Welcome to Capital Power's fourth quarter and year-end 2018 results conference call. At this time, all participants are in listen-only mode. Following the presentation, the conference call will be open for questions. This call is being recorded today, February 19th, 2019. I will now turn the call over to Mr. Randy Mah, Director of Investor Relations. Please go ahead, sir.
Good morning. Thank you for joining us today to review Capital Power's fourth quarter and full year of 2018 results, which were released earlier this morning. The financial results and the presentation for this conference call are posted on our website at capitalpower.com. Joining me on the call are Brian Vaasjo, President and CEO, and Bryan DeNeve, Senior Vice President and CFO. We will start with opening comments. Then open up the lines to take your questions. Before we start, I would like to remind listeners that certain statements about future events made on this call are forward-looking in nature and are based on certain assumptions and analysis made by the company. Actual results could differ materially from the company's expectations due to various risks and uncertainties associated with our business. Please refer to the cautionary statement on forward-looking information on slide number two.
In today's presentation, we will be referring to various non-GAAP financial measures, as noted on slide number three. These measures are not defined financial measures according to GAAP and do not have standardized meanings prescribed by GAAP and therefore are unlikely to be comparable to similar measures used by other enterprises. These measures are provided to complement the GAAP measures, which are provided in the analysis of the company's results from management's perspective. Reconciliations of these non-GAAP financial measures can be found in our fourth quarter 2018 MD&A. I will now turn the call over to Brian Vaasjo for his remarks, starting on slide four.
Thanks, Randy. Good morning. I'll start off by recapping the highlights from 2018. It was an excellent year, with nearly 600 megawatts of net additional contracted growth added to the fleet. This growth came from both development and acquisitions. We secured a 12-year contract for 150-megawatt Cardinal Point wind project and commenced construction of the project with COD in 2020. We completed the 99-megawatt New Frontier Wind project on time and below budget. On the acquisition side, we acquired Arlington Valley, which added 580 megawatts of contracted growth. As part of our joint venture for K2 Wind, we were presented with an opportunity to divest our one-third minority interest at an attractive valuation that resulted in a pre-tax gain of CAD 159 million. At our Genesee coal facility in Alberta, we advanced our eventual coal-to-gas conversion plans by securing additional physical gas delivery capacity to the Genesee site.
This will enable increased natural gas co-firing and allow for full conversion to natural gas in the future. We had strong financial performance in 2018 that included generating CAD 395 million in AFFO that exceeded the midpoint of our CAD 350 million-CAD 400 million target range. The strong AFFO performance and committed growth projects allowed us to increase the dividend by 7% for the fifth consecutive year and extend the annual dividend growth guidance to 2021. Turning to slide five, I'll briefly touch on the Alberta power market and its stable outlook. In 2018, there was a significant step change in power prices compared to 2017. This was primarily driven by the mothballing and retirements of coal plants, robust demand growth, and a higher carbon tax.
The average spot price was CAD 55 per megawatt hour in the fourth quarter of 2018, which more than doubled the CAD 22 per megawatt hour spot price in the fourth quarter of 2017. The forward prices are in the mid-CAD 50 per megawatt hour for the balance of 2019. In 2020 to 2021, forward prices are in the mid-CAD 40 per megawatt hour, due primarily to the lack of liquidity, but as well to carbon tax uncertainty and additional wind supply coming on. I'll now turn the call over to Bryan DeNeve.
Thanks, Brian. I'll start by reviewing our Q4 financial results on slide six. We completed two major planned outages at Genesee 3 in Decatur that lowered our average facility availability to 94% in the fourth quarter, compared to 95% a year ago. We recorded CAD 159 million pre-tax gain on the disposal of our one-third minority interest in K2 Wind. Adjusted EBITDA before mark-to-market was CAD 166 million in the fourth quarter. That was slightly below our expectations. We generated AFFO of CAD 80 million in the quarter, which was generally in line with our expectations. Of note, we incurred higher sustaining CapEx of CAD 25 million in the fourth quarter, compared to CAD 13 million in Q4 2017. Slide seven shows our fourth quarter financial performance compared to the fourth quarter of 2017. Revenues and other income were CAD 335 million, up 28% year-over-year.
