ATCO Ltd. (ACOX) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the ATCO Ltd. Second Quarter 2022 Results Conference Call and Webcast. [Operator Instructions] The conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Mr. Colin Jackson, Senior Vice President of Finance, Treasury, Risk and Sustainability. Please go ahead, Mr. Jackson.

Thank you. Good morning, everyone. We're pleased you could join us for ATCO's second quarter 2022 conference call. With me today is the Executive Vice President, Chief Financial and Investment Officer, Katie Patrick. Katie will begin today with some opening comments on recent company developments and our financial results. Following these prepared remarks, 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 atco.com and can be found in the Investors section under the heading Events & Presentations. I'd like to remind you all that our remarks today will include forward-looking statements that are subject to important risks and uncertainties. For more information on these risks and uncertainties, please see the reports filed by ATCO with the Canadian securities and regulators. And finally, I would also like to point out that during this presentation, we may refer to certain non-GAAP or segment measures such as adjusted earnings, adjusted earnings per share and capital investment. These measures do not have any standardized meaning under IFRS, and on the results, they may not be comparable to similar measures presented in other entities. And now I'll turn the call over to Katie for her opening remarks.

Thanks, Colin, and good morning, everyone. Thank you very much for joining us today for our second quarter 2022 conference call. ATCO achieved adjusted earnings of $92 million or $0.81 per share in the second quarter of 2022. This is $12 million or $0.11 per share higher than the second quarter last year. This $12 million of year-over-year growth was driven by the strong performance of our utilities combined with great results across our broader portfolio. Our Canadian Utilities investment saw its adjusted earnings grow $21 million from $115 million in the second quarter of last year to $136 million this year. This strong performance was driven by CU's Alberta base distribution utilities, which continued to deliver exceptional results in the final year of their second PBR cycle. Our ATCO Gas Australia investments also benefited from CPI investing, which pushed their earnings higher in the period. Speaking to CPI and inflation more broadly, it's worth reiterating that we have to date been well insulated against these pressures. Across our portfolio, we've been successful in leveraging our operating expertise and experience managing through challenging financial conditions to provide this insulation. As an example, we've been working with suppliers to fix costs and obtain forward forecasts on key input materials and have also leveraged escalation mechanisms in our contracts to manage this exposure. For our utility investment, we have structural protections embedded within our respective regulatory regimes. All that said, we continue to closely monitor inflationary impacts for our businesses. We will utilize the expertise of our team and long-held relationships to manage through this period. Before we move on to the performance of our ATCO Structures business, it is worth juggling back to a certain point that Brian covered during this morning's CU call, which will also impact ATCO for 2023. As Brian mentioned, all of our utilities have performed well this year. And in particular, our Alberta-based distribution utilities have delivered exceptional earnings growth in the year. This growth is due to efficiencies they have unlocked during the second generation of their performance-based regulation or PBR2. Looking ahead to 2023, however, we expect to see a reset of earnings for the Alberta distribution utilities as we exit the current PBR cycle. This resetting is normal within a PBR regulatory framework, which at its heart is designed to incent utilities to find efficiencies. The earnings benefit of these efficiencies are retained by the utility during the PBR term before being passed on to customers in the form long-term cost savings. Acknowledging the above, we still have expectations for outperformance across our utilities next year. The drive of our leaders to deliver top tier performance, our operating expertise and our historical track record, all support a view that outperformance above allowed ROEs will be attainable for 2023. This is further reinforced by the regulatory mechanisms embedded in the PBR framework aimed at improving earnings stability, including the efficiency carryover mechanism Brian touched on this morning. Turning to ATCO Structures. We delivered adjusted earnings of $16 million in the quarter, which was comparable to the prior year. This earning stability is worth highlighting, as the second quarter of last year included significant earnings from the LNG Canada project. This project was substantially completed in the second quarter of this year. And despite lower earnings from the project, overall earning of Structures remain consistent. As we said before, this stability comes largely from our ability to focus on the core fleet rental businesses, which performed well across all geographies. The Structures team remains focused on growing and expanding this core business of space rentals and workforce housing. These product categories typically account for 2/3 to 3/4 of our segment earnings and deliver stable and less cyclical earnings for the business. Year-to-date, we have improved key performance metrics here, including higher unit count, utilization and average rental rate. Beyond the core business, we continue to supplement our earnings with larger projects. This past quarter, we advanced our project with Bechtel, a longtime partner, to provide accommodations for the 2,500 workers involved in the construction of the Pluto II LNG expansion. This project, which is in Australia displays our ability to execute large-scale, multifaceted workforce housing projects and will continue to be a significant driver of earnings for us in the next 18 months. On the ATCO Frontec side of the business, we delivered earnings of $3 million, approximately $1 million higher than the same quarter last year. This increase was due to higher occupancy at our Trans Mountain camps along with new project work for the Defense Threat Reduction Agency, an organization within the U.S. Department of Defense. This project utilized Frontec's expertise in rapid response scenarios to support the field accommodation requirements for this exercise in the United Kingdom. Our proven ability to execute these highly complex projects demonstrates our versatile skill set and creates future opportunities in this key market segment. April 1 also marked the commencement of Frontec's North Warning System contract. As discussed last quarter, Frontec through it's Nasittuq joint venture won a 7-year contract from the government of Canada to operate and maintain the North Warning System. Nasittuq expects to assume full custody and control of the system by August 1. Moving on to Neltume Port. The business continues to provide a solid base of earnings to ATCO amidst the current economic environment and ongoing global supply chain turmoil. Neltume had a strong second quarter, which saw the business increased earnings by $1 million year-over-year. This increase in earnings was driven by higher activity across the portfolio of ports. Growth and the deployment of capital is a key area of focus for Neltume. Our pipeline of opportunities in the business is strong, and we're confident this will create meaningful opportunities for new investments in the future. Overall, ATCO had a great second quarter. I'm excited to see the work that our businesses have been doing to secure new projects, execute on their long-term strategies and drive earning stability. You can see this in our results, and I believe we're well positioned heading into the remainder of the year. That concludes my prepared remarks. I will now turn the call back to Colin.

