Tidewater Renewables Ltd

TSX:LCFS

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen. Welcome to the Tidewater Renewables Q3 Financial Results Conference Call. [Operator Instructions] This call is being recorded today, Thursday, November 10, 2022.

I would now like to turn the conference over to Mr. Ray Kwan. Please go ahead, sir.

[Ray Kwan, executive]

Thank you, Michelle. Good morning, everyone.

On the call with me today is Joel MacLeod, Tidewater Renewables' Chairman and CEO but before passing the call over to Joel for a review of the quarterly highlights, I'll remind you that some of the comments made today may be forward-looking in nature and are based on Tidewater's current expectations, judgments and projections.

Forward-looking statements we express today are subject to risks and uncertainties, which can cause actual results to differ from expectations. Further, some of the information provided refers to non-GAAP measures. To know more about these forward-looking statements and non-GAAP measures, please see the company's various financial reports, which are available at tidewaterrenewables.com as well as on SEDAR.

With that, I will pass it on to Joel MacLeod for a review of the quarterly highlights.

[Joel MacLeod, executive]

Thank you, Ray. Good morning, everyone. Thanks for making time today.

Tidewater Renewables delivered another solid quarter of outperformance with adjusted EBITDA of $16.1 million in the third quarter of 2022. Net cash provided by operating activities totaled $5.2 million for the third quarter of 2022, with distributable cash flow of $9.4 million.

The corporation's base business continues to exceed previous guidance, with 2022 adjusted EBITDA now expected to be between $55 million and $65 million. Tidewater Renewables remains confident in our ability to deliver 2023 run rate EBITDA of $140 million to $150 million before any value from clean fuel regulation CFR credits. Management estimates that the HDRD complex has the potential to generate an incremental $30 million of run rate EBITDA from CFR credits, assuming a price of $95 to $100 per credit.

Renewables business continues to outperform expectations, where we achieved both the adjusted EBITDA and distributable cash flow. But we do also want to highlight today that consistent with the global economic environment, Tidewater Renewables is experiencing capital cost inflationary pressures as we resolve supply chain disruptions while adhering to the construction timeline.

Tidewater Renewables expects gross capital costs to be approximately 10% above the previously announced guidance of $235 million of gross capital related to the HDRD project. The executive team and entire Tidewater team is taking this overrun seriously and personally. These incremental costs are not expected to have a significant impact on the HDRD complex's economic returns as renewable diesel and British Columbia LCFS credit prices continue to remain higher than previously forecasted.

We continue to hold schedule with commissioning to commence in 90 to 120 days where renewable diesel margins continue to exceed our expectations. Further, Tidewater Renewables remains confident in delivering $150 million of run rate EBITDA once the HDRD facility is online. Again, I want to emphasize the HDRD project still expects to have an extremely attractive 2-year payback.

The cost increases are comprised of below the 3 main buckets. So one is pipes, valves and fittings, which relate to supply chain,, lack of materials, a custom mill run, having to occur in China for exotic mill remaining pipes, valves and fittings. Higher costs anticipated as we've been paying premiums to expedite production and ship the product to site. The second bucket would be engineering and mechanical and the third bucket would be electrical and instrumentation.

During the quarter -- back to the quarter. During the quarter, we made significant progress on our RNG business, including the completion of preliminary engineering and design of the announced RNG facility located in Foothills County near High River, Alberta. On October 17, 2022, we announced that we entered into a 20-year RNG offtake agreement with Fortis Energy BC where Fortis BC expects to purchase up to 100% of the RNG facilities design capacity.

Tidewater Renewables has also secured a long-term feedstock supply from our strategic partnership with Rimrock Cattle Co. We want to thank Fortis for all their support and look forward to growing our partnership with Fortis.

On October 24, 2022, we also announced the closing of a $150 million 5-year senior secured second lien credit facility known as the AIMCo facility with an affiliate of the Alberta Investment Corporation for AIMCo. The AIMCo facility initially bears an interest rate of 6.5% but is subject to scheduled escalations in year 4 and year 5 as well as inflation-based adjustments. In conjunction with the AIMCo facility, we issued 3.375 million warrants to AIMCo, each warrant entitles a holder to purchase 1 common share of Tidewater Renewables at a price of $14.84 a share, subject to certain adjustments for a term of 5 years.

Tidewater Renewables, all of us want to thank Mark, Matt and Ben and the entire AIMCo team for all their support, and we look forward to growing our partnership with AIMCo.

