KKR & Co. Inc. (KKR) Earnings Call Transcript & Summary

Good day, and welcome to the Pembina Pipeline Corporation Business Update Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Cameron Goldade, Interim Chief Financial Officer. Please go ahead.

Thank you, Mary. Good morning, everyone. Welcome to Pembina's conference call and webcast to review our announcement this morning that Pembina and KKR are creating a joint venture to merge our Western Canadian Processing Assets. On the call today, we also have Scott Burrows, President and Chief Executive Officer; Jaret Sprott, Senior Vice President and Chief Operating Officer, Pipelines and Facilities. This call is also being webcast and will be available for replay on our website. Throughout this call, we will refer to an accompanying presentation, which is also available for download on our website. I'd like to remind you that some of the comments made today may be forward-looking information in nature and are based on Pembina's current expectations, estimates, judgments [Audio Gap] to risks and uncertainties, which could cause actual results to differ materially from expectations. Further, some of the information provided refers to non-GAAP measures. To learn more about these forward-looking statements and non-GAAP measures, please see the press release Pembina issued today available online at pembina.com and on both SEDAR and EDGAR. I will now turn things over to Scott and Jaret to review the transaction and the joint venture, and then we'll open up the line for questions.

Thanks, Cam. With the release of our fourth quarter and full year 2021 results last week, we once again highlighted the momentum in our business arising from higher commodity prices, the advantages we see in the Canadian energy space and the many exciting opportunities available to Pembina. Today, we are pleased to detail one of those opportunities: the creation of a new joint venture through which Pembina and KKR will combine their respective Western Canadian natural gas processing assets into a single new entity, which will be owned 60% by Pembina and 40% by KKR's global infrastructure funds following the closing of the transaction. The combined entity, which Pembina will operate and manage, will include Pembina's field-based natural gas processing assets, the Veresen Midstream business and the business currently carried on by Energy Transfer Canada. Concurrently, the new company will also acquire Energy Transfer LP's remaining 51% interest in Energy Transfer Canada. Pembina's Empress, Younger and Versal assets will be excluded from the transaction and Pembina will retain its current ownership position in those assets. Collectively, the ascribed value of these transactions is approximately $11.4 billion, excluding assets under construction. As part of the transaction, Pembina and KKR intend to dispose of Newco's nonoperated interest in the Key Access Pipeline System, or KAPS, following the closing of the transaction, subject to receiving acceptable purchase terms through the sales process. Completion of the transaction is subject to approval under the Competition Act, concurring closing with Energy Transfer's 51% interest in Energy Transfer Canada and other customary closing conditions. We expect closing to occur late in the second quarter or third quarter of 2022. We are very excited to be creating this joint venture with KKR. We have enjoyed a strong relationship as partners in Veresen Midstream. We work well together, and we share a mutual desire to invest capital and generate attractive returns. The formation of this joint venture is a natural extension of our relationship and the benefits, and strategic rationale of this transaction are compelling. First, the deal brings together 3 complementary platforms to create a premier, highly competitive Western Canadian gas processing entity with the ability to serve customers throughout the Duvernay and Montney trends from both North Central Alberta to Northeast BC. Second, efficiencies are expected from the combination of the 3 platforms, enabling cost reductions and enhanced customer service offering. When applied to the combined entity, Pembina's scale and supply chain advantages will translate into value for customers. Further, Pembina will look to operate the assets within Pembina's current operating management system with a focus on operational excellence and continuous improvement. Third, Pembina will increase its ownership in Veresen Midstream and its exposure to volume growth in Northeast BC. With LNG Canada set to come online in the middle of this decade, our own LNG project in partnership with the Haisla Nation and many of the largest and well-capitalized producers in the industry planning multiphase development projects, Northeast BC is among the most exciting long-term opportunities in Western Canadian Energy. Fourth, the transaction will further diversify Pembina's Gas processing asset suite and customer base. For example, Pembina will increase its exposure into the Sour Montney and the oily formations of Patterson Creek. As well, we will benefit from increased processing in the Fox Creek area, which will provide opportunities to maximize processing utilization to provide customers enhanced optionality and lower cost structure. Fifth, the transaction provides for an area of mutual interest for natural gas processing in Western Canada, which provides strong structural alignment for the joint venture partners. Within the area of mutual interest, Pembina and KKR will grow their franchise together. We know that KKR is trusting Pembina to be stewards of their capital based on our strong working relationship and our more than 65-year history operating in Western Canada. And finally, the new entity will be well capitalized and able to pursue future opportunities in a capital-efficient manner. As the energy sector has evolved, the opportunities available from partnerships such as this one between public and private infrastructure owners have become more compelling, particularly in the natural gas processing value chain. The financial merits of this deal are equally compelling with tangible and immediate benefits for Pembina shareholders. Upon closing, Pembina expects to receive approximately $700 million in after-tax proceeds, subject to final closing adjustments, with $150 million devoted to additional share repurchases and the remaining approximately $550 million used to repay debt. With $150 million allocation to share repurchases through this transaction, Pembina's overall repurchase target in 2022 will increase from $200 million to $350 million. Following the planned sale of Newco's nonoperated interest in KAPS, net proceeds after repayment of the KAPS construction facility will be distributed to Pembina and KKR according to their ownership interest. The joint venture is intended to have an investment-grade capital structure consistent with Pembina's financial guardrails with a target leverage of 3.5 to 4x debt to EBITDA. The entity will be independently funded and has obtained commitments for $4.75 billion of senior unsecured credit facilities, including a dedicated facility to support the construction of KAPS. We currently expect approximately $4.3 billion of these facilities to be drawn upon closing. We expect mid- to high-single-digit accretion to Pembina's adjusted cash flow from operating activities per share over the next 5 years. The accretion is expected to be driven by a combination of the net impact of the purchase and sale components of the transaction, synergies associated with combining the operations of the 3 businesses, significant tax synergies and the planned repurchase of Pembina's common shares using cash proceeds obtained from the transaction. And we are pleased to announce that upon closing and subject to approval and declaration by its Board of Directors, Pembina intends to increase its common share dividend by $0.075 per share per month. The 3.6% increase reflects the immediate cash flow accretion from the creation of the joint venture and recognizes Pembina's long-standing track record of sustainable growing dividend. I'm going to pass it over to Jaret now to talk a bit about the operational aspects of the joint venture.

