Tag Archives: irs

What Is The Best Valuation Metric For A Stock: P/E Ratio, EV/EBITDA Ratio, Or Price To Free Cash Flow Ratio?

The P/E ratio is quick and easy but can be inaccurate due to non cash accounting items. The price to free cash flow ratio only counts cash flow items but working capital fluctuations make it less useful. The EV/EBITDA ratio is the most comprehensive but does exclude some costs. There seems to be about as many different valuation metrics for stocks as there are stocks. You have price to sales, price to book, price to earnings, free cash flow yield, EBITDA multiples, dividend yield, and more. So which one is the best to use? In this article we’ll take a look at three of the most popular and widely used metrics: P/E, Price to Free Cash Flow (or Free Cash Flow Yield), and the EV/EBITDA ratio to uncover some hidden flaws o some of the metrics and find out which one is the best to use. P/E Ratio The P/E or Price to Earnings ratio is one of the most popular and easiest ways of valuing a stock. Unfortunately it’s also one of the most flawed ways to value stocks because of numerous accounting items that can drastically change a companies reported earnings. Let’s take a look at a few examples of some common occurrences that render the P/E ratio useless for valuing companies. For our first example we will look at the case of Lockheed Martin (NYSE: LMT ). Like all defense contractors Lockheed Martin is reimbursed by the US government for all pension costs associated with government contracts. Since over 80% of Lockheed Martin’s revenue comes from the government most of Lockheed’s pension costs will be reimbursed by the US government. As a public company Lockheed must account for pension liabilities and fund its pension plan according to Financial Accounting Standards (NYSEARCA: FAS ). However, the government reimburses Lockheed for pension costs using Cost Accounting Standards (NYSE: CAS ). This means that Lockheed’s pension costs and its pension reimbursements do not always match up. Some years these differences can be negligible but other years they can be enormous. In 2011 Lockheed Martin recognized a FAS pension expense of $1,821M and received a CAS pension reimbursement of $899M meaning the company recognized $922M in net pension expenses. Lockheed reported $2,667M in net income or $7.90 per share for FY2011. During FY2011 Lockheed’s stock traded at an average of approximately $74 per share so the company would have had a P/E ratio of 9.3. Looks pretty cheap right? Well, it was even cheaper at the time. The actual earnings power of Lockheed’s business was really the $2,667M in reported net income plus the $922M in pension expenses that would be reimbursed in the future. Lockheed actually earned around $3,589M in true net income for FY2011. With 335.9 shares outstanding Lockheed earned $10.68 per share and had a true P/E of 6.9! It’s no surprise that with Lockheed trading that cheaply its stock has more than doubled since 2011. The table below shows how the true P/E for Lockheed Martin in FY2011 was calculated. Computation of Lockheed’s True P/E in FY2011 FY2011 P/E 9.3 Net income as reported $2,667M Add: FAS/CAS pension adjustment $922M True net income $3,589M Shares outstanding 335.9M True earnings per share $10.68 FY2011 stock price $74 True P/E in FY2011 6.9 Lockheed is just one example. Many companies report onetime non cash charges that can artificially increase a P/E ratio making the stock look more expensive than it is. In our second example we will look at the case of Twenty-First Century Fox (NASDAQ: FOXA ) and an accounting item that makes the stock look cheaper than it is. As of this writing Fox trades at a TTM P/E of 7.77. The stock looks extremely cheap. However, in November of 2014 (part of Fox’s FY2015) the company sold its interest in Sky Italia and Sky Deutschland. That along with several other transactions netted Fox a onetime gain of approximately $4.2B. Fox reported net income of $8,306M for FY2015. After backing out the onetime gains Fox really earned $4,110M in net income for FY2015. With 2.04B shares outstanding and a share price of approximately $30 Fox’s true P/E is really 14.85. Fox still looks cheap, but not quite as cheap as first glance. The table below shows how the true P/E was calculated. Computation of Fox’s True P/E TTM P/E (for reference) 7.77 Net income as reported $8,306M Less: One time gain $4,200M True net income $4,110M Shares outstanding 2039 True earnings per share $2.02 Current price $30 True P/E 14.85 These are just some of the many examples of ways that the accrual accounting based earnings that companies report may not accurately reflect their true earnings and how P/E ratios widely reported by many financial data sites may be technically correct but inaccurate for assessing the true cheapness or “expensiveness” of a stock. One way to avoid some of the accounting rules based pitfalls of the P/E ratio is to use the Price to Free Cash Flow ratio. Price to Free Cash Flow The Price to Free Cash Flow ratio uses a company’s free cash flow (cash flow from operations less capital expenditures). Free cash flow offers several advantages over the P/E ratio. First and foremost it’s based on cash accounting which only counts income or expenses when cold hard cash is received or paid out. That means noncash items like restructuring charges or impairment charges are ignored. Items like onetime gains from the sale of investments such as Fox’s sale of Sky Italia and Sky Deutschland show up in cash flows from investments, not operations, and thus are not included in a company’s free cash flow number. One major disadvantage of using free cash flow is that free cash flow numbers tend to be lumpy and uneven due to timing issues surrounding the company’s cash payments and receipts and changes in a company’s working capital levels. This may make a stock look expensive some years and cheap other years solely based on a company’s working capital changes. For example the table below shows W.W. Grainger’s (NYSE: GWW ) net income, free cash flow as reported, and free cash flow before working capital changes. In $000s FY2014 FY2013 FY2012 Net Income $801,729 $797,036 $689,881 Free Cash Flow $709,954 $789,556 $689,071 Free Cash Flow Before Working Capital Changes $876,696 $850,675 $815,675 As you can see Grainger’s working capital changes produce large fluctuations in cash