Canadian All-Star Stocks: Dividend Increases – Week Of Oct.…

We are in the heart of earnings season and dividend growth is starting to ramp up. Not only are Canadian Dividend All Stars coming through for investors, but many in the gold industry are rapidly growing the dividend.

In one of my past updates, I wrote about the unappreciated dividend trend in the gold industry. They are quickly becoming relevant income plays, and are worthy of dividend investors’ attention.

Before we jump into what to expect this coming week, let’s recap the action from last week.

Of note, all figures are in Canadian dollars unless otherwise noted.

Recent dividend updates

Last week was the best week in terms of dividend growth since the pandemic began. First National Financial Corp. (OTCPK:FNLIF)[TSX:FN], Cogeco Communications Inc. (OTCPK:CGEAF)[TSX:CCA], Cogeco Inc. (OTC:CGECF)[TSX:CGO] and Waste Connections (WCN)[TSX:WCN] all announced a raise to their respective dividends.

Also last week, Brookfield Business Partners (BBU)[TSX:BBU.UN] announced it would acquire All Star Genworth MI Canada (OTCPK:GMICF)[TSX:MIC] at a price of $43.50 per share. Of note, Genworth is scheduled to release quarterly results on November 3, not October 27th as I had originally anticipated.

	EST DGR	EST Increase	ACTUAL DGR	ACTUAL Increase	NEW DIV
First National	3.08%	$0.005	7.69%	$0.0125	$0.175
Cogeco	10.00%	$0.0475	14.74%	$0.07	$0.545
Cogeco Comm.	10.34%	$0.06	10.34%	$0.06	$0.64
Waste Connections	13.50%	$0.025	10.81%	$0.02	$0.205

Let’s start with First National which not only surprised with a raise more than double its historical average, but also announced a special dividend of $0.50 per share.

Last week I questioned if the Office of the Superintendent of Financial Institutions (OSFI) – which asked banks not to raise – made the same request of other financial institutions. It does not appear that way which bodes well for dividend growth investors. It may also mean the OFSI has relaxed their stance, a rumor that was making the rounds after the banks last reported.

Cogeco and Cogeco Communications came through with their annual double-digit raises. The hostile takeover did not phase them, and Cogeco even came through with a larger than expected bump.

For its part, Waste Connections 10.81% raise was slightly lower than expectations. However, it does extent the company’s streak of raising by double-digits to 11 years.

Finally, SmartCentres REIT (OTCPK:CWYUF)[TSX:SRU.UN] – which we have been waiting on for a couple of weeks – kept the dividend steady. This was inline with our expectations as the retail industry has been one of the hardest hit during this pandemic. It is also why this week’s crop of All Stars are likely to deliver mixed results.

Upcoming dividend raises, cuts or suspensions

Granite REIT (GRP.U)[TSX:GRT.UN]

• Current Streak: 9 years
• Current Yield: 3.93%
• Earnings: Wednesday, November 4

What can investors expect: A rare dual-listed REIT, Granite’s focused on industrial, warehouse and logistic properties. The company usually announces an increase to its annual distribution along with third quarter results.

Granite is looking to extend its dividend growth streak to a decade. Over the course of the streak, the dividend growth rate has hovered in the low-to-mid single digits. At times, it has also been complemented with a special dividend.

The good news for Granite investors, is that the company operates in one of the few real estate industries that is doing quite well during this pandemic.

The company has a targeted payout ratio of 80% of adjusted funds from operations (AFFO). Through the first six months of the year, its payout ratio sat at 78% down from 83% over the first six months of 2019 thanks to strong AFFO growth (12.6%). Given this, the company is well positioned to raise the dividend next week.

EST DGR	EST INCR	EST NEW DIV
~5%	$0.013	$0.255

Canadian Tire Corp (OTCPK:CDNAF)(OTC:CDNTF)[TSX:CTC.A]

• Current Streak: 9 years
• Current Yield: 3.07%
• Earnings: Thursday, November 5

What can investors expect: Canadian Tire is one the country’s largest and most respected retailers. It has consistently raised dividends with third quarter results which will be released before the bell on Thursday.

Canadian Tire’s dividend growth rate has been on a steady decline. Last year, the company raised dividends by 9.64% which marked the first time dividend growth dropped to the single digits.

The question is, will the company reach a decade of dividend growth? Retail has been impacted in a big way by the pandemic, and there is a real risk of a second shutdown. If the company does raise the dividend, I’d expect another single-digit raise.

However, given the current environment it would not surprise me if the dividend was kept steady. It may be the prudent approach as retail is still facing considerable uncertainty.

EST DGR	EST INCR	EST NEW DIV
~5%	$0.0125	$1.20

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Disclosure: I am/we are long CDNTF, CDNAF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Source

In Defense Of Value Investing

I’m writing this note in response to an article by Professor Aswath Damodaran on his blog where he basically argues value investing is dead. The style should evolve to stay relevant. I disagree and believe value investing isn’t dead.

Lately, there are more and more calls that value investing is dead and buried. I don’t mean to single the professor out. This should be viewed as a general defense of value investing and not an exact rebuttal. But he’s a high-profile thought leader and his argument is well structured, which made it a great starting point for this defense of value investing.

This time value investing is supposedly dead, or at least in need of revival, because it’s based on investing in low price to book value or low price to earnings multiples. But also because the global economy has changed with ripple impacts on markets.

I self identify as a value investor. I’m not sure there’s a definitive definition of what a value investor is. I’m attracted to the investing styles of early Buffett, Klarman, Michael Price, Joel Greenblatt, and Horizon Kinetics, and these are just a few examples. I also take things from value investors with different styles like a Peter Lynch, Nassim Taleb or Andy Redleaf. But also from many investors that aren’t exactly famous or have a track record of insane returns over many years. They can still have great ideas or principles.

Not a precise definition – there are at least three ways of value investing that are widely practiced:

1. The academic way is to buy the stocks in the quartile with the lowest price-to-book or lowest price-to-some kind of profit or revenue multiple.
2. A practical way which is where value investors buy companies below what they perceive to be an intrinsic value.
3. A practical approach where value investors buy companies trading at (relatively) low multiples but not without discrimination.

Value investing has become too rigid

The first point the professor makes is that value investing has become too rigid and it’s focused on companies with significant tangible assets relative to their market value. But there are lots of value investors, if not most of them, that are more inclined toward earnings plays. The people that purely look at assets don’t have a job anymore. I consider myself an asset first kind of investor but I’ve decreased my allocation to the style because these investments just stay cheap for what seems to be forever.

Value investors don’t focus on dividends

In my experience, value investors do not focus on dividends. There’s some emphasis on the specific value provided by dividends. But over time value investors have come to understand the power of buybacks. Buybacks and dividends are in conflict. The value way is to favor buybacks over dividends. It makes sense, if you consider your company deeply undervalued right now, at this very time. You will favor capital return strategies over reinvestment strategies (except for the compounder sub-strategy). But that makes perfect sense because the baseline for capital allocation within companies is terrible.

Damodaran also argues value investors have been concentrating portfolios toward utilities, financial service companies, and consumer product companies. I agree value investors are betting on financial services. Both banks, asset managers, and other kinds are out of favor and generally quite attractive.

But utilities, I’m not so sure. I don’t see that many value investors, investing in utilities, except if the company is in bankruptcy or near bankrupt, like PG&E (PCG) or something. A few years back they were among the least valued names out there because the low-volatility factor was doing very well.

Dividends are not a key part of value investing. I think there are a lot of investors who really like dividends. And there’s definitely something to be said for them, but it’s such a weak signal I don’t think any well-studied value investor uses dividends as a major signal. Earnings yield or total shareholder return, that’s a different thing. Income investors, who want to receive frequent distributions, tend to gravitate toward dividends because these suit their needs.

Value investing is a religion

Damodaran also argues value investors have become ritualistic and he highlights the annual trek to Omaha.

I mean, I think there are some rituals, and discovering the value investing philosophy definitely can feel like having found religion. But Buffett and Munger certainly manage to say a lot of intelligent things every year. You can do a lot worse than going to an Omaha event and attending.

Many value investors that go beyond superfluous value investing develop their own style or brand. Even Warren Buffett has reinvented his style over the decades. He’s doing something completely different from what he was doing in his partnership days or early Berkshire.

I think Damodaran has a point that value investors can be a righteous bunch. But that’s not just true for some people within value investing. And I don’t think it’s that bad. Here’s a quote from him:

While investors of all stripes believe that their “investing ways” will yield payoffs, some value investors seem to feel entitled to high returns because they have followed all of the rules and rituals. In fact, they view investors who deviate from the script as shallow speculators, but are convinced that they will fail in the “long term.”

It’s a reasonable assumption to think value could do well from here. A lot of styles that are working right now like growth have terrible long-term track records vs. value. Because we’ve had a bad decade, should we disregard the last 100 years of data? Research, replicated in many different regions? Good luck with that kind of data and strategy.

Value investors can come across as righteous, pretentious, zealous, etc. I agree that can be annoying and it would be nice if we’d improve our attitude. I’m probably guilty of it too, I can be grumpy for sure.

If it’s any consolation value investors even disparage other “styles” of value investing. I’m not sure it’s unique to value investors though.

It’s hard to be a value investor, especially in times like these.

I can imagine a bit of zeal and conviction you’re style is “the one” makes it mentally easier to make it through the downturns without wavering. It’s so hard to stick to a strategy, with long dry spells, that surrounding yourself with people who are laboring away on that same goal can help. You are facing the same challenges and talking to others might help you not to pull a “Druckenmiller” who famously shoved $6 billion into the bubble of 1999. In his words:

I bought $6 billion worth of tech stocks, and in six weeks I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and I couldn’t help myself. So maybe I learned not to do it again, but I already knew that.”

A cult also can be dangerous and you can get caught up in a thought bubble. But it also has many advantages. Right now people are making tons of money, and value investors are not. And that really sucks. Professional value managers are getting fired. Almost every month there’s a sizable fund that liquidates. Flows are going toward the low-cost (and some expensive) ETFs and indexes. Taking money away from active management overall. This helps to keep the vicious spiral going. Clients continue to leave as results continue to be subpar.

I think the performance gaps have rarely or never been wider between growth and value. This is visible in passive strategies as well. Here’s the Russell 2000 growth (IWO) versus the Russell 2000 Value (IWN):

Data by YCharts

So, it’s natural that investors start to become a little bit more creative. If you are adhering strictly to something like a long value / short growth strategy, something very few people are capable of, you are getting trashed year after year. A lot of people are losing their religion a little bit. Maybe that’s right, maybe it’s wrong. I don’t know, but increasingly I see a lot of convoluted theories to explain why value investing isn’t working. I’m latching on desperately or cooking up reasons myself.

Now some argue the underperformance could be permanent. I’m arguing against one of these theories here. I believe it’s impossible to be a permanent state. At some point, all the value companies would be dead. At that point, the least expensive of the growth companies would be the new value companies. And if these die, at some point Facebook (FB) and Alphabet (GOOG) (GOOGL) will be the value companies opposing Amazon (AMZN) and Microsoft (MSFT). I guess, if Amazon eats the world it’s possible value never wins again. Only Bezos.

But it shouldn’t go that far. I can buy some stocks at five times earnings or three times earnings. If they do buybacks, and value investors love the buybacks, how are these going down? Companies that do a lot of buybacks are referred to as cannibals and they tend to have high returns.

At some point, free cash flow starts to reverse the gravitational forces that are pulling value down. If the disparity in valuation is wide enough it becomes increasingly difficult for growth to beat value yet another year.

The stock market is different from gambling in that the rolls of the dice aren’t completely independent. In the stock market, if you hold on to your dice, it tends to matter what you’ve been rolling in the past. If you’ve been on a hot streak, you are likely to continue to be hot. If you’ve been ice cold for the whole evening, chances are your fortune will turn.

I think it’s going to be fantastic to be a value investor at some point, but it does depend a little bit on how you define value investing. I can imagine a pure academic price-to-book strategy will never again deliver abnormal returns it has delivered in history.

I believe the reason value investing works so well is because the stuff that ends up being sold for non-economic (sometimes technical and most often behavioral) reasons ends up in its crosshairs. It also naturally avoids the companies that are most likely to become mispriced to the upside. It’s not so that value investors are superior at valuing businesses. The strategy exploits human nature.

Value and price

Here I’m going out on thin ice because Damodaran is the dean of value investing. I have incredible respect for his work. Meanwhile, I don’t spend all that much time on precise valuations. Damodaran argues value investors should make a clear distinction between value and price. He’s surprised that many value investors view discounted cash flow as a speculative exercise and rely on comparing P/E multiples from price to book value multiples.

Damodaran himself favors highly complex discounted cash flow models. I’ve seen him put incredibly complex and interesting models together. He does some very creative things and is the undisputed godfather at his craft.

My observations from studying great value investors who have track records over many decades is that often they fall back on simple metrics or use multiple methods. It’s not that Buffett can’t do a discounted cash flow model. Many investors rely on them for some type of business or have used them.

But experienced investors wield simple multiples knowing exactly what they are. They never use a single simple metric to determine whether to invest or not. Or rely on a simple heuristic of investing below 6x earnings or into the company within the industry with the lowest multiple.

That’s not how they do it. This is going to sound incredibly trite, but they study those businesses, they know exactly what they’re doing. They know how they performed throughout history. What’s causing them to have a bad year, what’s causing them to have a good year. They know when multiples are skewed, and why they’re skewed. When to look at one multiple vs. another one. When to look at normalized free cash flow. Free cash flow is like a favorite multiple for many value investors, but it’s very easy to skew it with some one-time, one-time event and that’s true for most of the multiples.

Value investors get a sense of what a company is doing. A sense of its immediate future. Then the multiple isn’t important. The entire financials give an idea of what kind of upside and downside scenarios are possible. There’s a tremendous focus among the greats on downside protection. Either by focusing on businesses where it’s hard to take a large loss from the initial investment or by focusing on businesses that will be extremely hard to disrupt. They may not do a discounted cash flow model. But if you get these decisions right and the right tail is uncapped you’re going to have some great outcomes even though you didn’t see them coming at all.

Value investors often buy when a company is at the lower end of the valuation spectrum. Sometimes only if they find the spectrum palatable to begin with. I actually think they’re often valuing the company very cleanly. Just understand the business. Understand the multiples. And they get to a decision

I’m sure there are actually a lot of value investors who do the discounted free cash flow models. But they are a lot of work to do reality any justice. All that time building those models isn’t spent working out other ideas. Can this company be disrupted or can I get impaired here? If you’re not buying bonds, the right tail tends to be free and clear.

I sometimes use models or algorithms to rank companies the way I like it. It works for me in bounded domains like M&A situations. There are only so many variables, and with every situation, you’re mostly looking at the same inputs.

But outside of that, I’m bumping into the strangest things in the investment landscape and so far I find it hard to capture all of that within a defined valuation framework. Most importantly, as a solo operator, I’m inclined to think it’s not worth it to spend enormous amounts of time on valuations. If it isn’t obvious, it isn’t good enough of an idea.

Value investors should embrace uncertainty

Damodaran argues value investors should face up to uncertainty, instead of avoiding it.

Many value investors feel uncertainty is bad, to be avoided. And this perspective kept them away from growth companies, where you have to grapple with estimates of profit in the far future.

I’d say value investing generally sticks to low multiple universes (admittedly increasingly less so) exactly because the practitioners don’t want to play the prediction game. That’s not to say they are afraid of uncertainty. Value investors often embrace situations where it’s uncertain how a business is going to turn around or how it will deal with controversy or scandal. Think Buffett buying American Express (NYSE:AXP) after the salad oil scandal.

But if you buy cheaply enough, when it does happen, the result will be good enough. Sometimes, a value investment turns around in ways I could never have foreseen.

There’s a famous value investor by the name of Mohnish Pabrai. I like his book called Dhando Investor. Pabrai says investors often confuse uncertainty and risk, and you should embrace uncertainty but avoid risk.

Value investors are completely fine with uncertainty, they’re just not fine with a lot of downside risk.

Investing in growth companies at multiples implying decades of high growth seems like a totally doable and interesting strategy at the end of a fabulous decade for growth. Historically it has been an extremely treacherous exercise. Some of today’s growth companies have long-term track records of outperformance going back to 1999. These have incredibly strong business models and competitive advantages and for the most part I’m not eager to bet against them.

Marc Andreessen famously said that “software is eating the world.” He’s been proven right and that emboldens people to pay higher and higher multiples for software companies. But not all of them have moats that are as defensible as that of Alphabet (GOOG) (GOOGL), Amazon (AMZN), Microsoft (MSFT) and Apple (AAPL). Tech makes up about 20% of the S&P 500 now Amazon and Alphabet are in other categories. What I mean to say is that software is now a much larger part of the market’s total value.

And software eats software too.

Value investors are not avoiding high-growth companies because they can’t value growth or deal with uncertainty. I personally love to invest in growth. I want as much growth as I can get. But if it comes in the package of a company that can get cut in half on missing earnings expectations by a few cents, that suggests to me I’ve started to play at a high stakes table in a highly competitive game. And I’m not sure who the patsy is.

Low multiple companies can be cut in half too, sometimes they go and die. But with many of the growth companies today it’s hard to tell where you end up if you misjudged barriers to entry.

It’s a misconception that value investors care a lot about tangible assets. They care about limiting downside risk. Tangible assets are an obvious way to get there.

We’re fine with losing money. It happens. But I view the strategy as fundamentally being about setting up asymmetrical trades, where it’s very hard to lose a lot of money. If you temporarily lose money, you have a higher degree of confidence things can turn around for you. Meanwhile, you have positions that have unlimited upside and you wait for the upside to materialize. That’s basically it.

I don’t think value investors need to expand their toolboxes to deal with uncertainty. They don’t need a lot of statistical tools and probability distributions, decision trees and Monte Carlo simulations. Warren Buffett and Charlie Munger know all about these tools. But “the back of the napkin way” is deliberate. Instead of spending a lot of time fooling themselves into thinking they are geniuses who have pinpointed valuation, they study businesses, review more opportunities, talk to people, think about mental models, and wander around. The recent reflection on value investing and criticism on Buffett (some say he’s washed up) reminds me of Aristotle’s story about Thales:

Thales, so the story goes, because of his poverty was taunted with the uselessness of philosophy; but from his knowledge of astronomy he had observed while it was still winter that there was going to be a large crop of olives, so he raised a small sum of money and paid round deposits for the whole of the olive-presses in Miletus and Chios, which he hired at a low rent as nobody was running him up; and when the season arrived, there was a sudden demand for a number of presses at the same time, and by letting them out on what terms he liked he realized a large sum of money…

One of the problems with all these tools is that you can become very overconfident in your process. You start thinking you got something down to a science and it’s very accurate. And those tools can have biases built in as well. I’ve seen intricate specialized models to value SaaS businesses. I’m sure the models worked really well for the last decade.

Models or valuation methods may get you into certain companies. To an extent that’s the point. Mine do for sure. And at some point, that’s not going to work either. I’m not totally against incorporating tools and models. I use both. But I view them all as highly fallible as well. If they help you cover your weaknesses, great! If they become crutches or hold you back from engaging your strengths – not so great.