Thank you, Scott. Good morning, everyone. As you can see on the map, the combination of these 3 platforms creates a scaled and highly competitive gas processing business. Altogether, the new company will serve customers through an industry-leading platform that includes 25 gas processing facilities, providing approximately 5 Bcf per day of capacity and generating approximately $950 million of adjusted EBITDA on a gross basis. The new business is expected to have the following characteristics: Physical capacity utilization of approximately 65%, offering a strong base cash flow stream and incremental low-cost processing capacity to meet customers' evolving needs; contract tenures ranging from 5 to nearly 25 years with an average 14 years; approximately 94% of the operating expenses across the asset portfolio are flow-through; approximately 80% of the counterparty credit exposure is with investment-grade or secured entities; and finally, tax pools of approximately $4.6 billion. Turning to the next slide, I want to touch on the government structure of Newco. Pembina will serve as the manager and operator of the new company, enabling the joint venture to benefit from Pembina's operating capabilities, institutional knowledge and management systems. Further, the joint venture will be led by Chris Rousch, current President and CEO of Veresen Midstream. With alignment being a governing principle, the joint venture includes area of mutual interest provisions where Pembina and KKR have agreed to pursue field-based natural gas gathering and processing assets in Western Canada within the joint venture. Finally, as you would expect, the shareholder agreement includes certain governance and liquidity provisions, including right of first offer, right of first refusal and tag along provisions. Importantly, the new company will adhere to and build on Pembina's strong program of continuously improving ESG performance. This includes aligning with Pembina's target to achieve 30% reduction in greenhouse gas emissions intensity by 2030 against the 2019 baseline, as well Pembina's policies and management systems related to health, safety, environment, cybersecurity, aboriginal and tribal relations and other ESG matters will also be maintained. An ESG strategy will be established after the company is formed, however, initial priorities that Pembina and KKR have identified include: building upon Pembina's leading safety culture to continuously reduce process and occupational safety incidents with the ultimate goal of 0 incidents; enhancing diversity, equity and inclusion across Newco assets; and embracing Pembina's commitment to meaningful partnering and engaging with indigenous communities with the aim of continuously increasing number of local indigenous suppliers each year. With that, I'll pass it back to Scott to close out. Thank you.