Adjusted EBITDA, before unrealized changes in fair values of commodity derivatives and emission credits, was CAD 166 million, down 3% from Q4 2017. The decrease was primarily due to weaker results in the Ontario, B.C., and U.S. contracted assets and higher corporate expenses that were partially offset by strong Alberta results. Normalized earnings of CAD 0.33 per share were up 38% compared to CAD 0.24 in the fourth quarter of 2017. As mentioned, we generated AFFO of CAD 80 million. That was down 15% year-over-year, primarily due to higher sustaining CapEx. AFFO on a per share basis was CAD 0.78 compared to CAD 0.90 in the fourth quarter of 2017. Turning to slide eight, which shows our 2018 financial results compared to 2017. Revenues and other income were at CAD 1.4 billion, up 22% from 2017.
Adjusted EBITDA before unrealized changes in fair value of commodity derivatives and emission credits was CAD 713 million, up 20%, primarily due to the strong results in the Alberta contracted facility segment and a full year of contributions from assets acquired and developed in 2017. Normalized earnings were CAD 1.20 per share, up 7% compared to CAD 1.12 in 2017. AFFO was CAD 397 million, was 10% higher than the CAD 361 million in 2017, and AFFO on a per share basis was CAD 3.85 compared to CAD 3.58 in 2017. Overall, we had a strong year-over-year performance in all our key financial metrics. Turning to slide nine, I'll provide an update on our Alberta commercial portfolio positions. There have only been moderate changes to our commercial hedging profile for 2019-2021 since our updates at Investor Day in December.
For 2019, we are 78% hedged at an average contract price in the mid-CAD 50 per megawatt hour range. For 2020, we're 34% hedged at an average contract price in the low CAD 50 per megawatt hour range. For 2021, we're 1% hedged at an average contract price in the low CAD 80 per megawatt hour range. This compares to current average forward prices of CAD 54, CAD 47, and CAD 45 per megawatt hour for 2019-2021, respectively. We continue to benefit from having nearly 500 MW of gas peaking and wind to capture the upside from low natural gas prices, higher power prices, and price volatility. I will now turn the call back to Brian.
Thanks, Brian. I'll conclude our comments by comparing our 2018 performance against our targets and outline our 2019 targets. As shown on slide 10, we met our average facility availability of 95%. Our sustaining capital expenditures of CAD 79 million came in below the CAD 85 million target. We reported CAD 238 million in facility operating and maintenance expense that was within the CAD 230 million-CAD 250 million target. We generated CAD 397 million in AFFO that was at the high end of the CAD 360 million-CAD 400 million target range. Slide 11 outlines our development and construction targets for 2018. We completed New Frontier on schedule with commercial operations commencing last December and received net tax equity financing of CAD 125 million from the tax equity partner, JP Morgan. The project was completed slightly below its CAD 182 million budget. Therefore, the returns on the project are forecast to exceed the original expectations.
We continue to construct Whitla Wind, the project is tracking on budget and on schedule with commercial operations expected in the first fourth quarter of this year. On the development side, our goal was to execute contracts for the output of 1-3 wind projects. We met this target by executing a 12-year PPA and a 15-year REC contract for our Cardinal Point Wind project. For 2019, I'll quickly highlight our targets starting on slide 12. Our operational targets include average facility availability of 95%, which was the same target for 2018. Our sustaining CapEx target range is CAD 80 million-CAD 90 million, which is consistent with the 2018 target. Our financial targets are shown on slide 13. Adjusted EBITDA is forecasted to be between CAD 800 million and CAD 850 million, a 16% increase based on the midpoint of the range compared to 2018 results.
Our target of AFFO was CAD 460 million-CAD 510 million, representing a 22% increase compared to 2018 results. Our 2019 development and construction targets are shown on slide nine. We currently have two fully contracted wind projects under construction. This includes Whitla Wind in Alberta that has a CAD 315 million-CAD 325 million budget, with commercial operations targeted for the fourth quarter of this year. We also have our Cardinal Point Wind project under construction in Illinois. The budget is CAD 289 million-CAD 301 million, with a target to begin commercial operations in March 2020. Once completed, these two wind projects will add 350 megawatts of long-term contracted generation to our fleet. We are also targeting CAD 500 million of committed contracted growth capital in 2019. I will now turn the call back over to Randy.
Thanks, Brian. Claudia, we are ready to start the Q&A session.
Thank you, sir. We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. Our first question is from Patrick Kenny with National Bank Financial. Please go ahead.
Hello, good morning, guys. On slide nine here, looking at your hedging positions. You are still fairly open in 2020 despite the normal backwardation forward prices, you mentioned the carbon tax uncertainty here. Just wondering how you are thinking about putting on additional hedges here ahead of the election in the spring, or do you think the forward prices in the mid-high 40s fairly reflects where spot prices will likely settle under a lower carbon tax scenario?