In August 2022, Phase 1 of our FCC coprocessing project was scheduled -- successfully commissioned ahead of schedule, and we began refining various renewable feedstocks, including those provided by the -- by our feedstock collection business, which is used cooking oil into renewable diesel and renewable gasoline. Final Phase II full commissioning of the FCC is expected to occur in 2023, but we do continue to co-process product through the FCC unit at strong margins.

As it relates to our renewable diesel, renewable hydrogen project, we again, we expect to be commissioning in 90 to 120 days and expect to deliver approximately $90 million of run rate EBITDA. We want to provide an update on the projects, so certain project milestones that were achieved in Q3, one completion, construction of 8 storage tanks, installed all pipe rack modules, completed liner installations for secondary containment, finished rail rack foundations and installed rail rack modules, installed approximately 80% of the equipment in the renewable hydrogen and reformer unit, completed the renewable hydrogen purification unit and shipped it to Prince George, installed utility buildings, including the electrical instrument air and firewater, pulled main power feeds from substation to new electrical buildings and stood up the flare stack. Again, we remain confident in our ability to more than double our current adjusted EBITDA over the next 6 to 9 months with the commissioning of the HDRD complex in the first quarter of 2023.

Our base business continues to materially outperform the majority of which is backed by 10- to 15-year take-or-pay agreements, and we do expect this to continue. Further, Tidewater Renewables continues to see material government support for various future renewable fuel initiatives and continues to be seen as a leader in clean fuels and gases within Canada and North America.

Thanks again to our staff, Board, shareholders, credit syndicate partners and all stakeholders for all of your support. We look forward to continuing to deliver strong results through 2022 and into 2023.

I'll pass it back to our Chief Financial Officer, Mr. Ray Kwan, and he will walk you through the financial highlights of our quarter. Thank you.

[Ray Kwan, executive]

Thank you, Joel.

As Joel mentioned, another strong quarter. Adjusted EBITDA for the third quarter of 2022 was $16.1 million, resulting in year-to-date adjusted EBITDA of $45.7 million. Our base plus growth assets continue to outperform with strong results from our logistics, marketing and storage, canola coprocessing as well as our used cooking oil collection businesses.

In addition, we were able to commission Phase 1 of the FCC coprocessing project, which contributed to part of the quarter. We also reported third quarter distributable cash flow of $9.4 million compared to $11.3 million in the second quarter of this year. The variance versus the second quarter is a function of higher interest costs due to draws on the senior credit facility to fund the HDRD complex through the summer construction season.

Total capital expenditures, including maintenance capital for the third quarter of 2022 was $58.2 million compared to $62.2 million in the second quarter of this year. 2022 capital relates largely to the construction of the HDRD complex but also includes the commissioning of the FCC and canola coprocessing projects, the engineering design of the RNG facility and the expansion of our renewable feedstock collection business. These expenditures were partially offset by funds received from the sale of BC LCFS credits awarded by the BC government for achieving milestones under the renewable diesel project Part III agreement, which totaled $11.5 million in the third quarter and $22.7 million year-to-date.

In terms of our financial position, we ended the third quarter with total net debt of $124.3 million up from $107.8 million in the second quarter of this year. On October 24, as Joel mentioned, we were pleased to announce the closing of the $150 million 5-year senior secured second lien credit facility with AIMCo. We are excited to partner with a respected strategic long-term institutional investor like AIMCo.

Finally, the proceeds from the AIMCo facility will be used to repay and extinguish the RNG credit facility and pay down the senior credit facility. The added debt capacity ensures that Tidewater Renewable has sufficient resources to simultaneously fund new growth projects and complete the HDRD project.

With that, I'll turn the call over to the operator to open up for any questions.

[Operator]

[Operator Instructions] Your first question will come from Justin Strong of Scotiabank.

[Justin Strong, analyst]

Just wanted to get an idea of what's coming up for construction activities, and I just want to get the near-term outlook for development of that HDRD facility.

[Joel MacLeod, executive]

Yes, no problem. Just, I don't know, Ray, if you want to jump in. I'll start, but Ray's welcome to jump in. We are heading out to Prince George tomorrow. So I'm excited to see the progress, but we do see updates daily, weekly. And I would say, to see construction 75% complete, all major process units either on site or within Canada and on route, Justin. We have a lot of confidence we're going to remain here on schedule. So what's remaining, Ray can probably speak to some of the details better than I can. I know our pretreatment facility is 80% to 90% complete. Our hydrogen units are -- I can see pictures of them in front of me right now, they're on site and/or on way to the facility, but it's more the commissioning process, which will start here in 90 or so days and starting to feed product through the pretreatment facility, the rail rack, the tanks and then into commissioning.