Thanks, Jaret. In closing, I want to reiterate how excited we are about this joint venture and the opportunity to extend to our relationship with KKR and achieve strong alignment in our gas business. We believe the strategic rationale and financial benefits we have outlined today are compelling for each of the owners as well as our many stakeholders. Through the combination of our platforms, we are creating a premier and highly competitive Western Canadian natural gas processing entity. With a meaningful platform which spans Montney and the Duvernay trend, our ability to provide reliable, safe and high-value service to our customers will create value for them as it will for Pembina and KKR. The entity will be an extension of the owners and apply the same ESG foundation and frameworks implicit in a broader business today. Finally, the financial merits of this transaction are compelling, and we've been purposeful in aligning Newco's financial policies with Pembina's guardrails. With approximately $700 million in cash proceeds, we are in a position to increase our 2022 share repurchase target by approximately $150 million to $350 million in total and also reduced debt by approximately $550 million. The net benefits of the transactions and associated efficiencies are expected to drive mid- to high single-digit adjusted cash flow per share accretion, setting us up for a solid dividend increase upon closing. Finally, longer term, having a well-capitalized entity able to pursue future opportunities in a capital-efficient manner gives us another tool in our toolkit as value creation opportunities present themselves. With that, we'll wrap things up. Mary, please go ahead and open up the line for questions.

[Operator Instructions] And now we can now take our first question from Jeremy Tonet of JPMorgan.

I just wanted to dig in on the synergies a little bit more, if we could. I guess what's the vision over time? Could these plants be physically connected to create a super system? What type of operating leverage do you see, I guess, to your downstream assets here? Or do you see other kind of capital synergies going forward here in the joint entity?

Jeremy, Jaret here. Thanks for your enthusiasm. I need a little bit of that right now. The team and myself are a little tired. I do want to start, Jeremy, by just staying into all those on the call, really big appreciation to the deal teams on both sides, KKR and Pembina and Energy Transfer as well as the external folks that helped us through this. It was a lot of hard work. So really wanted to get that out there. Jeremy, on the operating synergies, obviously, in the Duvernay area, some of these assets are within a radius that we would be able to connect, so that would be one potential synergy for our customers to really maximize the utilization of existing process in that area, drive down the cost structure for the customers, not only from the capital side, but also from the operating side. And then looking at the larger portfolio of assets, one of the things we really like about these 3 platforms is that they are actually kind of fairly distinct in where they're geographically located. As Scott mentioned, the Wapiti plant and the Patterson Creek plants, those are more focused in the areas where we don't really participate today. Obviously, we already have a working interest in Veresen Midstream. We'll increase that from 45% to 60%. So -- but across the entire portfolio of the gas processing business, Jeremy, we're really starting to take a look at our cost structure and really trying to drive that operational excellence and continuous improvement model, recognizing that costs are increasing for our customers. Even though this is a pretty much a flow-through operated asset, we're really trying to drive that down and looking at the customers' cost structure. So we believe there's a lot of benefits there.

Got it. And will your NGL pipeline system pick up any incremental volumes over time here? Or just wondering downstream synergies you might see as well?

All of these plants are in operation today, Jeremy. And Pembina's system picks up a lot of those volumes. Obviously, all of the GBU plants are connected into our pipeline system with the exception of -- that's in Saskatchewan. The Veresen Midstream plants today are connected into Pembina's Pipeline system. And obviously, all of the liquids that move into the Edmonton market today from other existing assets, Pembina has the benefit of moving those as well. So we will work with our customers. We recognize that there are going to be options out there, and we will work with our customers to continue to provide that integrated value solution.

Got it. And just one last one on the deal, if I could. Just wondering, if we think about competition antitrust, are there any areas to focus here to get the deal closed? Does KAPS need to be sold to make that happen? And then just later dated with KKR, this might be a question more directed to them. But is this an entity that could go public over time? Or any color on their exit strategy that you might be in a position to share?

Yes, Jeremy, I think I'll leave the KKR question to KKR to answer. I mean I think what we tried to highlight is we built in structural alignment into the agreements as well as protections for Pembina. So we feel like we're pretty well protected in various scenarios. But as it relates to KKR's ultimate plans, I'll let you ask KKR. As it relates to Competition Bureau, like any transaction of this side, it will go through the normal course. We believe, based on kind of our analysis that we should be able to move through the Competition Bureau here. We did indicate today in the press release that we would be selling KAPS as it's noncore and nonoperated.

And we can now take our next question from Rob Hope of Deutsche Bank.