Thank you, Katie. [Operator Instructions] I will turn it over to the conference coordinator now for questions.

[Operator Instructions] The first question comes from Mark Jarvi with CIBC Capital Markets.

First question is on Structures. It seems like you're expanding the fleet, some more invested capital going in, but utilization is down a little bit year-over-year and quarter-over-quarter. Can you help us sort of reconcile those 2 things? Is that just a lag on utilization that you essentially see that tick higher as you roll out the expanded fleet?

Yes. Thanks, Mark. Great question. And you've hit it quite clearly. We expanded our fleet, and we expect our utilization will take a little time just to catch up to that rapid expansion that we have. So we're not concerned about the slight downtick in utilization just, because as you say, we did have some expansion on the fleet side. So as those units come on rent throughout the remainder of the year, you should see an improvement of that overall.

So it'd be around year-end that we would start to see that sort of normalize out?

It should start to normalize out over the next few quarters here, because we had -- we are -- well, we're continuing to expand our fleet size still, but you should see it over the next couple of quarters start to improve.

Okay. And then turning to Neltume, obviously, lots of headline chatter around recession. I think GDP growth is good. So technical recession, if you can talk about that. And I know loan growth is down. How would you see that playing out in terms of the outlook for Neltume? And just remind us again, sort of, I guess, the volume sensitivity for that business or GDP sensitivity, if there is a bit of a softening in '23?

Yes. Genuinely speaking, we have said in the past that Neltume's volumes kind of track with GDP growth in the region and -- which is obviously predominantly in South America. But that being said, throughout the pandemic, we've been very strong, even when there was a little softening overall of GDP growth. And a lot of that is attributable to the diverse portfolio that we have within Neltume of different types of cargo. So while there is some sensitivity, particularly, we will see containers and those type of ports more sensitive to the economic environment. There's a broad range of different cargoes that we are servicing. So you'll see some resiliency, and we have seen resiliency since we've purchased into that investment as we move forward through various economic cycles.

