Edited Transcript of TEV.TO earnings conference call or presentation 9-Mar-20 5:00pm GMT

So first off, Linda will walk us through the key highlights from our Q4 results, then Rob will review our capital program. And finally, I will move into a review of our outlook for 2020.

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Linda Dietsche, Tervita Corporation – CFO [3]

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Thanks, John.

Q4 and full year 2019 results reflect the positive impact of our acquisition of Newalta, including both the contributions from acquired network and the successful delivery of targeted synergies ahead of schedule. Results also demonstrated our sustained focus on continuous improvements and cost management throughout our business, and particularly within Industrial Services. During a year event and industry activity declined, we delivered revenue of $591 million and $2.3 billion in the fourth quarter and full year, respectively, reflecting increases of 47% and 18% over prior year. And adjusted EBITDA of $59 million and $233 million for the quarter and year, improvements of 18% and 22%, respectively. Adjusted EBITDA margins remained strong, an 8 percentage point improvement over prior year to 34% for the quarter, and for the year, adjusted EBITDA margin of 33%.

Fourth quarter energy marketing revenue doubled compared to the prior year, primarily due to favorable Canadian crude oil prices as compared to the exceptionally wide differentials we experienced in Q4 2018. In addition, we had a 17% increase in marketed volumes, partially attributable to the addition of the Newalta volumes we began marketing at the beginning of 2019.

Energy Services divisional EBITDA of $60 million in Q4 2019 showed a modest improvement of 3% compared to prior year, driven by crude oil commodity pricing as well as increased marketed oil volumes and synergies related to the Newalta acquisition. This was partially offset by a 9% decrease in production-related volumes, reduced customer remediation projects and a shift to lower value waste stream.

Industrial Services Q4 2019 divisional EBITDA increased $3 million over — or 43% over prior year. This increase was primarily driven by higher project margins combined with increased volumes at our waste services facilities. These gains were partially offset by the impact of lower metals commodity prices. Divisional EBITDA margin improved by 4 percentage points in 2019 compared to the prior year, primarily reflecting our refocused efforts on higher margin, largely facility-based service lines.

G&A as a percentage of revenue improved 6% in the quarter compared to 8% last year, which reflects our focus on efficiency and cost discipline. For the full year, G&A costs were 7% of revenue.

For the full year 2019, we generated $90 million of discretionary free cash flow, a 14% increase over the prior year.

I will now pass it on to Rob to discuss our capital program.

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [4]

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Thank you, Linda.

With regards to capital spending, in 2019, we had capital additions of $139 million, including $33 million of maintenance. This align with the top end of our guidance. Our capital program is principally targeted at meeting our Energy Services customers’ needs in the time of tighter capital discipline and increasing water management requirements.

We are continuing to expand our energy marketing terminalling and blending business to further assist our customers in maximizing the value they receive for their products. We expect the majority of the benefits from this 2019 spending program will start to accrue this year in 2020. This would include the expansion of our storage and blending capacity at 5 of our TRD facilities; the sanctioning of our customer dedicated pipeline connected water disposal facilities, comprised of 3 disposal wells in the Montney region, supported by a long-term customer commitment; and the completion and tie-in of several additional water disposal wells at other active TRD facilities in both the Montney and heavy oil areas of operations.

In 2019, thanks in part to the customer-backed opportunity that provided a lower risk return on our capital, we spent a significant amount, which, combined with the external environment, led to smaller reductions in net debt than originally planned. In 2020, given our outlook and a continued emphasis on deleveraging, we plan to take a measured, disciplined approach to the allocation of discretionary free cash flow between our focus area of delivering projects within our growth capital pipeline of opportunities that meet hurdle and our plan to delever our balance sheet and thus create value for shareholders. We have therefore established our preliminary capital budget at approximately $85 million for the full year. This includes growth and expansion spending of $50 million, a reduction of about 50% from last year, and an anticipated maintenance capital spend of approximately $35 million. We will continue to exercise capital discipline, while remaining responsive to opportunities and market changes, and may revise our capital plans accordingly.

I will now turn it back to John who’s going to provide some operational highlights and talk about our outlook for this year.

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [5]

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Thanks, Rob.

While we are pleased with our strong performance, which demonstrates stability and resiliency in our business model, a broad exposure to every major oil and gas play in Western Canada and a diversified industrial business platform has positioned us to deliver solid results in this challenging current environment. Tervita demonstrated strength in its operating financial results through 2019, delivering a 22% increase in adjusted EBITDA over the prior year despite reduced energy industry-wide activity. These results in the challenging market are reflective of our waste volumes coming from a stable base of production-related volumes, continued focus on cost control, growing importance of our industrial business, and of course, delivery of the Newalta acquisition synergies.