I just want to get a sense of kind of how you envision the KKR relationship on a longer-term basis? Is this a relationship that you could see expand into other asset types? And then secondly, is there -- are these assets going to be held in the fund with a kind of a redemption date, so the relationship may have a sunset date?

Yes. I mean to speak to the last one, Rob, again, it's probably a better question for KKR. I mean I think the assets here that they've got are held across multiple funds. So I can't really speak to what their exact plans are, but they are held across multiple funds. So I think there was a second question there.

I'm just wondering like, could you see your relationship with KKR expand into other asset types there as well?

I mean, I think for now, we have a gas processing AMI. Never say never, Rob, but right now, the focus is on field-based gas processing.

Okay. And maybe just as a follow-up. As you take a look at Newco, is the focus of this entity, moving forward, going to be on greenfield development, including kind of building out Hythe expansion as you had pointed out? Or could we see it take a bit more of an M&A tilt and try to consolidate some additional gathering plants?

Well, I'll kind of talk kind of short term, Rob. Obviously, integration is going to be top of mind, not only from integrating the assets commercially, but also with respect to continuing to provide safe, reliable operations for our customers and our staff. So that will be priority one. And then immediately after that is to optimize the existing white space that we have in our assets to drive down our cost structure for our customers. That will be number 2. And then I think with respect to M&A, I can let Scott and Cam talk about this, but Pembina is always interested in accretive M&A projects. And I do think that this is a well-operated, well-funded growth vehicle that we now have another alternative to look at those types of opportunities through a different lens.

Yes. Nothing to add there. I think Jaret answered it.

And we can now take our next question from Robert Catellier of CIBC.

Just a follow-up question on the area of mutual interest. Can you describe the area that's contained in that? And if it's -- is it just limited to gathering and processing?

Yes, it's basically Western Canada. So the 3 Western provinces. And yes, well defined into the gathering and processing. But the typical assets that are included in our types of infrastructure, so also condensate stabilization, separation, those types of things. Yes. And it purposely didn't include our Empress and younger extraction assets. Those are more like mainline straddles with field-based fractionation. And those were left at Pembina's request.

Okay. And then just bigger picture here, what do you think this means for the Phase VII Peace pipeline expansion and also for frac capacity requirements?

I think I kind of view them as somewhat independent. The activity behind these assets today was already taking place. But just overall, the increase in activity that we are seeing in Alberta, and we ultimately will see in Northeast BC due to the high quality of that formation. New infrastructure will be required. And I think I spoke on Friday morning about the frac capacity for Saskatchewan and everyone's recognition that, that's tightening. So it will be business as usual on that front. We'll obviously try to provide the customers with a lower-cost option that ultimately will hopefully yield in more liquids for the customer, higher netback and more infrastructure for Pembina.

Okay. Last question for me, it just has to do with the accretion. So I'm curious as to the shape of that accretion over 5 years and really the source. So I'm curious as to how much you think is coming from the just the transaction itself, the purchase and sale, versus ability to get either lower cost or revenue synergies, especially in light of the cost being largely flow-through?

Yes. Maybe I'll try and tackle that, Rob. You are correct. There is a shape to the accretion. As you can appreciate, one of the benefits of this transaction is getting more exposure to Veresen Midstream, which with everything going on in Northeast BC, we believe at least has a solid growing profile to it over the next few years as it ramps into the LNG Canada time frame. You've also got the benefit of the tax synergies, which really provide for essentially no cash tax payable for the next 3 to 4 years in the entity, which is the savings there. There's obviously a portion of this, which is related to the buy-and-sell transactions there and the share repurchases, the latter being a fairly modest portion of the accretion. I would say the synergies, to Jaret's point, we've been relatively conservative so far on the synergies. It's not a huge driver of the accretion in the near term. But I think as we get into the operations and wrap our arms around this, certainly, as time plays out and we see more opportunities to serve the customers, there's potential for that to become more meaningful.

And we can now take our next question from Ben Pham of BMO.

Just had a couple of questions on the structure and maybe a bit of clarification on background. Was there any other structures you guys were contemplating as you went through this? Were you considering selling down versus on midstream getting out? Like, how do you figure what assets to contribute? Like, was there anything else that you were looking at as you went through this process?

No, Ben. I mean, I think from early on, we saw the strategic rationale of combining the 3 platforms. And I think as we've tried to highlight, we're bullish on natural gas, especially Northeast BC. So from our perspective, this was the transaction we contemplated.

