Brookfield Business Partners L.P. (NYSE:BBU) Q4 2017 Earnings Conference Call February 12, 2018 11:00 AM ET
Craig Laurie – CFO
Cyrus Madon – CEO
Geoffrey Kwan – RBC Capital Markets
Kane Ossorio – Yost Capital Management
Thank you for standing by. This is the conference operator. Welcome to the Brookfield Business Partners’ L.P. Year-End 2017 Results Conference Call and Webcast. As a reminder, all participants are in listen-only-mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]
At this time, I would like to turn the conference over to Mr. Craig Laurie, Chief Financial Officer. Please go ahead, Mr. Laurie.
Good morning, everyone. Thank you for joining us for the Brookfield Business Partners 2017 year-end earnings conference call. With me today are Cyrus Madon, our Chief Executive Officer, and Jaspreet Dehl, Managing Director of Finance.
I would, at this time, remind you that in responding to questions and in talking about new initiatives and our financial and operating performance, we will make forward-looking statements, including forward-looking statements within the meaning of applicable Canadian and U.S. Securities Laws. These statements reflect predictions of future events and trends, do not relate to historical events, and are subject to known and unknown risks. Future events may differ materially from such statements. For more information on these risks and their potential impact on our company, please see our filings with the Securities Regulators in Canada and United States and the information available on our website.
Brookfield Business Partners generated company FFO of $252 million in 2017 compared to $200 million in 2016. Our results benefited from stronger results in our business services and industrial segments, partially offset by weaker results at our construction operation. We reported net income attributable to unitholders for the year of $24 million compared to a net loss of $29 million in 2016.
Our industrial operations segment generated company FFO of $132 million in 2017, up from $6 million in 2016, as we benefited from the gain on the sale in January 2017 to Maax our bath and shower manufacturing operation. North American Palladium reported increased results in 2017. The company successfully implemented an improved mining methodology during the year, which resulted in over 30% increase in underground production.
Concurrently, palladium prices increased over $300 per ounce throughout the year, reaching over $1,000 an ounce in December. A combination of increased volumes and prices meaningfully enhanced NAP’s results.
BRK Ambiental our Brazilian water distribution collection and treatment business, which we acquired in April, began contributing to our 2017 results. Since we identified this opportunity two years ago, long-term interest rates in Brazil have declined from 14% to 7%, which should ultimately support higher valuations in this sector. We believe there will be considerable opportunities to expand BRK Ambiental’s operations, while achieving strong risk adjusted returns on capital.
In GrafTech, our graphite electrode operation, reported strong results in 2017, driven by increases in both graphite electrode pricing and volume, coupled with cost savings resulting from operational improvements we implemented since acquiring it. Cyrus will be speaking in more depth about GrafTech later on the call.
Our business services segment generated company FFO of $66 million in 2017, up from $54 million in 2016. Our results benefited from the positive contributions from our road fuels distribution and marketing platform, with the acquisition of Greenergy in May 2017 and Canadian gas station operations acquired from Loblaw in July 2017. We continue to build out this new platform with tuck-in acquisitions and we are in the process of rebranding our Canadian gas stations to the mobile fuel brand, which we expect to be completed by mid-2018.
We continue to grow our facilities management operations with a focus on building capability to handle large multi-site client portfolios and increasing specialist technical services. This business generates strong recurring cash flows from long-term customer relationships providing critical services to real estate owners. Subsequent to the year-end, we completed a small acquisition to increase our facilities management of data centers in United States.
Our real estate brokerage operations continue to perform well. Results in this segment were partially offset by lower results at our financial advisory business, which experienced lower — slower execution rate compared to 2016 during which, a record number of mandates were closed.
Our energy segment reported company FFO of $52 million in 2017, compared to company FFO of $63 million in the prior year. Our Western Canadian Energy Operations reported improved results over the prior year, with higher realized natural gas prices as a result of our hedging program at Ember, our natural gas operation and improved utilization rates at our oilfield services business CWC Energy Services.
During the fourth quarter, we acquired an additional interest in CWC from our institutional partners bringing our ownership to approximately 55%. We provided equity capital to fund its acquisition of C&J Energy Services Canadian division. We acquired Teekay Offshore, a marine oilfield services company in the third quarter of 2017, and it began contributing to our results. We expect Teekay’s Offshore contribution to increase in 2018, particularly as its growth projects are completed.
Quadrant, our Australian oil and gas operation continue to benefit from its long-term fixed price customer contracts for natural gas. It should be noted that 2016 results reflected our previous larger ownership of this company. Results were offset by a $16 million loss on the sale of Insignia, our smaller oil and gas producer in Western Canada.
Our construction services segment contributed $26 million of company FFO in 2017 compared to $94 million in 2016. We are repositioning our construction services operations amidst some industry and select project specific challenges, results were primarily impacted by underperformance in six projects, all of which were either completed in 2017 or will be completed in the first half of 2018.