The margin of safety is one example of a simple mental model. It’s basically an extension to the back of the napkin valuation. You do a back of the napkin valuation and then you discount it a bunch and in the experience of the greats, you’ll be good.

They prefer to hack the valuation but excel at the search process, sitting on their rear-ends when they don’t like the sums on their napkins and downside protection.

From time to time this may get one into too much cash. I can see the argument that may have happened to Klarman and Buffett. But if three years from now it turns out 2020 was an epic bubble, they will look like geniuses once again.

I think it will turn out terrible if it’s your permanent strategy to have a portion in cash. It’s completely fine if you opportunistically have cash.

But the point of it isn’t to keep you in cash. It forces you to keep evaluating ideas. It’s hard to find deeply-discounted ideas so you need to keep turning over those rocks.

I can see the argument that a margin of safety could lead to cash drag, especially as the market becomes more competitive. But instead of looking for more sophisticated tools, to fool yourself into thinking your competition can’t match these and you’ve gained an advantage, I’d favor looking for easier games. Spend less time building models and more time understanding businesses. Start investing overseas or less liquid markets.

Don’t focus on accounting

Professor Damodaran argues value investors focus too much on earnings and book value, that these accounting metrics play a central role in the investment strategy. He also argues there’s reason to trust those numbers less now than in the decades past and companies have become much more aggressive in playing accounting games using pro forma income statements. The center of gravity in the economy has shifted away from manufacturing companies to technology and service companies and accounting has struggled to keep up.

Value investing pays attention to those numbers because they have been audited. It’s a crime if you fudge too much with them. You can go to jail for that or get fined for it. Maybe they’re less trustworthy than in decades past. Many value investors have been arguing that accounting standards have to improve. That it’s ridiculous what kind of earnings metrics companies present. Like community-based EBTIDA and stuff like that.

But non-value investors are focusing on sales metrics, or margin metrics, or total addressable market measures. And those are way more susceptible to be manipulated. Maybe revenue not so much, except in a SaaS business or something. Good thing no one values a SAAS business on revenues.

R&D is understated in book value but I really don’t know a lot of fellow investors who invest based on book value in industries where R&D is a major expense. I’ve never heard value investors compare pharma or tech companies based on price-to-book. They’ll reserve it for banks, insurance or shipping companies where R&D is a rounding error.

Concentrated bets

The professor also argues against concentration. And I think he has a good argument that people concentrate too much. It’s hard to talk about this without having data but there’s definitely a trend among fundamental investors of focusing on their best bets. There’s also a cliche about a few eggs in a basket and then watch that basket.

I think many of these investors take enormous risks which they may not fully realize. They’re probably also maximizing their alpha if they generate any. If they don’t, they’re just increasing risk.

I’m supportive of the argument for diversification. But I do believe diversification is much better if you’re doing growth investing or momentum investing because the payoff profiles are different.

Growth and momentum have a lot more complexity in their positions. The individual positions also are much more prone to errors. They have payoff profiles where one winner makes up for everything and you can’t miss that winner. You still have to be selective in a way but it’s really bad if you miss huge winners.

Value investing is much more of a reversion to the mean game. And then you want to avoid losers. Like bond investors and put sellers. GARP investors, like Buffett, are in between.

In addition, I think that if you do great fundamental work where you really get an edge, that’s super time intensive. A momentum investor looks at some data or a graph and they’re done. Growth investing can be a lot of work as well. But you need to hold those positions for a super long time to get those interesting payoff profiles. So you become familiar with what you own, and it’s a smaller universe to begin with. There are a lot of mediocre value companies but high growth companies get all the attention because they are fairly rare.

These dynamics push fundamental value investors a bit toward concentration.

Value investors go for mature companies too often

Damodaran argues that value investors focusing on mature companies and precise valuation gets them on shaky ground. I don’t view value investing as focused on either. The core of the philosophy as I understand it is to avoid losing money while retaining exposure to large gains.

Value investing tends to avoid high-growth companies because of the uncertainties around their downside, not to mention they are often very popular with all kinds of investors which is not an efficient place to look for ideas.

Growth investors have a very limited universe to chose from. There just aren’t many high growers.

Value investors have a far broader universe. Naturally, their portfolios should be filled with mostly low-growth, no-growth or negative growth companies. Unless the market is somehow systematically leaving a lot of value in any particular category. It seems very unlikely that will be the high growth category…

Possibly value investors are spending more time on precise valuation as growth or momentum investors. Naturally, momentum investors don’t because it doesn’t matter to them. To growth investors, it’s not as important. I’m not a growth investor but I’d guess what’s really important to them is that growth can be sustained for a long enough time (growth investments where growth fades quickly unexpectedly are disastrous). The importance of initial valuation is dwarfed by the importance of getting the magnitude and especially durability of growth right.

If a value investor overestimates the initial value, that’s pretty bad because the initial investment determines the outcome for the most part.

My spin on value investing is that it’s most important to have a good sense of the downside. You need a solid downside quantification.

Investing is not a morality play

Damodaran argues that value investors believe morality is on their side and this leads them to underperform:

Investing is not a morality play, and there are no virtuous ways of making money. The distinction between investing and speculating is not only a fine one, but very much in the eyes of the beholder. To hold any investing philosophy as better than the rest is a sign of hubris and an invitation for markets to take you down. If you are a value investor, that is your choice, but it should not preclude you from treating other investors with respect and borrowing tools to enhance your returns. I will argue that respecting other investors and considering their investment philosophies with respect can allow value investors to borrow components from other philosophies to augment their returns.

My first investments were in China mutual funds, maybe 15 years ago. When I started to take it more seriously I started out with the premise markets are efficient. If you buy into the EMH you’re by definition skeptical of any investment strategy being able to beat a monkey and a dartboard. Value investing was the logical next step.

With every passing year, I’ve become more respectful of other strategies. I can’t agree more it’s absolutely worthwhile to step outside of the core value investing literature and look at what else people have come up with.

The danger is to start chasing performance in other strategies when they’re having a great decade.

Value investing is a very hard style to stick to for long periods of underperformance. There are many periods where your portfolio doesn’t do anything. It’s very out of favor. Often loaded with contrarian stuff.

It’s very hard to execute if you do not feel a little bit religious about your strategy because you’ll start wavering. And that’s when you really get killed. If I start momentum investing because that’s been the thing now. Just as the companies in the Russell 2k value trade at 12x earnings and those in the Russell 2k growth trade at 22x. And then I get killed next year and I’m switching back to value investing.

I remember the GFR pretty vividly as I was soaking up knowledge about investing. Prior to the crisis, there was a lot of talk about buy-and-hold strategies and not timing the market.

A few years and an illuminating experience onward in 2010 and 2009 everyone was a value investor. Everyone made investments only in sound balance sheets and everyone was looking for large cash balances. These companies were getting a bid. We’re 10 years further along and all those lessons (or bad habits however you want to perceive it) have been unlearned.

Death of value investing

With increasing frequency, the death of value investing gets called. Many commentators are wise enough not to use that exact terminology, but basically, that’s what they’re calling.

For value investing to be dead what needs to be true?

1. The academic way is to buy the stocks in the quartile with the lowest price-to-book or lowest price-to-some kind of profit or revenue multiple.
2. A practical way which is where value investors buy companies below what they perceive to be an intrinsic value.
3. A practical approach where value investors buy companies trading at low multiples but not without discrimination.

What needs to be true for value investing to be dead?

For that to be true the market needs to be efficient at assigning the lowest quartile of multiples. Essentially stripping the low-growth companies or high earnings multiple companies of any alpha.

The way I see it value investing means, you buy an earnings stream or collection of assets at a low enough multiple that you have quite a bit of visibility into the returns that are needed to get a good result.

To prevent value investors from outperforming the market must ironically be highly efficient at valuing the unexciting, declining and low-growth assets and earnings stream. There shouldn’t be companies that end up in the lowest quartiles, or troughs of the indexes because of non-fundamental reasons (like terrible oil spills, bribery scandals or affiliations to people that have fallen in disrepute).

Stocks never end up there through aggressive forced selling. Funds converting to ESG mandates may be puking coal stocks, but these coal stocks aren’t undervalued because ESG mandates are carefully calibrated not to forgo any intrinsic value even though that potentially speeds up their inflows.

I think it’s a great idea to explore investment strategies outside of the lexicon of Graham and Buffett. Munger would no doubt cheerlead the effort. But even if you don’t, I think value investing will be back, some day.

Bram de Haas writes the Special Situation Report. He looks at special situations like spin-offs, share repurchases, rights offerings and a lot of M&A events. If you are in a good mood follow him on Twitter here or reach out through email at dehaas.bram@gmail.com.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source

Aena S.M.E., S.A. (ANNSF) Q3 2020 Results – Earnings…

Aena S.M.E., S.A. (OTCPK:ANNSF) Q3 2020 Earnings Conference Call October 28, 2020 8:00 AM ET

Company Participants

Emilio Rotondo – Deputy CFO

José Leo – CFO

Conference Call Participants

Nicolo Pessina – Mediobanca

Elodie Rall – JPMorgan

Cristian Nedelcu – UBS

Siobhan Lynch – Deutsche Bank

Arthur Truslove – Credit Suisse

Patrick Creuset – Goldman Sachs

José Arroyas – Santander.

Stephanie D’Ath – RBC

Andrew Lobbenberg – HSBC

Nicola Mora – Morgan Stanley

Operator

Ladies and gentlemen, thank you for standing by and welcome to our Aena Nine Months 2020 Results Presentation. [Operator Instructions] I must advise you that this conference is being recorded today and now I’d like to hand the conference over to your speaker today Emilio Rotondo, please go ahead.

Emilio Rotondo

Hi. Good morning to everyone, and welcome to this presentation of nine months 2020 Results. Here we’ve José Leo, CFO of Aena; and myself, Emilio Rotondo. Well, I’ll leave the floor to José to start with the presentation. Thank you.

José Leo

Good morning, everyone and welcome to the quarter three 2020 results presentation. I’ll focus on the key highlights and then I’ll leave Emilio to deal with the business trends. As usual we’re showing the main parameters to show the performance over the quarter and till the end of September.

The passenger members fell by 68.7% and as you can see in the graph the size of the drop is different for the different airport senior group with Spanish network being the most severally affected with the fall close to 70%. Whilst the Brazilian group is the one which is facing the mildest decline that translates into revenue fall of close to 50%. As you will see later the relatively smaller decline in revenues is driven by the commercial revenue side of the business.

In terms of EBITDA a very significant reduction, 75.9% but that is still healthy and positive €560 million EBITDA given the circumstances. The debt result level we ran losses with the nine month loss totaling €107.6 million. Finally, the operating cash flow go down by 83% as well and the consequential debt is that the net financial debt to EBITDA reaches 5.5x which is more than double the usual level of this ratio. And we will comment on that later on as well.

Moving onto slide number 5, I’ll talk you through the main highlights, the main topics for discussion this quarter. Starting with the traffic I won’t make any more comments on that this is just rated 18 what you’ve seen the previous graph. What probably is relevant to you is to understand what are the latest trends, what’s going on around us and how we see the future of evolution. First of all, the expectation when submitting to the market the second quarter results was that this summer will show progressive, however, moderate but progressive recovery with every month showing better figures than the previous one. That was the case in July largely for August as well, but from the end of August onwards that trend was completely broken by the second wave of the pandemic and different restrictions, different actions taken by different governments particularly across Europe in response to that second wave.

So, from the end of August what we’re seeing is worst performance in traffic done we expect it and a performance which is worse than the performance we experienced in August itself. We’re running now at around 17% to 20% of the traffic for the same months in 2019 and I’m not, let’s say sharing with you any insight of information, this is something that you can see almost with a naked eye. That means that we expect the rest of the 2020, the rest of the months of 2020 to show clearly underwhelming performance that will lead us to a year-end figure that probably will be not very far from the existing one. So a total decline of around 70% give or take.

Full or not that means that there is no sign of recovery in the short term and there is no visibility at all as to when we can expect that recovery to kick-off. It’s very dependent on health considerations on health and medical developments, vaccines availability, remedies availability and as a result of that we don’t feel as strong enough to anticipate when that recovery come and show up.

In the meantime what is clear is that the international agencies that used to follow — that are following this evolution are reviewing their expectations down for instance, the ACI Europe figures or expectations for 2021 that were recently reviewed I believe it was the 10 October are going solved [indiscernible] so they are now pointing out that there was case done – pessimistic case that could evolve potential declines in 2021 vis-a-vis 2019 of up to 63%, so 63% of course, not the pessimistic case, I’m sure hopefully that would be the case. But what I mean is that they’re stretching the range of the scenarios to a point that 2021 in some cases could be potentially as bad as 2020 has been.

Of course, on the optimistic side of the spectrum I think they’re mentioning something like from memory it’s 37%, 38% decline. So my point here is, the point we’re trying to make is that we don’t feel we can share with you any meaningful view of 2021 at this stage and we don’t see any visibility as to when the recovery can start. But of course, we will share with you any information we believe is credible or meaningful if and when we have that information available.

The next relevant point here in this slide is the commercial revenue performance. The decrease in the commercial revenue is 19% year-on-year and that’s because we’re accounting for the minimal annual guarantee rent revenue in full. That is the way it should be taking into account two things. First of all, the way that IFRS 16 leases apply as long as you have contractual commitments, contractual obligations with your commercial operators they have to honor those commitments and we’ve reviewed those contracts long and hard and very deeply. So that’s the right way of accounting for these revenues.

Of course, there are two other considerations you have to make when accounting for those amounts. Consideration number one is, whether or not the application of different accounting standard which is the IFRS 9, financial assets that requires the assessment in terms of any receivables in terms of let’s say any impairment, any credit risks associated to that clearly you have to provide for that if and when you’re aware of that. Frankly so far, the credit risks implications in terms of provisions to cover these revenues are relatively small. Of course, they’re higher than previous year and you can see that in the P&L, but they’re not material. So there is no reason to provide for those amounts, there is no reason to consider any material credit risks associated to that.

Then second consideration is whether or not those minimal guarantee rents can be, might be affected by any commercial negotiation, any new commercial deal we can make with the operators. And of course that will be the case for — in any case when we achieve an agreement when we close the deal. But so far, no deal has been achieved with any of the operators. We’re in discussions, we’re in negotiations, negotiations are ongoing, I think they’re productive, I think in many cases the positions are increasingly closed, but so far we haven’t agreed or we haven’t signed any single commercial deal. So there is no reason to treat the annual guarantee rents, minimal annual guarantee rents in many of the way that we’ve to treat it then in this accounts we’re submitting today.

Then we can move onto the next slide, in terms of cost savings I think we’ve been successful. We’re satisfied with the outcome of the cost cutting plan. In the second quarter we’ve achieved savings of €127 million clearly less than the previous quarter for obvious reasons that we can discuss later on. But we’re keeping this plan in place clearly it is being adapted or is being adjusted as the traffic recover. But for the same token if there is any setback in terms of the recovery we will make sure that we keep the tension in the business and we keep saving to the extent that this is commensurate with the reality of the activity of the business on the ground.

The investment plan as you know was restarted and is ongoing, we keep investing and we believe this is the right decision for the time being. In terms of financing liquidity just to let you know that we hold cash on credit facilities available for €2.4 billion. Finally, for my section of the presentation, in terms of the debt covenants as we already announced back in July, we expect to breach the debt to EBITDA ratio at the end of the year and we’ve been in discussions with the banks and we’re making progress, over the coming weeks we’ve every expectation that we will get the temporary waiver from the banks.

And we’ve no other comments, Emilio will deal with them.

Emilio Rotondo

Yes. Move to the next slide that would be the traffic data. Well, on top of what José has already mentioned maybe highlight that Luton airport has had up a four months quite similar to what we’ve seen in the Spain. July and August was better than the Spanish network, but once this restrictions and new quarantines were announced in the U.K. the traffic went down and nowadays we’re in similar figures to what we’re seeing in the Spanish network.

Meanwhile in Brazil the performance is better than in Luton and Spain, as you may see up to September the traffic went down just by 53% and in October traffic is performing better than that rate so believe that the traffic performance in Brazil would certainly be better than what we’ve seen in the Spanish network and Luton.

Also highlight is, with regard to and we focus on the Spanish network highlight that the domestic traffic is performing better than international, I think that for obvious reasons – of the international traffic the European Union traffic is performing also better than long haul traffic due to all day, as I mentioned the restrictions and limitations we’re seeing from travelling from other countries outside the European Union.

Moving to the next slide, slide 9, the performance by business lines. The aeronautical P&L is showing the performance on traffic, if we in terms of revenue. Revenues fell by almost 64%, this was slightly lower than the traffic mainly due to a lower amount of incentives this year and also on higher amount in parking fees.

In terms of expenses you see that the expense has gone down by just 6.6%. This is because we have almost €28 million, in fact €27.5 million of extraordinary expenses related to COVID-19. And we also have included the impairment test of a multi airport of roughly €48 million. If we take out these two figures, the expenses would be down by 12% which is a figure similar to what we are seeing in the commercial line. And that’s also the reason why we see EBITDA margin that goes down by 9% versus the EBITDA of commercial that keeps and remains 81% not only because of the cut of expenses but also because of the revenues coming from the accounting of the minimum annual guarantees that have been already mentioned by José.

International area is also impacted by the traffic performance of Luton and Brazil and on the EBITDA level also by the €73 million impairment test impact on Brazil around last quarter that is impacted on the EBITDA values down to €-62.2 million. In fact Brazil during the last quarter had a very slight and small positive impact.

Real estate services going down by 14% on revenues, 7% in expenses and 19% in EBITDA is an activity that is a lot less impacted by the traffic performance let’s say is more independent on that part.

Moving to the slide number 10; the commercial business just highlights the two ideas here. First of all, the activities that have minimum annual guarantees namely the duty-free food and beverage specialty shops mainly have a lot lower impact in revenues than the rest of the activities just because these minimum annual guarantees that have been accounted during the period. That is you also see in this table that are in the amount of minimum guarantees is €456 million and also leads to an average commercial revenue per passenger of €11.72 per packs which clearly is impacted by these minimum annual guarantees and the lower number of passengers managed during the period versus last year.

On the international holdings, I think the most important ideas have already been mentioned. Luton impacted by the traffic performance also the worst traffic performance we are seeing now in October and that has impacted both revenue and EBITDA. In this case as you remember from June results, we don’t have any impairment test impact.

In the case of Brazil we have a lower impact coming from the traffic performance just minus 53% in terms of passengers as is clear last year, we didn’t have any of these concessions we are not accounting in the revenues and EBITDA which is coming in this year 2020 and EBITDA being impacted by €73 million impairment tests running in June and instead of the Colombian assets and the Mexican assets all the main performance comes from the traffic revolution.

And we end our presentation in this slide and we move now to the Q&A session. So please Operator if you can open the line. Thank you.

Question-and-Answer Session

Operator

Thank you so much. Ladies and gentlemen we will now begin the question-and-answer session. [Operator Instructions] And the first question comes from the line of Nicolo Pessina from Mediobanca. Please go ahead.