flows. Net income has risen each year but free cash flow has bounced around, rising and then falling. When you back out the effect of working capital changes you can see that free cash flow is far from lumpy, instead it has increased each year just like Grainger’s net income. Simply backing out all working capital fluctuations would be a quick and dirty method to produce smooth cash flows for your free cash flow calculation. However, as most companies grow they require additional working capital so we should try to do something to take that into account. The table below shows Grainger’s working capital changes for each year. In $000s FY2014 FY2013 FY2012 FY2011 Working Capital $1,705,833 $1,848,495 $1,820,637 $1,306,975 YoY Change -$142,662 $27,858 $513,662   In FY2014 and FY2013 working capital barely changed, and if you look at Grainger’s net income you will see it why. Net income barely increased so the company’s working capital needs stayed the same. In FY2012 working capital increased by more than $500M, likely to support FY2013’s large increase in net income compared to the previous year. Since Grainger is growing slowly now we do not need to make any working capital adjustments for our calculations. However, if you were producing free cash flow projections for a discounted cash flow model and projecting growing sales you would want to include a deduction to represent increasing working capital needs. I’d recommend looking at a company’s historical working capital levels and using some sort of average or median figure to model as your increase. Now back to calculating Grainger’s Price to Free Cash Flow. For our purposes we will term our working capital modified numbers “adjusted free cash flow”. Since Grainger does not have any working capital adjustments due to slowing growth the calculation is relatively simple as you can see below. We just take the current market cap divided by our adjusted free cash flow number to get the price to free cash flow ratio (and the inverse to get the free cash flow yield). Grainger’s Price to Free Cash Flow Adjusted Free Cash Flow $876.696M Market Cap $15,200M Price to Adj. Free Cash Flow 17.34 Adj. Free Cash Flow Yield 5.77% While price to free cash flow with working capital adjustments gives you a much more accurate valuation number then the P/E it’s a bit complicated to calculate and you have to make some estimates about working capital. While it fixes most of the flaws of the P/E ratio it still has one problem. It tells you nothing about a company’s debt load. Enter the EV/EBITDA ratio. EV/EBITDA Ratio The EV/EBITDA ratio is widely used because it includes the company’s debt load in the valuation as well. It also better Enterprise Value is the market value of the company’s equity plus the book value of its long term debt. EBITDA stands for E arnings B efore I nterest T axes D epreciation and A mortization. EBITDA is sometimes derisively referred to as “earnings before all the bad stuff” among accounting focused investors but there are good reasons for using it. EBITDA excludes interest charges which are not part of a company’s underlying business. Interest charges represent the financing decision of the company. Furthermore we account for debt levels by using the enterprise value rather than equity value. Taxes also do not reflect the earnings power of a business; instead taxes probably better reflect the lobbying power of the industry the business operates in. Some businesses like IBM pay almost no federal taxes while others like Paychex pay close to the statutory maximum of 35%. Depreciation and amortization are also excluded because those charges represent accounting decisions then business decisions (e.g. the accounting rules for calculating the useful life of a capital asset to compute depreciation charges). Note: Beware of “Adjusted EBITDA” Wall Street and company CFOs have taken the concept of EBITDA even further and many companies report something called “adjusted EBITDA” which varies from company to company based on what charges they want to exclude. Adjusted EBITDA usually really does resemble the accounting joke of “earnings before all the bad stuff”. When you see adjusted EBITDA I would avoid using that number like the plague unless there is a very good reason for the company adjusting the number such as a onetime gain on the sale of a business or a onetime payment such as the tobacco companies’ billion dollar settlements with the IRS a few years ago. Let’s continue with our example of W.W. Grainger to see how calculating the EV/EBITDA ratio works. As the table below shows we take the market value of the equity and add the book value of debt (I’m using FY2014 numbers for all calculations). That gives us $15.2B in equity plus $405M in debt for an enterprise value of $15.6B. To calculate EBITDA we start with Grainger’s net income of $802M and add back $8M in net interest payments, $522M in taxes, and $208M in depreciation which gives us EBITDA of $1.54B. Grainger’s EV/EBITDA Ratio Market Value of Equity $15,200M Book Value of Long term Debt $405M Enterprise Value $15,605M     Net Income (Earnings) $802M Interest $8M Taxes $522M Depreciation and Amortization $208M EBITDA $1,540M     EV/EBITDA Ratio 10.13 Now it’s worth noting that since EBITDA excludes many charges the numbers will be higher than both earnings and free cash flow and as such industry average EV/EBITDA ratios will always be lower than their respective P/E and free cash flow ratios. The Final Verdict The simple P/E ratio has too many flaws to make it useful. The EV/EBITDA ratio stands head and shoulders above the other metrics in giving investors a comprehensive valuation of a company’s underlying business. However, because it uses accrual accounting numbers from the companies income statement it can be vulnerable to manipulation and does exclude some costs. I favor using the EV/EBITDA ratio and then cross checking it with adjusted free cash flow information to make sure nothing funny is going on with a company’s numbers and to get a comprehensive look at a companies valuation. Disclosure: I am/we are long LMT. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

GreenHunter Resources’ (GRH) CEO Gary Evans Discusses Q1 2015 Results – Earnings Call Transcript