Our operations in Australia and Europe maintained strong levels of activity where we have been consolidating our Middle Eastern operation. Given our financial strength, we are confident, we will continue to succeed with this business. We operate this business with virtually no debt, so even during this period of weak performance the business has considerable financial flexibility. We believe in time the business will return to more normal historical levels of profitability, but will results — but full results will not return until 2019.
We continue to win new work and our backlog has increased to $8.7 billion, as we secured five projects during the quarter. These included, The Address Residences Jumeirah Gate, a mixed-use development in Dubai, the first stage of the mixed-use Melbourne Square project in Victoria in Australia, which is valued at $380 million.
Turning to the balance sheet, in 2017 we raised $630 million gross proceeds in the capital market. We also increased our revolving unsecured credit facilities by $100 million for an aggregate of $750 million of available credit, all of which remains undrawn. Our intention at this time is not to utilize corporate debt, except as a bridge for acquisitions or working capital needs with longer term debt placed at the operating company level.
I’ll now pass the call to Cyrus to speak our strategy and growth initiatives.
Thanks verymuch, Craig, and good morning, everyone. 2017 was our first calendar year as a public company and we thought this would be an appropriate time to remind you of our goals and ambitions for Brookfield Business Partners.
Our goal continues to be to acquire, own, and operate best-in-class businesses, which will enable us to generate strong long-term compound returns, without taking undue risk. Our access to permanent capital and unrestricted ability to make any form of investment are major advantages.
First we can acquire businesses outright or acquire partial ownership in a business, both privately or publicly and we can make loans to companies or acquire their securities in the public markets, which will be especially beneficial during periods of capital market dislocation, when debt and equity prices are trading well below the intrinsic value of underlying businesses.
Second, we can build businesses over the long-term, both organically and through acquisition. And finally we can acquire businesses in need of repositioning, where our contrarian approach should enable us to buy them at meaningful discounts to intrinsic value. These businesses are often help for shorter timeframe, but have the potential to generate substantial returns.
Our objective in all our investing is to create value per unit overtime, which means that some of our investments may generate little to no cash flow or perhaps even incur losses in the early years. The returns from such investments will be generated through capital appreciation, rather than consistent cash flow growth. Our income statement will therefore look lumpy from time-to-time, but all with the goal of maximizing long-term wealth creation for unitholders.
We have made great progress since launching our company to evolve and strengthen the business and during the past year we deployed or committed $3 billion of capital together with our institutional partners to acquire high-quality businesses. Today our business has strong fundamentals, greater scale and is more diversified than it was at the outset of last year.
Our unit price appreciated by 43% in 2017, reflecting both the progress in repositioning our overall business, but also very strong capital markets. This return is beyond our goal to earn 15% to 20% on investments and we are unlikely to replicate this appreciation for extended period. That said, if we execute successfully, we believe the intrinsic value of our units will continue to increase over the long-term.
The acquisitions I referred to are all in sectors — are all in new sectors and some are in new regions. Apart from having great potential these additions to our business have the added benefit of further diversifying our activities, a trend we expect to continue. These acquisitions were BRK Ambiental, our Brazilian water services operation to 15 million people and our first investment in Brazil.
Greenergy, which is a leading road fuels distributor based in the UK with growing operations in Brazil, Canada and the Middle East. Together with our portfolio of Canadian gas stations, which we required from Loblaw in 2017, Greenergy forms the core of our road fuels distribution and marketing platform and we’ve already grown this platform with four tuck-in acquisitions.
Teekay Offshore, our marine oilfield services company providing fee base critical transportation and production services to high quality primarily investment grade counterparties. Operating in offshore oil regions of the North Sea Brazil and the East Coast of Canada. And we were awarded the largest Canadian concession to manage and operate three gaming facilities in the Greater Toronto Area, which currently generates over $1 billion in gaming revenue.
During 2017, we made significant progress in enhancing the capabilities of our emerging businesses. In particular, North American Palladium and GrafTech. Craig has already spoken about the improvements at North American Palladium, which we expect to be a strong cash flow contributor going forward.
The most exciting story to come out of our business last year is that of GrafTech. We acquired GrafTech 2015 at an enterprise value of $1.3 billion and equity purchase price of about $850 million. We invested $295 million for approximately 34% of the equity. Last year on this call, we reported negative results from this business with the downturn in the global steel industry and we’re in the midst of implementing our operational repositioning plan.
We were successful in generating about $100 million of sustainable operating improvements at GrafTech and today this business is a global leader. Concurrently over the year a global shortage has developed for graphite electrodes and its critical raw material petroleum needle coke, driving spot graphite electrode pricing to unprecedented levels.