Nicolo Pessina

Yes. Good afternoon. First question is on the regulation. I would like to know if you can give us an update on the talks with the regulator about ARPU, in particular will you discuss the review as panned maybe in the next month and if so what should we expect in terms of tariff and traffic evolution?

Second question on the case factor. Looking at the reported per passenger numbers it seems like regulated aviation revenues are all performing, but stronger growth of [indiscernible] suggest the opposite. So can you give us an idea of the aviation in the regulated revenues and what should we expect for the K factor in 2022?

And last question on the renegotiation of the commercial contracts. I understand that you haven’t reached any final agreement yet. I wonder if it’s in-line with your expectations and if you can confirm that the renegotiation will be MPV neutral for the company? Thank you.

Operator

Please go ahead.

José Leo

Yes. Hi Nicolo. Well starting with the question on the DORA 2. DORA 2 process is expected to be followed in accordance with the regulations and the law which means that we have to submit our proposal by the end of the year. There will be consultations over the first quarter of 2021. Consultations with the airlines supervised by the regulator and the supervisor of the CAAI, sorry DGA, the direction general and the commission, the competencia. And then there will be as you may expect let’s say different views and discussions around it.

But I think it’s premature to say where this discussion will lead us is premature first of all because if normally this is a process that requires a number of iterations. This year this is probably going to be more so, the starting point is always the passenger forecast and I’m sure that will be a key element for the discussion. So I would stop short of telling you where this can end up. What is true is that the passenger forecast will be in any case completely different and significantly lower in terms of passenger numbers than it would have been one year ago.

Secondly that the investment plan is no doubt will be less ambitious, well ambitious is probably not the right word. It will be commensurate with the reality of the traffic. So it’s likely that the €1 billion per year plan that we had in mind and we discussed with yourselves a number of times won’t be any more on the table. Some of the key projects that were contemplated in that plan will go ahead because the sooner or later they will be required, but probably the timing will be different, the phasing will be different.

And very little else I can tell you because there is no even draft of any papers yet. So we are now in the process of pulling together information and submitting the plan by the end of the year. In the meantime, what is ongoing is the discussion or the consultation on the 2021 tariffs and that’s ongoing and progressing and with regard to the question on the K factor for 22 clearly the K factor in 2020 which is the relevant one for the 2022 tariff setting is going the other way around. Its showing concentration the yield in 2020 is being undergoing concentration rather than dilution. Until the end of September we have accumulated €95 million of yield concentration that we will have to return back.

We will have to give back to the airlines through the tariffs in 2022 and that’s not a surprise. When you have very little traffic the decrease in operations is less than the decline in traffic and there are some other elements of the airport charges that are still in place the consequence is that the revenue per passenger you achieve exceeds the one which is allowed by the regulation. So it is the matter of consequence of that. So there is no surprise on that.

With regard to the commercial discussions they are progressing, but clearly they are not easy. The conversations are difficult and there is a need to settle the dust and that takes time. But I feel that both sides generally speaking because this is a case-by-case situation. You cannot take a general view on that. Every operator is different and every one of them have their own interests and their own views. But generally speaking, the discussions are productive and I expect over the coming weeks but frankly it’s difficult to commit because you have, it takes two to tango. You have to I expect that we will be reaching in agreement. And of course as a result of those agreements some of the elements of the contracts will be tweaked.

Whether or not we will achieve the MPV neutral objective? Well this is a tough. It’s a tough thing. It’s a very tough thing particularly when you have today the situation has deteriorated further. So the expectations today are not the expectations three months ago because the pandemic evolution is worse than we expected and the traffic evolution is worse than we expected. So that’s a challenge to say the least.

Nicolo Pessina

I totally agree. Thanks a lot for all the explanations. Very much appreciated. Thank you.

Operator

Thank you so much. And the next question comes from the line of Elodie Rall from JPMorgan. Please go ahead.

Elodie Rall

Hi, good afternoon and thanks for taking my questions. First of all on the MAG quarterly reporting, you have already reported about I mean accounted for €456 million and I think you guided for €800 million for the year. So can you help us understand what we should expect for the last quarter of this year if it’s €200 million or €400 million providing that traffic stays as it is now? I think a little bit of explanation on the quarterly reporting would be helpful. So that’s my first question.

Second I’m not sure, I got cut a little bit, but I think you talked about tariff from 22 but what about tariff discussions for 21? Last time I think you said you expected flat tariffs for next year. Is it still your base case?

And last question on testing. What is your view basically on implementing the pre-departure COVID test given that it’s being adopted at other airports at the moment? Do you think it could make a difference on traffic? Thanks very much.

José Leo

Okay. Well, starting with the MAGs the €800 million, well €800 and something million MAG figure was meant to be the 100% of the MAG for the 2020, for the year as a whole. Clearly you only account for MAG to the extent that they are not somehow replaced by actual sales, by the variable element of the royalty of the fee. Clearly, in quarter one, we had significant revenues coming from the underlying sale activity. So there is no need to account for the MAG for that particular period of the year. Well, there is an element of MAG but this is quite limited. So the bulk of the MAG revenue accounting is driven by the quarter two and quarter three lack of activity so to speak.

If you look at the 20, at the quarter four without giving you any particular figure that we can give you later on if you wish in a more precise way. You can give or take, you can look at the same figure that in quarter two more or less. So clearly you can reach something in the range of €600 million, but the precise figure can be given to you by the IR team later on. Let’s say €600 plus million and that’s the amount of MAG that we are likely to end up accounting for recording. And then invoicing and collecting unless there is an agreement with the different operators to rearrange the contractual distances.

With regard to 2021, yes, the discussions are ongoing and I still believe there will be a flat tariff on that. That’s my expectation. We need to wait and see because ultimately that’s the regulator’s call. It’s not ours but that’s my expectation.

And then with regard to the pre-departure COVID test, honestly I will stop short of making comments on health processes and procedures or health decisions. Of course we have our view, but the most important part of our view is that we believe they should be consistent and common procedures applied at least by the different European Union countries. That’s what exactly is the solution in medical terms, I’m not going to comment on that. I might have my own view but that’s not relevant to this. But what is important is to make sure that we contribute to build the confidence of the passenger and we contribute to show the passengers that he or she travels across Europe in particular, they will find the same rules and the same routines.

I know there is a recently the European, the Council of the European Union released the paper recommending exactly the same and we are waiting for some instructions that my understanding is that they have been, they should be developed by EASA and the European body in charge of the pandemics and I don’t remember now the precise name but, so they will be, supposedly they will be issuing more detailed instructions, but we keep waiting for that.

Elodie Rall

Okay. Thanks very much.

Operator

Thank you so much. And the next question comes from the line of Cristian Nedelcu from UBS. Please go ahead.

Cristian Nedelcu

Thank you very much. Thank you for taking my questions. Two from my side if I may. So first of all, you are positive on an operating cash flow level in Q3 and this is before any cashing flows from MAGs, but could you help us understand at what level of traffic you would expect to reach free cash flow breakeven having in mind your current CapEx plans for 2021. So any type of indication there that could help us better measure that?

And secondly, a technical question on the MAGs. Some of your terminals are closed. Is it fair to assume that in this case you are not entitled to receive any MAGs related to the shops in these terminals and if that is the case out of the €600 million of MAGs for this year how much is related to shops in close terminals? Thank you.

José Leo

Okay. Christian with regard to the first question no matter how easy you think the mathematics are, I would ask you to wait and the IR team will give you the the precise numbers that I don’t have in my memory now. What is clear is that we are at very low level of traffic. We are able to generate positive cash from the operations standpoint clearly and that that means that let me dwell on that. That means that if the traffic levels remain really subdued over the coming months, the cash burn will entirely driven by CapEx. That’s I don’t mean that we are minded to stop investing, but what I mean is that can give us much more flexibility than we would have otherwise.

And then the answer to your question on those MAGs that were accrued over the period of time in which the facilities were shutdown. We have reviewed our contract in detail and our conclusion is that we are entitled to invoice and to charge and to collect all the monies regardless of the closure. So that’s a contractual right. On the back of that we are accounting for those revenues and believe me that’s the discussion, a very, very deep internal discussion and a discussion with the auditors and so that we are doing what is meant to be the right thing under the accounting rules. But of course that doesn’t mean we are, I would say, people minded to ruin the life of our operators. We are discussing with them different avenues. So we are minded to help them to help us. But in the meantime those revenues are legitimately recorded and we are entitled to recover them in full.

Cristian Nedelcu

Understood. Thank you very much.

Operator

Thank you very much. And the next question comes from the line of Siobhan Lynch from Deutsche Bank. Please go ahead.

José Leo

Hi good afternoon. Thank you for taking my questions. Just a couple from me please. So firstly the winter season is now due to be, I guess weaker than was expected back at the half year. In terms of kind of cost savings and the opening and closing of infrastructure, traffic at some of I guess the smaller airports in winter is usually low but probably going to be much much lower this time around. Could we see any closure of some of the smaller assets in Spain? And then, I guess similar on the bigger airports in Madrid and Barcelona could you just run us through the kinds of operations you have currently and if you’re channeling passengers through kind of only one or two terminals and just kind of your flex from that perspective on cost savings?

And then kind of next question on cost savings, in Q3 I think we can see that you’ve made some good progress. I think specifically on other operating expenses they seem to be down quite a lot for Q3. We don’t get the split at the nine months in terms of what’s driving that. So any kind of color you could give on that would be great?

And then just finally on MAG. Is there anything you’d be able to comment on whether the movement towards a kind of per passenger basis of MAGs is something that you’re considering? Are you negotiating that at all at the moment? And what could that mean in terms of your ability to kind of collect the MAGs that you’ve recognized? Thanks very much.

José Leo

Well, starting with different actions we are taking or we could potentially take on the cost saving side. Clearly, we don’t rule out anything without commenting on any particular measure, any particular decision. We remain vigilant if there is a need to tackle a really poor scenario such as the existing traffic levels remaining in place for many months to come. We don’t rule out anything at all from closing facilities to clearly addressing again our suppliers to move backwards. And I believe that we have proven that we are able to achieve the savings we target.

As you are mentioning in your second part of the question particularly in terms of the other expenses, the other general expenses which is the universe of costs that we are targeting, we have been targeting mainly more than internal costs or staff costs as you know. So, we have been able to deliver that. So, we remain absolutely confident that we will be able to do it again.

On the other hand I want to mention that in some of the contractual, in some of the new tender processes that we are now conducting, we are introducing in the tenders conditions, new features, new conditions along the lines of being able to suspend partially or totally the services provided by any particular supplier when the traffic goes down by a certain amount. So we are introducing elements of viability. Of course that will come with the cost because nobody will take more risks for free. But that will help us going forward because some of those contracts are being awarded as we speak. Some of them are very, very big ones like the security contracts.

So as a combination of our let’s say pre-tested cost cutting experience plus the new features in the contracts, we believe that we will be in good shape to deal with a very protracted let’s say worst case scenario. That hopefully won’t be the case.

I don’t know if I’m missing something else on that let me know otherwise and then on the MAG. The MAG, the discussions on the contractual terms and conditions are dealing with everything. We are not closing the door to anything that can help the operator to commit long-term and to make sure that long-term the conditions are not impacted and they really keep committed to the contract. So short term we can contemplate all sort of solutions including, I don’t deny that. Potentially the application of per passenger MAGs on the short term, only in the short term.

Siobhan Lynch

Brilliant. Thank you very much.

Operator

Thank you.

Emilio Rotondo

Sorry Siobhan, just to highlight that in the report, we publish the management report on page 28. You have the detail on the evolution of the different lines under the other operating expenses. In any case that if after reading that that part if you have any other doubt or additional doubt please contact us.

Siobhan Lynch

Brilliant. Thank you very much.

Operator

Thank you very much. And the next question comes from the line of Arthur Truslove from Credit Suisse. Please go ahead.

Arthur Truslove

Hi there Arthur Truslove from Credit Suisse. First question from me, just on the debt covenants. Obviously, you’ve been sort of consistently optimistic that you will achieve a temporary waiver on those and I guess my question is really at what point would you become more concerned if you are unable to reach agreement?

And second question on the minimum annual guarantee revenues gain. You clearly had €456 million of revenues year-to-date and are you able to give us any idea sort of how much cash you are actually expecting to receive in respect of that and if you do reach agreement with your concessioners, is it realistic to believe that you then would be impairing the receivables that you have put on your balance sheet so far?

And then third one from me, I think from your management report that you have incurred €28 million of COVID specific sort of safety and security cost and at what point you are able to start adding those back to the tariffs? Thank you.

José Leo

With regard to the waiver I have every confidence that we will get waiver in place. Simply this thing take time. Believe me I don’t have any concern about it. It’s clear that banks are now dealing with waiver requests let’s say in every corner of the globe, I will say. So they are busy, but there is no doubt that Aena, if they are agreeing to waivers with much more complicated animals, you can imagine that Aena that will have no trouble at all in dealing with the maturities and debt service won’t be an exception. So I am absolutely confident that we will achieve that over the coming weeks.

In terms of the MAGs, let me tell you because probably the terminology here is relevant particularly from the accounting point of view. We are accounting for the MAGs and we expect to collect them in full and when we expect to face any problem with collections, any credit risks in that case we will impair that particular amount which is what we have done in quarter three already. But if you look at the figures, the total provisions in the P&L are €15.2 million. That means that the result of that impairment exercise is not very material. We will do the same again at the end of the year with any minimum guarantee rent which is about to be invoiced collected. So that will be what you call impairing the receivables.

Different story is in those cases we reach a commercial agreement, a commercial deal. I wouldn’t call that impairment that will be restructuring of the contract and as a result of that there will be a need to rearrange the accounting of the revenues. And under IFRS 16 that can be relatively complicated in the sense that let’s say for the sake of argument, if we agree as part of the particular deal to waive a certain amount of minimum guarantee rents that won’t be hitting 100% 2019, sorry 2020 that will probably, probably and I don’t want to anticipate any particular information that could be probably spread across the life of the contract. That won’t be an impairment. That would be contractual restructuring and as a result of that let’s say the accounting will be adjusted accordingly. But this is just once again academic. The important point though is we have the right to collect those minimum guarantee rents. And every month we will be accessing whether there is a need to impair any of those amounts. So far, the conclusion is that the need for impairment is limited to relatively minor amount of rents.

And then I’m sure I’m missing something.

Emilio Rotondo

COVID expense.

José Leo

The COVID expenses, my understanding is that they will start being, clearly as they are incurred in 2020, clearly they will be affecting the tariffs of the second next year that will be 2022. So certainly that will mean that those costs will be contemplated in the DORA 2 discussions, but we are protected by a law in that regard. So we are absolutely relaxed and confident.

Arthur Truslove

Great, thanks. Just following up very quickly on the MAG again so what you’re really saying is that there might be a period of time in subsequent years for which the amount of revenue accrued could be less than the cash that you receive on the basis that you’ve already accrued some of the revenue in 2020, but you’re probably not going to get paid for it for a little while. Is that fair?

José Leo

No. Well, you mean after a commercial agreement has been reached or just as — because any minimum guarantee rent.

Arthur Truslove

I mean after a commercial agreement is reached. So let’s say recognize the revenue in the second and third quarter you then reach commercial agreement which brings that sort of down if you like. My question then is, given that you’re not writing that revenue off does that then mean that you’ll sort of recognize less revenue in respect of 2021 or 2022 or whichever year and then receive more cash for that fund?

José Leo

Yes. Certainly, this accounting will give rise to a divergence, I don’t know whether that will be material or not, but the divergence between revenues and cash definitely. You know, what I mean.

Arthur Truslove

Yes. Absolutely. Yes. Thank you.

José Leo

Thank you. That’s not helpful obviously from an intuitive point of view.

Operator

Thank you so much. And the next question comes from the line of Martin [indiscernible] from Bank of America. Please go ahead.

Unidentified Analyst

Yes. Thank you. So firstly, since the last conference call in Q2 have there been perhaps any discussions with airlines in terms of potentially granting further commercial discounts or incentives to airlines given the deterioration in traffic outlook and do you think it could be in the interest of the company to perhaps incentivize traffic in the recovery phase?

Number two is on CapEx. It looks like CapEx is now much more normalized. So do you expect traffic for Q4 and for 2021 to be roughly in-line with what was in the DORA 1 determination?

And thirdly apologies, just following up on MAGs. My understanding was that you receive a significant amount of cash typically for MAGs for your partners in Q1. So is that the case and on that basis would you expect to have some progress in those negotiations about MAGs so that there is better clarity on cash to be received by 2020-2021?

José Leo

Okay. Thank you, Martin. Well, your first question is absolutely on time because yesterday the Board of Directors approved and I think today has been published in a number of papers a change in our incentive scheme. I don’t know if you are familiar with the scheme, we approved some three months ago, two months ago where what we were trying clearly the previous incentive schemes made no sense in the COVID environment. So we approved this scheme involving incentives to operations. Regardless the number of passengers, we were incentivizing the airlines to add capacity, to add aircraft in operation with the number of thresholds. So, we were committing incentives provided they reach a number of thresholds.

Okay. That scheme has been in place what’s meant to be in place until the 31 March 2021 covering both the summer 2020 and winter 2020, the reality is that we have realized that in the current circumstances that the scheme would be completely useless. While they managed to earn some €50 million in incentives until the end of August, in September and within October where we were heading for close to nothing. So we changed this scheme and yesterday we approved a new scheme in which we are providing incentives to operations regardless with no thresholds at all to the extent that they get over the 20%. So they put in place more than 20% of the operations of the same month in 2019. They will start earning the incentive.

The incentive roughly means that if they any airline operating 30% of the total number of operations they run in the same month of 2019 will earn 30% of incentive then if they operate 40% they will earn 40% of the incentive and then so on and so forth up to 100% of the incentive always applying on the landing element of the airport charge. The landing element of the airport charge is roughly 25% of the total airport charges. And we believe that’s much more consistent with the reality we are living through and that will be a good help to the airlines and we are very pleased to announce that.

Clearly, we didn’t include it in the presentation today because it came at the same time and honestly speaking we don’t expect that to have a material impact. But if it has a very material impact for instance if they reach 100% of the operations of 2019, we will be more than happy to celebrate that. But we are helping in a way that we believe is meeting the needs of the airlines at this moment in time. Then CapEx. Well, CapEx you mentioned something that confused me a little bit. You said that whether we expect traffic in Q4 and 2021 to be.

Unidentified Analyst

The question is just what do you expect for CapEx, for maintenance CapEx for Q4 and 2021. Is it in line with your original projections from the DORA document?

José Leo

Exactly. Remember back in July we said that we were restarting the investment plan and clearly we wanted to catch up because the plan was halted for three months. So our intention is to catch up and to deliver the entire CapEx commitment for DORA 1. Clearly, we keep an eye on that as you can imagine we need to monitor what’s the situation of the traffic. I don’t mean we are going to be, I don’t know if you like coming hello or hi, we are going to keep the same position. If the poor traffic figures remain in place for many, many months we will see. But for the time being that’s our commitment and our objective.

And then in terms of the MAGs. We can think of two different scenarios. Scenario number one with any operator that by the end of this year or by the time we are due to invoice and charge the MAGs, with any operator we haven’t reached an agreement we will send the bill. We will send the invoice and we will charge the MAGs and we expect to collect them in full. For any operator with which we have achieved an agreement, the agreement will apply and as part of that agreement, I’m pretty sure at least partially the MAGs that were due for January next year won’t be due anymore. But that will be on a case-by-case basis.