When we look at forward prices in 2020 and 2021, we feel they do materially understate where we believe prices will settle, even with some changes in the carbon compliance program. If that gap persists, you probably won't see us selling much forward into the market at those current forward prices.
Okay, that's great. Just with respect to your sustaining CapEx target of CAD 80 million-CAD 90 million here in 2019, can you remind us what happens to that range, as you ramp up your coal-firing capabilities at Genesee into 2020? Does that target come down at all?
No, we'd expect it more or less remain within that range. As we burn more natural gas, we do expect there'll be some benefits in terms of maintenance CapEx, but it wouldn't be material enough to make a substantial change in that projection.
Okay. I'll jump back in the queue. Thanks.
Our next question is from David Quezada with Raymond James. Please go ahead.
Yeah. Thanks. Morning, guys. My first question, just generally, in the U.S. wind market, as we start to get closer to the sunset period of the wind PTC, just any thoughts you have on how development will play out over the next couple of years as that approaches potential supplier bottlenecks, if any, and how bidding seems to be going?
There continues to be significant interest in construction and development of wind farms across the U.S. Our general expectation is that there will be a sort of a re-pause in the market without any real serious disruption in what you consider normalized development and construction activities. I think all recognize that the level of activity in 2020 is not normal, though somewhat higher. Again, we would expect 2021 and 2022 to be somewhat softer, but more in line with historical levels.
Okay, great. Thanks. That is helpful. Then maybe just one other question. What are your thoughts on potential to participate in future solar development in Alberta, as that seems to be getting going now?
We've always had an interest in moving into solar facilities. As you know, we do have one solar farm. Certainly, the acquisition of the Arlington facility added a tremendous amount of acreage that at some point in time we would expect to be in solar. In addition to that, we have recently acquired a site in Alberta that is a solar site, that is well along in the permitting process. We do expect sometime over the next few years to develop and build a solar farm somewhere.
Great, thanks. Appreciate that. I'll get back in the queue.
Our next question is from Robert Hope with Scotiabank. Please go ahead.
Good morning, everyone. In your prepared remarks, you mentioned the possibility of lower carbon taxes in Alberta, just given the political uncertainty there. Taking that even further into 2021, have you seen any changes in how you see capacity markets forming depending on how or which government is in power at the time?
In terms of any narrative on the capacity market, we haven't seen anything from any of the parties in terms of it being a political issue for the election. I'd say at this point, nothing has been said, nothing's been stated. We wouldn't expect it would be the kind of issue that would become a political issue at this point in time. Would reiterate that as evidenced by our ongoing and past results, we're extremely comfortable in a capacity market and certainly would continue to do very well if things move that continued with the energy-only market. In a capacity market, again, properly structured, that would be fine by us. Either way, we would expect to continue to do very well in the Alberta market.
As a follow-up, just looking back at Q4, in your prepared remarks, you mentioned that EBITDA was below your expectations for Q4, but that free cash flow was in line. Can you just walk us through some of the drivers there, or why it was below your expectations?
In Q4, it came in below our expectations. From an EBITDA perspective, there were a couple of factors. One was wind production came in below forecast at a couple of our wind facilities. The other driver was the accounting treatment at K2. That became an asset held for sale at the end of October. No longer contributed to EBITDA for the last two months of the year. Those were the primary drivers. The one other one was at Bloom. Because of the change tax reform, the benefits to the tax equity investor, which is consolidated in our results, that was lower than expected. You may recall, we renegotiated the tax equity agreement in net net for 2018. There would've been a positive lift in terms of EBITDA.
All right. Appreciate that. Thank you.
Our next question is from Mark Jarvi with CIBC Capital Markets. Please go ahead.
Yeah, good morning. Just wanted to touch on Decatur first. First full year of operations owning the asset. Just wondering how it came in relative to the expectations when you guys acquired the asset.
Yeah. Decatur had a strong year in 2018, and actually has had more generation than anticipated. Positive results relative to our initial expectations.
Relative to the CAD 60 million of EBITDA, how much incremental did you guys eke out in 2018?
Yeah, it was probably CAD 2 million-CAD 3 million.
Okay. Then just going to the Alberta Commercial Segment, obviously, some of your peakers were more active, higher average price, AECO was a bit lower, yet kind of flat year-over-year in the quarter, but also flat year-over-year, for the full year. Maybe just talk a little bit about why maybe we're not seeing a bit higher EBITDA and cash flow out of those assets.