Petroleum needle coke is the most critical material used in the production of graphite electrodes and is seeing increase demand for use in the production of electric vehicle batteries, as well as from underline increased demand for steel. This has resulted in graphite electrode producers’ experiences difficulties in securing sufficient petroleum needle coke for their production.
And this is a key to the GrafTech story because GrafTech’s ownership of a petroleum needle coke plant means it is the only large scale graphite electrode manufacturer with substantial vertical integration in petroleum needle coke production. Making at the only producer able to provide customers surety of long-term graphite electrode supply.
As demand for electrodes increase GrafTech adopted a new commercial strategy, which is the first of its current for this industry. The company successfully negotiated multiyear take or pay agreements for 60% to 65% of its production capacity over the next five years at a weighted average price of $9,700 per metric ton. To put this in perspective, this is about double the historical average, although for a variety of reasons we expect go forward average pricing will be higher.
With these contracts GrafTech benefits by mitigating the risk associated with pricing volatility. And as a result of these contracts GrafTech now expects to generate $260 million to $290 million of EBITDA for the first quarter of this year. And to generate significantly higher cash flows for at least the next five years.
Our successful repositioning of GrafTech has created an opportunity to start monetizing the business. In mid-January, the company announced its intention to complete a debt offering during the first quarter, as well as an initial public offering in the coming months. And we’re pleased to tell you that the debt offering is now committed and will return $380 million to Brookfield Business Partners. And I think we’re expecting that cash to come in, in sort of eminently.
This is well and access of the $295 million we invested to acquire our 34% stake in the company. Should the IPO be successful, we will receive additional proceeds at a valuation, which is a multiple of our original investment. These proceeds will fund a meaningful part of our acquisition activity in the coming year and a public listing a GrafTech gives us liquidity for our shares in the company in case we wish to recycle this capital into other opportunities. And we believe there will be many. The most recent of which we announced immediately following year-end Schoeller Allibert and Westinghouse.
In regard to Schoeller Allibert, we reached a definitive agreement together with our institutional partners to acquire a 75% interest in this company for €205 million. Schoeller Allibert is one of Europe’s largest manufactures of returnable plastic packaging systems with a product portfolio of over 1,000 types of returnable plastic crates. The company has a very strong competitive position serving a diversified customer base in attractive end markets.
The returnable packaging industry is growing from an increased global focus on sustainability, waste reduction, e-commerce and logistics automation. And we believe Schoeller Allibert is very well positioned in this industry. The Schoeller family will continue to hold a 25% interest in the business and upon closing in the second quarter of 2018 we look forward to working with them as a long-term partner. We also hope to replicate this partnership approach with family owned businesses in Germany and more broadly across Europe.
Moving on to Westinghouse, in early January we reached a definitive agreement together with institutional partners to acquire this business, which is an iconic American company for purchase price of approximately $4.6 billion. Headquartered in Pennsylvania, Westinghouse is a global leader in nuclear energy technology and market specialized infrastructure services to its utility customers to keep plant safe, reliable and efficient.
The company provides utility customers around the world with sophisticated engineering, maintenance, facilities management and repair services as well as plant components and parts. Westinghouse’s roots in the U.S. go back to the 19th century and it has been operating in the nuclear energy space for more than 50 years, helping the world to meet growing electricity demand.
Most of the company’s profit is generated from regularly scheduled services provided under long-term contracts. It generates stable cash flows and its services and products are critical to the success of its customer. Its technology is world class and there are opportunities for growth within both existing and new markets, as well as great opportunities to introduce Westinghouse’s AP-1000 design into many regions where nuclear capacity is increasing. To be clear, Westinghouse does not own or operate any nuclear electricity generation facilities.
In 2008, Westinghouse became involved in the construction of two nuclear electricity generation facilities and subsequently contracted to build these at fixed prices. Due to delays and cost overruns in the billions of dollars the company became financially insolvent and was forced to seek bankruptcy protection in March 2017. Westing exited the construction business while under bankruptcy protection and the business that we are acquiring will no longer have any obligation with respect to its legacy construction projects, nor will it be in the construction business going forward.
But for the company’s bankruptcy, a business with Westinghouse’s attributes would rarely become available for acquisition. Our goal will be to refocus Westinghouse on its core business of providing services and products to operating facilities. Under our sponsorship Westinghouse will continue to be a U.S. based provider of first class infrastructure services and cutting edge nuclear engineering and products to the company’s diverse global customer base.
As we begin the year we are optimistic for 2018, but with markets near record highs. We will be cautious in our investment approach. We are well positioned for further growth in any environment given our significant liquidity and flexible investment approach and expect to realize significant profits in our industrial segment benefitting from the value we’ve created in these businesses.
In closing, we’d like to welcome to David Court to our Board of Directors. David is a Director Emeritus at McKinsey & Company and was previously McKinsey’s Global Director of Technology, Digitization and Communications. Data analytics impact all of our businesses and we believe David’s extensive experience in this area will be invaluable as we grow our company.