Unidentified Analyst

Very clear. Thank you.

Operator

Thank you so much. And the next question comes from the line of Patrick Creuset from Goldman Sachs. Please go ahead.

Patrick Creuset

Hi, good afternoon. Just one question for me if we can come back to your thinking on the DORA. So to just have your thoughts basically on some of the parameters I mean, do you for example see K to argue for higher costs of capital in the current contract type of stuff equity and do you actually see a way to possibly even ask for higher aviation fees in the next DORA despite the cap you have in place until 2026? And do you see potentially also a mechanism to reclaim some of the losses or under during the COVID period 2020/21 basically for the next DORA system for credit?

José Leo

Okay. You want me to show the cards. Well, I am being serious. I don’t think it would be sensible and indeed clever or smart to discuss some of these things because we will need to submit our proposal in due course. Until then we have time to run scenarios, to review figures, to update our position with the latest information particularly now that things are evolving very, very rapidly. And so I’m afraid, I won’t be able to answer any of your questions. But at the same time I won’t rule out anything.

What is true in my view and this is a general comment is that the level of risks that this business carries is higher than many people thought one year ago. So these things should be reflected in the right way. I’m sorry.

Patrick Creuset

I understand. Simply in terms of mechanics do you actually see a procedural way to get around the cap on raising tabs in the next DORA because I think the cap for 2026 specific procedure, do you see a way to for example get a credit under or to raise the fees apart from the negotiations?

José Leo

Well I think, initially the only element of cost that could support any scenario of let’s say exceeding the cap would be the COVID related costs by the legislation approved some months ago, stated very clearly that the cap won’t apply to any COVID related cost recovery process. Beyond that I’ve frankly struggled to see that change. But I don’t think we will need it. Honestly I don’t think we will need it. Because the driver for everything will be the passenger forecast and if the passenger forecast is really, really awful, the investment plan should be commensurate with that pretty bad scenario. So I believe it would be probably wrong to preempt that we will need to exceed the cap.

Patrick Creuset

Okay. Thanks very much.

Operator

Thank you very much. [Operator Instructions] And the next question comes from the lines of José Arroyas from Santander. Please go ahead.

José Arroyas

Just a couple of questions. First one is on taxation. The Spanish government announced for 2021 yesterday and there appears to be some confusion on whether there will be new taxation Spanish corporate particularly on dividends. Does Aena have assessment of what these might mean for the company? That’s question number one.

And question number two on the MAGs. If you can give us some flavor as to what categories of retailers are being harder to negotiate with, is it the food and beverage retailers, is it specialty shops I mean if you can qualify that that would be helpful? Thank you.

José Leo

Okay. Our understanding, our assessment of the changes in taxation is that there will be close to nothing, there will be close to no impact on us. The point you mentioned on the taxation on dividends from subsidiaries, we understand that in practical terms what will happen is that they will, there won’t be any more, there will be no 100% relief on that. There will be 95% relief on that. So in practical terms the impact is not material at all. And the rest of the changes in the taxation landscape are not very relevant to us. So no, the answer is, we don’t expect at this stage any relevant impact to come up.

With regard to retailers yes there are some people more difficult than others, but I am not going to share that with you. I am afraid José.

José Arroyas

Alright, thank you.

Operator

Thank you so much. And the next question comes from the line of Stephanie D’Ath from RBC. Please go ahead.

Stephanie D’Ath

Hi, good afternoon and thanks for answering my question. The first one is on retail outcome. You remind us of the average length of the contract and how big the biggest retailer is and am I right to understand that your negotiation on commercial agreement would therefore cover the remainder of the contract probably the years to come?

And the question to that is how long the retailers has to pay MAG between the moment it’s built and is it the quarter and how long, what’s the time line between I guess the quarter receivables and the payment?

And certainly in terms of 2021, would you see to expect to be able to breakeven or book positive operating cash flow and what about free cash flow?

And then last question is could you please give us bit more of understanding on the third party contractors to which extent can you flex those contracts today and I remember well this quarter high number of people working at the airport within the infrastructure which are not contracted by Aena but those third party contracts and to which extent can you just get those on because my understanding was that you had been negotiated a lot of third party contractors for the years to come and I would have thought that those contracts right therefore will not really negotiable in the near term? Thank you so much.

José Leo

Sorry Stephanie, but I am likely to ask you refresh some of your questions because I was unable to, I couldn’t cope with the speed. I am afraid. But anyway starting with maybe Emilio can you remind me some. Okay the length of the contract. Well, I cannot tell you about any average length of the contract clearly there are contracts that are still running for five years. Some others for three years, for two years. There is a variety of them. So there is no such a thing as an average. For instance, we’re duty free or free contract we run till for five years. Then what I can tell you is that the most important retailers in this business are in no particular order other than the first one that I am sure it is in the right place which is duty free group but then you have RAS, SSP, [indiscernible] so those are the outer [indiscernible], so those are the main retailers, the main commercial operators. And indeed they represent a very material, very significant chunk of the total minimum guarantee rent revenues that you are seeing today in our accounts.

So with no more than 10-15 retailers or operators you can cover well in excess of 85% of the minimum guarantees. So those are the most critical ones, but each and every one of them have different views, different interests, different lengths of contracts. So it would be misleading probably to give you a one-size-fits-all answer to that. Then the next one is?

Emilio Rotondo

The second one was related to the MAGs and the timeline, but I didn’t get exactly what you meant. So maybe you can.

José Leo

Yes. You mean from billing to collection is what you mean.

Stephanie D’Ath

Yes. That’s right.

José Leo

Well, 30 days. Then which else 2021 cash flow break even. Okay. The cash flow, free cash flow break-even levels is something that you mean in terms of traffic I suppose is something that it was asked already before and I committed to provide you with some more color. I don’t want to get it wrong but rest assured we will share that information with you.

Obviously subject to, because one thing is traffic and the second point is costs so by sharing that information with you we will give you a proviso, we will make a proviso as to what is the level of operating cost savings we are contemplating otherwise the scenario would be different for different levels of cost savings. So I would like you to take it as a sort of academic helpful exercise rather than a forecast of anything.

Emilio Rotondo

Flexibility of the contract to the suppliers.

José Leo

With regard to the suppliers definitely it has been a very challenging process. We have been in tough discussions with them, but I believe that overall has been successful. We have no, to put that way we haven’t faced any legal action, any issue of this kind. So everybody has been very, very committed. Of course the air test, the furlough scheme in Spain is always helpful to today, but I think there is, my feeling is that we have been working relatively well together. Everybody has suffered the fair share of pain, but I don’t feel there are major issues. Some of the contractual agreements that we will be entering into in the future as part of the new tender model will incorporate provisions for this kind of situations and that will also be helpful and that will add flexibility to our ability to manage the costs.

Stephanie D’Ath

Thank you and maybe just following up on that last point please the follow scheme so that basically means that your third-party contractors were able to use the furlough scheme in order to still survive I guess. How long is that stage furlough in place and once it stopped would you then expect other operating expenses to increase?

José Leo

Well, definitely that helped a great deal. This is coming to an end I believe some of the businesses in the first quarter of 2021, first quarter I was being held by Emilio. So by the end of the first quarter of 2021. Hopefully by that time we won’t need it, but is true without that instrument in place things will get more complicated. I cannot deny that.

Stephanie D’Ath

Thank you very much.

Operator

Thank you very much. And the next question comes from the line of Andrew Lobbenberg from HSBC. Please go ahead.

Andrew Lobbenberg

Hi it’s Andrew. Hi, sorry. I did come late into the call. So you may have answered this already but what’s the status of the MAG revenues that relate to the period of emergency which I think is €196 million because I think earlier question you spoke with confidence that other than some very modest impairment you didn’t to have, you expected to claim and get paid all of the revenue for the negotiation. What is the status with that [indiscernible] please?

José Leo

Well, the strategy that we accounted for them as probably you Andrew managed to listen before because the contractual rights are there for everything, for every element of the MAGs including the €198 million of MAGs over the state of alarm. So our plan is for every operator that by the end the year or by the time we are due to charge or to send the invoice, for any operator we haven’t reached an agreement we will send the bill, we will collect the monies. That’s the plan.

As I said before the impairment element of that won’t stop us from claiming from, from invoicing and from claiming that. Simply the impairment element of that will be the way we are due to treat any credit risks in accounting terms. That’s all. So we feel, we should provide for something because there is a risk, there is a credit risk associated. We will provide but that will mean we are not going to send the invoice to pursue the collection. We will do it. Different things is when we have reached an agreement with the particular operator in that case the agreement will supersede the previous contract and will amend the previous contract, potentially will waive part of those minimum guarantees and then of course we won’t send the invoice. We won’t try to collect that particular element.

Andrew Lobbenberg

Thanks. Does that mean if we got an agreement with people and you end up waiving a portion of those fees I know you spoke earlier about moving that impact over the remaining life of the contract and indeed if you send the contract which is part of your goal that will make it smaller. But does that mean that we are going, I mean is there risk of right size of that one 196 in the fiscal 20 results or no, you will stand by that and you will revert it out over the remaining five years, seven years whatever your fee?

José Leo

Well, there will be a write back for sure. For every particular contract this is not the general solution. It’s just for every particular contract when you reach an agreement I am pretty sure that there will be a restructuring of the contract. You will need to account for that and there is will be a write back for sure. Also importantly the cash that would otherwise be received in January, February time won’t be received anymore.

Andrew Lobbenberg

Yes.

José Leo

But that will be on a case-by-case basis and I cannot anticipate. I understand that this can be a little bit confusing, but believe me there is no other way around. We cannot account, we have been discussing that long and hard and you probably know that three months ago I was myself still trying to get my head around. But the reality is that this is the way we should account for that. There is no other way around.

Andrew Lobbenberg

And in terms of the adjustments being made and you spoke of the impairment previously. Would they be excluded from an EBITDA and would drive back excluded from EBITDA would they be in EBITDA and I am just wondering about sensitivity around the covenants or do you think by the year end it’s all irrelevant that’s the way it is, so it doesn’t matter?

José Leo

No. It will impact the EBITDA for sure.

Emilio Rotondo

Andrew let me clarify in terms of this impairment, I think it’s important to know that when you have any collection pending the first analysis you do is compare it with guarantees that we have. That’s the reason why maybe in terms of the numbers or the risk that we have in order to — of that impairment would be the amount or the difference between the amount pending and the guarantees. Not the whole amount pending. That’s the reason why numbers we are talking about are maybe lower or it’s more than you could expect.

José Leo

That’s a very good point Emilio. Exactly yes.

Andrew Lobbenberg

Okay guys thanks for your attempt to explain it. I know it’s been complicated.

Operator

Thank you so much. And the next question comes from line of Arthur Truslove from Credit Suisse. Please go ahead.

Arthur Truslove

Hi there. Just a quick follow-up from me, I mean obviously in Q3 you limit cost savings of just over €40 billion a month once again. Is that something that we sort of assume you are going to achieve through the winter as well? Is that a reasonable assumption and if not then what would be more sensible? Thank you.

José Leo

Well, I believe what we can tell you is that if the traffic levels don’t recover beyond the point we are today that’s our target to be able to save no less than this amount or something in the region, yes. Different thing is if there is a ramp up, if there is a recovery I always said that it will be harder to commit to any particular level of cost. Obviously, committing to be extremely, extremely focused on cost but it’s much more difficult to anticipate how costs will evolve in response to a particular percentage of traffic recovery. But to the extent that we remain at the current levels which as you know are really, really poor of course we will work hard to get at least that level of savings.

Arthur Truslove

Thank you.

Operator

Thank you so much, and the next question comes from the line of Nicola Mora from Morgan Stanley. Please go ahead.

Nicola Mora

Yes. Good afternoon gentlemen. Just a few follow-ups. First one on OpEx, I mean so far you have done great on the third party services cost and staff cost that remain a bit [indiscernible]. I mean how long do you see that continuing basically flat year-to-date?

Second one, sorry to come back to the MAGs but just considering the different environments where your clients or the travel retailers, food and beverage concessioners are, some have done a couple of right issues already, some just one, some not at all. I mean are they more interested in cash rebates or on lower fees just for us to understand maybe the risk on basically the cash collection in 21 and 22?

And on follow-up on that just noticing that the working cap for the first time is a bit unusually high in terms of outflow in Q3. What is the expectations for the full year and into next year? Can you give us a ballpark figure of the risk around not collecting the MAGs? Are we talking about 100 million shortfall, 400 million I mean the whole 800 million? What’s your gut feeling from here? Thank you.

José Leo

Well, you are right that so far the staff cost or the staff element of your cost to base has been [indiscernible] and I don’t think there is need to change that approach now. I share with you some time ago that well there were a number of reasons for that. Of course, some of them have to do with a very limited amount of savings that you can reach through that unless you disband the significant part of the organization. But also the fact that at the point in time it was the right approach to be able to deal with the rest of them of the challenges in terms of cost savings coming from third parties. So far, no change in our mind. We need to keep vigilant because we don’t know where we will be in one year from now.

Hopefully we will be celebrating the recovery and also the return of the healthy war. With regard to whether I understand that your question about whether they prefer cash or lower fees you mean from the point of view of the operators our customers not ourselves.

Nicola Mora

Exactly yes.

José Leo

Yes. Well, I think probably they have, I think it’s a case-by-case basis and I guess what really matters to them is cash. I guess but don’t forget that this accounting standards that apply to us they also apply to them. IFRS 16 for instance can be terribly complicated for some of them and that can only be cured through fees adjustments. You know what I mean because they don’t follow cash or the cash don’t follow the accounting rule as we have been discussing before and probably that generates confusion. But that means that for some of them adjustments to the fee regime can be very, very relevant in terms of how that will impact the level of debt in their balance sheets and the ratios and so on and so forth. But I guess I might be wrong honestly that for them the cash is king. And then, yes.

Nicola Mora

On the working cap just for us to fine tune a bit expectation?

José Leo

The expectation is that we will be collecting the MAGs, we will get all the money back and then the working capital will evolve accordingly. I cannot tell you. Well honestly, if we feel at any point in time that there is a risk of collection we will need to reflect that in the accounts through providing for that. There is no — that IFRS 9 will be, will force us to provide for that to create provisions and then to show that openly to yourselves. So far we don’t believe there is such a risk so far.

Nicola Mora

No. I understand the nuance, but I was more talking about within agreements you might be, I mean — aggressively enticed to sign before you invoice anything by the end of the year. I mean there is going to be a big part of that focused on cash collection whether or not they pay 0%, 50%, 100% of what they own?

José Leo

It will depend on the number of agreements, but you are right if we agree let’s assume that we agree with everybody before the end of the year that well in that case there will be a significant impact on those collections. I don’t deny that. That’s exactly what we have been discussing for months already and I know that can give you some degree of, I don’t know can generate confusion but that it is what it is. If the agreements take place we will be waiving part of that cash in exchange for longer term commitments. That’s the approach because we are conscious of the difficulties for the end of the current times. We don’t ignore that situation.

Nicola Mora

All right. Thanks a lot.

Operator

Thank you so much and the next question comes from the line of Charles [indiscernible] please go ahead.

Unidentified Analyst

Hi good afternoon. This is Charles [indiscernible] just actually one last one on my end and it’s not about the MAGs don’t worry more a boring topic. I’ll say on real estate if you can give us an update on the project? Is everything on hold now and if you expect to resume the process, you expect to make any changes to your initial plans? So just maybe a quick update on that business segment?

José Leo

Hi Charles. I really appreciate you changing directions. Thank you very much. Well, the real estate plan on one side it was halted for obvious reasons and we are now thinking and I’m not telling you that decision has been made finally. But what we see is that the logistics markets are very, very active and there is, if you like is a market that is still strong and we have premium locations available. So we may well reactivate the plan in 2021 and when I say we may well I don’t mean the decision has been made, but clearly focusing on the logistics. That would make a great deal of difference to the original plans because frankly in the first stage of that plan, the offices and hotels played a part but still it was relatively minor. So that would make a big change to the original plan. But yes, we believe that ironically so the logistics business is benefiting from the current situation.

Unidentified Analyst

Yes. Thanks. And maybe on the follow-up on that logistics, I mean you expect to actually be in the operations as well or just rather lease the land so what’s the risk profile you want to take there?

José Leo

No the base case model that doesn’t mean we can’t take a different role on a case-by-case basis, but the base case model is we would contribute, we will create a JV vehicle with a partner whichever partner wins any particular tender process and then we will contribute the right to use the land over a number of years. Let’s say 75 years or whatever or 50 or 25 depending on the nature of the business that is meant to be run on that line. And we won’t contribute any Euro at all. The partner will be taking care of the rest of the development investment. Then we will be collecting, well we will be getting the return out of the global business not only out of the right to use rent element but beyond that we will be hopefully collecting dividends as a result of the global business, the whole business.

Okay, we are running out of time probably if well we have two more people queuing but let’s deal with those two individuals and we will close the call if you don’t mind.

Operator

Absolutely. So the next question comes from the line of [indiscernible] from BNP Paribas. Please go ahead.

Unidentified Analyst

Hi good afternoon everyone. A question for me on contract, you mentioned you negotiated some of the contracts. What percentage of these contracts are under renegotiation especially I guess with the third party suppliers? And can we expect this to last for the rest remaining of the contract or is a temporary effect? And also what rate, what cost savings or increase are you seeing as you renegotiate this contract? Thank you.

José Leo

Sorry, maybe there is some confusion. One side we have been in discussions and in some cases we have been making decisions with very little discussion with the existing contracts and the existing suppliers over the second quarter if you remember. March, April we were imposing so to speak or making decisions to reduce the level of service, the level of resources and obviously the cost associated to that with every single third-party supplier of the main services we are provided with and that will be the case going forward. We will be adjusting the level of service and the costs to the traffic conditions. That will be it across the board and then what I said before and as a result of that we have achieved the savings that you can see today. The savings that over the quarter three has been 127 million in the previous quarter was something close to 160 million.

And then on the other hand with new tenders that will take place over the number of months and potentially years, we are adjusting some of the terms and conditions of the contractual arrangements including provisions to deal with significant reductions in traffic. So to be able from day one from the outset of any problem to be able to just adjust the contract down to the new reality without the need to run any discussions. But that will be the case from now on. What is true is that the security contract that we tender some weeks ago and that are now about to be awarded they already incorporate that provisions and that’s important because those contracts represent no less than well €400 million cost over three years. So they are very significant ones.

Operator

Thank you so much and the last question comes from the line of Stephanie D’Ath from RBC. Please go ahead.

Stephanie D’Ath

Yes. Thank you. Just a quick follow-up, I understood that from billing to collection there is 30 days for the retail operators. But what I still didn’t get is the time between you recognize MAG in your P&L and the time to send the invoice because I understand some of the invoice related to the state of alarm has not been sent yet. So could you please help me understand how long that takes and then you were mentioning that you have guarantees from your retailers. I guess those might be depleted over time. So could you be specified in more detail how those work. Thank you so much.