Okay. And it looks like -- I mean, correct me if I'm wrong. It looks like you're contributing 55% of EBITDA. You're getting an uplift in money back. So it appears that the value that you're vending down is more than energy transfer. So I'm just curious, why 60%, and like why not 55%, 50%? You could have effectively sold down more value or created more value by moving ownership levels around?

Yes. I mean, you can appreciate there's a lot of factors that go into that. Obviously, we always want to be at least 50-50. That's been pretty consistently within Pembina's DNA as we've looked at other JVs. In terms of the 60-40, some of it comes down to our partners' wishes, too, and where they want to be and their desire to take funds out or put funds into the venture. So that obviously played in. We're quite comfortable at these levels, and whether we're somewhere between 50-50 and where we are today or higher as time goes on and evolves, we're comfortable with that level of ownership.

Okay. And maybe one last one on the structure. Again, like how do you how do you think about really cost of capital to this Newco now? It seems like the market is 12x EBITDA. It's above where you're trading. So like what extent do you maybe drop down more assets or sell on assets of Pembina? Like how do you think about that process?

Yes, sure. So let me -- I think first and foremost, we very much structured this vehicle to comply or to fall squarely within Pembina's guardrails. That was really important to Pembina from the get-go. And so we talk about, in the materials, an investment-grade capital structure. We think this entity will certainly have an attractive capital cost or cost of capital, excuse me, to be able to execute its business. As Jaret said, in terms of dropping down more assets or extending this vehicle, I think for the moment, our view of the scope of this entity is around the field-based processing. But certainly, as other opportunities become available, whether it's greenfield or, as Jaret suggested, if there's a compelling acquisition opportunity that arises, that's certainly something that we would look to envision to this vehicle.

We can now take our next question from Patrick Kenny of National Bank Financial.

Just maybe back to the conversation around counterparty risk and cash flow quality profile. I see the 80% there from IG and secured entities, but just curious if we exclude the secured entities, if you had a percentage of EBITDA that was generated from IG counterparties on a stand-alone basis versus pro forma?

Pat, it's Cam. I don't have that number on my fingertips. You can appreciate if we go back to where Pembina is. I think we're sort of north of our guardrail on entities without security or close there to it. The impact, obviously, Veresen Midstream is very accretive to that guardrail given the 2 entities who are behind the Cutbank Ridge partnership. There is a slightly higher concentration of non-investment-grade counterparties in the ETC portfolio, although with the relative contribution of ETC to this entity, it doesn't move the numbers in any meaningful way.

Okay. And then also just on a [ Propcon ] debt-to-EBITDA basis, I know you mentioned you were remaining within your guardrails here, but can you just confirm if the deal is credit-accretive out of the gate here pro forma? Or does it take some time to get that metric back down to where you might be on a stand-alone basis?

Yes. If you look at -- Pat, if you look at the corporate credit metrics, I mean, the way the agencies would look at it, they don't include joint venture debt in those metrics. Those would certainly be credit-positive, strongly credit positive in some cases through our upgrade metric levels. If you look at it on a proportionately consolidated basis, I think you have to remember that there is some debt in that $4.3 billion associated with the KAPS construction facility. So when you take that out, we are essentially leverage neutral. I think we lever up by 0.1 or 0.05 of a turn of [ Propcon ] leverage, but we're essentially there. And clearly, as time goes on and that profile grows with what we see in Northeast BC, we're there if not leverage accretive.

Got it. And then just maybe for Jaret or Scott, Just curious, with this expanded gas processing footprint, what this might mean for the expansion or longer-term vision for the Prince Rupert LPG terminal? Do you see an opportunity to maybe upsize your physical presence on the West Coast? And as well, maybe comment on perhaps increasing the contracted profile of that asset base as well?

Pat, yes, I think I mentioned on Friday that we're actively, in the foreseeable future, want to make a decision on Prince Rupert expansion. Long term, we like international markets for the propane product specifically. This deal doesn't have a bunch of influence on that. So very similar to kind of the frac conversation, and I see them just as a little bit of independent outcomes.

All right. Well, that looks like it's the last question. So I just wanted to thank everybody for jumping on at short notice. As Jaret said, thank all the deal team and our external parties that participate in this transaction. We're really excited about what the future holds. So thank you very much for joining us today.

This concludes today's call. Thank you for your participation. You may now disconnect.