Channel Infrastructure NZ Limited (CHI) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Refining NZ's half year results briefing conference call. [Operator Instructions] I would now like to hand the conference over to Ms. Naomi James, CEO. Please go ahead.

Good morning, everyone. Thank you for joining us today for Refining NZ's results presentation for half year 2020. I'm Naomi James, and also with me on the call is our Chief Financial Officer, Denise Jensen. We will take you through the results presentation before opening up for questions. Before we go through the presentation, please take a note of the company's disclaimer. Now let's turn to the presentation, starting with Slide 3. As you know, I joined Refining NZ at the start of April this year, right in the middle of the level 4 lockdown. And this is the first set of results I'm delivering to you after a couple of investor calls we have had to update on our strategic review. In one sense, there is no new news in these results, which is exactly as I want it to be. We have done what we said we were going to do. We've safely operated the refinery at around 50% of normal levels, effectively in stop-start mode in response to the significant fuel demand reduction we saw through the COVID lockdown. The fee floor in our processing agreements has protected us against the full extent of the drop in refining margins and fuel demand. After starting the year with a cash cost base for 2020 around $80 million above the fee floor, we have reset our 2020 cost base to run cash neutral at the fee floor and have run cash neutral since April. Our debt levels are flat. We have strengthened the balance sheet, acting early to extend maturities and add additional lines so that we have significant headroom in our debt facilities and no significant near-term maturities. And at the same time of doing all of this, we have undertaken a strategic review, recognizing the structural changes that have occurred in the refining market, completing the first phase of that review across April to June, and we are now well advanced in the second stage of detailed planning. As I said, there's no news in this. But now is the right time for us to reflect on what an achievement that has been in the challenging environment we have faced through the first half of this year and to give you some more detail around how we have been able to achieve these outcomes because this is what underpins the confidence I have that the company will be able to continue to navigate its way through the ongoing challenges of the current environment to a future path which returns the company to profitability and importantly, to paying dividends to our shareholders. Please turn to Slide 4. So let's start with safety as we always should. Irrespective of the environment we're operating in, safety and well-being is one of our company values, and it remains our highest priority. The first half saw an outstanding safety and operational performance with no recordable injuries and no process safety Tier 1 or 2 incidents. We achieved this through a period of frequent changes in our mode of operations as the refinery has been operating on a cyclical basis and rotating its processing units in order to reduce production in response to COVID-19. The ability to do this without disruption or incident reflects the capability we have in our workforce and a strong focus on operational discipline, which underpins our operational risk management. The refinery continued to operate as an essential service through COVID-19 alert levels, and Refining NZ adapted work practices to ensure everyone working both on-site and at home continued to work safely. Through these changed operations, including a full shutdown of the refinery over the last 6 weeks, we have had strong support from our workforce for the changes we needed to make. This included establishing an extra operational shift through COVID level 4 and employees taking both paid and unpaid leave through the temporary shutdown of operations in July and the start of August. Our efforts in the personnel safety space has been recognized externally with our E Tu Tangata safety culture program nominated as a finalist in the upcoming New Zealand Health and Safety Awards. And our process safety performance, where we have not had any Tier 1 or 2 process safety incidents for over 2 years, rated strongly against external benchmarks like Concawe, which is the European oil peak body. Turning to Slide 5. This slide shows the significant impact the COVID travel restrictions have had on demand in New Zealand. Through April and COVID level 4, we saw New Zealand refined fuel demand fall to approximately 20% of pre-lockdown levels before diesel and petrol recovered to normal levels at the end of June. In response, we substantially lowered production rates and adopted strategies to minimize jet fuel make to align with reduced demand. We did this through agreement with our customers as it took us outside of the parameters within which we were required to operate the refinery under the processing agreement. And this has allowed us to recover the incremental cost of operating in this mode from customers while playing our role in maintaining fuel supply to New Zealand. By the end of June, gasoline and diesel demand had largely recovered to pre-COVID levels. However, jet fuel demand remains weak at around 40% of the prior corresponding period. This continues to impact on the way in which we operate the plant and our revenue given the reduced supply of jet fuel into Auckland Airport. As a result of COVID-19 lockdown demand destruction, refinery and pipeline throughput for the 6 months ended 30 June were 27% lower than the same period in 2019 and around 40% lower from the time that the pandemic was declared. At the weekend, we commenced the restart of our processing units after a temporary 6-week shutdown to balance fuel supply and we'll have all units brought back online by early September. Turning now to Slide 6 and refining margins, and you will see both the impact of COVID and the volatility in the charts on this page. Because of the volatility over the last 6 months, we've included on this slide the 2 monthly breakdown through the half for both the Singapore Complex Margin and the RNZ uplift. We started the year with negative Singapore Complex Margins, which became even more negative as COVID-19 impacted global oil demand and we saw supply and inventory shocks through the supply chain in May with oil pricing going below USD 20 a barrel at one point. The Singapore Complex Margin, the benchmark we use for our refinery, averaged negative USD 1.60 per barrel for the half but ranged between $0 and negative $4 per barrel when you look at the bimonthly breakdown. The uplift earned by Refining NZ over the Singapore Complex Margin averaged USD 3.42 per barrel, so well down on the first half of last year, and it was similarly volatile in the half with the COVID demand impacts. We saw higher crude freight rates as crude ships became floating storage, and we saw a significant discounting of crude as a result of the oversupply caused by COVID-19. The combined impact of lower Singapore Complex Margin and lower uplift was an average GRM of USD 1.82 per barrel before the fee floor, which is around $3.50 per barrel or over 60% lower than the same period last year. So having given you that context on the challenging environment we've had for demand and margin in the first half, I will now hand over to Denise to take us through what that has meant for our financial performance.