GreenHunter Resources, Inc. (NYSEMKT: GRH ) Q1 2015 Earnings Conference Call May 15, 2015 09:00 ET Executives Kirk Trosclair – Executive Vice President and Chief Operating Officer Gary Evans – Chairman and Interim Chief Executive Officer Analysts Brian Butler – Stifel Operator Good morning. My name is Mariama and I will be your conference operator today. At this time, I would like to welcome everyone to the GreenHunter Resources First Quarter 2015 Financial and Operating Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Executive Vice President and Chief Operating Officer, Mr. Trosclair, you may begin your conference. Kirk Trosclair Thank you, operator. Welcome everyone to today’s first quarter financial and operating results conference call. Before we start today, I will go ahead and read the Safe Harbor statement before we get started. Today is Friday, May 15, 2015. And before we begin with the content of today’s call, I would like to advise you that today’s call may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The following discussion provides information, which management believes is relevant to an assessment and understanding of our financial condition and results of operations. The discussion contains forward-looking statements that involve risk and uncertainties and may include statements regarding our expectations, beliefs, intentions, or strategies regarding the future. Actual events or results may differ materially from those indicated in such forward-looking statements. This discussion should be understood in conjunction with the financial statements accompanying notes and risk factors included in our SEC filings. The discussion should not be construed to imply that results contained herein will necessarily continue into the future or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment by our management. Actual events or results may differ materially from those indicated in such forward-looking statements. This disclaimer is an effect for the duration of this conference call. Okay. We will get started here on the first quarter financial and operational highlights. We know it’s only been pretty much exactly 30 days since we have had our 10-K operations update call, but we have had some changes and want to give you an update on all of different projects with the use of proceeds in the capital that we are putting to work from our funding process, which happened in April 15, which we haven’t announced to you guys on the call in the K. So, we will go back through the first quarter here just some of the highlights that we hit in the first quarter and substantially improved our operating margins related to water disposal itself year-on-year from 32% in the first quarter of 2014 to 42% in the first quarter of 2015. Also improved the operating margins as it related to internal trucking, you can see how those went from 12% last year up into the 20s of this year. We mentioned this on the 10-K call as well that’s mostly due to eliminating significant portion of the third-party trucking that we were utilizing inside of our own group and dispatching those trucks in handling the billing for those third-party companies. We have pretty much stopped that and using our internal trucks first and foremost, when you can see what happens with the results when we do that having much more control over that fleet. We also decreased our SG&A from $2.1 million, down to $1.7 million in the first quarter, which is equated to a decrease of 19%. And then also we had mentioned to you guys that we had our first deployment of our rented MAG Tank, which we sent out in late February and so that was – that was really good news in the first quarter. On March 16, we closed our sale of the last remaining renewable asset in the Mesquite Lake project biomass plant for $2 million. And then we also in the first quarter we finished paying off the 2.2 promissory note that with the financing in place for the initial purchase of the first three disposal wells in Appalachia. So, we retired that debt setting us 66,000 or so a month in principal and interest. And then as you all know where at the same time, we have the call on April 15, we announced the new money, the $16 million financing for the capital projects, which we will go into more detail about the actual percentage of completion and where we are at with those projects right now. The operational numbers on the results of the first three months, you can see where the loss from continuing operations was $1.4 million in 2015 and $1.3 million, that’s pretty flat in that area. The revenues were down basically this quarter $5.1 million to $8.5 million. And I will go through the reasons why on that in a second. The majority of that was due to our increased margins in third party trucking, I mean internal trucking by not having that third party expense out there. And then you also were made aware of in our K from the call that we still had a couple of wells that were running at 50% capacity and one of the wells that was down in the first quarter. So and then we also had a – from year-on-year we had a MAG Tank sale in the first quarter of 2014 that we did not have a sale in the first quarter of 2015. So that’s the majority of the difference in your revenues. So we also provided you guys in there a pro forma on the selected balance sheet. If you had a chance to review the press release this morning and in the filings, you will see that we placed the pro forma to show you how much we have improved the balance sheet with the funding that we have in place. And I will go into some more details how that use of proceeds is being put to work currently right now. So I think what we will do is just go straight into that and give you an update on all the projects. And since it’s been a short time and really after I give you this update we will probably just go ahead and open it up for questions. And I had failed to mention earlier that Gary is on the line as well with me. And we can answer those questions for you as soon as I go through the update on the projects itself. So I guess the biggest improvements that we have had is obviously been done in the Mills – at the Mills facility, that is our largest project, our hub. And we have – I will give you basically some updates on each individual step of what’s been taking place since we started putting the capital to work. But before I do that, I guess I want to give you guys an update. We announced the funding on April 15 and there was a good process for us here at GreenHunter