The WCSB continues to be challenged by egress as well as pricing constraints, which has reduced drilling and completions activity and impacted producers’ capital investment levels. Assuming WTI of approximately $55 per barrel, upstream oil and gas production similar to 2019 levels and a reduction in drilling activity of approximately 10% from 2019, we would expect adjusted EBITDA growth in 2020, which is driven by contributions from our predominantly contracted 2019 investments in growth capital projects, which were focused on increasing our water handling capacity in the Montney region and our enhancing our clean oil energy marketing capabilities, and our ongoing focus on cost control and incremental business improvements in our Energy Services segment, and the continued optimization of our waste and environmental service businesses in the Industrial Service segments.

Now with the recent market developments, including COVID-19, they have clearly introduced volatility and corresponding decline in commodity prices, which temper growth expectations for 2020.

With regards to COVID-19, our operations have not been impacted to date. We have a robust business continuity plan, both for our business units and for our corporate office, which we have recently reviewed in light of the COVID-19 threat.

In 2019, the attention to environment, social and governance, or ESG, grew and became a key focus to the investment world in our industry. We understand that investment in sustainabilities and investment in our future as a company and also for our industry. For 40 years, Tervita has been in the environmental business, which are — with our solutions contributing directly to the sustainability objectives of customers. On the nature of our business, we are guided by a responsible environmental stewardship in the areas we operate. We use our industry expertise and technologies to reduce the environmental footprint of our customers. And we see ESG as a continuing opportunity, an opportunity to better ourselves through ESG initiatives and targets, and an opportunity to engage employees and customers through incorporating best practices, and an opportunity to work with stakeholders and customers to assist in meeting their ESG goals. As a commitment to transparency and accountability, we will release a sustainability scorecard later this year as well as build on our road map for future ESG reporting.

In closing, our results in Q4 demonstrate that the steps we have taken since 2016 to strengthen our business have improved our resiliency and stability. Energy industry continues to face headwinds. However, we remain excited about the opportunities in front of us to leverage our infrastructure and create efficiencies for customers, including our Montney water disposal infrastructure facility, which is on schedule in the process of being commissioned. With attractive margins, stable discretionary free cash flow and a well-capitalized balance sheet, we are taking advantage of our many opportunities to generate strong growth from our expanded network.

Lastly, I would like to take the opportunity to thank our employees for their extraordinary efforts and dedication in building the business where we are today. I’m extremely happy with the progress we have made this year and last year. Our people are the reason we are a leader in our industry, and we are so successful at driving continuous improvement on behalf of our customers and our shareholders.

So that concludes our prepared remarks. We would be happy to now take questions regarding our Q4 results and the outlook for 2020.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Greg Colman from National Bank Financial.

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Greg R. Colman, National Bank Financial, Inc., Research Division – MD and Energy Services & Special Situations Analyst [2]

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Good looking quarter on a bad looking day, just the way timing works, I guess. I don’t want to spend too much time talking about your forecast because, John, you spent a lot of time talking about forward-looking statements, and that’s a moving target second by second. But let’s talk a little bit about the structure of the business at the moment. Last year, you talked about your Energy Services EBITDA. We know 13% of your EBITDA is over there in Industrial. But you have your Energy Services EBITDA, and you approximate that about 2/3 are driven by production volumes, with the remaining 1/3 more exposed to drilling and completions activity. Do you still see that as — currently, as we stand today, kind of maybe call it today, Q1 2020, is that 2/3, 1/3 split in your EBITDA still makes sense? And then my follow-on question about is, how does the turn on of the Montney project change that, if at all?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [3]

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I think directionally, it would be still in that range, so 2/3, 1/3. It’s probably getting a little bit more balanced on the Industrial Service side as we continue to see that business grow. So that would be what we — certainly, what we saw last year and what we would expect in Q1.

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Greg R. Colman, National Bank Financial, Inc., Research Division – MD and Energy Services & Special Situations Analyst [4]

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Sorry. I’m just — I’m ignoring in the Industrial Services and just focusing on the Energy Services. My understanding was that was 2/3, 1/3. Is that accurate? Or is it the overall business mix is 2/3, 1/3?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [5]

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Yes. Yes, sorry. Yes, it is. Yes.

