South Bow Corporation (SOBO) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the South Bow First Quarter 2025 Results Conference Call and Webcast. [Operator Instructions] Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Martha Wilmot. Please go ahead.

Thank you, Kevin, and welcome, everyone, to South Bow's First Quarter 2025 Earnings Call. With me today are Bevin Wirzba, President and Chief Executive Officer; Van Dafoe, Senior Vice President and Chief Financial Officer; and Richard Prior, Senior Vice President and Chief Operating Officer. We also have additional members of our leadership team in the room to help with the question-and-answer session. Before I hand it over to Bevin, I'd like to remind listeners that today's remarks will include forward-looking information and statements which are subject to the risks and uncertainties addressed in our public disclosure documents available under South Bow's SEDAR+ profile and in South Bow's filings with the SEC. Today's discussion will also include non-GAAP financial measures and ratios, which may not be comparable to measures presented by other entities. [Operator Instructions] With that, I'll turn the call over to Bevin.

Thanks, Martha, and good morning, everyone. We appreciate you joining us today as we have many items to update you on since our last call. First, I would like to touch on our first quarter results as we had a solid financial start to 2025 and accomplished important milestones on our road to independence. We now have 2 quarters under our belts, and the financial resilience of our business is becoming increasingly evident, thanks to our highly contracted assets and the fundamental need for our services. In the first quarter, normalized EBITDA was $266 million, and we successfully maintained our debt metrics despite a volatile market backdrop. We demonstrated strong project execution in completing the pipeline scope of our Blackrod connection project and implementing our new enterprise resource planning system. We also demonstrated our commitment to returning value to shareholders through our latest quarterly dividend declaration of $0.50 per share, which will be payable on July 15 to shareholders of record on June 30. South Bow's journey began in July 2023, and we have consistently achieved every target set as we transitioned into an independent company. The team has done an outstanding job demonstrating our ability to operate independently, and we will continue doing so in the future. Moving on to Milepost 171. I've spoken with several of our shareholders since the unfortunate incident in North Dakota. And I shared with them that maintaining safe and reliable operations was the most important goal we had to meet in becoming an independent company. I can't underscore the significance of our system's safety and reliability, which is why we have shown it in our actions through significant investments in our integrity programs over the last several years. We will continue investing in these programs as we work through our remedial action plans. As I have said many times, no incident is ever acceptable at South Bow, but I'm proud of the way our team came together and demonstrated South Bow's ability to execute and get our system back up quickly and effectively while meeting the expectations of our regulators, the surrounding community and local leaders. The collaboration I witnessed throughout our organization showed our strength to be agile and perform as a stand-alone entity while coming together to find answers. This unified partnership will continue as we complete [indiscernible] and more importantly, find solutions to prevent future incidents. At South Bow, we have significant financial protections to safeguard our cash flows during incidents. 90% of our EBITDA is contracted over the next 7 years, meaning there is no commodity price or volumetric risk in our base business. Our transportation service agreements contain provisions which enable continued collection of fixed tolls during outages, and we have insurance that will cover most of the costs associated with such incidents. Taking that into consideration, we are reaffirming our adjusted EBITDA guidance of $1.01 billion for this year. You'll hear more on that in later remarks. With that, I will now ask Richard and Van to walk through the more critical aspects of the incident and how we are managing the business operationally and financially. Richard?

Thanks, Bevin, and good morning. So today, I'll share the progress we've made in our response to the Milepost 171 incident as well as next steps as the root cause failure assessment is completed and we address PHMSA's corrective action order. I'll start with a few details in itself. On the morning of April 8, our operational control center detected a pressure drop on a Keystone segment in North Dakota and immediately began implementing a system-wide shut down. Almost simultaneously, we had field technicians on site in North Dakota that initiated an emergency shutdown at the upstream pump station. The speed at which our teams responded allowed South Bow to protect the surrounding community and contain the environmental impacts. During the incident, we worked closely with the regulators, local leaders, landowners, customers and the community. We mobilized over 300 resources during our round-the-clock response, and our field crews successfully contained the release to a single agricultural property without impacting sensitive habitats or any waterways. And over the following 6 days, our engineering and construction crews replaced the damaged section of pipe. The team did an outstanding job returning the line to service late on April 15. We've now substantially recovered the 3,500 barrels of released volume, reinjecting more than 85% back into the pipeline with the remainder being disposed at an approved treatment facility. As of last night, we have completed removal of all contaminated soil from the site, and we forecast to reclaim the site with clean soil in the coming weeks. Our insurance policies are expected to largely cover the cost of the incident. Today, we're operating the pipeline under pressure restrictions in accordance with the PHMSA corrective action order. With these limitations, we still expect to meet our Keystone contractual commitments of 585,000 barrels per day. Our effective operations and strong [indiscernible] evidenced by a system operating factor of 98% in the first quarter [indiscernible] confidence that we'll be able to continue delivering our contracted volumes. While still early in the root cause failure analysis, I can confirm the pipeline was operating within its permitted and design pressures at the time of the incident and was not subject to unusual operating conditions. As for next steps, we are coordinating closely with PHMSA to progress the incident investigation, develop remedial work plans and implement enhanced integrity programs going forward. This includes a metallurgical analysis of the pipe feature that we expect to be completed by June and the root cause failure analysis conducted by an independent third party that is expected to be completed by late summer. We are also working with our suppliers, service providers, engineers and other third-party experts to determine the cause of the failure. As we are able to provide more information about the root cause, we will share our findings with our regulators as well as our industry peers so they can also learn from the incident. While we have a lot of work ahead of us, we'll continue prioritizing the integrity of our pipeline system to ensure its safety and reliability as we always have. With that operational update, I'll let Van talk to South Bow's financial outlook for 2025.