And how would you characterize recent months in terms of activity and how that business is performing?

Neltume has been performing very well, to be honest. We have, as I just mentioned -- like we have seen some strong results from some of our container ports picking up on excess volumes because of the supply chain shortages. But across the whole portfolio, most of our -- most of the ports are doing very well, with the diverse commodities driving that. We obviously have a lot of exposure to some of the commodities in Chile, and those have all been doing quite well. So the portfolio is doing well. As well as we've seen some benefit from the way that the exchange rate is working in our favor from an operational perspective.

The next question comes from Maurice Choy with RBC Capital Markets.

Maybe just to stick with the similar theme to previous question and maybe your thoughts on the outlook of new contracts for the workforce housing and permanent modular construction. Obviously, if there is a recession that some customers might want to hold back from coming to new projects. But on the other hand, the energy sector is doing well, given the high oil and gas prices. And looks like that is a big portion of your customer base. So your thoughts on new contracts.

Yes. I think we still have a very strong pipeline of new opportunities within Structures. As we've talked about before, we really have tried to transition that business to have the core stability of the space of the smaller projects. But that being said, we do have some of the larger projects still in the mix. And by design, they are not as predictable in terms of when they will come in to our earnings stream. And they're obviously dependent on large capital expenditures, large projects around the world moving forward. But we have a good global footprint in that business. So to the extent, not even within Alberta, but other jurisdictions, those are the projects moving forward. We're obviously very well positioned to capitalize on those. So I think overall, we have a good outlook, both potentially for some large projects and also for the core business, which remains stable.

And this [ has far been, say, ] strong pipeline. Like we've see this pipeline whether by way of customer or size or even case of delivery. Have you seen those change over the last 3 or 4 months?

I think we are pretty consistent over the -- through this year in terms of the pipeline and what we're seeing from an economic perspective. Obviously, inflation continues and the interest rate environment continues to be a challenge. But I don't think we've seen significant changes in the most recent period of that -- the pipeline of potential activity.

Got it. And just last question on -- sticking with the Structures & Logistics. As you look at your contracts to help build new infrastructure for customers, what generally is your ability to pass through higher costs due to inflation or supply chain issues to your end customer? Take the Pluto contract in Australia as an example. What inflation -- per Brian's comments this morning, Australian CPI is running quite high. How exposed is ATCO?

Yes -- no. I mean we -- to date, we've -- actually we've done a pretty good job of passing on some of those costs to our customers within the Structures business. And we've utilized a number of different tools. Short validity periods for our contracts are closed. As I mentioned in my prepared remarks, we have line of sight with our suppliers in terms of long-term costs. And we do have various mechanisms to increase the prices in some of our contracts as well. So to date, we have done a pretty good job of that. Obviously, inflation is -- and persistent inflation is something we have to continue to monitor. And inevitably, there will be [ it will compound ] and we'll have to work hard to maintain that ability to pass it on.

The next question comes from Ben Pham with BMO Capital Markets.

I'm wondering -- my first question is, it sounds like -- I mean you mentioned the CU, the reset of earnings on the Utilities' side. But it sounds like there's some good tailwinds in Structures heading into 2023, next 18 months. Do you have enough earnings increases coming out the back for some of the CU reset?

I mean -- I think as we saw in the last reset of PBR, there is a pretty meaningful change in the ongoing room for our distribution utilities. So there is quite a bit of a reset there that we did manage last time to make up over time. At least in the outset, it's pretty hard to overcome some of that with the other businesses just due to the magnitude of how much our distribution utilities do account for our overall earnings at ATCO. We are hopeful that the -- obviously, there's strong tailwinds. But I think it would be -- we would have to have significantly stronger results within Structures to overcome that.

And maybe to stay on that point, when you think about PBR3 versus 2, do you anticipate the same trend on ROE that's lower -- more lower in the front-end than the back? And then anything else to add on, on really the base O&M year, the regulators looking to the CapEx? Is there a ticker in ROE? Is it similar to the second period? Or is there some subtle differences you can comment on?