Where we're struggling a bit is on some of the smaller components, just given the lack of supply of specialty metals but we do feel through our network and the mill run, we are going to run, the small components aren't going to be an issue.

But if you ask kind of where is the risk, it would be around some of the very small components and just ensuring that we don't have to reengineer a small amount around a butterfly valve and convert it over to a ball valve, but none of the major equipment, major reactors do we have any concern as they're all either on site or within Canada and on route to Prince George.

But Ray, I'm sure I missed 1 or 2 pieces there. Anything you want to add?

[Ray Kwan, executive]

Yes. The only thing I'll add is that we've had close to 188 workers on site last week and expect that to peak at around 220 through December and January here. So as Joel mentioned before, all the tanks are done, secondary containment in place, rail rack installed. I mean those should quickly be commissioned in Q1 there.

And then in addition to that, the pretreatment should be next followed by the HDCR and then finally, the renewable diesel facility would be the last piece to be commissioned here in Q1.

[Justin Strong, analyst]

That's great. It sounds like things are going pretty well. Just one follow-up for me. On the -- so it's been a while since you guys IPO'd and laid out your initial kind of assumptions around the economics. I know you said that economics still look strong, but just wondering if you see any kind of like deviations from what you were thinking a year ago in terms of either like obviously, credit prices have strengthened, but like maybe feedstock prices? Just any color around that.

[Joel MacLeod, executive]

I think, Justin, there's a piece that the positives would be, there's more positives than negatives when we see diesel prices. Even if you look at diesel prices on your question 12 months ago to today, we're probably up $30-plus a barrel on the diesel price, which is helpful. The CFR, Canadian clean fuel standard credit, which obviously we talk about quite a bit in our IPO, we didn't model any value there. And obviously, being able to forward sell those credits at $95 and now $100 adds about an incremental $40-ish a barrel, should credit values hold there. So those 2 are very significant.

On the feedstock question, to your point, you'll see in our financials at September 30, feedstock prices were actually about the same as the IPO. That was a low. You'll see our mark-to-market was slightly negative. But since September 30, today, Again, you'll see the feedstock prices have moved up. We do have those hedges on. So those hedges protect us. We're about 50% hedged in 2023, 40-ish percent in 2024 and a small amount into 2025. So overall, the economics on renewable diesel have definitely improved, and that's why we want to hold the timeline and get this facility online and generate this large amount of cash flow.

[Operator]

Your next question comes from Robert Catellier of CIBC Capital Markets.

[Robert Catellier, analyst]

I just want to follow up on the cost increase. Judging from your comments, it was largely related to material costs. I'm wondering if you're seeing anything on the labor, FX or any other source of cost pressure?

[Joel MacLeod, executive]

Yes, you hit it on the head. Majority is materials, especially for our small pipes, valves and fittings that are exotic metals and finding these items that are typically off the shelf and having to have a custom outrun. The good news is the dollar amount is fairly small. It's not a $10-plus million type incremental cost as they're small components.

On the labor side, where we do have to look to reengineer around some of these small valves or component, there is an incremental labor cost, our rates have not gone up. So our team has done one heck of a job of locking in rates, working with our staff. I think from -- or even over the past 6 months, we said coming into winter if oil prices are $100 plus, I'd still say I'm a little nervous that our staff could get pulled away or poached onto other projects. If energy prices are back in that $100 plus. We haven't seen that, Rob, but just want to say that it's still a risk the same as it was 6 and 12 months ago.

Again, no one has been poached. We still have incredible people out there. Labor rates are locked in. But we have, in this 10% increase, we have included some allowance for the potential for there be some form of increased labor costs, but we are not seeing that right now.

[Robert Catellier, analyst]

Okay. You're kind of walking into my second question there. I'm just wondering how we can know -- how do you know the revised estimate is the right number? So I guess another way to say it is, what are you doing to manage risk on the balance?

[Joel MacLeod, executive]

So detailed board meetings, 2 days of board meetings, walk through in detail. What are we doing to lock things in? I think locking down labor, having control over those remaining materials, which we feel we do with a custom mill run and then double, triple checking. We have 4,900 components. We're double, triple auditing those items daily and just ensuring some of these small components that are specialty metals. We don't need to reengineer around them.

All the large components are -- we are highly confident we will have on-site and most of which are on-site today. So what are we doing to lock down all kind of the remaining risk? I think just continuing to stay on top of the project, going up to site tomorrow to just continue to motivate the team. They're in good spirits, whether it's -- I guess you're sitting in Toronto, but if you were sitting here in Calgary or in Prince George, we definitely want tourists here. We expected this, but just want to be there to support our team and continue to be on top of the project. But Ray, there may be some other pieces you can think of that we're doing to just minimize the risk of any further increases.