With that, I’d like to thank you for joining us today and I’ll turn it back to the operator for questions.
We will now begin the question-and-answer-session. [Operator Instructions] The first question comes from Jeff Kwan with RBC Capital Markets.
Hi, good morning. My first question was if you can talk about the deal pipeline. I know you talked about investing by geography and what not there. But also maybe a little bit more specific, you made the reference with the Schoeller Allibert acquisition of potentially some partnering with families in Germany and the rest of Europe. Just wondering how significant opportunity that might be?
When we set Brookfield Business Partners up, part of our thinking is this company would be a great long-term home for other businesses that didn’t want to be public on a standalone basis. And I’d say over the last year and half we’ve met many, many, many potential companies that would fit very nicely into our business. So I can’t give you any specifics, but I can tell you, we have — we’re very active in our pursuit of this partnership approach.
And in particular, it seems to be resonating in Europe, where there is a very large proportion of family owned businesses that have global aspirations from where we can help them. Our pipeline generally, I would say it’s pretty well split across geographies there’s no one geography where we see much more activity and I would say that’s across North America, Europe, Australia — Australasia I should say. The biggest parts of the pipeline today by a little bit is probably North America and as we look at the type of business there’s a good mix of business service companies and industrial companies in that mix.
Okay, thanks. And then on the Ontario Lottery gaming investments, now that it’s closed, is there anything you kind of talk about up there, because I think you guys are in the development plans right now at the municipal level, but just if there’s anything you can share on timeline and any plan that you want to execute on that business strategy?
Yes Geoff — thanks for the question. We — I can tell you that, we’re in transition period, because we’ve taken over management of this — of the facilities now with our gaming partner. And we are working on development plans, they are subject to getting some municipal approvals. We can’t go into any specific figures unfortunately, because we have a confidentiality agreement with the OLG and on the procurement process generally. But we are moving ahead, everything is moving ahead, as we hoped, it would at this stage. And we continue to think this will be a great investment for us.
Okay. And maybe, if I can just make in one last question. On Multiplex obviously there has been those issues with certain contracts throughout 2017, but just thinking as you go through the first half of 2018, are you able to kind of directionally you think the results as you see them right now will be better than what you saw in Q4?
Look, as you know, we don’t give guidance. But I can tell you our thought is we should be returning to past levels of profitability in 2019 and beyond. There are some risks Geoff, which include, we are seeing a slowdown in the Middle East, we are seeing some supply-chain challenges in the UK and obviously we need to avoid the execution issues that we encountered over the last year or two.
Okay, great. Thank you.
Your next question comes from Kane Ossorio with Yost Capital Management.
Hey, guys. My questions revolve around GrafTech. So I know as of the September day, there is the general guidance that $500 in pricing would be $75 million in EBITDA. But, I know that was on 150,000 tons of capacity and you guys are expanding capacity. So I was wondering, if there was a new guidance that I can think about. And on capacity, generally if there were any plans to bring St. Marys [ph] back online or what the conditions would need to be to sort of make you guys do that $4 million to $11 million to bring it back online?
Sure, Ken this is Craig. I can answer the first part and then pass it to Cyrus for the second. In terms of the first part, Ken I’d probably guide you towards an 8-K that GrafTech put out two weeks ago, where they actually provided guidance for the first quarter of 2018 and laid out in terms of their production, their forecasted sales, their forecasted costs and all the other different measures. And that’s where they provided an operating profit forecast between 245 and 274.
And on St. Marys, look as you know the facilities currently idle, we have warm idle this facility, so it can come back online. And there is certainly enough electrode demand to run this facility, but there’s not enough needle coke supply today. And as I mentioned earlier in my comments, there’s a global shortage of needle coke. So we would consider restarting St. Marys if demand remains strong and we are able to source enough needle coke.
Got it, understood. And one last one, I guess it on the take-or-pay contracts, can I think of those as contractual, is it a penalty they pay, if they don’t take it or do they pay that price no matter what? And on the cash flow are you guys receiving 34% net cash flow flowing down to BBU to utilize overtime as well.
So what I would say the customer has to pay the full amount. These are true taker-or-pay contracts. That’s the answer of your first question. And the second question as GrafTech generates cash flow, like all of our business, we’re in a position to use that cash flow for many different things at the GrafTech level. And then if GrafTech doesn’t necessarily have a productive use for the cash flow it can choose to dividend that cash flow out or do whatever it needs to do.
Got it. Perfect, thank you guys.
This concludes the question-and-answer-session. I will now hand the call back over to Mr. Madon for closing comments.
Thanks very much for joining us. Feel free to call Courtney or any one on the team if you have further questions and otherwise we’ll speak to you next quarter.
This concludes today’s conference call. You may now disconnect.
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