It is similar. We will go into 1 year of the cost of service, while we are still figuring out the final logistics of the next PBR3. So we don't have all those details yet, but I think you can expect a similar trajectory of ROEs, as you saw through PBR2 in that sort of flat to upwards throughout the course of the PBR term in the next few years. But we don't have all the details yet, but those will be coming shortly.

Okay. And then maybe lastly, when you say what's on these trends, obviously, you have to come off of a good year, Australia helping out. How do you -- I think about the -- your payout ratio, your dividend at ATCO, I know it's a tad slower at ATCO and CU. Maybe more of a reminder of your target and thought process going forward on your dividend?

Yes. We don't -- we haven't set a public target on the payout ratio. We are relatively -- at the ATCO level, we are relatively comfortable with our current payout ratio. And overall, we do aim to grow our dividend consistent with the base sustainable earnings of our business. So even if we have a significant outperformance in the year, we're not necessarily going to boost our dividend on [ a 1-10 ] basis consistent with those earnings. We do look for the long-term sustainable growth in that dividend that you've seen over the past, and that will continue to be our policy going forward.

Next question comes from Andrew Kuske with Crédit Suisse.

Maybe just coming back to the Structures business. Given some of the work you've done and continue to do with LNG-related customers, do you see an interesting business opportunity or a niche that you've built up for future potential, given just some of the global LNG dynamics that we're seeing?

Yes, for sure. I mean just generally -- thanks, Andrew. The ATCO Structures is a global leader in workforce housing, if not the global leader, certainly amongst them. So I think to the extent we have a lot of expertise, LNG Canada and a lot of relationships with that community, so I think we do have a very strong advantage for future global LNG projects. And they do tend to be obviously more remote, hence the need for the workforce housing. So I think that's certainly an area that we would look to continue to capitalize on.

Have the conversations changed meaningfully with that clientele in the last few months or a couple of quarters just as the LNG market has really tightened up?

I would say that we -- obviously, these are long lead time projects. So you're not going to see an immediate jump to getting new projects there. But there is certainly, I guess, tangentially more chatter, more interest, more discussions around some of these projects, given the global dynamics and the need for the movement of gas. So yes, I think there's an increase, but it will take a while, obviously, before these come to fruition.

That's helpful context. And then maybe just at the top-of-the-house view for ATCO. When we think about the cash position and just the balance sheet that you've got, you've got a lot of flexibility. How do you think about capital deployment? Is there some market dislocations happening, just given the concerns on recession, rising interest rates, inflation? There's a whole cluster of things happening, and you sort of said that you're very well positioned with capital to deploy should you choose to do that. And then just how do you think about market opportunities at this point?

Yes -- no, that's a great question. I think we have great pride in our historical -- we've been conservative, and we've been prudent with our balance sheet and maintained a strong cash balance. And I think that mentality will hold through this current turbulence. But at the same time, as you say, it does position us well to look for specific opportunities where there could be a value, accretive opportunities for ATCO in any one of our companies. So we are looking broadly, and there's lots of activity going on to look for new growth. But we will be prudent in how manage that capital in our balance sheet throughout these times. What we haven't really necessarily seen yet, so it's pretty new still, a softening in the valuations of some of the growth opportunities we're looking at. So -- but one would expect, with the rising interest environment, et cetera, that we'll come and we should remain well positioned to capitalize there.

If I can sneak it in, because you kind of opened the door. Are there certain opportunities that are more interesting than others at this point in time?

Sure. I mean I think Brian touched on it that we've been pretty consistent that the energy transition and the opportunities we're seeing through clean fuels, renewables, obviously, we've announced quite a few initiatives in that world and energy storage are probably high on our list. If we can get some policy clarity, those would be the areas that certainly is key focus for the organization as a whole.

As there are no more questions from the phone line, this concludes the question-and-answer session. I would like to turn the conference back over to Mr. Colin Jackson for any closing remarks.

Thank you, operator, and thank you all for participating today. We appreciate your interest in ATCO, and we 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.