[Ray Kwan, executive]

Yes. Like -- I mean, to your question on like currency, I mean luckily, a lot of the assets, a lot of lipid components were ordered prior to the big drop that we saw from a currency perspective was and, let's call it, September, late September, overall. So I think we've mitigated that issue fairly okay from that side of things.

But in terms of what Joel brought up, I think labor is the thing that certainly that we're concerned -- not concerned, but see that as potential risk, I think, from our perspective wise. But at the same time, the good thing is we've locked in the unit labor cost, I think overall, it's just depending on productivity is kind of the key thing.

So again, what Joel has indicated, we are -- every week, we have a meeting in terms of talking about the HDRD project. We're ensuring that we have enough people and labor to actually functionally continue on and move forward on this project and accelerate and meet our commissioning and start-up timelines here.

[Robert Catellier, analyst]

Okay. Sorry if you've already touched on this, but how much has been spent to date? Or said another way, how much is left to spend on that project?

[Ray Kwan, executive]

So as of September 30, we've incurred about $195 million, and we're about 75% complete overall on the project.

[Robert Catellier, analyst]

Okay. Last question from me. I'm just curious as to why you're not including the CFR credits in your guidance? Or what's it going to take for you to have the confidence in the value there to address it in your guidance?

[Joel MacLeod, executive]

Yes. I think from day 1, even the IPO, Rob, which I know you were involved, we want to have some cushion just given the moves in the volatility in the components. Even the LCFS component remains strong. The diesel price has moved way more than we anticipated all out, but we want to just have some cushion and some allowance here.

And two, even with elections, politics, we don't foresee any risk on CFR. But for us to say we know with 100% confidence CFR values are going to continue to hold $100 of credit. The good news is since press releasing those 2 sales, we've had inbound interest and potentially even at slightly higher amounts, but there's just so many variables that we do not want to try and be over promotional. We want to have some conservatism and it's great that we have $30 million of incremental annualized EBITDA as cushion.

I've never had a project where you have $30-plus million of annualized EBITDA of cushion, and we want to just have that available.

[Robert Catellier, analyst]

I'll jump back in the queue.

[Operator]

[Operator Instructions] Your next question will come from Robert Kwan of RBC Capital Markets.

[Robert Kwan, analyst]

Just around the inflationary pressures outside of the specific project. Are you seeing similar trends, though, with some of your other projects? Or do you see this as more of a large project issue or Northern BC issue outside of, obviously, the components that you talked about?

[Joel MacLeod, executive]

Yes. It's a good question, Robert. I think if you read through the parent company, which I know you're well aware of, even on our maintenance CapEx, you'll see parent company saw a similar 10% type costs. So I think in general, oil and gas, when I talk to even the big producers, everyone in Calgary and Western Canada is seeing inflationary. I think there's a range of 5% up to 20% plus, depending on what it is. There's definitely a pull on labor. I would say our labor rates even an example would be in our board meeting yesterday, our auditors presented and mentioned a 36% increase in 12 months on their staff within our audit. We're not seeing 36%. I'm not trying to be -- to scare anyone, but I'm just giving you examples real time that we're seeing. We are very fortunate that we locked in our labor rates on this project.

So we don't see -- there's high, high unlikelihood that that rates could change within -- in the construction of HDRD, but I think you're asking across other projects. And maybe RNG, if we speak to our RNG project, I would say in general, a 5-ish percent increase, but we continue to be on top of those pieces as well. But it's really what's hit us here on this project is those exotic components, and North America is essentially sold out on a lot of those small components valves fitting. So we've had to set up a custom mill run, confident those will be delivered, but you focus on all the big items, which we have done a heck of a job, and it burns us to see that some of these very small components are actually resulting in the cost increase, but we're seeing cost of 5x and 10x for some of these very small valves and components that are specialty metals, which are typically off the shelf.

[Robert Kwan, analyst]

Got it. And I guess then with that, as the backdrop, does this change your approach to pursuing other projects, particularly as you get the renewable diesel facility up and running -- I said to that just cause you to take a step back and just let the cash come in? Or you still produce -- pursue projects here?

