Welcome to Capital Power's first quarter 2017 results conference call. At this time, all participants are in listen-only mode. Following the presentation, the conference call will be open for questions. The call is being recorded today, May 1st, 2017. I will now turn the call over to Mr. Randy Mah, Senior Manager, Investor Relations. Please go ahead.
Good morning, thank you for joining us today to review Capital Power's first quarter 2017 results, which were released earlier this morning. The financial results and the presentation slides 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'll start the call 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 conference call are forward-looking in nature and are based on certain assumptions and analysis made by the company. Actual results may differ materially from the company's expectations due to various material 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 GAAP measures in the analysis of the company's results from management's perspective. Reconciliations of these non-GAAP financial measures can be found in the company's first quarter 2017 MD&A. I will now turn the call over to Brian Vaasjo for his remarks, starting on slide four.
Thanks, Randy. The highlight of the first quarter is Capital Power's execution on its growth strategy with the recent acquisitions of contracted natural gas assets totaling 1,079 MW of capacity. On April 13th, we completed the acquisition from Veresen of the York Energy Centre and East Windsor facilities, both located in Ontario. The transaction was originally announced in February of this year. On April 12th, we announced the acquisition of Decatur Energy Center from LS Power, which I'll provide more details on shortly. These acquisitions are expected to increase the company's AFFO by CAD 67 million and adjusted EBITDA by CAD 115 million in the first full year of operations. Overall, our long-term contracted adjusted EBITDA as a percentage of total adjusted EBITDA is expected to increase from 66% in 2016 to 80% in 2017.
Turning to slide five, I'll provide more details on the Decatur Energy transaction. We have an agreement with LS Power for the purchase of the Decatur Energy Center for US$441 million, subject to working capital and other closing adjustments. Decatur is a 795-megawatt natural gas combined cycle plant located in Alabama. The facility operates under a 10-year tolling agreement which expires in December 2022. This is the third PPA for Decatur, and it's well-positioned for recontracting based on its recontracting history and the need for capacity in the region. There is also optionality for Decatur, as the facility will sell power into the PJM market starting in 2023. The acquisition is being financed with both equity and debt. This includes the completion of the subscription receipt offering for gross proceeds of CAD 183 million.
The debt portion will come from utilizing a temporary expansion of our credit facility, followed by long-term financing. Decatur is expected to add CAD 43 million in AFFO in the first full year of operation and expected to generate approximately CAD 60 million of adjusted EBITDA per year. We expect the acquisition to be completed in June of this year, subject to regulatory approvals and satisfaction of other customary closing conditions. For the next two slides, I want to highlight the benefits from adding the two Ontario facilities and the Decatur facility in the U.S. First, slide six illustrates our geographical breakdown based on capacity. At the end of 2016, 74% of Capital Power's megawatts were in Alberta. This was followed by 13% in BC, 7% in Ontario, and 6% in the U.S.
With the recent acquisition and including our Bloom Wind project in the U.S. that is expected to be in commercial operation soon, you can see how we've achieved geographical diversification away from Alberta. The capacity in Alberta will be reduced from 74% to 53% and will largely shift to the U.S., where capacity will increase from 6% to 26% of our total. Turning to slide seven, we've updated this chart to include Decatur. This chart shows the growth in our contracted adjusted EBITDA from 2010 to 2017. As you can see, our contracted adjusted EBITDA has increased 211% during this period, which translates into an 18% compound annual growth rate.
For 2017, you can see the significant increase in contracted adjusted EBITDA from several sources, which includes Bloom Wind starting in the third quarter, the start of annual off-coal compensation payments from the Alberta government, and contributions from the acquisition of the three natural gas plants that I discussed. Moving to slide eight. This slide summarizes the availability operating performance of our facilities for the first quarter of 2017 compared to the same period a year ago. We had excellent operational performance in the first quarter, with average availability of 97%, which was unchanged from a year ago. Our annual 2017 target is 95%, which reflects major scheduled maintenance outages for Genesee 1, Clover Bar, Southport, Roxboro, and Keephill s 3. I'll now turn the call over to Bryan DeNeve.
Thanks, Brian. I'll start on slide nine with a review of our first quarter financial performance. Overall, first quarter 2017 financial results were in line with our expectations. This includes generating CAD 91 million in adjusted funds from operations and normalized earnings per share of CAD 0.34. Alberta power prices in the first quarter averaged CAD 22 per megawatt hour, compared to CAD 18 per megawatt hour in the first quarter of 2016. Our trading desk performed well and captured 150% higher realized average price of CAD 55 per megawatt hour on our Alberta commercial assets versus the spot price. Turning to slide 10, I'll review our first quarter financial results. Overall, the financial results this quarter were comparable on a year-over-year basis. Revenues were CAD 338 million, up 1% from the first quarter of 2016. Adjusted EBITDA before realized changes in fair values was CAD 134 million, up 5% from the first quarter of 2016.