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Greg R. Colman, National Bank Financial, Inc., Research Division – MD and Energy Services & Special Situations Analyst [6]

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Got it. And how does the turn on of the Montney project impact that? Is that increasing your exposure to drilling and completion activity or increasing your exposure to production volumes?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [7]

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It would increase our exposure to production volumes.

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Greg R. Colman, National Bank Financial, Inc., Research Division – MD and Energy Services & Special Situations Analyst [8]

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And on that production volume side of the business, can you talk to us a little bit about the contractual nature of the volumes coming through your facilities? Is it area of dedication? Is it take-or-pay? Is it memorandums of understanding? It’s a minimum volume commitments on any or most or some or none of that?

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [9]

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Greg, it’s Rob here. I would say, on the — with an average tenor of 1 to 3 years, approximately 15% to 20% of our revenues have a commercial structure of one of the above of all the various — the things that you suggested there. We do have a few take-or-pays. The most notable of which is this new project that we’re just in the process of commissioning. And then a variety of other commercial structures which we would consider contracted for longer than an evergreen MSA basis out to that 1 to 3 years. Another large chunk of firm committed business that we do have is our on-site business, which represent pretty substantial pieces of equipment that are embedded within our customers’ infrastructure and are backstopped by long-term take-or-pay contracts. But it’s in that 15% to 20% range. And obviously, going forward, what we’re adding is going to have a much higher percentage. And so it should slowly accrete over time.

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Greg R. Colman, National Bank Financial, Inc., Research Division – MD and Energy Services & Special Situations Analyst [10]

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Got it. And then just quickly on free cash flow, and then I’ll turn it back here. With your capital program materially lower in 2020 as opposed to 2019, depending on how the year shakes out, we see quite a bit of free cash flow coming through. So my 2 questions are, one, on the capital program, how is it structured over the course of the year? Is it fairly evenly distributed or is it front-end loaded or back-end loaded? And then secondly, on the free cash flow, can you give us sort of your waterfall priorities? Broadly speaking, organic growth, debt reduction, share buyback and M&A.

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [11]

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It’s Rob again here, Greg. So on the profile of the capital spending, I think we’ll see a cash sort of call in the first quarter, due mainly to the tail end of our capital program from last year and then a relatively stable spend for the amount that we’re spending this year, particularly, a lot of it’s in the summer building season. And then as far as the allocation of discretionary free cash flow, again, we do — we are maintaining discipline on what we’re seeing as far as financial metrics for organic growth. So we’ve guided to above a 20% hurdle rate in the 3- to 5-year simple payback. We’re not necessarily going to be looking to degrade any of those expectations. And if we don’t see those, then we’ll keep the cash back as dry powder. And we’re executing on those. If we do have customer backed opportunities that provide us with highly probable, good risk-adjusted returns, we would likely look to find ways to spend that money. But in the absence of that, we’re probably going to remain a little more disciplined and look to keep some cash in the bank. On the other uses of cash, as you know, we do have an NCIB program underway at the moment. That expires in May, and we’ll be looking to reevaluate it at that time. And then I would say delevering would probably be the priority over any of those other uses.

You did mention M&A. We do have a pretty good pipeline of small tuck-under acquisitions. We would view those as competing with our organic pool of capital. So we don’t really view them as 2 different pools of capital. There might be some value, kind of, discovery that takes place just because there’s been such a rapid change in the market environment. So obviously, I can’t predict that, but I wouldn’t expect there to be much of that in the near-term here.

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [12]

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This is John. Just to piggyback on this a bit. So for the priorities, obviously, maintenance capital, we would clearly do that. On the growth and expansion, just — the only thing I would add to what Rob said is anything that we have a surety of cash flow streams, they would be ranked. And if they meet the hurdle rates, we would go through them, and then we’d look at the delevering.

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Greg R. Colman, National Bank Financial, Inc., Research Division – MD and Energy Services & Special Situations Analyst [13]

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Got it. And then I guess just a lighter bit 1 more follow on, and then I’m done. I mean given it’s a rapidly evolving situation on the macro, how much of the $85 million would you be able to ratchet back and not spend? i.e., how much of it is not committed, not preorders, not signed off? Like in a sort of scorch year scenario, what could you bring your spending down to in 2020 if you needed to?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [14]

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Well, we could certainly squeeze it. I mean we’re working through that right now. Like another way of saying is, not all of it is committed and we could flex down. Whether it’s 1/3 or a little bit more than that, that would be in the range.