Thanks, Richard. South Bow's business is underpinned by highly contracted cash flows that are stable and predictable. Approximately 90% of our normalized EBITDA is contracted for over 7 years, which means the variability in our business is limited to our uncommitted volumes and our marketing business. South Bow is reaffirming our 2025 outlook for normalized EBITDA at $1.01 billion. We modeled several scenarios relating to Milepost 171 incident and are adjusting our range to account for those effects. As Richard mentioned, we expect to deliver on our committed contracts for the remainder of the year, though we expect to have limited capacity to transport any uncommitted or spot volumes on our Keystone system with the pressure restrictions in place. With that, we are adjusting our upside case to 1% from 3% of our base case. Our downside case has improved slightly after delivering a strong financial start to the year and generating $266 million in normalized EBITDA during the first quarter. We've also gained clarity on tariff impacts on our business and our ability to mitigate that exposure. As a result, we are adjusting our downside case from a decrease of 3% to a decrease of 2% of our $1.01 billion base case. With our relatively unchanged outlook on normalized EBITDA, we expect to exit 2025 with a net debt to normalized EBITDA ratio of approximately 4.8x, increasing modestly through the year as we advance our Blackrod connection project and complete spin-off activities. Our deleveraging journey will begin as the cash flows associated with Blackrod start in 2026 and increase through 2027. I'll now hand it back to Bevin for closing remarks.

Thanks, Van. As Richard indicated, our system safety and reliability remains our first priority. And as Van pointed out, the resiliency of our base business provides stability in our cash flows. As we continue to learn about the Milepost 171 incident, we are committed to providing transparent updates to all our stakeholders. This is fundamental as we advance our industry practices going forward. Finally, South Bow remains firm in our capital allocation priorities and will maintain our risk-managed approach to delivering shareholder value. Our continued focus on strengthening our investment-grade financial position is paired with pursuing growth that leverages our existing infrastructure in the most strategic corridor in North America, while connecting the strongest crude oil supply to the strongest demand markets. I'll now ask the operator to open the line for questions.

[Operator Instructions] Our first question comes from Jeremy Tonet with JPMorgan Securities.

I was just hoping maybe to dial in a little bit more, I guess, on the range of outcomes here. I think there was a line in the press release talking about next steps forward here post the incident could further impact the company's financial and operational outlook for 2025. Just wondering if you could walk us through maybe a little bit more of the open items that could have more of a meaningful impact at this point, given everything that you know so far.

Yes. Jeremy, I think it's really important for us to focus on the fact that really our outlook is our base business is fully underpinned, and 90% of our EBITDA is contracted. And so we have no further risk on the base business. As per steps going forward, Richard highlighted the great progress of having no further contaminated soil on the site and also working really closely with our regulators. So we're working through the root cause failure assessment. That will give us good insight into how we may adjust maintenance activities through the year. But as Van pointed out, we've modeled those scenarios in assessing what our range could be. So the few steps are simply to work closely with our regulator, look at what our changes to our pipeline integrity maintenance program will be through the year and then continue to operate at the levels that we have been so that we can move our contracted barrels.

Okay. Got it. And maybe just taking a step back here as far as, I guess, what's known with root cause so far and I guess, other historical incidents in the past. Is there any kind of bigger thoughts with regards to preventing incidents in the future or across the system? Any other learnings here, I guess, that could derisk, I guess, the future?