This is primarily due to lower corporate expenses, reflecting the off-coal compensation and higher contributions from the Alberta, Ontario, and B.C. contracted facilities. Normalized earnings of CAD 0.34 per share were up 3% compared to CAD 0.33 in the first quarter of 2016. As mentioned, we generated adjusted funds from operations of CAD 91 million, which was down 2% on a year-over-year basis. Of note, 2017 marks the beginning of annual off-coal compensation payments that will be received in July of each year. Our financial results will include the accounting recognition of this income that will be distributed equally throughout the year. From a cash flow perspective, AFFO will include the coal compensation annually in the third quarter when the cash is received. On slide 11, I'll conclude my comments with an updated financial look for 2017. As mentioned, the annual off-coal compensation payments of CAD 52.4 million start this year.
The acquisitions of York Energy in East Windsor in April and Decatur Energy expected in June will provide partial year contributions to AFFO and adjusted EBITDA. Brian will provide an update on our revised financial guidance for 2017 shortly. Our commercial hedging profile for 2018 to 2020 as of March 31st, 2017, is shown on the slide. For 2018, we are 61% hedged at an average contracted price in the high CAD 40 per megawatt hour range. For 2019, we're 40% hedged at an average contracted price in the lower CAD 50 per megawatt hour range. For 2020, we're 33% hedged at an average contracted price in the high CAD 40 per megawatt hour range.
In summary, our baseload merchant exposure is fully hedged in 2017, and we continue to increase our hedges in 2018, which has increased from 53% at the end of 2016 to 61% at the end of the first quarter 2017. I'll now turn the call back to Brian Vaasjo.
Thanks, Bryan. The charts on slide 12 show our first quarter operational and financial results versus the 2017 annual targets and, in some cases, our revised annual targets. The revised annual targets reflect the expected contributions from the acquisitions discussed earlier. In the first quarter, average availability was 97%, which is ahead of our 95% plant availability target for 2017. Our sustaining CapEx in the first quarter was CAD 4 million, compared to the CAD 80 million revised annual target. We reported CAD 49 million in facility operating and maintenance expense in the first quarter versus the revised CAD 215 million-CAD 240 million target. Finally, we generated CAD 91 million in adjusted funds from operations in the first quarter. With the acquisitions, we have increased our 2017 AFFO target range to CAD 340 million-CAD 385 million, which is a 12% increase compared to the original target. Slide 13 shows our growth targets for 2017.
This includes the completion of our Bloom Wind project on time for commercial operations in the third quarter and on budget. Our growth targets also include the execution of contracts for the output of two new developments. We continue to make progress on our development pipeline in the U.S. and in Alberta under the Renewable Electricity Program, we are well positioned to provide renewable generation from our Halkirk 2 and Whitla wind sites. I'll now turn the call back to Randy.
Thanks, Bryan. Operator, we're ready to start the question and answer session.
Yes, 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're 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. The first question comes from Robert Hope with Scotiabank. Please go ahead.
Good morning. Congrats on a good quarter. Maybe just looking at your strategy moving forward, we've seen you being quite active on the M&A front. Looking forward, can you add some color on your U.S. strategy? Is this now more of a greenfield for renewables as well as potential M&A for thermal assets? Is there anything else in the hopper?
Good morning. In actual fact, our general strategy has not changed over the last number of years. We've looked for contracted opportunities both from a greenfield perspective and from an M&A perspective across North America. What's happened of late is that we've seen the progress of that in terms of the opportunities we've looked at. We've seen that from a natural gas perspective, we are becoming more and more competitive, and hence our ability to prevail on two bidding processes, one here in Canada and of course, one in the U.S. We will continue to look at opportunities as they arise and again, continue to apply the same discipline we have historically, that if acquisitions make sense for Capital Power, we'll go forward and execute on those opportunities. If they prove to be not meeting our financial characteristics or not meeting our strategy, we won't pursue them.
It's more a case that, again, we seem to have become more and more competitive on opportunities, and as we look forward, if those types of opportunities continue to arise, you could expect to see more and more M&A activity. On the other hand, if they don't meet our criteria, you won't see any.
All right. Thank you for that color. That is appreciated. Moving on, and I realize that it's still early days, but how have the discussions and kind of framework for the Alberta capacity market, how are those shaping up versus your expectations?
I think your opening comment that it's early days is reflective of where we're at. There's been some, I'll call it modest consultation taking place. I wouldn't say anything that is overly indicative directionally. Again, not really a lot to comment on at this point.