Thank you, Naomi, and good morning, everybody. So let's pick up on Slide 7 of the presentation and start with a snapshot of the financial results. As Naomi has already said, refinery and RAP throughputs in the first half of the year were down 27% on the prior corresponding period while margins were down more than 60%. In the refinery revenue, you can see the protection the fee floor has provided against those impacts with refinery revenue down only 34%. Our infrastructure revenue was down 11%. This was less than the drop we saw in RAP throughput because of the higher per barrel rate being charged on pipeline volumes. While total revenue was down $52.5 million on the prior corresponding period, adjusted EBITDA, which really means EBITDA adjusted for noncash items, was down by $35.7 million. This reflects the cost reductions which have partly offset the decline in revenue. I will come back to CapEx and the net loss after tax, which was impacted by the previously announced impairment. But before we leave this slide, I wanted to highlight free cash flow and net debt. Free cash flow was an outflow of $8 million, all within the first quarter. And since April, we have operated cash neutral and held net debt flat at around $250 million. So turning now to Slide 8. This slide provides a waterfall between the adjusted EBITDA for the 6 months ended 30th of June 2019 to half year 2020. You can see the split between the margin and volume impacts on refining revenue, both have been significant, and then the significant protection from this we've had through the fee floor with the fee floor payments of $39 million from our customers, which has effectively increased the gross refinery margin by around USD 2.29 per barrel from the USD 1.82 per barrel to USD 4.10. Although pipeline volumes were down by 27%, infrastructure earnings were only down 11% due to the increase in the fee per barrel charged to our customers. We also see the benefit we have had from cost reductions, which I'll talk to further on the next slide. So if we could please go to Slide 9. I wanted to now focus in on the action we have taken in response to the significant reductions in both throughput and margin. At the start of this year, our cash breakeven level in 2020 was significantly higher than the fee floor in our processing agreements. You may remember that in the profit matrix we published with our February results, at the fee floor levels, we were forecasting an increase in debt or cash outflow in 2020 of around $80 million. So that was a significant challenge for us heading into a period of low margins, which combined with the COVID-19 impact on volumes. The reset in the 2020 cash breakeven to fee floor levels from the second quarter by around $70 million has been through a combination of OpEx and CapEx reductions. These reductions have come through stopping -- through -- by stopping all nonessential activities on site, reducing our contractor workforce, freezing head count, lower variable costs, particularly electricity and deferring the platformer and crude distillation shutdown into 2021 as well as making changes to our asset management strategy. CapEx guidance for the year has been reduced by a further $5 million for the year to $35 million, which reflects a 50% reduction on the previous guidance of $70 million at the start of the year. We'll now flip over to Slide 10. As Naomi mentioned earlier, revised refining margin assumptions, which reflect the excess global refining capacity and COVID-19 impacts, has resulted in an impairment of the company's refining assets by $158 million after tax. The impairment has reduced the company's net tangible asset backing by around $0.50 per share to $1.74. This is higher than the current share price, which has tracked down the decline in refiner's margins over the last 18 months, and that's illustrated in the chart on the left-hand side of the slide. The impairment assessment was based on the existing refining business model and processing agreements, with all of the assumptions underpinning the assessment fully disclosed in note 3 to the interim financial statements. We do, however, highlight the significant uncertainty and volatility in the market at present and the fact that the outcome of the strategic review is not yet known. Evaluation of the company's infrastructure resets, which is important in considering a potential new commercial framework, is currently underway as part of the strategic review. Now turning to Slide 11. Looking at the balance sheet, you'll see the impact on our debt levels of the action we have taken, which has put us in a position to hold net debt flat since April and to continue to meet our covenants. The gray boxes show what net debt would have been had we not taken the action that we did. We've also provided further detail on the slide regarding our covenant position. You will see our 3 financial covenants on the slide, and we have significant headroom on both gearing, which is shown after the impact of the impairment that we recognized at 30th of June; and interest cover. The interest cover covenants are measured 6 monthly on a rolling 12-month basis. And so the covenants reported at 30th of June include 8 months of processing fee revenue at the fee floor. For the first 2 of those months, so going back to November and December 2019, we did not receive the benefit of any fee floor payments due to the higher margins that had been earned earlier in that half. Through this period, we have also had around 70% of our interest costs fixed, dating back to the time of the Te Mahi Hou project, which has given us an average interest cost of 5.4% in the half. The remaining $100 million of interest rate hedges are due to expire at the end of this year, which will provide us with further covenant headroom next year as we benefit from the current low floating interest rates, so we remain comfortable that we can continue to meet covenants at the fee floor. Now we'll go to Slide 12. As well as protecting the balance sheet from the COVID impacts, we've taken steps to create the runway for value creation through the strategic review. In the first half, Refining NZ extended and expanded its existing bank facilities, increasing the weighted average term of total debt to over 5 years and adding $50 million of additional capacity. This brought our total available debt funding facilities to $400 million, which includes the company's $75 million subordinated notes on issue. In July, we further extended our debt maturities securing full year money and moving $40 million of 2022 maturities out by a further 2 years to 2024. This has put us in a position where we have significant liquidity headroom and no significant maturities until 2023, providing the runway to implement the outcomes from our strategic review. And on that note, I'll just hand back to Naomi to allow her to talk about the strategic review.