Resources, it really made us dot our eyes and cross our tees and get everything cleaned up in the back office. You know that when you do a senior secured funding like that you really have to have everything in order and it really it was a good process for us. And it will help out here going forward. We were delayed a little bit in funding because of some of that and had to jump through hoops to get all this type of back end paperwork and recording of some leases that were not recorded and things like that. But we have gotten that cleaned up and we have been funded as of two weeks ago. And we are ready and proceeding as quickly as we can with the projects. So at Mills the last time we had spoken we had only had maybe 10% or 15% of the actual injection lines in the ground. The pipe was actually on-site, but it was not deployed. Now we have made considerable progress and all but one line has been laid to all of the additional four injections wells at the Mills Hunter facility. The final line will be complete in approximately two weeks. It’s the furthest away from the injection facility. And we will get that complete in the next couple weeks. All the roads and the creek borings have been done. And we have witnessed those yesterday. I was in the field in Appalachia and we saw where those guys had just completed all the bores. So that allows them to really move forward and finish this rather quickly. The pump house section is currently 90% complete. The last few electrical items are being installed today. And we should have the completion of the pump house to write it at about 100% by the end of next week. The construction on the third pump house, we had to do a little redesigning of the facility, which will in turn save us the money and become more efficient on our processes. So we started construction of that third pump house. We witnessed that yesterday and it’s been under construction for about three weeks now and will be complete in about five to six weeks for the second two wells. So what’s crucial to understand there is that the initial pump house that’s almost 100% complete, will feed the two wells that will go online first. If you remember, we had mentioned in the last call, we will have two wells that will go online in approximately – now that we have a little delay, will probably in the second week of June for those, the first two wells to get operational. And then in that time, we’re finalizing the third pump house and all of the lines will be complete, all the pumps would be in, and the second two wells to make the total of six wells at Mills Hunter will go online near the end of June. The secondary containment is complete, about 95% complete. We have to do a little dressing up on the walls and then we’re awaiting the installation of the 20,000 barrel tank, which is about three to four weeks out. The first set of the aged pumps will arrive next week and be installed in the first pump house and then the following set of pumps will come in the following week. And then as you remember in the use of proceeds, we also have other aged pumps coming in to change out the existing pumps at all of our facilities, which will help us decrease that maintenance expense at all of the facilities. But we will wait to deploy those additional pumps at the other facilities once we complete Mills, that’s our number one priority right now is getting Mills up and running. An update on the Ritchie Number 2, we had mentioned I think when we were on the call K, that we were actually just completing the drilling of that well. The well is complete and it’s ready for injection. We’ve done everything we can do on our side. We’re awaiting the final permit from the West Virginia DEP, which we hope to have in the next 30, 45 days. It’s been brought to our kitchen that those guys at the WVDEP, our backlog quite a bit at this point and that’s why we were typically getting those permits and turned around in less than 60 days. And it’s already been 60 days since we filed, but – so they have up to six months and we just – we anticipate we will see in the next 30, 45 days. We are also looking at some additional wells around the Ritchie County area. As you can imagine that’s a hotbed for Marcellus and the Stacked Utica play in the Northern portion of West Virginia there, it is right off of Route 50. So we look to doing somewhat similar to what we did on at Mills and find additional wells that we can hook into the existing facility and maximize our efficiency there. The trucks we – that’s part of the use of proceeds as well. We’re evaluating bids right now on new and some pre-owned trucks that are out there to mix and match between straight trucks and tractor-trailers. The availability on 407 trucks out there is still pretty tight at this point, but we have gotten in several bids over the last couple of weeks and we plan to make that decision and get those trucks ordered possibly today or no later than Monday or Tuesday of next week. The MAG Tank, we’re still working on securing some new contracts. As you are definitely aware with commodity prices kind of had a low rebound this week, but has been a little slow in Appalachia on the completion side, therefore slowed down the process of actual deployment of tanks. We have been in contact with our clients that had requested the court back in February and in March. And they are still very interested. It’s just a little slowdown in the actual drilling program and the completion that follow. So we still anticipate that to pickup during the second half of the year. We are – something that’s new right now to tell you guys about, we’ve started in the first quarter and into the second quarter, the initial stages of securing some LOIs for a pooling agreement with several E&P companies to utilize brine and freshwater pipeline network in the Southeastern Ohio area and basically taking that down through via the trunk line to the Ohio River for anticipation of barging brine further south. So just to give you an update on that, now you guys can ask some questions about the Coast Guard on the permitting. We have hired an internal government relations manager, who will help us expedite that process and we have also hired outside help to basically provide a detailed plan to the Coast Guard of how we plan to execute the barging of oilfield waste. We were actually at the site yesterday with one of the professionals