Yes. Jeremy, pipeline integrity and the safety of our systems is our #1 priority. And we've invested a tremendous amount over the last 5.5 years. We've done a significant number of in-line inspections, and we've been working very closely with our in-line service providers, and we anticipate doing more in-line tests very quickly on the system. And the combination of evaluating all of that new data with the historical data will be key in moving our business forward and ensuring that we can remain safe and reliable going forward.

Our next question comes from Robert Hope with Scotiabank.

Maybe just going to the corrective action and just maybe on the pressure restrictions and the duration there. Is it fair to use the prior pressure restriction as a proxy for what you think the duration will be for this one? I guess, really, it seems -- and while we do appreciate the 2025 guidance, but I'm just wondering as we take a look to 2026, whether or not you think you'll be able to do any spot volumes there?

It's Richard Prior. I'll jump in. I'd just say, at this stage, it really is too early to speculate around the time frame on how the investigation will unfold, exactly what it will determine and then how long it will take to work through the remedial work programs. I would say, if you look at the Milepost 14 incident, because of the locational factor and some of the things that we had to go out and investigate in the field, it was -- that was a fairly protracted time frame because some of the investigative work was quite complicated. If you look at this specific circumstance, it doesn't share some of those same complications. So I don't know that I would necessarily take that proxy and just apply it to this. But I don't want to prejudice the investigation. We do need to work through the metallurgical studies and the RCFA. We expect we'll have the RCFA completed by the third party in the summer time frame. I do want to mention though that these are -- these investigations are typically quite dynamic in that we will learn more as the investigation is unfolding versus waiting to hear everything this summer. And in parallel with the investigation, our own internal engineers and integrity providers are also starting our own remedial work program. As Bevin mentioned, we're going to be running in-line inspection tools and completing investigative digs here starting within the month of May. And as we learn more about all of this, we'll certainly share more information. And maybe the last thing I'd leave you with is I wouldn't necessarily expect that the pressure restrictions and the corrective action order like all comes off all at once. Like these are often, again, a dynamic process. And as we learn more and resolve certain issues, these things tend to happen in phases. So with that, I'd just highlight, obviously, we're going to attack this with the resources and the urgency that it needs because keeping our lines safe is the most important thing to South Bow.

All right. I appreciate that. And then maybe going over to the -- some commentary on enhanced maintenance. Just taking a look at guidance, maintenance capital hasn't changed. So I just want to get a sense of is this kind of the baseline and that could move up depending on what happens with the investigation? Or will this be a multiyear endeavor?

Yes. I think just on maintenance, we mentioned on previous calls that we had planned to do some -- to bring some routine maintenance into 2025 that we were going to take advantage of some of what we thought was going to be some available system capacity. And so what we're likely looking at doing there is revising more of the longer-term plan. So we'll bring in some integrity work and remedial work specific to Milepost 171, and then we'll shift out some of the other nonurgent work into subsequent years. And then just lastly, I would remind you though that we do expect that all of that work is operational in nature, and that operational costs are permitted within the variable toll on how Keystone as commercial deals are structured.

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

Maybe I'll just finish off a question about the incident, but more on the leverage side. Given that you've not amended your trajectory to exit 2025 at 4.8x debt to EBITDA, is that a reflection of how low costs that you think won't be recovered from this? Or is this that you expect to recover mostly everything by year-end, even if the amount is large?

Yes, Maurice, it's Van here. So we expect all costs related to Milepost 171 to be covered by insurance or through our variable toll. So -- within the year. So that's why our debt-to-EBITDA for year-end has not changed.

Just to make sure I didn't miss it, but have you disclosed what the total cost has been so far? Or is this one where even if the cost has been incurred, what is the total cost that you expect from this incident overall?

Maurice, it's Bevin. It's a great question. It's really early days, but the response went extremely well. We're in a location that is also very different than historical. And so at the time when we're ready to disclose those costs, we will. But we -- so we haven't disclosed it, so you haven't missed anything. We're working on the remediation, as Richard has highlighted. And so we're progressing really well. And once we have the total estimate, we'll share that with our shareholders.

Understood. And just to finish off a question about just the volumes in general and the outlook for spot volumes on Keystone. Beyond the pressure restrictions from Milepost 171, was there something during Q1 or maybe just more broadly about the market that motivated the more moderate outlook for spot volumes that you can kind of discuss here?