Thanks, Denise. Turning to Slide 13. A bit like the results, there is no new news here. But I can talk to where we are at and what we are trying to achieve. As you know, we commenced the strategic review in mid-April and completed the first phase of that process, which was to assess all of the options in June. We are now in the second phase of the process, which is detailed planning ahead of implementation. We have taken 2 options through to this detailed planning phase. The first is a simplification of the refinery within the existing processing agreements. We are well advanced in our development of these plans, which are focused on how we structurally reduce operating costs while continuing to meet our minimum obligations under the processing agreements, making the business robust through an extended period of low margins. By taking this action now when combined with the action already taken to strengthen the balance sheet, we are creating time and optionality in what is a period of significant uncertainty. And that's time we will use to determine if we can negotiate a new commercial structure for an import terminal with our customers, which reflects the value of our infrastructure assets. Our simplification plans will be finalized around the end of the third quarter, ready for implementation in Q4, and we will provide a further update on the specifics of those plans at that time. The second option of a future staged transition to an import terminal is being progressed in parallel. Our independent directors are overseeing negotiations with our customers. And as we said in our 25 June update, we expect this decision will ultimately sit with shareholders to make. In addition to customer negotiations, we are looking closely at what is the appropriate balance sheet structure for what would be a very different business in terms of earnings, cash flow and volatility than the one we have today. We are looking at how we can self-fund the transition, having regard to the timing and level of transition costs, balance sheet opportunities and the tariff structure negotiated. We will provide a further update on the import terminal negotiations at the same time that we update the market on our simplification plan around the end of the third quarter. Turning to Slide 14. Before we wrap up, I wanted to make a few comments on outlook, which, of course, is very challenging in the current environment, even more so with the developments over the last week. We expect margins to remain volatile through this year, both global margins with the ongoing COVID impacts on demand, U.S.-China tensions and the state of the global economy; as well as the uplift that Refining NZ earns over those global margins. That uplift is largely driven by crude selection and transport costs. So with inventory levels at record highs, that remains uncertain. We have included a chart showing global crude and product levels and you'll see there's been a massive stock build, significantly greater than what we saw through the last oil price correction in 2015-'16 and that significant destocking will need to occur through the next 18 months. Our current plans based on customer forecasts are to return to low production mode after the temporary shutdown. With the very recent COVID alert levels in the Auckland region, we will need to review the impacts on diesel and petrol through the coming months, but in any event, are expecting jet demand to remain low through 2020. Even if GRMs were to improve significantly, we are not expecting the 2020 full year margins to recover above fee floor levels, taking into account the fee floor payments in the first half which would need to be repaid before Refining NZ earns margin above fee floor levels this year and in the second half, throughput remaining below normal levels, with the temporary shutdown of the plant in July and August and the ongoing impact of COVID on New Zealand demand, including jet. And so our focus remains on keeping our cash breakeven at fee floor levels through 2020 while completing detailed planning on our strategic review options. Turning to Slide 15 now. So to wrap up, looking ahead, we are not relying on an improvement in the external environment but remain focused on ensuring the business is robust through an extended period of low margins and reduced demand for transport fuels, particularly jet. This means maintaining our cash breakeven at fee floor levels through 2020 and completing our simplification planning so that we are in a position to maintain our cash breakeven at the fee floor into 2021. And in parallel, we will be continuing to work at pace to explore the import terminal option with customers and determine the best future path for the business, which enables a return to profitability and dividends for shareholders. I will now open up the line for your questions.