from the Appalachian region who barge this product up and down the Ohio River every day and looking at the dockside facility and given us some recommendations on how we can expedite that as far as once we have given the forego ahead to have a dock in place and ready to go. So all-in-all everything, the outlook for the company with the funding in place is really good. We have a lot of work to do in a short time to get it done. And I can’t express my gratitude enough to our management staff and our field employees out there in the Appalachian region here in the office, in the corporate office that had helped us get everything done and expedite the process. So with that, I’ll go ahead and open it up to some questions. Question-and-Answer Session Operator [Operator Instructions] Your first question comes from the line of Michael Hoffman from Stifel. Your line is open. Brian Butler Michael, this morning. Kirk Trosclair Good morning, Mike. Brian Butler This is Brian. Kirk Trosclair Hi, Brian. Brian Butler Hi, just kind of on a macro activity level on the Utica and Marcellus. You touched on it a little bit about completions going on. But can we get a little bit more color on kind of where the drilling stands and the trend. Is it rising, declining and then what you kind of just thoughts on it progressing through 2015? Gary Evans This is Gary. Maybe I can respond to that a little better. Of all the shale plays in the United States, the Marcellus and Utica has seen the least drop in activity, predominantly for a couple of different reasons. Number one, it’s the lowest finding cost reserves in the country with respect to gas, but number two, most of the companies are very well-capitalized, larger companies and they have ongoing programs. So we’re turning down about 20 to 25,000 barrels a day of water that we can’t handle because we’re full. And based on the drilling programs and the budgets that had been established by our customers and others, we don’t see that changing. As soon as we get all these wells up and running they will be full. And so we got to go to the next level of where do we go to take this from 30,000 barrels a day to 50 to 60,000 barrels a day. So, we are in a very unique area. Water has to be handled properly. There’s people bringing water six and eight hour truck drives to get disposal. So we don’t see that changing. The permitting process is a long process. The states are not – they don’t bend over backwards to get these permits push through. So we’re in a unique part of the country that is going to require us to continue to build out new disposal capacity. Brian Butler Okay, that’s helpful. And on that new capacity, it sounds like almost all of its going to be up and running on – at the beginning of the third quarter. Is that the right way to think about, does it ramp immediately to near capacity, full capacity or is there a ramp up timeline as the next capacity comes on? Gary Evans It’s a ramp up there. As Kirk mentioned, we’ll be able to turn a couple of wells on mid to late June, they could add between 5 and 8,000 barrels a day of capacity, then there would be other wells coming on. So it will be a gradual increase in June, July, August. Would you agree with that, Kirk? Kirk Trosclair Yes, I agree, Gary. I mean – the volumes are there, but we definitely want to – we are known for protecting our wells and we don’t want to just turn this, pick it on and start pumping aggressively at that point, we’d like to take it easy for the first couple of days and really massage the well and then go to full capacity after that. So yes there will be a small ramp up period and then obviously you’re going to have your cash flow lag as invoices go out and you start to see them payables come in. So you will have somewhat of a lag but it won’t be that much. Brian Butler Okay. And of those wells that are coming on, kind of in the next, call it month or so. That’s the two wells at the Mills facility and the Ritchie well, right? Kirk Trosclair And as the Ritchie well is ready to go we are just waiting on the state. Brian Butler Right. But that’s 30 days or 45 days, so it’s not going to taking anything for a month? Kirk Trosclair Mills Hunter, Brian, already has two active injection wells currently today that we are injecting into now. And then the second too will come on in a couple weeks through two or three weeks out. And then following that will be the last two wells, which will go, one will be like a week later and then the final well which is the furthest away from the injection facility is the one injection line that still has to be completed and that will be the last one to come on. So you will have two come on at same time, then one first to follow and then the last one will come on sometime late June timeframe. Brian Butler Right. That’s just to know [indiscernible] that will be in addition to that once you get the permit? Kirk Trosclair That’s correct. Brian Butler And that’s typically incremental 16,000 plus barrels per day. Kirk Trosclair Because if you remember, right, we had to pull back our injection capacity at the Ritchie while we were drilling that well until we get the permit for the new Ritchie number two we are running at half capacity at the Ritchie number one. Brian Butler Okay. So then thinking it through by the end of the third quarter we should expect these are at – all the new wells are more or less that capacity or very close? Gary Evans That’s correct. But end of the third quarter you should have them all operating at 100% utilization and capacity, ready to go. Brian Butler Okay, that’s good. And then on the new plan for the barging, so what’s the timeline now look like for when you might actually see barrels offloaded on from the barges? Kirk Trosclair We are still looking at September, August timeframe. So we have given the new group that we have hired to help along with our government relations manager a 90-day push period to try to get this thing done. They have already been to DC once last week – week before last. And they have got several more meetings lined up with some dignitaries and congressional health and we are trying to get with the coast guard to work through the issues to lay out the plans on how we proposed to operate at the terminals. I would propose to do everything to the – to load the barges and offload down at Mills and just have everything in place once for that