Yes. We've been very consistent with our outlook on the year even starting last year where we saw some headwinds against our uncontracted barrels. And just to remind everyone that we only have -- we reserved 6% for uncontracted volumes out of Canada. So 94% of our volumes are fully committed. So with the tremendous uncertainty in the first quarter, particularly in January at the start of what we were seeing with potential tariffs and the necessity to make decisions around how you move your barrels as a producer, we saw some volatility and headwinds against our uncontracted capacity, but that was in line with what we expected given the basin has extra pipeline egress capacity.

Sorry. Just to follow up on that one. So if the January events were as you had expected, and as you just said earlier, your messaging on the outlook is consistent throughout, so what has changed to cause this moderate outlook?

Yes. I think our first outlook, we were -- the headwinds were primarily and solely the fact that there was additional egress. And so we envisioned that there'd be challenges on our uncontracted barrels exiting the basin. Now we've just added a couple of different layers of headwinds, Maurice. We have -- now we have the tariff headwind. That provided some uncertainty. But again, because our base business is contracted, it's just that headwind was going against the same headwind of the additional egress. And now with the operational kind of restrictions that we have with respect to Milepost 171, those headwinds, again, are going against that same uncontracted space. So while our outlook was originally based on egress, it's just going to be consistent. It's just which headwind is kind of blowing the hardest doesn't really change our outlook going forward. And that's why we were able to tighten our outlook in terms of our guidance for the year.

Our next question comes from Robert Catellier with CIBC Capital Markets.

I just wanted to address the longer-term guidance. You gave some pretty good detail in your 2025 guidance. But I wonder, given that you have a relatively modest view of uncommitted volumes and marketing in 2025, I'm wondering how that plays into the long-term 2% to 3% EBITDA growth. And is that still the right number? Or stated another way, what has to happen to reach that goal if market conditions don't change?

So Robert, a couple of things. First of all, we've made great progress on our Blackrod project, which was, as we indicated in the circular, kind of the first underwritten project that will contribute EBITDA to that 2% to 3% growth guidance. And we see that, that project will be able to finish our component of the scope here by year-end. And then our customer will ramp up through the year. So our outlook in terms of that contribution of a partial year or half year of EBITDA growth in 2026 remains. We had indicated in our -- at year-end disclosure and the discussion at the quarter call that we still see strength in supply growth. And so our outlook was that we may start to see some tightening of egress volumes in 2026, and that is where we'll see the potential to have some growth back in our uncontracted volumes, but we anticipate that to be a little later in the year. We've now managed to come through 2 different administration changes in both the United States and Canada. And so we're getting the market, and our customers are getting some additional certainty around how that macro environment will shape, and that's what will affect the supply growth and demand for our services.

That's a good segue to the other question I wanted to ask. Given that we have seen changes in both administrations, so what are you seeing in the policy and permitting environment on both sides of the border that gives you -- that builds your confidence about your outlook, both for production, but also for projects, specifically thinking about permitting?

Yes. So one of our top jobs as a management team is capital allocation. And for capital allocation, we look to certainty around outcomes. And so what we've seen in both administrations make commitments to look at the regulatory process and provide some additional certainty around how capital allocators like ourselves can look to make those investment decisions. So we think it's constructive on both sides of the border that we work in. But every project is different within our portfolio. And so we build our business to be agnostic to administrations and look to make sure that we can allocate our capital in the risk preferences that we've demonstrated to date.

Our next question comes from Benjamin Pham with BMO.

Just want to ask a question on potential asset sales. Can you remind us your restrictions on that and your overall thoughts around useful on First Nations partnerships and potential ability for you to look at that?

Yes, Ben, great question. So we -- all our assets are core assets. When we spun out, we were fortunate that we -- our business didn't have any noncore assets within our portfolio. But directly to your questions around First Nations and potential equity investments, we may - we have demonstrated as a management team in the past, the ability to prosecute those types of investment opportunities as parts of developments of new projects. And it will always be something we will consider. We don't have any plans at present on any of our specific projects to date, but it's certainly something that we have the capability to consider as part of our capital structure going forward on new investments.

Okay. Got it. And then the next question, maybe your initial thoughts on structural M&A and just any reads on the basin, the outlook and just overall initial thoughts would be helpful if you can.

Well, a little bit out of our scope to talk about a third-party transaction. I think in general, capital markets have shown that scale and consistency of delivering on objectives is important. So I don't know exactly what's driving the interest in that situation. For us, we're focused on our base business. We've got a strategic corridor, and we'll stick to our capital allocation priorities of allocating capital to strengthen our corridor.

Yes. So you don't think there's any -- I mean, the production outlook for oil heavy and just in terms of direct and indirect implications, just not much really to really say that on a preliminary basis at this point?