[Operator Instructions] The first question comes from Andrew Harvey-Green with Forsyth Barr.

A couple of questions from me. First one, just around the pipeline revenue and just understanding that a little bit better. I'm assuming there's some sort of fixed capacity payment that is in there to sort of -- which is the main driver for increasing the price per liter. Is that a reasonable assumption as opposed to a significant increase in a variable charge?

Andrew, the key driver has been a year-on-year increase in the rate, and that's based on increases in shipping rates, which is how the RAP fees are calculated under the current processing agreements.

Okay. So assuming shipping rates stay where they are, we could assume then when the throughput volumes recover, you're actually looking at quite a significant increase in revenue from the pipeline?

Yes. That's an accurate assumption. One thing to note is that there's a lag in the shipping rates. So the ones that would have been used to calculate the 2020 rates would go back a period of time. So the rates will be looked at again as we go into 2021. And quite possibly, we'd see another increase again in rates, which, as you say, depending on what throughput does as well, may lead to a step-up in that income.

Yes. Okay. Next couple of questions I had was just around the [ SCA ] write-off and the quite fulsome information on that note that you talked to, Denise. A couple of questions on it, though. Some of the key assumptions are OpEx of $150 million per annum and CapEx of $60 million per annum. Both of those numbers are, I guess, quite a bit lower than what we have seen historically, I think. And the CapEx number, I think, is about $10 million below what had just most recently been disclosed about what the 10-year average is looking like. Are you able to sort of talk to why the valuers have used such low numbers? I'm assuming that's come from company guidance in some way.

It has. Andrew, they are our current forecasts and assumptions for future, our CapEx and OpEx levels. Now what that's come out of is the work that we did through stage 1 of the strategic review, where we looked very closely at those costs and what was possible in a lower margin environment. And so they are our current assessment of future costs for the refinery as we are running it today. Some of the things -- sorry, you go.

I was going to say, I mean, but that is based on 41 million barrels per annum as well though, so we've got no throughput back to sort of, I guess, historic normal and you're still getting a $30 million sort of OpEx saving coming through?

That's right. Yes.

Yes. Okay. In terms of -- I mean, it looks like the write-off you have been valuing, I guess, the total cash flows of the refinery, so there's been no separation, I guess, of terminal versus the refinery other than the fact that there's an assumption about a conversion in the [ mid-20, 30s ]. I mean, I guess where I'm going to with this is in terms of the write-off that we will see in the December year-end accounts, I'm assuming most of it is -- or all of it's going against the refinery asset as opposed to anything in the pipeline. And it looks like, intuitively, the pipeline value has probably increased relative to what's currently on the books. Is that a fair assumption?

So as you say, Andrew, our approach to the impairment testing has been to assess the carrying value of those assets as one group, and that's consistent with what we've done previously. The write-off is going against refining assets and not infrastructure assets. And as to how they might be valued sort of on a separate basis and what might come out of the strategic review in that regard, probably a bit early to speculate on that. But we have wanted to be quite clear in how we were valuing the company at the moment, which, for impairment testing purposes, is reflecting the business as it is being run today.