José Leo

Well all the MAGs are built in January, February the year after they are accrued. So any MAG accrued in 2020 being that in January, February, March whatever will be billed in January 2021 and then collected one month later. That’s the approach. And clearly in previous years the amount of MAGs to be billed and collected next year was significantly lower than now for. And that’s the challenge if you like.

And then with regard to the guarantees they remain in place for the entire life of the contract and they only decay when the contract comes to an end and all the obligations have been fulfilled. So they are in place all the time. Obviously they are not protecting you against everything because if you accumulate that what you have to do is just to execute the guarantee and to move on. But for the time being they are extremely helpful because when providing for the impairment — of any potential impairment they are there to protect us. Thank you.

Operator

Thank you so much that does conclude the Q&A. Sir, please go ahead.

Emilio Rotondo

Thank you everybody for joining us today. Hopefully you have a well Merry Christmas and we get back in February with full year 20 results. Thank you. Bye.

Operator

Thank you so much. That does conclude our conference for today. Thank you for participating. You may all disconnect.

Source

PotlatchDeltic Corporation (PCH) CEO Mike Covey on Q3 2020…

PotlatchDeltic Corporation (NASDAQ:PCH) Q3 2020 Earnings Conference Call October 27, 2020 12:00 PM ET

Company Participants

Jerry Richards – Vice President & Chief Financial Officer

Mike Covey – Chairman & Chief Executive Officer

Eric Cremers – President & Chief Operating Officer

Conference Call Participants

Ketan Mamtora – BMO

Steve Chercover – D.A. Davidson

Paul Quinn – RBC Capital Markets

Mark Weintraub – Seaport Global

Buck Horne – Raymond James

John Babcock – Bank of America

Operator

Good morning. My name is Lindsay, and I will be your conference operator today. At this time, I would like to welcome everyone to the PotlatchDeltic Third Quarter 2020 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

I would now like to turn the call over to Mr. Jerry Richards, Vice President and Chief Financial Officer for opening remarks. Sir, you may proceed.

Jerry Richards

Good morning, and welcome to PotlatchDeltic’s Third Quarter 2020 Earnings Conference Call. With me in the room are Mike Covey, Chairman and Chief Executive Officer; and Eric Cremers, President and Chief Operating Officer.

This call will contain forward-looking statements. Please review the warning statements in our press release, on the presentation slides, and in our filings with the SEC concerning the risks associated with these forward-looking statements. Also, please note that a reconciliation of non-GAAP measures can be found on our website at www.potlatchdeltic.com.

I’ll now turn the call over to Mike for some comments, and then I will cover our third quarter results and our outlook.

Mike Covey

Thank you, Jerry, and good morning. Historic third quarter spotlights the power of PotlatchDeltic’s leverage to lumber prices. Timberlands and Wood Products as well as the total company all established new quarterly EBITDDA records this quarter. Although lumber prices are currently declining from unprecedented highs, we expect fourth quarter EBITDA will be higher than third quarter’s $135 million.

As a reminder, we expect to close a large Minnesota conservation sale in the fourth quarter. We also believe that strong housing fundamentals point to a solid outlook for lumber pricing.

I want to thank our employees, whose outstanding execution on all three businesses drove our strong quarterly results. This includes their continued focus on operating safely during this challenging time. Safety remains our top priority in managing the risks presented by the COVID pandemic requires continued diligence.

Our Wood Products business generated $82 million of adjusted EBITDA in the third quarter. We ran as much overtime as we could in our sawmills to meet strong customer demand, and our Saint Maries and Warren sawmills, both set quarterly shipping records.

Overall, our lumber shipments exceeded the top end of the range that we provided on last quarter’s earnings call by 11 million board feet. We ended the third quarter with a lumber order filed that extends into early November. While it will be down sequentially, we expect Wood Products’ adjusted EBITDA to remain well above trend levels in the fourth quarter.

Our Timberlands business harvested 1.7 million tons in the quarter, which is a quarterly record. Given that about 70% of our Idaho sawlog deliveries are indexed to lumber prices on about a six-week lag basis, we expect our Idaho timberlands adjusted EBITDA will remain strong in the fourth quarter.

Sawlog pricing remains relatively flat across our Southern markets, with little change expected anytime soon. In our Real Estate business, we continue to expect that the sale of approximately 72 acres in Minnesota to the conservation fund for about $48 million will close in the fourth quarter.

In addition, sales activity in our Chenal Valley Masterplan community in Little Rock has fared better than we expected when the COVID pandemic began, and we expect to sell approximately 130 residential lots for the year.

Looking ahead, housing fundamentals are stronger than at any point since the great financial crisis. This sets the stage for continued growth in lumber demand. U.S. single-family housing starts continued to increase through the summer and exceeded 1.1 million units in September.

That’s single-family alone. This was a 9% increase from August, and is up 22% compared to last year. Single-family starts are important to lumber demand, because each single-family home utilizes three times more lumber than does a multi-family start.

Many industry experts believe that the new residential construction — that new residential construction is on the cusp of a multiyear boom. Massive underbuilding since the great financial crisis, record low inventories of homes for sale, historically low mortgage rates and millennials entering their prime home buying years, all set the stage.

U.S. housing permits at 1.55 million units in September, homebuilder confidence at an all-time high and September order growth of 49% reported by four homebuilders last week, all suggest that housing construction will remain robust in the near-term. Additionally, a shift from urban to suburban living appears to be positively affecting housing demand.

The repair and remodel segment is also expected to continue to grow. That view is supported by the age of U.S. housing stock, which is now 42 years on average high levels of home equity and the work-from-home trend.

The random lengths framing lumber composite peaked at $955 per thousand board feet in September, or 64% higher than the prior nominal peak which was reached, in June of 2018. The record high prices reflected industry inventory drawdowns at the beginning of the COVID crisis, combined with strong demand and COVID-related operating disruptions.

Now the long order files stretch into a seasonably weaker part of the year, the pace of new lumber orders has slowed down and as expected lumber prices have begun to retreat. That said, underlying lumber demand remains strong. And lumber inventories are estimated to be at the low end of their historic range.

The strong housing and repair and remodel outlook, coupled with the limited announced lumber supply increases suggest that lumber prices should settle, at attractive levels. We are very optimistic about the setup heading into the 2021, building season.

Switching now to capital allocation for a minute, we returned $96 million to shareholders in the form of dividends and share repurchases, so far this year. We are committed to growing the dividend sustainably which we’ve increased 116%, since 2012. Discretionary mill capital projects represent some of for our highest potential returns.

We recently added $14 million of new projects to the slate, with a weighted average IRR of about 35%. We plan to complete these attractive projects, over the next 18 months. Accretive acquisitions represent the third leg of our capital allocation priorities. We are invested in acquiring timberlands, mills or a combination of the two, near our current operating areas.

We recently published our inaugural environmental, social and governance report in September. PotlatchDeltic has a strong ESG story. And we’re committed to do our part, to mitigate climate change. And continue our legacy of responsibility, across the ESG spectrum. We look forward to updating you regularly on our progress in this area.

To wrap-up my comments, business conditions remain good. We expect to report strong results for the fourth quarter as well. PotlatchDeltic is well positioned to take advantage of favorable industry fundamentals. And our strong liquidity and low leverage provide a high degree of flexibility, as we seek to maximize shareholder value.

I’ll now turn it back to Jerry, to talk about the third quarter and our outlook.

Jerry Richards

Thank you, Mike. Starting with page four of the slides, adjusted EBITDDA of $135 million, in the third quarter was $100 million higher than the second quarter. The increase was driven primarily by the historic run in lumber prices. And seasonally higher harvest volumes.

I’ll now review each of our operating segments. And provide more color on the third quarter results. Information for our Timberlands segment is displayed on slides 5 through 7. The segment’s adjusted EBITDDA was $59.7 million in the third quarter, compared to $25.6 million in the second quarter.

We harvested 555,000 tons of sawlogs, in the North, in the third quarter. This is up seasonally from the 303,000 tons that, we harvested in the second quarter. Northern sawlog prices were 30% higher on a per ton basis in the third quarter, compared to the second quarter.

The higher sawlog prices were primarily the result of significantly higher prices, for indexed sawlogs. In the South we harvested 1.1 million tons in the third quarter. This was 15% higher than the second quarter and reflected strong sawlog demand. Our Southern sawlog prices were 2% higher in the third quarter compared to the second quarter.

A higher proportion of higher-priced hardwood sawlog of volume, more than offset slightly weaker pine sawlog prices. Turning to Wood Products on slides 8 and 9 adjusted EBITDDA was $81.7 million in the third quarter, compared to $10.9 million in the second quarter.

Our average lumber price realization increased 55% from $412 per thousand board feet in the second quarter, to $637 per thousand board feet in the third quarter. Note that, the effect of increasing lumber prices on our results lags the spot prices reported by random links by roughly four weeks due to our record order file link.

To provide context, it’s helpful to look at our lumber prices by month. Our average lumber price realizations increased about $100 per thousand board feet in July relative to our second quarter average. They increased another $100 per thousand board feet in August and then accelerated to $779 per thousand board feet in September. The September average price is 22% higher than the third quarter average.

Lumber shipments increased from 249 million board feet in the second quarter to 291 million board feet in the third quarter. Higher production hours led to better fixed cost absorption, which more than offset the effect of higher index log costs in our Idaho mills.

Moving to Real Estate on slides 10 and 11. And the segment’s adjusted EBITDDA was $13.4 million in the third quarter compared to $9.3 million in the second quarter. The increase was primarily due to sale of more rural acres compared to the prior quarter.

Shifting to financial items, which are summarized on slide 12. Our total liquidity remains strong at nearly $530 million. This amount includes $149 million of cash and availability on our revolver, which remains undrawn. We did not repurchase any shares during the third quarter.

The 10b5-1 plan that we announced last month becomes effective this Thursday. This reflects our ability and commitment to repurchase our shares at attractive prices as part of our broader capital allocation strategy focused on increasing shareholder value over the long-term.

We plan to refinance $46 million of debt scheduled to mature in December 2020 and have locked the interest rate. Annual interest expense will decline approximately $800,000 on this debt beginning in December.

Capital expenditures were $10.7 million in the third quarter. As Mike mentioned, we added some high-return mill projects to the slate. We currently expect that our capital expenditures will be $46 million to $49 million in 2020. Note that the amounts I just mentioned include real estate development expenditures, which are included in cash from operations in our cash flow statement and exclude timberland acquisitions.

I will now provide some high-level outlook comments, the details are presented on slide 13. Harvest volumes in the North are planned to be seasonally lower in the fourth quarter compared to the third quarter. We expect Northern sawlog prices to increase significantly in the fourth quarter due primarily to higher index prices as well as higher cedar sawlog prices.

Harvest volumes in the South are expected to decrease seasonally in the fourth quarter. We expect Southern sawlog prices to be comparable to the third quarter. We ended the third quarter with a lumber order file that stretched into early November. Our average lumber price thus far in the fourth quarter, including orders booked but not yet shipped is approximately 7% higher than our third quarter average lumber price.

We expect the long order files will dampen the sequential decline in our fourth quarter realizations relative to print prices. As a reminder a $10 per thousand board foot change in lumber price equals approximately $12 million of consolidated EBITDA for us on an annual basis. We plan to ship 260 million to 270 million board feet of lumber in the fourth quarter.

Shifting to Real Estate, we expect to sell 73,000 to 74,000 acres of rural land and approximately 60 to 70 Chenal Valley lots in the fourth quarter. We still expect to close the previously announced 72,000 acre Minnesota transaction in the fourth quarter.

Overall, we expect fourth quarter total adjusted EBITDA to be higher than the third quarter, which would establish a new quarterly record for the company. The amount of the sequential increase depends upon the level at which lumber prices settle.

The primary risk to achieving our fourth quarter outlook remains the pandemic’s potential to disrupt our mill operations. We’re encouraged by industry fundamentals and we believe that we are well-positioned to grow shareholder value over the long term.

That concludes our prepared remarks. Lindsay, I’d now like to open the call for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ketan Mamtora with BMO. Your line is now open.

Ketan Mamtora

Good afternoon, Mike, Eric and Jerry. And congrats on a strong quarter.

Mike Covey

Thank you.

Jerry Richards

Thanks.

Ketan Mamtora

First question maybe to start-off on that. Some of the projects that you all highlighted on the lumber side, can you just clarify how much of that will show up in 2020 versus maybe 2021? And if you can just highlight kind of maybe one or two kind of big projects within that and what you all are doing there?

Eric Cremers

Yes. So Ketan, this is Eric. As Mike and Jerry had mentioned, we’re going to pull forward about $14 million of capital projects into our current thinking for our [Indiscernible]. Of that $14 million, roughly $6 million will get spent this year, $5 million will get spent in 2021 and then about $4 million is going to get spent in 2022.

Some key projects that we’ve got at our Ola sawmill, we’re going to put in a green stacker, a new stacker. Right now, that mill’s production volume is constrained by the stacker. And by adding the new stacker which will happen early next year, we expect our production volumes to increase at that Ola sawmills. Another key project for us is, also — this will happen in Q2 of 2021. But our Bemidji mill, we are going to put in a new auto grader.

As you probably are aware, our recovery — excuse me, our grade yields at our sub mills are really important and help us serve our home center customers. So that new auto grader is going to increase our high-grade subs that we produce at that Bemidji sawmill. Those are just some examples.

Ketan Mamtora

Got it. That’s very helpful. And then, just turning to lumber realization and I was a little bit surprised at pointing to Q4 realization kind of just down quarter-over-quarter, given sort of the lengthy order files and given how much prices continue to go up through Q3. Maybe just help provide some sort of color on what are the — either sort of the offsetting things or some other things that I may be missing?

Eric Cremers

Yes. So Ketan, our price in Q3 was around $637, it was our gap price. We are expecting prices to fall in Q4 mid single-digit kind of a number. If you look at what resi is thinking, if you look at what FEA is thinking, they’re talking about 15%, 20% kind of drops for lumber prices in Q4. So you saw a gap in Q3. It looks like the index did a lot better than us due to the lag in prices, but now, it’s going to reverse as we get out into Q4.

And while we were shipping in August and September out into October and November, there is going to be a December price and that December prices who knows where it’s going to settle out it, but it may be down in the $500 kind of range. So, that’s going to pull the average down for the quarter. But like I said, we expect to do much better than the index for the quarter.

Ketan Mamtora

Got it. So, did I hear you correctly that, you said you expect your realizations to be down sort of mid-single digits on a percentage basis in Q4?

Eric Cremers

That’s correct.

Ketan Mamtora

Got it. That’s very help. And then just final question from my side, before I turn it over. On capital allocation, net leverage is down to just a little over two times. Q4 should be another strong quarter from a cash standpoint. Just sort of — I’m just curious to sort of understand, how you all are thinking about whether it’s in terms of leverage target or do you sort of feel comfortable building some sort of cash considering the volatility in lumber prices?

Jerry Richards

So Ketan, this is Jerry. In terms of leverage, our overall goal is to keep leverage kind of under four times through a cycle. And certainly, it’s moving towards one as we’ve talked — as we’ve discussed publicly recently. So, leverage is really low. And certainly, you look at it on a relative position that gives us a lot of strength and a lot of financial flexibility as we think about allocating capital to grow shareholder value over time.

So we’re not going to borrow money just for the sake of keeping leverage higher in the range, within the range of our target. In fact, we’re getting ready to refinance some debt, but certainly don’t have any near-term plans to borrow. If we were, it most likely be because, there was an attractive large acquisition. So, the short answer is, I think it’s most important to invest the excess cash in the right type of return opportunities as opposed to putting it to work near term. And given high valuations on the mill side as well as kind of light activity on the timberland side, I think it’s fair to say that we probably will hold a bit excess cash for a bit, but we are very excited about the opportunity to look for opportunities to put that cash to work.

Ketan Mamtora

Got it. That’s very helpful. I will turn it over.

Operator

Our next question comes from the line of Steve Chercover with D.A. Davidson. Your line is now open.

Steve Chercover

Thanks. Good morning, everyone.

Mike Covey

Hi, Steve.

Steve Chercover

So I wanted to start with Minnesota. Once you’ve completed the land sale there, I think, you’ll be down to about 30000 acres in the state so I would assume that’s barely operational scale. So does the residual land there consist of HBU?

Eric Cremers

Yes. So what’s going to happen after we sell a large number of acres to the conservation fund here in the fourth quarter, we’re still going to have some residual acres left over maybe 20000 or so. But don’t forget that 16 of those are already contracted for again with TCS and what we call the Plan B transaction. About half of that is going to go in 2021 and half of that is going to go in 2022. So there’s going to be a couple of thousand acres left over once we’re done here that are unspoken for. And we continue to believe we’ll sell those out probably in 2021 if I had to guess.

Steve Chercover

Got it. Okay. Thanks for clarifying that. And then I want to talk a little bit about the Saint Maries sawmill. I mean that’s — I think — it’s 185,000 board feet. Can you tell us how much of that is cedar? Because cedar has still got ahead of steam and it looks like it’s going to be really good for 2021.

Eric Cremers

Yes. Steve, we don’t produce any cedar at our Saint Maries sawmill. We do produce a lot of cedar volumes about 10% of our Idaho sawlog harvest each year is cedar. And cedar continues to perform very well. Prices were up about 20% in Q3 and we’re looking for about another 12% here in Q4. Cedar demand is really driven by a lot of the repair and remodel work that you hear about. So we’re continuing to be optimistic about Cedar.

Mike Covey

We sell those logs to half a dozen customers in the Northwest.

Eric Cremers

Yes. And they process them.

Steve Chercover

Got it. Okay. Thanks for that clarification. And then given your optimism for 2021, maybe you can hazard a guess of what your 2021 tax rate might be?

Jerry Richards

Steve, we will come back to you on that one once we go through our budgeting process. So not prepared to give any, sort of, 2021 guidance on this call. We’ll do that on the Q4 call.

Steve Chercover

Can’t blame us for trying. Okay. Thank you.

Jerry Richards

Thank you.

Operator

[Operator Instructions] Our next question comes from the line of Paul Quinn with RBC Capital Markets. Your line is now open.

Paul Quinn

Okay. Great. Thanks, guys. I got to call late so I sort of missed some of the front-end stuff, but I’m just curious as to your — I mean, obviously, balance sheet is in a great spot and it looks like it’s going to improve going forward. But what are your capital allocation priorities at this point?

Mike Covey

Well, this is Mike. We spoke to that a little bit earlier, but so far this year, we have done a combination of — in returning cash to shareholders and the share repurchase that we executed on in the first half of the year as well as obviously the dividend continues. With the cash that we have on the balance sheet and growing, we’re certainly in a meaningful position to do an acquisition if one should come along that is either timberland or timberland and mills that are adjacent to our own property that continues to be one of our priorities for kind of geographic compatibility with where we already are.

We stepped up and accelerated a little bit Paul some CapEx this year in the Wood Products business just $14 million. It’s kind of above and beyond the normal amount on some attractive high-return projects. So I think in sum — and as you probably can infer the balance sheet’s in solid shape. We’ve got debt in a position where we really can’t do much more with a weighted average cost of debt of about 2.3% I think. So there’s really not a lot of opportunities there. So really it comes down to acquisition opportunities growing the dividend. And if we see our stock fall significantly below what we think is fair value then we’ll buy back our stock through a 10b5-1 program we just put in place which goes effective this Thursday.