final go ahead. Brian Butler Okay. And then we will have another one now kind of in the fourth quarter hopefully you will be able to taking volumes from the barges? Kirk Trosclair That’s correct. Brian Butler Okay. And last one here, just any update on – or maybe one more – two more – any update on the MLP status? Gary Evans We received a letter from the IRS about a month and a half ago asking specific questions about our business. We responded to that letter and we have been told that other water companies are looking to go public got similar letters. And we are waiting for that response. So, it’s back in the IRS hands. I will still say though they have given out some more information it appears that water is going to be clear. Their real focus has been on chemical companies’ ethylene, polyethylene, various chemical products that we are trying to do MLP. So we feel pretty good about the feedback we have been hearing regarding our sector. Brian Butler Okay. And then this one for you a little last one. Just regulation wise, with news about seismic activity on the disposal wells, any color on what maybe going on or if there is any pending changes? Gary Evans Our neck of the woods, we haven’t seen anything. The areas that had seismic issues, there had been areas that have either been injecting into a much deeper horizons or near falls. And we have been very careful in the selection of our disposal wells, not to have either. So I haven’t noticed anything in West Virginia or Ohio that would lead us to be concerned that they were going to – the stage we are going tightening up activity or producing permitting activity in anyway. It’s been in other parts of the country. Brian Butler Okay, great. Kirk Trosclair To validate that Brian, we had a meeting yesterday with one of our customers on one of our sites. And he had just left meeting at the Ohio Department of Natural Resources. And they had a meeting on that same very subject. And the guys in the DNR told him that there has been no change. They don’t foresee anything coming down the pipe for the next foreseeable future. And so that was promising to hear that coming from one of our customers as well and the USA guys. Brian Butler Okay, great. Very helpful. Thank you very much guys. Kirk Trosclair Thank you. Operator There are no further questions at this time. I will turn the call back over to the presenters. Kirk Trosclair Thank you so much operator. And with that, no other questions, I think that will conclude today’s call. Thanks for dialing in and we will talk to you next quarter. Bye. Operator This concludes today’s conference call. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com . Thank you!

SJW’s (SJW) CEO Richard Roth on Q4 2014 Results – Earnings Call Transcript

SJW Corp. (NYSE: SJW ) Q4 2014 Results Earnings Conference Call February 20, 2015 1:00 PM ET Executives Suzy Papazian – General Counsel Richard Roth – Chairman, President and CEO James Lynch – Chief Financial Officer Palle Jensen – Senior Vice President, Regulatory Affairs, San Jose Water Company Analysts Operator Good day, ladies and gentlemen. And welcome to the Fourth Quarter 2014 SJW Corp. Earnings Conference Call. My name is Lisa, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Suzy Papazian, General Counsel. Please proceed. Suzy Papazian Okay. Welcome to the full year and fourth quarter 2014 financial results conference call for SJW Corp. Presenting today are Richard Roth, Chairman of the Board, President and Chief Executive Officer; and James Lynch, Chief Financial Officer. Before we begin today’s presentation, I would like to remind you that yesterday’s press release and this presentation may contain forward-looking statements. These statements are only projections and actual results may differ materially. For a description of factors that could cause actual results to be different from statements in the release and in this presentation, we refer you to the press release and to our most recent Form 10-K and 10-Q filed with the Securities and Exchange Commission. All forward-looking statements are made as of today, and SJW Corp. disclaims any duty to update or revise such statements. You will have the opportunity to ask questions at the end of the presentation. As a reminder, this webcast will be available until April 27, 2015. You can access the release and the webcast at the corporate website, www.sjwcorp.com. I will now turn the call over to Rich. Richard Roth Thank you, Suzy. Welcome, everyone, and thank you for joining us. I am Rich Roth, Chairman and CEO of SJW Corp. On the call with me today are Jim Lynch, Chief Financial Officer of SJW Corp.; and Palle Jensen, Senior Vice President of Regulatory Affairs of San Jose Water Company. As Jim will discuss in further detail, SJW delivered solid results for the year, despite continuing water supply challenges in both of our utility service areas. Further, looking back at 2014, SJW made substantial progress that I believe will lead to a better and stronger company at every level. San Jose Water Company, our flagship utility received its long overdue but constructive General Rate Case decision for the three years 2013 through 2015. The decision provided much-deserved earnings relief and validated the company strong sensible and systematic investments in infrastructure. Accordingly, nearly $90 million was invested in utility plant during 2014, upgrading critical infrastructure, improving service levels and increasing gross utility plant and service to more than $1.3 billion. These investments directly correlate to an increase in rate base which in turn could contribute to earnings for many years to come. SJWTX, Inc., our Texas water and wastewater utility has experienced growing demand for new services. SJWTX’s growth and earnings potential continues to mature owning to our efficient regional business model, economical business processes and a strong acquisition program. Customer count and gross utility plan have increased by nearly 60% and 300%, respectively, since we acquired the business in 2006. With our diverse portfolio of water supplies, a growing wastewater business and continued additions to customer base both through organic growth and acquisitions. We continue to be optimistic about the prospects of expanding our Texas operations. I will now turn the call over to Jim who will review our financial results. After Jim’s