Yes. Okay. Sort of a -- no, second to last, slightly detailed question. Depreciation guidance, it's the -- in the matrix, I think it was $107 million for the full year, and depreciation came in, I guess, quite a bit below the run rate for the first half. And I'm assuming there's going to be a step down again given the write-off that's taken place. Are you able to just give us some updated guidance on what the depreciation number is going to be, Denise?

Denise, do you want to...

Sorry, Naomi. Yes, Andrew. Look, we will be -- now that we've finalized what the impairment will be, we will be working through on the depreciation assumption, obviously, to reflect the asset life as we've set out on that note 3 to the financial statements. But also importantly, you would expect depreciation to reduce in line with the write-off that's being recorded. So that will -- to be [ worked ] during the second half.

Okay. Okay. And final thing for me. Are you able to give us any indication in terms of the, I guess, the second part of the strategic review, which is looking at the conversion to a terminal, time frames around that? Any sort of further update on that? Are we going to get an answer this year? Or are we looking probably sometime in 2021?

So what we've said, Andrew, is the part, if you like, that's in our control, which is the simplification of the refinery, we will have completed the detailed planning in the next quarter. And so around the end of Q3, there will be an update on that, and we'll be in a position to provide further specifics of what that's going to involve before we move into implementation of those plans in the last quarter of this year. The other option around the import terminal, we're obviously not in control of the timing in terms of how quickly that might progress, in particular, the commercial negotiations that are underway with customers. So what we've said there is we'll give an update on that at the same time as the simplification update. And hopefully, there'll be more we can say then about what might be the timing around that option.

[Operator Instructions] The next question comes from Nevill Gluyas with Jarden.

Just a couple of questions for me following on. The first one is just to confirm your OpEx guidance that you've got in the pack at the moment, that is before any savings you get under a simplified model in quarter 4? Or is it inclusive of those?

It's before those, Nevill. And we wouldn't expect there probably to be significant savings this year. We're really looking at Q4 as the implementation quarter to make sure we're all set up to run cash neutral through 2021. What we haven't included in those cost forecasts, either any sort of restructuring costs, so that's something we'll be looking at as well as we finalize those plans.

Great. And then just, I guess, I'm thinking about 2021, assuming the negotiations sort of continue into next year, that $150 million OpEx assumption in the valuation, should we assume that, that is a number to think about for 2021?

I think the answer to that's not necessarily, Nevill, no. We are looking through the simplification how we can reduce OpEx levels. So the -- what we've done with the impairment assumptions -- and again, we've sort of provided additional disclosure just to try and make it really straightforward to understand how that's being done. We've, for that case, used the current external forecast that we use for margins, which would see an improvement next year above the fee floor and also the cost base, the reduced cost base, but based on full refinery rates. So that's how the impairment testing case is done and really reflecting that's the business we have today. What we're looking at in simplification is really focused on how do we keep that cash breakeven level at the fee floor for an extended period of time. And so that is going to involve changes in the OpEx cost base, but we're just still obviously working through what that looks like and how we get that to that cash breakeven level.

Okay. Great. And just -- and this is really my last question following on the cash breakeven into 2021. Obviously, deferred CapEx this year and a fair amount next year. I mean, how low -- what's the lowest you could bring CapEx down to next year?

Look, I guess what you're referring to, Nevill, on that question is we do have a turnaround that we need to do next year. That is, we expect, going to be at a much lower cost than what we had previously forecast in our 2020 guidance. But as you say, we need to make sure we can fund that and remain cash breakeven at the fee floor. So that's what our planning work is focused on doing.

Okay. Great. And just maybe just one follow-on question. Was there any terminaling fee revenue? Or was basically all the uptick you saw in the terminaling and sort of pipeline revenue just due to that higher pipeline rate?

I believe, Denise will correct me if I'm wrong, there has been very little in the first half of -- in terms of terminal revenue. There will be some in the second half because there has been some imports of finished product. And so as we sort of -- we'll talk to that through the half as we provide our bimonthly updates where that's coming from. So you've got the visibility of where that contributes to the earnings position.

[Operator Instructions] There are no further questions at this time. I'll now hand back to Ms. James for closing remarks.

Thank you. Denise and I would like to thank you all for your time this morning. Our next briefing will be around the end of the third quarter when we will provide you with a further update on the strategic review. And so we look forward to talking with you again then. Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.