Paul Quinn

Okay. That’s great. And then just talking about the M&A opportunities. I think you referenced high valuations at the mill side. Just wondering how high those are and what the expectation on the timberland side for potential acquisitions?

Mike Covey

Well. The timberland acquisition pipeline is — it’s been pretty quiet, for the whole year. But it’s starting to see a little bit of life. We’ve seen a couple of properties that have come to market, through investment bankers and others. So, there’s starting to be a little bit of activity on the timberland side and at least in the U.S. South.

And on the mill side there’s not been a lot of transactions. But certainly based on the cost of some of these new construction projects, which I think are north of $600 per thousand board feet. You have to think that the valuations on the mill side are pretty high. And obviously buying at the top of this cycle has never been a way to measure success.

Paul Quinn

All right, that’s all I had. Best of luck, guys.

Mike Covey

Thanks.

Operator

Our next question comes from the line of Mark Weintraub with Seaport Global. Your line is open.

Mark Weintraub

Thank you. And just one more on capital allocation, in particular, how would you be thinking about the dividend recognizing it’s a Board decision. It’s been a few years, since you made a move on it. What sort of would have changed, in terms of the cash-generating capability that would support a type of move in the dividend? And if there’s any sort of, directional sense you could share that be appreciated.

Mike Covey

Well. We always use the word sustainable and dividend, in the same sense. We’ve tried to make dividend increases that are sustainable. And we don’t want to have to go through a period of either suspending it, or lowering it.

In the recent events that have given us a bit more confidence certainly the Deltic acquisition is — I think we’ve exceeded the synergy expectations that we had there, largely on the backs of a really strong lumber market. And a really strong real estate market on that property that we didn’t really foresee.

That’s done better than expected. I think that would be one thing, we’d point to today the dividend can be supported by a stronger business there than we thought. The Idaho sawlog price recovery since the great financial crisis has been really exceptional.

The cedar market is part of that. And that’s tended to be, I think a sustainable increase step-wise, that’s made a difference. The higher return Wood Products projects, those can come and go with the vagaries of the lumber market.

But those are a couple things that we’d point to. And I think we’re gaining confidence that especially with the cash balance that we have, that are raising the dividend on a modest amount is a pretty low-risk proposition and is well substantiated by the strength of the business.

Jerry Richards

The only thing that I would add to what Mike just said Mark, is the fundamental underlying demand for lumber remains pretty positive, the story does, if you think about where housing starts are headed. We’ve seen a lot of people are forecasting starts are heading back to 1.6, 1.7, over the next few years.

Repair/remodel markets are incredibly strong. So we’ve got a generally pretty bullish outlook on, lumber demand base case. As Mike said, there’s not a lot of new mill construction right now. And it’s costing over $600, a thousand of capacity to build a new mill. And it takes two years to get it done. It’s hard to see people stepping up to make those kinds of investments. So we have a fundamental, favorable outlook on lumber.

Mark Weintraub

All makes sense. Thank you. Just one little quick follow-up too, on the lumber, you had mentioned, shipments 260 million to 270 million. And then, when you gave the up 7% you noted that, that included shipped plus already booked. Roughly how much of that 260 million 270 million might effectively have been included in the plus 7%, that’s a number you have handy?

Jerry Richards

Yeah. I have that handy, Mark. That’s about 90 million feet. And that’s a combination of ship to-date. But plus also priced and still in the order file.

Mark Weintraub

Okay. Thank you.

Jerry Richards

All right, Mark.

Operator

Our next question comes from the line of Buck Horne with Raymond James. Your line is open.

Buck Horne

Hey. Thank you. Thanks a lot guys, comment on, quite a lot question here. I think you’ve mentioned it. I just wanted to maybe dive in a little further if you can add any additional color on just the state of how you guys see lumber inventories in the supply chain right now in terms of the kind of the standoff between buyers and sellers at the moment with these extended order files?

And maybe it’s a little spec-ed a little bit. How do you think some of this resolves itself? And do you think that, you’re going to see more buyers, in anticipation of what’s probably going to be a very robust spring selling season for homebuilding and repair/remodel next year? Is there a need to restock inventories, maybe above trend ahead of that, or how do you think the supply chain plays out over the next couple of months?

Mike Covey

Yeah. That’s a great question Buck. So, our view is that inventories in the supply chain are at relatively low levels. And it kind of makes sense when you step back and you think about it, who would want to overbuild their inventory levels when we’re selling for $800, $900 a thousand. There’s not a lot of people who want to do that.

People were ordering just to meet immediate needs, is our view. And so they depleted their existing inventories to very low levels, knowing that there’s seasonal weakness in the fourth quarter almost every year as you get into wintry weather and construction slows, demand for lumber tends to come off and prices tend to come off.

So, we think lumber inventories are very low throughout the supply chain. And today, most mills are probably living off of lengthy order files from when prices were sky high. There will be price discovery. There is price discovery taking place now as we speak, especially in Southern Yellow Pine.

Prices are starting to find the floor, we think. And so this will continue over the next month, six weeks, eight weeks. And then you’re going to see dealers have to step in and build inventories to support the coming season, which as you mentioned, looks like it’s going to be pretty strong next year between new housing starts, Mike mentioned, those new homebuilder orders, up 40% pretty spectacular, plus continued strength in R&R.

Both the resi and FEA have indicated they think R&R markets are going to continue to be strong next year. So, our view is that dealers are going to step back in and have to rebuild inventories as we get out into the first quarter. And that should help support industry pricing.

Buck Horne

That’s the idea I was hoping to you get [ph]. That’s really helpful. Thank you so much for that.

Mike Covey

Sure.

Buck Horne

And maybe also — maybe switch gears on to the timber harvesting side. Are there any cost items or things that are moving around that could affect harvesting margins from — going from the third quarter to fourth quarter? Whether it’s diesel fuel or anything else that we should keep in mind in terms of harvesting margins sequentially?

Eric Cremers

No. Our — the largest cost item for our timberlands business is our harvesting and our hauling, we call it Log and Haul. And those costs are relatively flat year-over-year. They have been for several years now. There’s a little bit of inflationary creep, I suppose. This year prices are a little bit lower perhaps because of lower diesel prices, but not a lot of movement there.

Buck Horne

Okay. Perfect. Got it. Thanks, guys.

Mike Covey

Thank you.

Operator

Our next question comes from the line of John Babcock with Bank of America. Your line is now open.

John Babcock

Thanks for taking my questions. Just actually wanted to quickly follow-up on the Timberland segment. I was wondering, just the solid volumes and the movement that you’re expecting from 3Q into 4Q, is that largely seasonal, or is there anything else to be mindful there?

Mike Covey

Yeah. The real big effect there, John, is as you probably recall we index about 70% of the price of our sawlogs in our Idaho business. And we have on about a six-week lag. So, we have a pretty significant price move on Idaho sawlogs Q4 to Q3. That would be the other big factor on side.

John Babcock

I guess I was more wondering about volumes than pricing.

Mike Covey

Yeah. So in terms of volumes, it’s just seasonally down. So we were at 1.7 million tons in Q3, and we’ve guided a range of 1.3 million to 1.4 million. And it’s just a seasonally lighter part of the year.

The other thing is we had pretty favorable harvest conditions for the most part early in the year. So, we were able to get a large part of our harvest complete going into the fourth quarter. That plays a role.

And as you probably recall, we do expect our Southern harvest will be lower than planned this year and that’s largely the COVID disruption that occurred early in the year that we’ve said, we’re not going to make that volume up.

John Babcock

Okay. And then just quickly on the dividend. Does the Board meet, is that in December? Am I remembering that correctly?

Mike Covey

The Board does meet in early December, yes.

John Babcock

Okay. And then, just the last question. I was just wondering, with the large land sale that you have in real estate this upcoming quarter, the Minnesota timberlands there. Could you give any sense as to whether EBITDA will still be up excluding that land sale?

Jerry Richards

Will EBITDA for real estate be up excluding that land sale?

Mike Covey

No, no overall. So, the short answer is, no. I mean, that sale was about a $48 million sale and what we have is a situation where that particular transaction’s effect on EBITDA sequentially will outweigh the lumber price decline and the volume decline that we’ve talked about, both on the harvest and the lumber shipment side.

John Babcock

Okay. Thank you. That’s all I had.

Mike Covey

Thanks.

Operator

Our next question comes from Ketan Mamtora with BMO. Your line is now open.

Ketan Mamtora

Thank you. Jerry, if I may on the northern sawlog prices, you said a couple of times it will be up substantially. I also know there is this offsetting drag impact in Q4 from density. Is there a way to sort of frame it, sort of its high single digits on a net basis, low double digits? Can you hazard a guess in terms of kind of directionally what it could be?

Eric Cremers

Yes. So Ketan, this is Eric. Yes, there is going to be a little bit of density drag in the fourth quarter. It’s about 5%, 6%. But more importantly, those high lumber prices that we saw particularly in September are really going to work in our favor as we get out into Q4. And we expect our Northern sawlog prices to be up about 40% in Q4 versus Q3.

Ketan Mamtora

And this is net of the density or this is without the density?

Eric Cremers

This is net of the density.

Ketan Mamtora

Net of the density. Got it.

Eric Cremers

That’s 4-0, 40% 4-0.

Ketan Mamtora

Got it. I have done it all. Thank you.

Operator

At this time, I’m showing there are no more questions. I’ll now turn the call back over to Jerry Richards.

Jerry Richards

All right. Thank you, Lindsay. And certainly, I appreciate everybody’s interest in PotlatchDeltic. Available for the detailed modeling questions the rest of the day and look forward to catching up on our next quarter’s earnings call.

Operator

This concludes today’s conference call. You may now disconnect.

Source

Navient: A Misunderstood Business

Thesis Summary

Navient Corporation (NAVI) primarily provides loan management services for student loans. Its revenues and the balance sheet have been shrinking since 2015, and the stock now trades at around half the price of its all-time highs. We see this as an excellent value investing opportunity. Despite falling revenues, Navient has been able to increase its profitability, as evidenced by the increases in EPS. As long as the financial ratios can be maintained, the company can easily sustain the dividend and pay off its obligations, even under the assumption of falling revenues. Therefore, we rate NAVI a strong BUY.

Company Overview

The Navient Corporation is a loan management company, primarily servicing and collecting student and healthcare loans, but the company operates in four different segments; Federal Education Loans, Consumer Lending, Business Processing, and Other. To understand the path that Navient has been on and where it is going, we must zoom out and see how revenues and income have been moving over the last few years:

Source: 10-K

Above, we can see a breakdown of select operating data going back to 2015. This was an important year because it represented a peak in both EPS and share price. The company’s revenues have for the most part been falling since then. This is due primarily to the reduction in Education loans, specifically those under the FFELP (Federal Family Education Loan Program). The company’s asset base has decreased considerably since 2015. Having said this, the fall in revenues has been “offset” by lower operating costs and sustained profitability, allowing Navient to achieve similar EPS in 2019 as in 2015, despite the setbacks.

2019 showed a promising outlook, especially given the increase in consumer lending, but the events of 2020 have meant that revenues are once again down, around 30% compared to the first two quarters of 2019. Once again though, Navient is “weathering the storm” thanks to reduced delinquency rates and improved profitability metrics, as well as by delivering value to investors through share buybacks and dividends.

Source: Investor Presentation

As we can see, core earnings return has improved above expectations, while net interest margins for both consumer and federal loans have increased significantly. Lastly, it is worth talking about the financial solidity of the company, so let’s look at the balance sheet:

Source: 10-Q

The company currently carries around $88 billion in long-term debt, mostly funded by senior notes. Against this, we have just over $91 billion in assets. For investors, it is concerning that the company’s D/E ratio is at its highest ever, just over 37. The biggest worry here is that the company will not be able to meet its financing needs, especially if the current trend of falling revenues and fewer assets continues.

Financial Metrics

A company like Navient relies heavily on outside credit, and as such, investors and financiers are always looking at financial metrics for the company. Even small changes in margins and delinquency rates can have big effects on the cash flow, which, in turn, affects their ability to repay debt. Worsening metrics could lead to a lower credit rating, which, in turn, would significantly hamper the valuation of the company. Let’s look at how these metrics have evolved in the last few months in the two most significant segments:

Source: Investor Presentation

The Federal Education Loans segment, which represents the biggest part of NAVI’s portfolio, has improved significantly on most accounts. Net interest margin is up by 32%, while delinquencies are down significantly. Of course, this might have to do with the increased rate of forbearance. Expenses are down by 21%, and net income is higher than a year ago.

Source: Investor Presentation

Looking at the Consumer Lending Segment, we see similar positive results. NIM and charge offs are both down by 38%, and delinquency rates have decreased by 60%. It is also worth noting that average private education loans have increased since this time last year, as has net income.

Overall, the company has been improving its profitability metrics for the last couple of years. The net income margin has been rising steadily since the second quarter of 2018, and this makes us confident that the company can meet its obligations.

Source: Investor Presentation

Navient claims to pursue a “conservative” approach to debt and has reduced its debt load by around 10% in the last year. Combined, Navient’s education portfolios are projected to generate 9.4 billion in cash flows, which is more than enough to cover the debt burden. Furthermore, we expect Navient could recover its previous BB rating in the near term, despite the recent downgrade to BB- by Fitch.

Future Outlook

NAVI’s future outlook will be unavoidably tied to that of the average American consumer. A strong economic recovery will aid NAVI in growing its portfolio and reducing defaults. For the most part, we remain bullish on the medium-term outlook given the most recent advancements in finding a COVID-19 vaccine and lower than expected unemployment rate.

Source: Tradingeconomics.com

Trading Economics projects that unemployment should trend around 6.5% in 2021 and 4.5% in 2022. At the same time, GDP is projected to grow around 1.7% in 2021 and 1.9% in 2022.

This is relatively good news for Navient, especially as it relates to its portfolio of consumer loans. In 2019, Navient increased its Private Education Loans by 75% YoY, and we expect this trend to continue over the mid term. We also see the potential for further growth in the healthcare sector and business service sector, where the company already has a presence following the acquisition of Xtend. More recently, the company acquired Earnest, which will also aid it in positioning itself in the fast-growing fintech space.

Of course, much of what happens in the next year will depend on the results of the upcoming elections. A Trump win, combined with further stimulus would be a tailwind for NAVI, and the stock could certainly jump on the news, which also gives us the opportunity of locking in profits in a short amount of time.

On a final note, it is worth mentioning that the company recently updated its EPS forecast for 2020 at around $2.95, significantly higher than analyst consensus. Navient has a long track record of beating EPS estimates (11 out of the last 12 quarters), giving us reason to trust their forecast.

Valuation

We have estimated a return on investment in Navient’s common stock, using our valuation method.

The valuation method is based on our estimates of potential unlevered free cash flow to common shareholders. To do this, we analyze some key ratios regarding investment, revenue, and operating expenses.

As an indicator of investment levels that drive revenue, we look at the level of long-term assets for operations and use the recent trend for their relation with previous and future revenues to estimate the levels of investment and revenue in the future. We do the same for operating expenses and working capital, relative to revenue. Note that we may include some items in the operating expenses which are not considered operating in the official income statement, but we think are a regular part of the company’s activity.

We also use recent trends in ratios to estimate the rest of the items, which usually include financial income or expenses (based on the net level of debt, as per our interpretation of the balance sheet), minority interest (based on the level of net income), dividends to preferred equity (based on the level of preferred equity), and the level of net debt (based on the recent trend in leverage). For Navient, we have chosen not to separate operational and financial concepts since they operate in finance, so all assets and liabilities are considered operational.

We may add manual changes to some items or ratios based on qualitative analysis and information from the latest quarterly reports. For Navient, we see that our model projects a similar fall in revenue to that of consensus estimates by 2022 (near 1bn of revenue), so we did not make any changes to that. The estimated 5-year CAGR for revenue is -7.84%.

The final valuation is a sum of the discounted value of future unlevered free cash flow to common shareholders, minus the current level of debt (none in this case). To evaluate cash flow potential, we assume a net investment of 0 in the fifth year of the forecast, which we use to calculate terminal value. In this case, since the revenue, earnings, and cash flow are projected to fall and to err on the pessimistic side, we assumed cash flows will continue to fall perpetually by the same rate as the revenue in the fifth year of the forecast (-4.6%).

With Navient, as you can see in the forecast and valuation summary below, we get an expected return of 38% for common stock at the current price of $9.05 (October 26). Items are in millions of USD except ratios and per-share items.

Source: Author’s work

Risks

Navient does face significant risks in three main areas; political, legal, and structural. Politically, it is believed by most investors that a blue win would hamper the prospects of Navient. Democrats could enact legislation that directly affects student loans and healthcare. If the government were to take over these areas or issue some kind of debt relief, Navi could be left “holding the bag”. Having said this, polls and analysts may be understating the likeliness of a Trump win, which is leading to a high discount on NAVI’s stock. Evidence of this can be found in the recent numbers to come out regarding voter registration in key states such as Florida and Arizona, which show that Republicans are outnumbering Democrats.

Legally, Navient is still involved in six different lawsuits that claim the company may have misinformed borrowers to its advantage. Nonetheless, we don’t expect litigation costs to have a significant effect on income.

Lastly, Navient would be in deep trouble if the economy fails to recover. High unemployment leading to higher delinquencies would reduce income margin and could even force rating agencies to downgrade Navient’s debt status. The company’s reliance on capital markets is certainly a weak point to watch out for.

Takeaway

We believe Navient to be a misunderstood company. Investors see falling revenues as a bad sign, but a company like NAVI can still return value to investors even with negative growth. The key lies in the fact that it has been able to continually increase its profitability. Given our cash flow projections, we believe NAVI is a sound investment, the dividend is more than covered and there is little risk of insolvency. While political and structural changes remain a risk factor, the reward far outweighs the risk in this scenario.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Money Market Fund Closures Signal Trouble

Liquidity is oxygen for a financial system. – Ruth Porat

While the Federal Reserve’s current expansionary monetary policy supports the broader market and the economy, it isn’t helping out yields. Rates are low and struggle to maintain any move back up, as shown in the graph below. No upside is in sight as, according to Federal Reserve Chairman Jerome Powell, the Fed is “not even thinking about thinking about thinking about” raising rates.

Risks to low rates

You may be asking yourself, what’s the harm in low rates? After all, low rates prompt more borrowing and can bolster economic expansions. But rates are so low, even Treasury ETFs are generating negative returns, as shown below.

Rates this low are disastrous for money market funds. Recall, money market funds are mutual funds that invest in highly liquid, short-term instruments. A money market fund’s goal is to offer high liquidity and low risk yet still providing yield.

Breaking the buck

As a mutual fund, money market funds trade to Net Asset Value (NAV) with money market funds specifically aiming to maintain a NAV of $1. If a money market fund’s NAV falls below $1, it is called “breaking the buck,” and if not rectified, this can trigger a wave of redemptions that force the fund to liquidate. In 2008, the well-known Reserve Primary Fund broke the buck as it held obligations from Lehman Brothers when it filed for bankruptcy. The subsequent liquidation of the Reserve Primary Fund sent shocks throughout the rest of the market.