remarks, I will address regulatory matters and provide additional perspective on key operational and business issues. Jim? James Lynch Thank you, Rich. Net income for the quarter was $6 million or $0.28 per diluted share, compared to $5 million or $0.23 per diluted share for the fourth quarter of 2013. Year-to-date net income was $52 million or $2.54 per diluted share compared to $22 million or $1.12 per diluted share for 2013. Quarter and year-to-date results reflect the impact of our California General Rate Case decision, the ongoing California drought and newly elected tangible property tax regulations. As previously noted in August, we received a final decision from California Public Utilities Commission or the CPUC on our 2012 general rate case application. The decision authorized a 9.8% revenue increase for 2013 that became effective in August 2014 and a 5.2% revenue increase for 2014 that became effective at the end of September. The decision also authorized a surcharge adjustment for the retroactive application of a newly adopted rate to January 1, 2013, the day interim rates initially went into effect. The surcharge totaled $47 million, of which approximately $25 million related to 2013 and $22 million to 2014. We recognized a surcharge revenue in the third quarter, offset by approximately $3 million in balancing and memorandum accounts, included in the decisions that were previously recognized. For 2015, the third and final year covered by the decision, we received authorization to implement a 2.9% rate increase that went into effect, January 1st. Rich will provide more color on our rate case application for 2016 through 2018 in a few moments. The end of 2014 marks our third consecutive year under historic drought conditions in California and our first year of operating under a targeted 20% reduction in water use set by the State Water Resources Control Board and the Santa Clara Valley Water District. Water consumption for the quarter was down 19% compared to the same quarter in 2013. Year-over-year consumption was down 10% and when compared to authorized annual usage, consumption was down 8%. Recall that the company established memorandum accounts with the CPUC in March 2014 to track the financial impact of conservation for future recovery. The memorandum account balances will be recognized by the company once profitability recovery can determined, and finally collection is assured. In 2014, we also established our method of complying with capitalization elections in the tangible property regulations issued last September by the IRS. As a result, we changed our policy for capitalizing certain asset improvement cost. This resulted in the $16 million reduction in federal income taxes payable for the year with the commensurate increase in federal deferred income tax liabilities. For state income tax purposes, the adoption resulted in a $5 million reduction in state income taxes payable and a commensurate state income tax benefit. The reduction in federal and state income taxes payable included $13 million and $4 million, respectively related to 2013 and prior years. Fourth quarter revenue was $69 million, an increase of 3% over the fourth quarter of 2013. Year-to-date revenue was $320 million, an increase of 15% compared to the same period in 2013. The increases were primarily due to the new rates provided in California General Rate Case decision and for the year the general rate case true-up and higher rates related to pass-through water cost increases from the Santa Clara Valley Water District of approximately 9%. These increases were partially offset by lower customer usage and the impact of certain balancing and memorandum accounts. Water production expense for the quarter was $27 million, a decrease of $3 million over the fourth quarter of 2013. The decrease was attributable to a $5 million decline in usage, partially offset by higher cost for purchase water and groundwater extraction charges and essentially no available service water supply. For the year, water production expense was $123 million, an increase of $2 million over 2013. The increase was due to higher cost of purchase and groundwater of $8 million and $5 million due to a decrease in available service water supply, partially offset by an $11 million decrease in customer usage. Operating expenses excluding production costs were $27 million in the fourth quarter, an increase of $720,000, when compared to the fourth quarter of 2013. Higher depreciation and maintenance expenses during the quarter were offset by lower general and administrative expenses due primarily to lower pension costs. Year-to-date, 2014 non-production operating expenses were essentially flat compared to 2013, due to the same factors. Non-operating income and expenses for the quarter were also essentially flat, when compared to fourth quarter of 2013. Year-over-year, non-operating income and expenses included a $2 million gain on the sale of California Water Service Group stock and gains on the sale of real estate investments in Texas and California, totaling $600,000. The effective tax rate for the quarter and year was 50% and 33%, respectively, compared to 32% and 39% for the same two periods in 2013. Fourth quarter 2014 income tax expense includes a reduction in the state income tax benefit related to the adoption of the IRS tangible property regulations to true-up the previous tax estimate and an increase in income tax expense related to fixed assets. In addition for the year, income tax expense includes the credit of $880,000 related to California enterprise zone sales and use tax credits. Turning to our capital expenditure program, we added approximately $22 million in utility plant during the fourth quarter, bringing our total additions for the year to more than $91 million. In 2014, we completed essentially all of our planned capital expenditure programs. In addition, for the fourth quarter, we added $3 million in developer funded capital projects, bringing our total for the year to $10 million. By the end of 2014, utility plant investments in California and Texas increased to $1.3 billion and $97 million, respectively. With that, I will stop and turn the call back over to Rick. Richard Roth Thanks, Jim. The California drought, now going on its fourth year continues to be an issue of concern for us, for our customers and state regulators. On December’s record