I think what we've seen out of the Clover Bar facilities and Joffre, they came in quite significantly ahead of our expectations in 2018. In particular, with the lower gas prices and higher power prices, and in effect, a much higher spark spread, that contributed to a significantly higher generation at our peaking facilities.
Okay. Then, I guess on the other side, is there anything at Genesee 3 or Keephills 3 in terms of anything in 2018 that sort of was a drag on performance? What you guys generated this year or this quarter should be pretty reflective if power prices hold in here through 2019?
Yeah. The generation should be consistent on a go-forward basis with what we saw in 2018.
Okay, thanks.
I did want to just mention my response to Decatur. For the full year in 2018, it's actually had about a CAD 9 million positive variance in EBITDA for the entire year. Part of that was due to higher-than-expected generation, as I described earlier. Also we saw a positive impact due to a favorable exchange rate.
Oh, right. Okay. Maybe just one last question from me. In terms of how much you guys have been substituting coal for gas, either in Q4 or in the current outlook right now here in the beginning of 2019.
We were utilizing a lot of gas during the period of low prices during the summer and fall of last year. As gas prices have recovered, particularly with the cold weather we've seen in Alberta, the coal-firing has dropped off completely. We do expect, however, we'd start to see that resume again with lower natural gas prices as we move into the spring and summer months.
Okay, thanks for that.
Our next question is from Andrew Kuske with Credit Suisse. Please go ahead.
Thank you. Good morning. Given some of the robust prices we've seen for renewable generation, do you see some further monetization opportunities across your portfolio?
Andrew, as we look at that, and I think when we look at the K2 sale, one of the other elements associated with that sale was the fact that we would move to being a one-third owner among three to be a one-third owner and the other owner having two-thirds of the interest in the facility. That was somewhat of a compelling factor for us to look at the value that came forward. As we look across the rest of our assets, we would need an extremely compelling price, I would say, beyond what we saw with K2, for a wholly-owned asset. We're not looking to monetize any of the balance of our renewable assets at this point, and wouldn't expect the situation to evolve where we would.
Okay, appreciate that. Then maybe just an update on what you're seeing with deal flow across North America, as far as asset transactions that are being shopped at this point in time, things that you're actively looking at, if you could give us any color on what you're seeing on a broad market basis.
There continues to be a fair amount of activity related to natural gas contracted assets, and we continue to look at those and are, at any point in time, actively involved in a couple of them, I would say. There continue to be some renewable opportunities in terms of larger portfolios, et cetera, like the Sempra facility sale that was announced last week. Again, those, depending on the particular circumstances, we may look at. There continues to be a relatively robust pipeline overall.
Okay. That's great. Thank you.
Our next question is from Ben Pham with BMO. Please go ahead.
Okay, thanks. On the 2019 outlook and also the change in your hedges, with it being mid-50s hedge for 2019 versus lows in the recent guidance. I wanted to clarify, are you modestly more positive on your outlook than the 2018 Investor Day?
No, I would say we're probably consistent with our outlook at Investor Day.
Okay.
As we look at the year so far, power prices came in somewhat below expectations for January 2019. February has been significantly above expectations. On balance, what we've seen to date, and then looking over the balance of the year, we sort of have similar expectations as we would have had in December.
Okay. Then on the same topic, the CAD 500 million of CapEx. I was more curious how to think about, if you were to not successful on the development side. Is this thinking that it's going to be acquisitions that backfill that? If not, it looks like you put it in NCIB. Is it then number 3, the buy back stock?
Maybe Ben, starting backwards. I think you can always expect we'll have an NCIB in place. I think that's just proper balance sheet management and dealing with supporting share price when appropriate, et cetera. I think you can always expect that, and I wouldn't read anything in particular has changed in terms of our views around that. In respect of our outlook for 2019, we would expect that, and I think we reflected it in our discussion in Investor Day, but we do expect that we should be able to secure a whole wind farm development in 2019. We'd see that as part of the mix. Certainly, I was just commenting, we see a lot of opportunities associated with acquisitions. Like the last couple of years, we would hope and expect that we could meet and beat that CAD 500 million target.
Again, we'll see as the year unfolds.
Okay. Can I clarify, when you think about stock buybacks, is buying back 250 the equivalent of the CAD 500 million deployed on organic growth?
Roughly speaking, it would be, yeah.
Okay. All right. Then lastly, I don't think you're part of the recent solar RFP that was announced. Just wanted to check on that.
That's true. Yes.
All right. Okay, thanks a lot, everybody.