Fund closures

As regulations have tightened in the aftermath of the 2008 financial crisis, money market funds under pressure today are waiving fees or simply shutting down. Managers of the T. Rowe Price Cash Reserves Fund recently waived fees to avoid yield negative returns. Fund giants Vanguard, Northern Trust, and Fidelity have recently closed funds.

Money market assets

The number of holdings in money market funds is staggering, with total money market holdings peaking at over $5 trillion earlier this year. In contrast, for most of this decade, total holdings were closer to $3 trillion. The total holdings are on the decline in the third quarter of 2020, though still well above historical levels. The chart below shows the total money market holdings over time.

Source: Federal Reserve

Searching for safety

Instead of parking liquidity in money market funds, I’d suggest you consider the Case For Gold I recently made. Specifically, I’d recommend using the iShares Gold Trust ETF (NYSEARCA:IAU), which enables you to hold physical gold without the encumbrances of transporting and storing the metal. Gold can be a reliable inflation hedge, as excess central bank liquidity is likely to increase inflation expectations. Also, gold functions well during heightened volatility, making it an attractive place to hold funds until volatility settles down after the election.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Week Ahead – The Final Stretch

The countdown is on

The next couple of weeks will be crucial to how we end the year in financial markets and investors are standing by, waiting to respond. It’s deal making time, with months – or in the UK’s case, years – of negotiations coming to a head as the clock ticks down. The US election is in the final stretch and every passing week brings us one step closer to a COVID vaccine. A huge amount of event risk that will ensure it’s a fascinating end to an otherwise horrific year.

Country

US

In addition to the November 3rd Election Day, the focus in the US will fall on the advance reading of GDP, the COVID-19 spread, and big tech earnings. The US economy is expected to post a record-breaking rebound in economic growth in the third quarter. The Q3 growth measure is expected to rise 32.0%, erasing away the -31.4% contraction seen in the prior quarter. This is the last big data release before the election and could influence some voters on the direction of the economy.

The virus spread is intensifying in the US and record high cases seem very likely. The third wave of the virus continues to cripple the Midwest, but hospitalizations are not rising as sharply as many younger individuals are getting exposed. For now, the US has not seen anything close to the lockdown and restrictive measures happening in Europe, but that could change if another surge happens.

The third week of earnings season heats up with some mega-cap tech results from Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), and Amazon (NASDAQ:AMZN). Close attention will also fall on industrials and transport earnings reports from General Electric (NYSE:GE), 3M (NYSE:MMM), Airbus (OTCPK:EADSF) (OTCPK:EADSY), Boeing (NYSE:BA), UPS (NYSE:UPS), Caterpillar (NYSE:CAT) and Honeywell (NYSE:HON).

US Politics

It is all about the Senate race. President Trump had a strong performance in the final and civil debate, but it was not likely enough to move the needle. Former-VP Biden did not have any major slip-ups, although will some argue his oil statement was an unforced error. Biden did a good enough job to keep his lead intact. President Trump will likely see a bump in the polls, but with almost a quarter of the vote likely in and the number of undecided voters being in single digits, Wall Street can continue to price in a Biden victory.

Just as important is the Senate race and that will likely take a big queue after the confirmation of Amy Coney Barrett to the Supreme Court. Biden has stated he will come out with a clear position before Election Day about where he stands on expanding the Supreme Court. This could be the biggest risk to the blue wave. Republicans who disapprove of President Trump may want to vote red for the Senate to keep the conservative majority on the Supreme Court. Several Senate races are up for grabs and it appears we won’t have a clearer picture until after Election Day.

EU

The ECB meeting next week could lay the groundwork for more easing in December as the euro area economy flirts with a double-dip recession. COVID is wreaking havoc once again which means more restrictions across the bloc. This is particularly taking its toll on the services sector with manufacturing performing relatively well, aided by the economic rebound in China. Policy makers have kept a lid on the euro after Christine Lagarde’s blunder in the last press conference and easing hints next week would go some way to easing deflationary pressures for now.

Brexit

Negotiations are back underway, with Michel Barnier arriving in London on Friday promising to intensify talks and work towards a deal, one based on mutual compromise. This follows months of both sides pushing the other for concessions and, it seems, last week’s post-EU summit comments were a step too far. Neither side can be seen to be getting a raw deal and comments from Barnier in recent days have convinced Number 10 to return to the negotiating table. A breakthrough now looks possible that will enable both sides to claim a success and avert no-deal. Interestingly, sterling never came under much pressure in response to talks breaking down, with traders clearly having had enough of political theatre and empty threats of the last four years. There is clearly more optimism now that the foundations are in place for compromise and a deal in the coming weeks.

UK

The UK is continuing to see rising COVID cases and hospitalisations forcing tighter restrictions around the country. The situation is going to get much worse before it gets better, which is going to be a drag on the economy. Expect more stimulus from the Bank of England this year. Brexit remains a huge downside risk for the economy but negotiations took a significant step forward this week.

Turkey

The CBRT has a real credibility issue and recent actions haven’t helped. The currency hit new record lows against the dollar this week, bringing losses for the year to 25%, as the central bank refrained from raising interest rates, despite markets expectations of a 175 basis point hike. They appeared to have engaged in a tightening cycle last meeting in order to stabilize the currency and address inflation issues, but this week showed it still prefers to tighten conditions using other means. Clearly politics is continuing to play a role in the decision making and that comes at a cost for the currency and, ultimately, the economy.

China

China Communist Party plenum runs Monday to Thursday to set new 5-year plans. Potentially important policy releases to come on Friday.

China Industrial Profits Tuesday should continue the growth tone of recent data, supporting the CNY and China equities.

Ant Financial IPO opens Tuesday-Thursday with payment Nov. 2nd. Potentially strong tailwind for China tech stocks next week.

China Official PMIs released Saturday, 31st October, followed by Caixin PMI Monday, 2nd. Main risk is disappointing numbers that could lead to a large fall in equities Monday, November 2nd.

Hong Kong

All eyes will be on the Ant Financial IPO this week, which will open and close this week with trading starting after the Nov. 3rd US election. Bullishness on IPO should mollify any risk based selling ahead of the US election.

USD/HKD at the bottom of its trading band with heavy buying from the HKMA. The demand for HKD is due to the Ant Financial IPO this week.

HK GDP and BoT expected to show the real economy remains deep in recession with Cathay Pacific (OTCPK:CPCAY) (OTCPK:CPCAF) announcing massive layoffs this week.

India

No significant data this week.

Indian Rupee continues to weaken after appalling GDP data. Rampant COVID-19 continues to crush economic activity and India’s potential recovery. Weak BoP, monetary and fiscal positions with stagflation potentially India’s biggest headache. Continues to be Asia’s weakest link along with Indonesia.

New Zealand

Landslide victory for Labour at elections boosted NZ Dollar. Equities mostly unmoved. No significant data this week.

RBNZ continues to telegraph negative rates and the NZ Dollar could come under sustained pressure this week ahead of the US election as risk is taken off the books globally.

Australia

Australian markets shrug off reports of China coal bans now, focusing on a potential rate cut from the RBA on November 3rd. COVID-19 restrictions eased. Financials and resource sector outperformance to continue.

Copper and iron ore remain near year highs supporting the resource sector and offsetting China’s bans in minor Australian export sectors. Australian markets will remain resilient unless China starts messing with copper, iron ore or LNG. Unlikely at this stage. The rise in risk aversion tensions is threatening to flip the Australian Dollar into a potentially large downward technical correction. This remains the major risk factor next week.

Australian Dollar and equities may suffer downside pressure this week as risk is reduced globally ahead of the US election. That should be a temporary state of affairs, though. The lucky country should remain lucky with domestic data showing recovery remains on track.

Japan

Japanese Yen rallies strongly on haven demand from onshore investors ahead of the US election. USD/JPY could potentially fall to 102.50 ahead of the election, especially if the US Senate result is too close to call, or odds of contested election increase.

Heavy data week with Leading Index, Retail Sales, Tokyo CPI and Industrial Production. All are expected to underperform as Japan’s domestic and export recovery remains sluggish in contrast to Taiwan and South Korea.

Bank of Japan rate decision on Thursday. Unchanged at -0.10% but a high chance of increased measures to pump money into the economy via lending facilities, and potentially an increase in JGB buying. Yen negative theoretically, but repatriation flows will subsume. The BoJ should be equities positive, offsetting risk reduction flows into the US election.

Markets

Oil

Oil prices were given a big boost on Thursday, as Vladimir Putin refused to rule out postponing production increases planned for January by OPEC+. This was by no means a commitment to do so, nor an acknowledgement that it had been discussed, but his openness to it has been welcomed.

OPEC+ cuts remain at 7.7 million barrels but are scheduled to fall to 5.7 million in January. This is a significant increase that could hit oil prices if the global economy falters in the coming months, as many expect, due to COVID-related restrictions. At this time, the group sees no reason to delay anything but that view may change between now and December, when they’re scheduled to meet and Russia will be critical to any delay.

WTI is back above $40 on the comments which, as we’ve seen so often before, could simply be a simple means of manipulating prices in their favour in the near-term. But if not combined with action, should demand slip as expected, it will only be a short-term boost. Brent continues to see considerable support around $41.80, with WTI seeing it around the $39.50 region.

Gold

There isn’t an enormous amount to add on gold in recent days and weeks. The yellow metal continues to hover around $1,900, as we await movement on some of the major risk events that are coming to a head in the coming weeks.

Momentum is just about with the bulls, despite gold spending a little time below $1,900 yesterday, but ultimately, the next move will be event driven and that will probably come from the stimulus talks on Capitol Hill. We may not have to wait too long for movement on that front. A close below $1,900 may signal that talks are collapsing, with a break above $1,930 perhaps meaning good news from Washington.

Key Economic Events

Monday, Oct. 26

– New Japanese Prime Minister Yoshihide Suga addresses parliament for the first time as premier.

– The Chinese Communist Party’s Central Committee begins its 4-day all-important plenum, where it’s expected to outline the plan for the economy’s development for the next 15 years.

– WTO holds a dispute settlement meeting where it’s expected to grant the EU legal authority to impose retaliatory tariffs on $4 billion of US exports.

– India Energy Forum (4-day event) by CERAWEEK.

– US Senate Republicans are expected to confirm Judge Amy Coney Barrett to the Supreme Court.

Economic Events

• US new home sales
• Mexico economic activity
• Japan PPI, leading index
• Singapore industrial production
• Germany Ifo business climate

Tuesday, Oct. 27

Economic Events

• U.S. durable goods, FHFA house price index, Conference Board consumer confidence
• Mexico trade balance
• New Zealand trade
• South Korea GDP
• China industrial profits
• Spain unemployment
• Hong Kong trade

Wednesday, Oct. 28

– The CEOs of Facebook, Google and Twitter (NYSE:TWTR) to testify before a Senate hearing on hate speech, misinformation, and privacy on their platforms.

– Bank of Canada Governor Tiff Macklem and Senior Deputy Governor Carolyn Wilkins hold a press conference to discuss the Bank’s expected decision to keep rates on hold.

– Dallas Fed President Robert Kaplan takes part in a virtual discussion with former BOE and Bank of Canada Governor Mark Carney.

– Weekly EIA crude oil inventory report.

– South Africa releases medium-term budget.

Economic Events

• US wholesale inventories
• Canada rate decision
• Brazil rate decision
• South Korea consumer confidence
• Turkey economic confidence
• CPI: South Africa, Australia
• Spain retail sales

Thursday, Oct. 29

– European Central Bank rate decision: Expected to keep Main Refinancing Rate unchanged at 0.00%.

– The advance reading of US Q3 GDP is anticipated to be the strongest on record, a 32.0% rebound from the record dive of -31.4%. Weekly Initial Jobless Claims will also be released.

– Big Tech Earnings from Facebook, Amazon and Apple will closely be watched.

Economic Events

• US Q3 Advance Q/Q: 32.0%e v. -31.4% prior, Weekly Initial Jobless Claims, pending home sales
• Bank of Japan rate decision: Expected to keep policy unchanged
• Japan retail sales, consumer confidence, department store sales
• New Zealand ANZ business confidence
• Australia NAB business confidence
• Euro-area economic/consumer confidence
• Germany unemployment, CPI
• Italy manufacturing/consumer confidence
• UK mortgage approvals
• Singapore unemployment
• Hungary Central Bank: Decision on 1-week Deposit Rate(primary transmission for short rates)

Friday, Oct. 30

Economic Events

• US personal income/spending, MNI Chicago PMI, University of Michigan Sentiment
• GDP: Canada, Mexico, Germany, France, Italy, Spain, Austria, Portugal, Czech, Hong Kong
• Euro-area Q3 Advance GDP Q/Q: 9.4%e v -11.8% prior; Y/Y: -7.4%e v. -14.7% prior, CPI, unemployment
• South Korea industrial production
• Japan CPI, jobless rate, vehicle production, housing starts, industrial production
• Australia private sector credit, PPI
• Trade balance: South Africa, Turkey
• Polish CPI

Sovereign Rating Upgrades

– Finland (Fitch)

– Romania (Fitch) Czech Republic (S&P)

– Denmark (Moody’s)

– Netherlands (Moody’s)

– Saudi Arabia (Moody’s)

– Italy (DBRS)

Original Post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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Reckitt Benckiser: Performance Is Improving

U.K. consumer goods manufacturer Reckitt Benckiser (OTCPK:RBGPF)(OTCPK:RBGLY) continues to see uplift from the COVID-19 crisis, as shown in its recently released third quarter numbers. However, the effect is less than it was earlier in the year and its nutrition business continues its underperformance.

The Company Continues to Benefit from Pandemic Headwinds

The company manufactures a number of brands with clearly established connections to household hygiene in consumers’ minds, such as Lysol and Dettol. So it is no surprise that it has seen a sales benefit during the pandemic. This continued during the third quarter, when like for like revenue was 19.% higher in its hygiene division than last year. That is an impressive figure. Like for like revenue in its two other divisions also rose versus the prior year, though the health division growth is slower than it had been in the year to date.

Source: company Q3 trading statement

It’s also worth noting out the impact currency shifts have on this global company: while like for like is a useful measure of business health, the key question for shareholders is how much coin comes into the company, and when taking exchange fluctuations into account, the nutrition division’s performance is actually less than last year. With significant swings in sterling, the dollar, the Chinese yuan and more in the current year, that is a substantial drag when Reckitt comes to convert profits into sterling. The company provided specific standalone guidance on this point here.

Performance continues to be very unevenly spread. While the company’s three geographic regions all did well, North America by far showed the strongest growth. That was led by Lysol, Finish and Airborne, according to the company. It seems fair to infer that the Lysol and Airborne surges have been motivated by the pandemic: while sales volumes may continue to be elevated versus their pre-pandemic level next year, I suspect that this year’s high growth rate may turn out to be a one-off phenomenon.

Note that Reckitt hasn’t purely benefitted from the pandemic. While hygiene brands such as Dettol have seen sales surges, it also owns the Durex condom brand. With many people locked down in recent months, condom demand had withered. It now shows signs of increasing again, with the Durex brand showing double-digit growth in the quarter. This was driven by some markets where lockdown restrictions were relaxed, but I expect to see similar firming in other markets in coming months. The company has also just launched its first polyurethane condom, which its thin fit should further improve performance in the Durex segment.

The question on the minds of investors eyeing long-term uptick in Reckitt’s performance under the current management, which remains fairly new, is how much of the recent strong revenue performance is due to structural shifts not the rather opportunistic COVID-19 uplift, and also how the profit line is faring as well as the revenue line. There are some positive indicators: a productivity program is said to be ahead of schedule, with £300m of savings in the year to date. E-commerce sales continued to grow, with 45% growth in the third quarter, and now stand at an estimated 12% of group net revenue year to date. I remain skeptical about whether that helps the company – I favor consumers goods company focussing on working with distribution channels not trying to run them – but that is the company strategy and they are performing well against it.

The company upgraded its full year outlook for like for like net revenue growth from high single digits to low double digits. While that is positive – and makes sense given the third quarter performance – there is no update to profit guidance, which is a bit disappointing for investors.

Nutrition

Reckitt Benckiser’s nutrition acquisition turned out to be a bit of a lemon. For now, it remains unclear whether the company is turning it around. This has been one of the biggest drags on the company’s shares – and the acquisition is the reason for the bloated debt burden which continues to drag on financial performance – so management needs to prove that it can fix nutrition to gain credibility longer term.

The quarterly performance was disappointing, and revenue reported in sterling continued to fall.

Chart compiled by author using data from company quarterly filings

While the fall is not huge in percentage terms – this year’s third quarter was 98% of last year’s – it is still a fall, and the trend this year is not good. Bear in mind that this division includes Airborne, for which the company said there was “very strong demand” in the quarter, with revenue on that brand more than doubling. So the core problem – the infant formula business – may continue to be more problematic than is obvious from the numbers above. Travel restrictions seem to be heavily affecting this business, especially in its core China market. The company specifically called out difficulties in markets including a decline in sales in Hong Kong due to far fewer shoppers crossing over from mainland China and purchasing infant formula. Additionally, the pandemic is expected by the company to lead to a reduction in birth rates, a further headwind to the nutrition business which it explicitly called out.

Overall, there is little firm evidence to date that the baby and infant formula business is being turned around. While travel restrictions in a key market are outside the company’s control, they may hang around in some form for the foreseeable future. For now, there are few concrete indicators that the formula business (when stripped out from the reporting segment “nutrition”) is holding its own let alone improving. No matter how well the hygiene division does – and it is flying – the company needs to prove it has a plan to fix the formula business and have proof that it works before the shares deserve positive rerating.

Conclusion: Reckitt Is Improving

I think Reckitt Benckiser is showing progress in key areas. It is more focussed than before and its hygiene brands are doing excellently, especially in North America. That is not purely by accident: the company deserves credit for building a brand portfolio well suited to the current consumer environment and responding well to the pandemic.

However, some of this gain – while welcome – is clearly opportunistic, and the formula business which carried such a high price tag continues to weigh down sentiment on the name. So, while I think a lot of work remains to be done, we are starting to see some signs of strategic recovery. At their current price of 7,090p, the shares trade on a p/e of 20x and yield 2.5% so I don’t see them as a value play. However, if the company can turn in another good quarter next quarter – which it may – it may merit reassessing its long-term valuation prospects. For now, although there is increasing evidence of growth, I remain neutral.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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SVXY: More Upside Remains For This Volatility ETF

Over the past month, the ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY) has recovered somewhat following its decline earlier this year with shares trading up nearly 5%.

It is my view that purchasing SVXY at these levels makes for a good trade for long-term investors. For shorter-term investors, better prices will likely be available in the coming weeks; however, I view the long-run trend of SVXY as a net positive to shareholders and believe a long position is warranted.

About SVXY

To start this piece off, let’s perform a deep-dive analysis on SVXY’s methodology. In the volatility ETP space, there are several different strategies employed and luckily SVXY follows one of the more simple indices out there.