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Operator [15]

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Your next question comes from the line of John Bereznicki from Canaccord Genuity.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division – Analyst of Oil and Gas [16]

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I just want to pick up on one of Greg’s questions here. In terms of the overall business, can you maybe talk a bit about your heavy oil exposure and how you view the risk of potential shut-ins on your business?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [17]

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I mean, yes — it is John. Yes, it is a risk. So there could be some shut-ins at these kind of low WTI commodity prices. It’s early in the game. And to react quickly to it, we’re not quite sure. But that’s a potential risk, and we’re profiling that out with our customer base and our operations and seeing if there is suspension of — temporary suspension of locations to flex to that, that would be what we would look at.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division – Analyst of Oil and Gas [18]

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Got it. And is there anything you can do on your end to kind of mitigate that risk? Or how would you view that?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [19]

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Well, I mean there are some where there’s contractual commitments and some of our customers have a hedging program in place. So we’ve worked with them on that. We are heading into spring breakup. So that’s another factor that perhaps would buy us and the industry time to work this through. So I’m not sure I totally answered your question, but those are the factors that we’ll take into consideration. I think we demonstrated overall that when volumes and revenues are down, Tervita adjusts.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division – Analyst of Oil and Gas [20]

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Fair enough. Okay. Appreciate the color. And then just secondly, it looks like remediation is still a big part of the landfill volumes. Can you maybe talk a bit about how you would see those volumes in the current oil price environment in 2020?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [21]

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Well, they could be dominantly moved, if I could put it that way. However, as an overall long-term platform, we actually see that growing for all sorts of various reasons. But we could have a temporary downturn in reclamation and remediation work.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division – Analyst of Oil and Gas [22]

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Got it. Okay. And I think, Greg, stole my question on CapEx. So that’s good for me. Appreciate the color.

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Operator [23]

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Your next question comes from the line of Tim Monachello from AltaCorp.

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Tim Monachello, AltaCorp Capital Inc., Research Division – Analyst of Institutional Equity Research for Energy Services [24]

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I think Greg asked most of my questions. But I guess, the one that’s outstanding here is just, how should we think about the impact to the marketing segment in a lower crude price environment? Like if you were to see crude staying in the $30 to $40 range through the year, what would that look like on a year-over-year comparison for 2019?

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [25]

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Tim, it’s Rob Dawson here. I think there is — if there is volatility with the differentials between all the different crude qualities, there are certainly continuing opportunity for us to purchase blend and sell for profit. And so that is less diminished. I think the one thing that would diminish opportunity would be if there is a significant shut-in of volumes because there needs to be volumes for us to be able to trade. On the other hand though, we do have some storage in caverns available to help some of the heavy oil customers that have a lot more trouble shutting in to store for several months at a time and so forth into a future market that might be a little better. And we do have other ways to, I think, to try to shore up some of the volume cuts that may or may not be occurring. But it’s really more of a volume business. I think the opportunity on the margin side will remain pretty stable.

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Tim Monachello, AltaCorp Capital Inc., Research Division – Analyst of Institutional Equity Research for Energy Services [26]

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Okay. And then on the fluid disposal side, maybe using 2016 as, I don’t know, maybe sort of like a case study. How much did you see pricing drop on that side in 2016? And what do you think the potential for that is in this market?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [27]

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Well, I don’t — we don’t really see — I think back in 2016, prices in the industry in this sector dropped by 25% or more. We don’t see that magnitude. However, prices probably will go down in some areas. But we don’t — to us, price erosion is not the primary thing that we’ll be thinking about. It’s more on the volume side that we’ll be thinking about because we’ve got — our costs are one of the better bases in the industry. So our margins are — overall, we have given ourselves flexibility to provide price if it has to do with our customer base to give them value, but I don’t — we don’t see a 25% decline.

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Tim Monachello, AltaCorp Capital Inc., Research Division – Analyst of Institutional Equity Research for Energy Services [28]

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Okay. Is there a significant room to adjust the cost structure of the business if you were to see volumes come down significantly?

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [29]

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Well, everything’s fixed cost to a certain point. So I mean we do have the flexibility of suspending operations on a temporary basis in our landfill portfolio and others. So we do have that capability if it ever gets to that point.

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Operator [30]

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Your next question comes from the line of Ian Gillies from Stifel.

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Ian Brooks Gillies, Stifel Nicolaus Canada Inc., Research Division – Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [31]

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I wanted to follow on Tim’s questions around the marketing operations. And I was wondering if you could highlight what may have transpired today with the rapid change in commodity prices, and perhaps how you’re — how Tervita was positioned and whether you’re expecting any outsized gains or losses because of what happened today.