rainfall and recent storm a very good start, it may take many years above average precipitation for our water supplies to normalize. As Jim mentioned, rules limiting certain outdoor water usage were adopted in July 2014 by the State Water Resources Control Board. The Santa Clara Valley Water District are also a water supplier has also asked all of its retailers to continue to curtail water use to ensure adequate supplies are available in 2015 and beyond. While the lack of precipitation is challenging, we anticipate San Jose Water Company’s water supplies to be adequate this year, owing to our diverse portfolio, which in addition to treated imported water includes groundwater and drought-tolerant recycled water. Customers in California have clearly done a remarkable job of conserving and helping stretch our precious water supplies in response to calls for conservation. However, lower water sales ultimately result in higher rates for all water customers, a rates conservation nexus that continues to perplex and frustrate. To maintain the high service and reliability levels, our customers have come to expect. We continue to conduct in-depth operational modeling and planning to balance the availability in cost of both existing and new water supplies. It is clearly evident that new water supplies will be needed. In light of the big area and California’s continued growth, environmental restrictions and other stressors on California’s aging and inadequate water delivery systems. The quality of life for our customers and the economic vitality of Silicon Valley are inextricably linked to a reliable, high-quality and sustainable water supply. Rapidly increasing water supply costs will impact rates but at less than a penny per gallon, water service remains a great value. The time is right to advance local water supply solutions that ensure sustained reliability for our customers and the residence of Santa Clara County. To that end, we have sought permission from the California Public Utilities Commission to expand our recycled water system distribution network. Recycled water has been and will continue to be a critical water resource for the region. San Jose Water Company also continues to evaluate solutions and partnership opportunities that can fast track the expanded use of recycled water. Turning our attention to regulatory affairs, SJW received final decisions on key regulatory filings in both Texas and California in 2014. Almost three years after filing San Jose Water Company’s 2012 General Rate Case application seeking new rates for the years 2013 to 2015, the California Public Utilities Commission issued its final decision on August 14, 2014. Importantly, it approved new rates that reflect lower customer usage, higher water supply costs and the infrastructure investments we have made. Importantly, the decision also allowed San Jose Water Company to implement new rates retroactive to January 1, 2015. Since the decision was nearly two years late, San Jose Water Company has already filed its next General Rate Case with the commission for the three years 2016 through 2018. The filing sees rate increases of $34.9 million or 12.2% in 2016, $10 million or 3.1% in 2017 and $17.6 million or about 5.4% in 2018, respectively. It also requests the commission approval for capital budgets of $106 million, $114 million and $116 million for the years 2015 through 2017, respectively. Inclusive of the approved Montevina Water Treatment Plant improvements, the total capital investment for 2015 is anticipated to be approximately $130 million. These investments are critical to ensuring our customers continue to receive high quality and reliable water service. This is all the more important in the light of the water supply challenges now facing the region. We’re hopeful that our current filing will be processed on a timely basis for the benefit of customers and shareholders alike. The commission also improves San Jose Water Company’s request to delay its cost of capital filing until March 31, 2016. This cost of capital filing for San Jose Water Company is one part of the larger group of filings for all the other publicly traded water utilities, including California Water Service Company, Golden State Water Company and the California American Water Company. Since a change from currently adopted interest rates is unlikely due to the current economic environment, the one-year delay allows the utilities and the commission to defer potentially significant processing expenses. Also in 2014, the Public Utility Commission of Texas issued a decision on SJWTX’s 2013 general rate case application. The final decision settles all issues with the Coalition for Equitable Water Rates, the commission and the Office of Public Utility Counsel. The decision authorized the requested average system wide rate increase to be phased in annually, beginning January 1, 2015 to January 1, 2018 and provided that no refunds or credits will be owed to customers for rates that affect between December 2, 2013 and December 31, 2014. The New Year saw several changes at the California Public Utility Commission. Liane Randolph was appointed to the commission on December 23, 2014 and replaced outgoing Commissioner and President Michael Peevey. The Governor also named Commissioner, Michael Picker the commission’s new President. We welcome Ms. Randolph to the commission and President Picker to his new post and look forward to working with them, their collogues and commission staff to resolve the many water related issues facing California’s regulated water utilities. Finally in January 2015, the SJW’s Board authorized a 4% increase in SJW’s annual dividend to $0.78 per share. The dividend increase demonstrates a strong commitment to our shareholders and evidences the Board’s confidence in the company’s business plan. In summary, increasing cost for new water supplies, accelerated infrastructure needs and a rigorous regulatory and compliance environment will continue to present challenges to SJW and require us to refine and diligently execute our business strategy. The need to reorganize, reinvent and innovate in all aspects of our business has never been greater. SJW is committed to these principles and to working with stakeholders to deliver cost-effective solutions and safe and reliable water service. With that, I’d like to turn the call back to the operator for questions.