That's helpful. Thank you.
The next question is from Andrew Kuske with Credit Suisse. Please go ahead.
Thank you. Good morning. Maybe just following up on the diversification and just the rigor that you put on your M&A activities and that they have to be accretive to CPX. Just wondering, just longer term, how do you think about the strategy in the U.S.? If we go back a number of years ago, you had the networked hub strategy, I think you called it, around the IPO, and trying to build up effectively regions of influence in certain geographies. Is that something that if all the conditions are fine from an economic standpoint, that's something that you would endeavor to do again?
Good morning, Andrew. Certainly, there is some value in having facilities close to each other. We are certainly finding that with our two assets in North Carolina and in Canada, too. Obviously, great efficiencies of having a significant amount of assets in Alberta or certainly in Ontario. That benefit continues to be there. Where we have opportunities that are in the same geographic regions, we see that as being quite positive. Generally, in those circumstances, we can see some synergies associated with, again, operations being close to each other.
Very helpful. Maybe just closer to home, in your home market of Alberta. We have seen maybe some signs of life in the Alberta power market that look interesting, that there has been fewer hours trading at extremely low levels. I guess, what is your read of this in the market? Is it some positive indications of the economy is back that are giving good support to demand? What extent is it weather? Maybe just some color around what you are seeing in the market activity right now.
Yes. Bryan DeNeve. We would agree, Andrew. We have seen some recovery in pricing in Alberta. There is a couple things we would observe. The first one is when you look at demand growth for electricity in Alberta over the first three months, it certainly was very strong, running around the 3.5% range on an annualized basis. You have strong demand following. We actually saw a little bit of negative demand growth in 2016. That is one positive. The other one is we are starting to see some clarity in terms of older existing coal-fired assets and the intent to shut down or mothball those facilities. We had TransAlta comment around Sundance one and two, and today we had Maxim comment around their Milner facility. I think that clarity is also as we see that supply exit the market, that is helping bolster pricing.
Just finally on that, given the signs of life in the market and everything starts to look more positive, does that change the dialogue you have with the government in relation to the market transition?
No, it would have really no impact from the perspective of, this is the energy-only market that we're referring to. Certainly, there's an element of energy in the capacity market that'll evolve. Certainly, it wouldn't have a significant impact on the dialogue. It actually has more of a significant impact with investors.
Okay. Very helpful. Thank you.
The next question is from David Quezada with Raymond James. Please go ahead.
Thanks. Good morning, guys. First question on the Decatur asset. Any additional operational detail or color you can provide there? Are there any synergies involved at all with that acquisition?
As you know, and we've indicated, we're under some degree of confidentiality around that acquisition. Once we close, which we continue to believe to be in the June timeframe, we'll be in a position where we can disclose much more to the market.
Okay. That's fair enough. Just my other question on the renewable side, your U.S. pipeline. Any commentary on how things are trending there? Are you still comfortable with availability of financing and power hedge opportunities? Are there any trends noteworthy there?
No, certainly, we still continue to actively bid in two to three of those opportunities at any given point in time. There's still an appetite in the market. In terms of financial capability, as noted in the materials, we still anticipate two development projects coming across the line the balance of this year. Certainly, we would expect at least one of those to be in the U.S. As we look forward, those are part of our capital allocation that we're looking to finance as we move forward in time.
Okay, great. Thank you. That's all I had.
The next question comes from Robert Kwan with RBC Capital Markets. Please go ahead.
Good morning. Just with respect to the new AFFO guidance range, just given you initially reaffirmed that range with the Decatur acquisition, I'm just wondering, what are some of the major drivers? Is it just at the time you just didn't want to have a new range, or was it the Q1 results, or is there something else as you think about 2017 that's driving the number?
Yeah. No, Robert, in hindsight, we should have included that updated range when we announced Decatur. We thought this just provided an opportunity to clarify that we're on track in accordance with our original guidance, and then the acquisitions are just adding to that as we move forward.
Okay. Maybe just to finish here, is there any kind of updates in terms of your potential involvement around the renewable electricity call? Just your expectations for that, given the number of renewable facilities that have already been permitted and ready for transmission connections.
Robert, in respect of the upcoming call, as you say, it will be very competitive. Our Whitla site, specifically, is an extremely competitive site with an excellent wind regime. Certainly, we think that there are some advantages being in Alberta that we can bring to bear. We expect to be very competitive in that first round.
Do you think that the call itself is shaped, probably is the wrong word, but kind of to your advantage or to your liking as it relates to location, and any advantages of being in the right places?