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [32]

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Well, Ian, it’s Rob here. I would say just categorically that we don’t have a spec book at all. So we buy and sell physical matched in every transaction such that we tend not to have any overall commodity price exposure. We’re just locking in a margin. Some things would price for the average to the month. That month has already been set in stone, so we’re trading February — we’re trading on March to April right now. So what happened today isn’t necessarily going to cause us any significant changes in what we think where we’re going to be looking for March as an example. Going forward, it will obviously have an impact on the new contracts that we’re going to be looking to lock in and set. And as I mentioned before, it’s how many volumes will there be to attract to our facilities versus what we can do with those volumes to blend and sell at different crude qualities and prices.

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Ian Brooks Gillies, Stifel Nicolaus Canada Inc., Research Division – Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [33]

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That’s actually very, very helpful. Moving to the balance sheet. I mean as you guys have worked through a processor, as you guys think about the notes that are due at year-end ’21, I mean has there been any contemplation or conversation about increasing the size of the credit facility just so you have some flexibility if market rates aren’t favorable?

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [34]

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It’s Rob here again. We — it’s a bit of a chicken and an egg where the indenture on our senior notes that are outstanding, our second lien notes limits the amount of senior debt that we can have, which is our credit facility. Right now, our credit facility is at the top of that. So we have had a lot of discussions with our banks, and we have a very supportive bank group to upsize that facility, but it requires us to take on our bonds for that facility to be put in place. So one will have to beget the other. In the meantime, though we’re completely undrawn on our credit facility, on a net basis, we’ve taken the opportunity before Christmas, as we’ve noted in our MD&A here, to buy back some debt at below par. And as a result, you see we have a little less cash on the balance sheet, but net debt has remained relatively stable and our available liquidity remains, we think, very abundant. So we don’t see, even if in a protracted situation where we don’t have access to the bond markets to upsize our credit facility as that necessarily causing us any indigestion.

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Operator [35]

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Your next question comes from the line of Elias Foscolos from Industrial Alliance.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division – Equity Research Analyst [36]

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I just have a follow-up question from Greg. Just in — if you roughly have this — in terms of the production orientation out of the Energy Service business, can you give a feel, if possible, on the amount of investment-grade counterparties that are coming through? I’m guessing on a dollar volume basis, it doesn’t really matter. Is it 50%, is it 75% or 25%? That’s about it.

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [37]

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Yes. Good question. The investment on our — across the whole portfolio, but to our Energy Services business, the investment quality of our customers is very, very strong. We have a kind of a very stringent internal practice to ensure that we watch that and measure that carefully. There’s no one customer — our largest customer is 6% of our total revenues, and that’s a [may] plus-plus, I could put it that way, credit-worthy customer. So — and to combat that to, as Rob was alluding earlier, we have 20% of our book revenue as contracted out in that world from a 1- to 3-year term. So yes, we’re pleased with the creditworthiness of our customer base.

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Operator [38]

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Your next question comes from the line of Keith MacKey from RBC.

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Keith MacKey, RBC Capital Markets, Research Division – Analyst [39]

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Just a question here following up on the growth CapEx of $50 million. Wondering how many — or what the breakdown of that $50 million is between the water disposal projects and other upcoming projects, and then if there’s anything in the Industrial Services in there as well?

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Robert P. Dawson, Tervita Corporation – EVP of Strategy & Corporate Development [40]

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Keith, it’s Rob here. I’d say the breakdown of how much for Industrial Services versus Energy compared to 2019 is largely the same ratio. So there’s a modest amount of industrial capital in there. It’s a less capital-intensive business. But there is some capital associated with that, mainly directed at new facilities in Manitoba and the Northeastern British Columbia and some rolling stock. On the Energy side, there is some landfill expansion in there, a modest amount, but it’s mostly directed at water and waste infrastructure and a little bit of blending for some storage tanks. So it’s probably the same mix as it was last year, just in smaller — the same proportion, but in smaller absolute amounts.

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Operator [41]

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There are no further questions at this time. Mr. John Cooper, I turn the call back over to you.

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John William Cooper, Tervita Corporation – CEO, President, COO & Director [42]

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Thank you, Christine. And thank you, everybody, for being on our conference call, particularly for today. A tape broadcast of the call will be available on our website. And we look forward to providing you with updates on our performance after the completion of the first quarter of 2020. Thanks, everybody, and hang in there today.

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Operator [43]

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Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.