Well, I think both of those 2 operators have demonstrated tremendous success, both in the oil sands and in the emerging plays in the Clearwater, which is why we are bullish around the supply fundamentals out of Western Canada and why we believe that, that supply, one of its natural homes, is the strongest demand market in the Gulf Coast. So I think if the industry, as it potentially consolidates or looks to grow, is just really strong support for our business.

Our next question comes from Patrick Kenny with NBF.

Just on the business development front and with line of sight to Blackrod being completed early next year. Just wondering if you can comment on how the inbound interest has evolved over the past couple of months from customers, both upstream postelection as well as downstream now that we're seeing record exports out of the Gulf Coast. Just curious where you might be seeing the most interest in terms of extending the system on either end.

Yes. Patrick, I'm very encouraged by what we've seen as we've stood up our business and being focused on trying to find customer solutions. Our teams talked on both ends of the system, the downstream delivery points and also the aggregation and gathering of new volumes in the north of our system in Alberta. So I would say pretty consistent interest and acknowledgment that we're now an independent company that has its own capital structure and can work to find really good customer solutions. So I'm encouraged that we're building a good hopper, and those opportunities are going to take some time to mature. We're just over 6 months old. But even with that, I feel good about what the team has been developing on both sides on, as you say, Patrick, down in the delivery points and also up in Alberta with our existing assets to the north.

Okay. And I guess on a larger scale, if the pressure restrictions limit your ability to offer the uncommitted egress for a longer, say, more sustained period, might this bring the big sky open season back on the table? Or I guess, what stars need to align, macro or otherwise, to bring this opportunity back to the front burner?

Yes. So we did close with our partner on that opportunity, the open season. There's a lot of commercial reasons why that didn't advance. But that hasn't stopped us. Actually, in terms of some of the things we're maturing, there are other opportunities to leverage that corridor that the team has been working on. So we haven't stopped. We haven't stopped looking at ways to continue to grow our business and look for egress. That isn't necessarily tied to our outlook with respect to our uncommitted demand. We feel that, that volume, as I said, the supply fundamentals and the demand, we think the longer-term outlook and even midterm outlook are very robust. So we're working those in parallel.

Our next question comes from Keith Stanley with Wolfe Research.

First, I wanted to just start on the contractual commitments. Can you clarify that you can move 585,000 barrels a day through the affected segment? Or are there other tools like market purchases or other things you need to use to meet commitments?

Yes. I can clarify that we expect to be able to physically move the 585,000 barrels of throughput. There's not any synthetic conditions that are being applied to achieve that.

And I think that comes, Keith, from -- as we've been mentioning, we've had tremendous operational performance improvements over the last 5 years. And as Richard said, in the first quarter, we've demonstrated 98% system operating factors. And that's being able to deliver so effectively is giving us that opportunity to continue to serve our customers well.

Great. Second one, a bit theoretical, but just thinking about future scenarios. You have very good sort of insurance coverage and contract structures that keep you whole in situations like this. If you did go down the road and eventually have to replace some of the pipe that has had multiple issues like the Berg steel, is there -- how can we think about insurance coverage for a scenario like that or how costs might be recovered under contracts and realize we're certainly not there at this point.

Yes. Well, Keith, the history has been and our outlook continues that we're -- we do identify operational projects. Those operational projects or maintenance capital get flowed through the variable toll with respect to digs, portions of pipe replacement or wraps or things. And that's consistent across the industry. That's not something that's just something that we do. But I think across the industry, that's regular. The insurance, I would say, is not something that we would lean into on ongoing maintenance capital-type projects.

I wouldn't mind just adding in there, though, that we're -- I think it's far too early to make assumptions around the Berg pipe. Like this is a world-class American pipe mill. We're not aware of broad systemic issues with respect to their pipe. There are -- we've had 2 incidents that were failures on the long seam that at this stage, we can't say that they're related or that the issues are related yet. We really do need to work through the -- both the metallurgical analysis and the root cause failure analysis. And from there, we will develop remedial work plans. These pipelines are designed for very long service lives. And I'm confident that through our integrity programs, our in-line inspection, our integrity verification digs and other various remedial work that we'll put in place that we'll be able to solve the issue that occurred here and have a robust integrity program going forward that will keep our assets safe and then the oil in the pipe.

And I'm not showing any further questions at this time. I'd like to turn the call back over to Bevin for any further remarks.

Well, thank you for your interest in South Bow and for the thoughtful questions today. We look forward to connecting with you again in a few months.

Thank you. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.