulated base and a capital-light approach putting these assets that haven't been recognized in the rate base. How long do you anticipate that capital-light approach to last? And how does this feed into your expectation of mid-term EPS growth off the reset base?

Yeah. Well, certainly, it really depends on how quickly we can advance the rate cases that we need to advance and our success rate on those. We're talking about a few years. I mean, that's the timeframe we'd be expecting. We're focused on raising our game when it comes to how we work through things with regulators, how we actually make decisions around regulatory investments, and improving the accountability across the business. All those things are going to be important parts of all this.

Yeah, John, we have to prove, just add to what Chris is saying, that we can add more capital in a disciplined way and get appropriate returns with very little regulatory lag. I'm with Chris; probably a few years of restraint. But we do see growth after that. From that kind of 2025 starting point, we see an ability really to grow earnings without growing capital, just by increasing the returns and getting more efficient in the business.

Understood. Okay. That's all I have for now. Thanks, guys.

Okay. Thank you.

Our next question comes from the line of Nelson Ng from RBC Capital Markets. The line is open.

Thank you and congrats on the transaction. The first question, I just want to have a quick clarification. In terms of the 11.5 times to 12.5 times next year's EBITDA, is it roughly the run rate EBITDA of the assets, assuming that they're fully constructed and commissioned? And does it exclude the development expenses that you have within that business?

Yeah. You got it, Nelson. You got it.

Okay. Perfect. And then the next question is just more about capital allocation. Obviously, you will need to start the hydro sales process shortly, if you haven't already started. But with the proceeds, can you just talk about capital allocation in terms of debt reduction, share buybacks, and utility growth sometime, whether it's next year or the year after?

Yeah. Nelson, for us, it's around getting that strong balance sheet, right-sized dividend; primarily this is all going to debt repayment. With that strong balance sheet, we will have some flexibility to make differentchoices from there. But the primary focus is really to be more self-sustaining, earn on what we have today, and just be in a position of strength.

Yeah. And I'd say, Nelson, we're not ruling out buybacks, but at the end of the day, it's flexibility that we want and strengthen our balance sheet. Those are the two things that are primarily on our minds. So at the end of the day, we'll make those decisions as time unfolds.

Okay. So, primarily debt repayment, but not ruling out buybacks?

Correct.

That's right.

Okay, thank you. I'll leave it there and get back in the queue.

Okay, thank you.

Thank you. Our next question comes from the line of Mark Jarvi from CIBC Capital Markets. The line is open.

Hey, good morning, everyone.

Good morning, Mark.

Can you provide more detail about the recent changes in the utility spending? Initially, it seemed that if the balance sheet improved, spending could be accelerated. However, it appears to be moving in the opposite direction now. I understand the concerns about regulatory delays, but I'm trying to grasp what has caused this shift in the last few months or quarters. Is it simply a tougher regulatory landscape or delays in some rate cases? It seems to diverge from what you were previously indicating.

Yeah. We still see that future as described. But at the end of the day, we believe we need to put a substantial amount of discipline into this business. As we work through accountability and how we want to structure and run our utilities, the main word is discipline. We want to be absolutely certain that we understand when we put $1 of capital in the business, how we're going to recover that $1 of capital, how that's going to advance our relationship with our customers, the service to our customers, and ultimately, value for our shareholders. That's really what we've come to. The opportunity to do capital-light growth is unique and we are happy to take advantage of that.

And Mark, I want to emphasize that our position remains unchanged regarding our ability to invest $1 billion annually in this business. However, we need to improve our discipline. Without the right discipline, we can't allocate capital effectively. It's essential that we manage our capital responsibly for our customers and shareholders. We need to enhance our returns, and once we achieve that, we will increase our capital spending.

Understood. And then, Darren, coming back to the question of where the proceeds go? It doesn't seem like it's a buyback. You did mention that the APCo bond was a break fee. If I assume those get repaid as well as the construction financing. If you think about the residual proceeds, what you expect to get from Atlantica, you may be at a point where you don't have to pay more floating-rate debt or variable-rate debt and you meet your credit metrics. Will you sit on a cash balance for a while? Is that the expectation as you work through the repositioning of the utility franchise?

Yeah. I think we'll continue to look at what's the most optimal capital structure is. I think there's options to repay debt, but have the ability to adjust credit facilities up and down. So, we'll give more of that. We do plan, as we've said before, to provide updates closer to the closure of the renewables business.

Just remember, a fair bit of time will pass before this cash actually comes to us. So that's another factor in this. It's going to take time to get through the regulatory approvals that we need for these transactions. Including AY, we're not sure exactly when that will be approved either.

All right. And then just Darren, is there improved disclosure assurance and use of pro forma utility business after the close of the sale? I know you're trying to inform us where the earnings are going to be with the payout ratio. But is there some way you could show the trajectory as you go into 2025, 2026, 2027? Is that something where you think you could be a bit more explicit on the earnings outlook on an annual basis that's guidance on a multi-year basis or just a cadence of EPS uplift over time?

Yeah, absolutely. We will, like I said, at an Investor Day, give you as much transparency as we can so that you understand what we're doing. We're not prepared to do that today, but we definitely will as we get closer to the closure of the deal give you more.

Yeah. As we get into some regulatory processes, we'll have a better idea as to when these things might close. So that will be the biggest factor is when do the proceeds come in.

Understood. Thanks for the time today. Appreciate it.

Yep. Thanks, Mark.

Thank you.

There are no further questions at this time. I'll turn the call over to Mr. Chris Huskilson.

Okay. Well, with that, we'd like to thank everyone for their interest in Algonquin. I also want to thank the team from across the entire business that actually pulled this together. The folks in the renewable side and the folks across the business, this was a tremendous effort and obviously very successful. So, thank you all for that and thank you for your time today.

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