Our next question is from Jeremy Rosenfield with Industrial Alliance Securities. Please go ahead.
Yeah, thanks. Just a couple of questions. First, in terms of the capacity market auction for later this year, do you expect that the ISO will be able to get that schedule locked down and be able to execute a capacity market auction by the end of this year?
They definitely continue on that path. Having said that, it's a pretty aggressive schedule, and there's a lot to be done between now and then. Again, we'll see.
Okay. Maybe just turning to Arlington for a second. I'm just wondering if there are any updates in terms of off-peak contracting discussions and negotiations or outlook on that at this point.
Sure. Going back to when we made the acquisition at Investor Day, we had indicated that we had expected to close fairly quickly on getting a contract for the balance of the year that would be somewhat parallel in length to the underlying summer contract. As events unfolded, there was a bit of a softening, a very temporary softening in the market in and around our closing date. I'm happy to say the market has been firming up since then, and we would expect sometime in the first quarter to secure a longer-term tolling arrangement or arrangement for the balance of the facility that's not contracted.
Okay, good. We'll look forward to that. Then, maybe just to clean up, there's a note about REC sales into PG&E, and I'm just wondering if you can clarify the materiality of that. Also, just linking that to Arlington, was Arlington able to wheel power into PG&E? Does the bankruptcy sort of remove a potential counterparty over the short term?
Starting with Arlington, it certainly does have the capability to sell into the California market. I'm not aware that there's been any sales recently or expected through to PG&E. I don't think there's any implications for Arlington by the PG&E situation. In terms of the RECs, we do sell RECs off of our Halkirk Wind facility into PG&E. When we completed that facility in 2013, we had mentioned that 40%-45% of the revenue was sourced from that contract with PG&E. Our view currently is that, based on external legal view and what we're seeing out there's still a high probability that contract will remain in place. If by some chance it was terminated, we would be free then to take those RECs and remarket them, and we would do that most likely in the Alberta market.
Okay, great. That's it for me. Thanks.
Our next question comes from Robert Kwan with RBC Capital Markets. Please go ahead, sir.
Good morning. If I can just come back to the plans for the NCIB. Brian, you mentioned it being good practice to have it outstanding. Given the step-up in the CapEx or the committed growth CapEx for this year, is it fair that at least your base expectation is not to materially use the nine or so million shares?
Subject to share price, I think that's reasonable.
Okay. I guess, on that comment subject to share price, certainly tactically utilizing it, where would you look to from the source of funds given the committed CapEx program? Like, would you be taking leverage up? To an earlier question, would you actually look to sell assets?
maybe I can come at it from this direction, Robert. When we look at a target of CAD 500 million committed capital for 2019, that's over and above the capital expenditures we're making on Cardinal Point and Whitla Wind 1. That incremental CAD 500 million, we'd be able to do that without having to go to the equity market. Our balance sheet is positioned to be able to do an incremental CAD 500 million of growth CapEx based on internally generated funds. If that growth doesn't materialize, and if we feel our share price is undervalued, that then would be a situation that we had utilized the NCIB. It would basically be utilizing the capabilities of the balance sheet that would support that CAD 500 million in committed capital growth.
Okay. Got it. In terms of just coming back to the Alberta election, you've touched on carbon and market structures. Just wondering, is there anything else that's on your minds as you think about how the politics could go post-election in terms of an impact to you?
Well, certainly the status quo is what we've managed to and what we're positioned for. I did comment earlier about the fact that, if a change in government resulted in continuing with the energy-only market, we'd be happy with that. Likewise, a properly structured capacity market, we'd be fine with that as well. When it comes to the carbon side and carbon tax side, the narrative from the UCP had started off suggesting moving back to SGER. Comments of late have been more around continuing with something that's like a CCIR. We would expect that, again, with the general direction of reducing carbon tax, that there'd be some reduced carbon tax exposure for Capital Power. It's too early, and there hasn't been enough said to appropriately assess that.
Got it. Okay. If I could just finish and just confirming, I think it was in the explanation that you gave, for Ontario and B.C., the year-over-year decline, that sounds like it was largely due to you not or stopping booking K2 into the segment. Is that fair?
It would be that combined with falling short on a couple of our wind facilities in those jurisdictions in terms of output.
Okay. That's great. Thank you.
Once again, if you have a question, please press star and one on your telephone. There are no further questions registered at this time. I would like to turn the conference back over to the management for any closing remarks.
Okay. If there are no more questions, we'll conclude our conference call. Thank you for joining us today and for your interest in Capital Power. Have a good day, everyone.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.