As we understand it, and the messaging has been very consistent, that there's essentially going to be two criteria. One is that from a transmission perspective, that it's at a site that you basically plug it in. Both of our sites, Whitla, in particular, meets that status. The second one is, as we understand it again, and it could change over time, but it's strictly economic. What is the price that you want to be paid per megawatt hour, over your production over the next 20 years? Again, we think we'd be very competitive from that perspective. Our understanding is that is the only two criteria.
Okay. If I can just clarify then on at least your understanding on number 1. Is it just that you need to be able to be physically connected to the transmission system, even if the transmission system itself is bottlenecked or has problems getting into the main grid?
That is our understanding.
Okay. That's great. Thank you.
For any further questions, please press star and one on your telephone. The next question comes from Patrick Kenny with National Bank Financial. Please go ahead.
Morning, guys. Just back on the M&A front here. You've been able to achieve, call it, mid-single-digit accretion on the last two transactions, in large part because of the dry powder you had on the balance sheet, as well as, in the case of Decatur at least, utilizing some old tax shield. Looking forward, if you assume a more normalized 50/50 debt equity split, let's call it, on the financing structure, and also a more normalized cash tax burden, just wanted to get your thoughts on whether or not you'd still be comfortable transacting on deals going forward, just given the strategy to diversify geographically or to continue ramping up your contract to cash flow profile, even if the transaction didn't result in near-term accretion.
Morning, Patrick. When you look at the issue of dry powder, certainly one of the elements around that, as you mentioned, was our tax situation in the U.S. We continue to have some capability to utilize tax shield in the U.S. I guess to put it in your terms, there continues to be some dry powder there. In terms of utilization of our balance sheet, we continue to have significant cash flow coming into Capital Power, which certainly we're utilizing for both greenfield and acquisition purposes as they would arise. Also what we've seen, and I think as you've obviously seen, there's been some significant appreciation in share price. The accretion criteria that we have, obviously as share price increases, becomes easier and easier to meet from a financing and from a shareholder result perspective.
Over this last year since December, the aggregate of analysts' expectations have increased over 10%, which again, gives us a currency that's much more conducive to generating accretive acquisitions.
On the contracted cash flow profile, I know that you guys mentioned over 80% contracted pro forma Decatur. I guess with Genesee 1 and 2 PPAs coming off at the end of 2020, is that 80% mark, is that the target that you're looking at heading into next decade as you bring on other contracted assets?
Yeah. Certainly we'll have a drop in contracted cash flow as the PPA expires post 2020. When we look forward and as we see more opportunities and continue to develop our pipeline of construction opportunities, we would see, coming into 2021 in the 70% range and that increasing over time in the next decade back towards 80%.
Okay, great. Thanks, Bryan. Just lastly, any update on the seven U.S. wind farms that you have, the PTC safe harbored, just with respect to timing of maybe locking down some PPAs there?
Yeah. We're still optimistic that we're going to see one to two of those come across wire here in 2017 with offtakes in place.
Just to confirm, I think back to Bryan's comment about you still have a little bit of tax shield in the U.S., safe to assume for now you'd be bringing in the tax equity partner. Your tax appetite isn't quite there yet?
That's correct.
Okay. That's all I had, guys. Thanks.
The next question comes from Jeremy Rosenfield with Industrial Alliance Securities. Please go ahead.
Yeah, thanks. Just one strategic question related to dividend payout, really, as you move forward with the higher sort of contracted cash flow profile. Has there been any thought at the board level in terms of altering or modifying the dividend payout strategy to give some of that cash back to shareholders in the form of a higher payout ratio over time? Obviously recognizing the balancing act between maintaining that cash flow for growth purposes versus paying that back out. Just your thoughts on that.
It is an ongoing discussion with our board and within management as to what is a reasonable payout ratio for our business going forward. As you know, we've indicated what our intentions are for 2017 and 2018, and those continue to be the same. We may have additional guidance at Investor Day of this year in December, or we may well continue with our guidance of 2017 and 2018.
Okay. It's on the table, but nothing definitive.
That is correct.
Just on Bloom, maybe a little bit more precision in terms of the Q3 timing. I'm just wondering if the current assumption is that it's going to be early Q3, mid Q3, late Q3. Relatively speaking, we're talking about a matter of months, but just if you're going to have any additional detail there.
Certainly, the original COD target was very early Q3, in fact, probably early July. The construction is going very well, we would expect there's a possibility that could move up into the June timeframe.
Okay, great. Thank you. That's it.
There are no other questions at this time. I'll turn the call back over to Randy Mah.
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.
Ladies and gentlemen, this concludes Capital Power's conference call. You may disconnect your lines. Thank you for your participation, and have a nice day.