[Joel MacLeod, executive]

It's a really good question, Robert. I think you know myself, our team are typically pretty aggressive, but I would say definitely, our risk tolerance has moved down given the inflationary pressures and on this project, and we're taking it to heart. I still think we've done a hell of a job to keep it at 10%, but it still stings. So to your point, as we evaluate other projects, that government support is extremely helpful. And we do expect to see continued government support on future projects. But yes, we need to have more cushion contingency within the economics as well.

So yes, I would say our selectivity, our projects have to compete, and we have to pick the best projects and move forward. But it's unlikely you'll see us progress 3 projects at a time. And even that next project and the RNG project, potentially one after that, we're going to be very selective in our projects.

Then Ray, jump in.

[Ray Kwan, executive]

Yes. The thing that I would mention, Robert, is that I think our go-forward projects were likely to be sub-$100 million in terms of what we're looking at versus obviously, the $260 million HDRD project, of course. So I think we're trying to focus on more smaller bite-size type of projects, I think, overall versus kind of the mega projects that -- obviously, that we're trying to commission and complete with HDRD here.

So hopefully, that gives you a sense of how we're thinking about things.

[Robert Kwan, analyst]

Got it. And then maybe I'll just finish. Joel, you mentioned government support so along those lines. Was there anything in the Fed's fall economic update, just your general thoughts? Do you see it is creating opportunities, whether that's new projects, lowering risk or increasing return? Or do you think that maybe it just creates more competition as others want capital flow into the space?

[Joel MacLeod, executive]

It's a good point, Robert. We definitely, I would say, see more opportunity. But to your point, even the IRA, Inflation Reduction Act, I think it's -- and the inflationary pressures in Canada, it's reduced some of our competition in Canada. We haven't seen multiple IPOs, multiple projects. So we're excited. And definitely, we are one of the groups that would be in weekly, monthly discussions with both the federal and provincial governments. And what potentially is to come is very exciting for Tidewater Renewables. I do feel we continue to probably be the -- one of the parties that has received the largest amount of government support within Tidewater Renewables and also Tidewater Midstream. We do expect that to continue, Robert. We have multiple grounds. We've applied and continue to have dialogue. And I would say it's likely you're going to see in the next 6, 12 months incremental support.

And then the rules of the game as you're kind of heading, what additional grants government incentive is going to be their contract for differences. There's a lot of hydrogen wording that I'm sure you're reading as well. So we're pretty interested and excited about the next 2, 3, 4 months, but want to see the rules, the policy, the incentives before we get too excited.

[Operator]

Your next question comes from Nate Heywood of ATB Capital Markets.

[Nathan Heywood, analyst]

All right. Great. I just want to talk a little bit about CCUS. We saw that your parent company was awarded 2 projects, 1 at BRC, 1 at Ram River for CCUS hub. And just wondering, thinking long term, I know it's a ways out, but do you think that there is potential for drop-downs to Tidewater Renewables? Or how are you thinking about getting exposure from the subsidiary here for CCUS?

[Joel MacLeod, executive]

It's a really good question, Nate. As I hope you know, we try not to be too promotional. So we kind of thought should we put something in here. I think the key piece for those on the line is our [ F pool ]. So Tidewater Renewables F pool gas storage asset is at Brazil, where our parent company was selected for 1 of 19 CCUS hubs in all of Alberta. And our understanding is there was well over 100 applicants.

So the strategic value and nature of that asset is in the value of the parent company being selected as a carbon hub, but it's definitely significant to that asset. Just realize it's going to probably take years before we all know the rules of the game and the economics and even Robert's questions on hydrogen incentives that we think are coming in our other pieces are going to be another component.

So still lots of work to do. But to your point, it feels as though there could be significant even with the 50% ITC on CCUS equipment, we're definitely exploring low-capital opportunities and government incentives and the government continues to push us to be involved. So to your question, I think there's going to be a lot of opportunities to work with our parent company on various CCUS opportunities and the parent company is also an emitter, which is helpful to have an emitter where we can help reduce their footprint, their emissions with 2 approved carbon capture hubs.

So still lots of work to do. I don't want to -- we didn't put it in our releases for a reason. We don't want to come across as too promotional. But even the number of inbounds we've seen since the government selected Tidewater Midstream are significant. Other potential capital providers potentially come in at a promote.

So just a lot of work to do before Tidewater Renewables gets too excited, but definitely a material positive for us over the next 2 to 10 years.

[Operator]

There are no further questions at this time. I will turn the conference back to Joel MacLeod for any closing remarks.

[Joel MacLeod, executive]

Well, just big thank you to everyone for making time today, and please don't hesitate to reach out to us if you have any question, concerns. Thanks, everyone, and have a great day.

[Operator]

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask that you please disconnect your lines.