SVXY is an ETF which is giving a half-leveraged inverse exposure to the S&P 500 VIX Short-Term Futures Index. This index holds and rolls exposure in the first two months of the VIX futures curve – it starts a month 100% in the first contract and ends a month 100% in the second-month contract (at which point the front contract expires, the second month becomes the first month, and it starts the process over again). It’s a relatively simple and straightforward method for tracking VIX futures and tends to exhibit the highest degree of correlation to the short-term changes in the VIX as seen in the following chart.

To understand why one would even want to short this volatility index, have a look at the below chart.

Yes, you are seeing this chart correctly – it really does drop that fast and it really has dropped for this long. What you are looking at is an index which has collapsed fairly consistently for the past 10 years at an annualized rate of nearly 50%. Here’s another chart that looks at the year-over-year changes seen in this index over the past decade.

While there have been brief spikes in the index which have resulted in yearly gains, a shocking 90% of the time for the last decade have seen this index lose money on a year-over-year basis. This is the appeal of wanting to short this index. It loses value quickly and it consistently loses money through time.

While some investors may be tempted to simply jump in and buy SVXY based on the above charts, I believe we get the best value from understanding what is driving this key relationship. This will help us understand and frame up expectations for a trade in this instrument and better enable us to profit from what’s driving the changes here.

To understand the problem in a nutshell, here is the current VIX futures curve.

At present, the VIX futures curve is in what is called “backwardation,” which means that futures prices decrease in value along the curve. If we were to assume that the spot VIX level of about 28-29 were to not change over the next seven months or so, then each of these prices would move to eventually approach the spot level. In other words, if you were holding VIX futures, your gain or loss on the futures contract itself is more than just a function of the changes in the level of the VIX: it is subject to the degree to which the futures contracts you are holding converge to the spot price on any given day.

This may seem a bit dense, but if this is an unfamiliar concept, I’d encourage you to read through that last paragraph until it clicks. The reason why it’s important to understand this concept is that this is almost the sole driver of returns in SVXY over lengthy time periods.

But wait a minute, didn’t you just say the curve is in backwardation and wouldn’t that mean that futures would be increasing in value as they approach the spot and therefore SVXY would be losing money since it short these futures?

Yes, at present, the slight backwardation seen in the curve is a detriment to SVXY holders – SVXY is shorting futures which are slightly below the spot level of the VIX and are converging by increasing in value during a typical trading month.

However, the catch here is this: the VIX futures curve has historically been in contango (futures above spot) the vast majority of the time. For example, over the past decade, the first few VIX futures contract have been above the spot price of the VIX a whopping 85% of the time. In other words, on 85% of all days for the past 10 years, VIX futures holders have been suffering from futures slowly converging to the spot price. This relationship is so strong that it can be seen simply through averaging the level of the spot VIX and various VIX futures contracts over the past 10 years for each trading month.

This chart shows the average price of various futures contracts and the VIX itself using the last 10 years of data and grouped by the days until expiry in every month during this time period.

Notice the clear trend? On average, VIX futures are priced above the spot level and on average the front contract converges to parity by the time of expiry with other contracts converging as well, but to a lesser extent depending on the time until expiry of the futures contract. In other words, futures converge to the spot price, which means that since they’re largely priced over the spot, futures are losing value through time.

This is the winning thesis for the long SVXY crowd. Since it is short a persistent relationship seen in VIX futures, it is poised to capture this convergence. However, it is important to note that this relationship plays out over time and is a gradual impact upon prices. In other words, if you’re going to capture this relationship, you need to have a fairly long holding time period. To gauge the duration of holding of a short position needed to capture this, here is the historic probability that the short-term index was lower over a certain number of months using the last 10 years of data.

This chart shows the percentage of occurrences in which the index SVXY shorts has historically fallen grouped by the holding period. On average, if you had held a short position in the short-term VIX futures index, you would have made money in 72% of all months and 90% of all years. In other words, the longer you hold a short position, the greater the chances you have historically seen of earning a profit.

The thing to watch out for however is VIX spikes. This is the negative side of a short VIX strategy. It is entirely possible that the VIX will rally by 100% or more in short time periods which can result in devastating losses for unhedged long traders in SVXY, since it is in essence short the VIX. For this reason, I suggest that any long positions be hedged with put options.

I suggest puts because some movement in VIX futures may result in a position which gaps sizably against you and a simple stop-loss order won’t be able to be executed in a market which gaps rapidly from one price to another. Alternatively, I’d suggest ownership through calls or call spreads. In other words, I believe that very firm risk management needs to be in place prior to buying SVXY because while the returns are fairly consistent, the downside risk can be enormous if you are not appropriately hedged.

I believe that this relationship of higher futures prices along the curve will continue going forward for several reasons. The most important of which is the logic of the relationship. Put simply, during “normal” times, it makes absolute since for the VIX futures curve to be in contango.

Contango (prices increasing in value along the curve) would imply that the market expects higher levels of volatility in the future. Volatility tends to rise during abnormal times, but remain low during normal times, which would mean that most of the time (which is normality by definition), the VIX futures curve should be in contango due to the market’s expectation for higher volatility at some point in the future. This relationship is logical and established in the data as seen by 85% of the time (or the normal times), VIX futures are in contango. A VIX futures curve in contango means futures are rolling down into the spot, which means that a short position in these futures will earn this return.

Based on this clear relationship as well as the logical continuity of it, I suggest buying SVXY at this time. Short-term traders may benefit by waiting for a pullback in the instrument; however, the long-term numbers clearly suggest this is likely going to be a winning trade – provided of course risk management is firmly managed.

Conclusion

SVXY has continued trading higher in a move which has started to erase the gains seen earlier this year. SVXY is shorting an index which has exhibited negative yearly returns for 90% of days of the last decade. VIX futures are normally in contango, which means that long-dated strategies on SVXY are likely going to prove profitable.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source

NextEra Energy’s (NEE) CEO Jim Robo on Q3 2020…

NextEra Energy, Inc. (NYSE:NEE) Q3 2020 Earnings Conference Call October 21, 2020 9:00 AM ET

Company Participants

Matt Roskot – Investor Relations

Jim Robo – Chairman and Chief Executive Officer

Rebecca Kujawa – Executive Vice President Finance and Chief Financial Officer

John Ketchum – President and Chief Executive Officer-NextEra Energy Resources

Conference Call Participants

Steve Fleishman – Wolfe Research

Julien Dumoulin-Smith – Bank of America

Shar Pourreza – Guggenheim Partners

Michael Lapides – Goldman Sachs

Michael Weinstein – Credit Suisse

Operator

Good morning and welcome to the NextEra Energy, Inc. and NextEra Energy Partners Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Matt Roskot of Investor Relations. Please go ahead.

Matt Roskot

Thank you, Andrea. Good morning, everyone, and thank you for joining our third quarter 2020 combined earnings conference call for NextEra Energy and NextEra Energy Partners. With me this morning are Jim Robo, Chairman and Chief Executive Officer of NextEra Energy; Rebecca Kujawa, Executive Vice President and Chief Financial Officer of NextEra Energy; John Ketchum, President and Chief Executive Officer of NextEra Energy Resources; and Mark Hickson, Executive Vice President of NextEra Energy, all of whom are also officers of NextEra Energy Partners; as well as Eric Silagy, President and Chief Executive Officer of Florida Power & Light Company. Rebecca will provide an overview of our results and our executive team will then be available to answer your questions.

We will be making forward-looking statements during this call based on current expectations and assumptions, which are subject to risks and uncertainties. Actual results could differ materially from our forward-looking statements if any of our key assumptions are incorrect or because of other factors discussed in today’s earnings news release and the comments made during this conference call, in the Risk Factors section of the accompanying presentation or in our latest reports and filings with the Securities and Exchange Commission, each of which can be found on our websites, nexteraenergy.com and nexteraenergypartners.com. We do not undertake any duty to update any forward-looking statements.

Today’s presentation also includes references to non-GAAP financial measures. You should refer to the information contained in the slides accompanying today’s presentation for definitional information and reconciliations of historical non-GAAP measures to the closest GAAP financial measure.

With that, I will turn the call over to Rebecca.

Rebecca Kujawa

Thank you, Matt and good morning, everyone. NextEra Energy delivered strong third quarter results and continue to perform well on managing the ongoing impacts of the COVID-19 pandemic.

NextEra Energy’s third quarter adjusted earnings per share increased by more than 11% versus the prior-year comparable quarter, reflecting strong execution at Florida Power & Light Company, Gulf Power and Energy Resources.

Year-to-date, we have grown adjusted earnings per share by over 10% relative to 2019. We continue to execute well on our major initiatives, including continuing to capitalize on the best renewables development period in our history and we are well positioned to meet our overall objectives for 2020 and beyond.

Before moving on, I would like to say a few words about hurricanes Isaias, Laura, Sally and Delta. As you know, residents throughout the eastern and southeastern U.S. were recently impacted by the severe effects of these dangerous and deadly storms. Our deepest sympathies are with those, who have been impacted by these storms widespread destruction. We are grateful for the support that others have given us over the years and we were fortunate to be in a position to assist other utilities this year. As part of our assistance efforts, we sent several thousand of our employees and contractors as well as transmission equipment to help rebuild the grid to support the restoration efforts of the impacted utilities.

Gulf Power itself was impacted by Hurricane Sally, which experienced an unexpected change in intensity and path before striking the service area. Approximately, 285,000 customers or more than 60% of Gulf Power’s customers experienced outages as Sally brought heavy rain and severe flooding. Through a restoration workforce that totaled approximately 7,000 workers, including approximately 2,000 FPL employees and contractors. Gulf Power was able to restore service to essentially all impacted customers within five days.

We are pleased with the efficient and safe restoration response to Hurricane Sally, which was made more challenging by the ongoing impacts of the COVID-19 pandemic. Our focus on preparation and execution, including our annual storm drills helped ensure a timely response to the hurricane despite the pandemic.

Our Florida Power & Light earnings per share increased $0.14 year-over-year. All of the major capital projects including one of the largest solar expansions ever in the U.S. remain on track as we continue to advance our long-term focus on delivering outstanding customer value. FPL’s typical residential bill remains 30% below the national average and the lowest among all of the Florida investor-owned utilities. All while FPL maintains best-in-class service reliability and an emissions profile that is among the cleanest in the nation.

As part of our continued focus on doing what is right for our customers, last month, FPL announced that among other measures, it was offering direct relief of up to $200 per customer to those that are experiencing hardship and are significantly behind on their bills due to COVID-19. We remain committed to supporting our customers during this challenging time.

Gulf Power also had a strong quarter of execution as we continue to deliver on the cost reduction initiatives and smart capital investments that we have previously outlined. We remained focused on improving the Gulf Power customer value proposition by providing lower costs, higher reliability, outstanding customer service and clean energy solutions, and continue to expect that this strategy will generate significant customer and shareholder value over the coming years.

At Energy Resources, adjusted EPS increased by roughly 23% year-over-year, building upon the success of recent quarters, our development team had the best quarter of origination in Energy Resources’ history, adding nearly 2,200 megawatts of signed contracts to our renewables backlog.

After accounting for the removal of several projects, which I’ll talk about more in a moment, our backlog increased by approximately 1,450 megawatts, and now totaled more than 15,000 megawatts. To put this into perspective, our backlog, which we continue to expect and expect to construct over the next several years is now larger than Energy Resources entire existing renewables portfolio, which took us more than 20 years to complete.

Our engineering and construction team also continues to execute, commissioning more than 800 megawatts since the last earnings call and keeping the remainder of the – more than 5,200 total megawatts of wind and solar projects that we’re expecting to complete this year on track to achieve their 2020 in-service dates. Overall, with three quarters complete in 2020, we are pleased with the progress we are making in NextEra Energy and are well positioned to achieve the full-year financial expectations that we’ve previously discussed, subject to our normal caveats.

Now, let’s look at the detailed results beginning with FPL. With the third quarter of 2020, FPL reported net income of $757 million or $1.54 per share, an increase of $74 million and $0.14 per share respectively year-over-year. Regulatory capital employed increased by more than 11% over the same quarter last year and was the principal driver of FPL’s net income growth of roughly 11%.FPL’s capital expenditures were approximately $1.3 billion during the third quarter and we expect our full-year capital investments to total between $6.5 billion and $6.7 billion, which is a reminder, is higher than our expectations at the start of the year.

Our reported ROE for regulatory purposes will be approximately 11.6% for the 12 months ending September 2020, which is at the upper end of the allowed band of 9.6% to 11.6% under our current rate agreement. During the quarter, we restored $258 million of reserve amortization to achieve our target regulatory ROE leaving FPL with a balance of $994 million.

As we’ve previously discussed, we expect FPL and Gulf Power operating as a single larger Florida utility company, we’ll create both operational and financial benefits for our customers. Earlier this month, we were pleased to receive for – approval for an internal reorganization, whereby Gulf will merge into FPL in January of 2021. Gulf Power will continue as a separate operating division during 2021 serving its customers under separate retail rates. We continue to expect the companies will file a combined rate case in the first quarter of next year for new rates effective in January of 2022.

Turning to our development efforts. all of our major capital initiatives at FPL are progressing well. The next six SolarTogether projects, totaling approximately 450 megawatts remain on track to be placed in service later this year. The final 600 megawatts of the roughly 1,600 megawatts community solar program are expected to be placed in service next year. This significant solar expansion combined with low-cost battery storage solutions such as Manatee Energy Storage Center that remains on track to be complete next year represent the next phase of FPL’s generation modernization efforts. Beyond solar, construction of the highly efficient roughly 1,200 megawatt Dania Beach Clean Energy Center remain on schedule and on budget as it continues to advance towards its commercial – projected commercial operations date in 2022.

During the quarter, we are pleased that the Florida Public Service Commission approved FPL’s Storm Protection Plan settlement agreement that allows for clause recovery of storm hardening investments, including undergrounding. The agreement supports the continued hardening of FPL’s already storm-resilient energy grid in a programmatic manner through the deployment of billions of dollars of incremental capital for the benefit of customers.

Let me now turn to Gulf Power, which reported third quarter 2020 GAAP earnings of $91 million or $0.18 per share, an increase of $0.02 per share relative to Gulf Power’s adjusted earnings per share in the prior-year period. Gulf Power’s reported ROE for regulatory purposes will be approximately 10.5% for the 12 months ending September 2020. For the full-year 2020, we continue to target a regulatory ROE in the upper half of the allowed band of 9.25% to 11.25%.

During the quarter, Gulf Power’s capital expenditures were roughly $350 million and we expect our full-year capital investments to total between $1 billion and $1.1 billion. All of Gulf Power’s major smart capital investments continue to progress well. The Plant Crist coal-to-natural gas conversion and associated natural gas laterals are expected to be complete later this year, supporting NextEra Energy’s coal phase-out strategy and commitment to remain a clean energy leader. Although Gulf Power has not completed the final accounting, our preliminary estimate of the Hurricane Sally recoverable storm restoration costs is roughly $200 million. The storm restoration costs have been deferred and recorded as a regulatory asset on Gulf Power’s balance sheet.

Under the terms of Gulf Power’s current rate agreement, beginning 60 days following the filing of a cost recovery petition with the Florida Public Service Commission and subject to a review and prudence determination of our final storm costs, Gulf Power is authorized to recover storm restoration costs on an interim basis from customers through a surcharge.

Similar to FPL, Gulf Power’s Storm Protection Plan settlement agreement was also approved during the quarter. We expect that these future hardening investments will lead to a stronger and more storm-resilient grid at Gulf Power and support an even more rapid recovery from storms in the future.

Similar to other parts in the country, the Florida economy continues to recover from the impacts of the ongoing COVID-19 pandemic. Recent economic data reflects an improvement in the Florida unemployment rate since the start of the pandemic and an increase in consumer confidence that are roughly in line with the changes to the national averages of each metric. We continue to believe that the financial strength and structural advantages which Florida entered the crisis and the continued attraction of the state to both new residents and new businesses will support a rebound as we move beyond the pandemic.

We will continue to do our part to support that outcome, including pursuing our smart capital investment program and economic development efforts, which help create jobs, provide investment in local communities and further enhance our best-in-class customer value proposition.

During the quarter, FPL’s average customer growth was particularly strong, increasing by nearly $80,000 from the comparable prior year quarter. FPL’s third quarter retail sales increased 2.8% year-over-year as customer growth, weather and underlying usage per customer all contributed favorably. For Gulf Power, the average number of customers increased approximately 1.1% versus the comparable prior year quarter. Gulf Power’s third quarter retail sales declined 6.7% year-over-year, primarily as a result of unfavorable weather comparison relative to the particularly strong third quarter last year and a decline in underlying usage, primarily associated with Hurricane Sally.

At both FPL and Gulf Power, third quarter weather-normalized retail sales were roughly in line with our expectations at the start of the year, and we do not believe that the pandemic had much of an overall impact on underlying usage. At FPL, we continue to expect the flexibility provided by our reserve amortization mechanism will offset any fluctuation in retail sales or bad debt expense and support a regulatory ROE at the upper end of the allowed band of 9.6% to 11.6% under our current rate agreement.

Let me now turn to Energy Resources, which reported third quarter 2020 GAAP earnings of $376 million or $0.76 per share and adjusted earnings of $551 million or $1.12 per share. This is an increase in adjusted earnings per share of $0.21 or approximately 23% from last year’s comparable quarter results, which have been restated to reflect the results of our NextEra Energy Transmission business, formerly reported in corporate and other.

New investments attributed $0.06 per share, primarily reflecting continued growth in our contracted renewables program. The contribution from existing generation assets was flat year-over-year as the decline in wind resource and costs associated with the retirement of our Duane Arnold nuclear facility were roughly offset by increased PTC volume from our repowered wind projects as well as the lack of an unfavorable state tax item, which impacted last year’s third quarter results.

Contributions from both NextEra Transmission and our customer supply and trading business increased by $0.01 year-over-year. All other impacts increased results by $0.13 per share, driven primarily by the absence of the write-off of development costs, the negatively impacted 2019 results.

The Energy Resources development team continued to capitalize on what we believe is the best renewables development environment in our history during the quarter, with the team originating a record of nearly 2,200 megawatts. Since our last earnings call we have added 580 megawatts of new wind, 911 megawatts of solar, 594 megawatts of battery storage and 86 megawatts of wind repowering. The significant additions include a new 325 megawatts four-hour battery storage system. This project which is the largest standalone storage project in the world is expected to support California’s aggressive clean energy goals and help improve reliability across the regional electric grid when it comes online in 2023. We also executed 180 megawatts solar build-own-transfer agreement during the quarter, which is not included in our backlog additions.

Partially offsetting this quarter’s strong origination success was the removal of several projects we had previously included in our backlog. A majority of the reductions are the result of an unfavorable ruling from the Alabama Public Service Commission related to several solar plus storage projects. We expect the customer to hold a future procurement for this generation capacity, and are hopeful that the projects may receive new contracts during that process.

After accounting for these projects, removals the Energy Resources backlog had a net increase of 1,446 megawatts during the quarter. Reflective of our customer demand for low-cost wind, solar and battery storage projects that is stronger than ever. The repowering projects added this quarter include our first project for beyond 2020, and adds to the recent significant increase to our 2021 new wind and repowering backlog, which now totals roughly 2,000 megawatts. With the addition of the 2021 repowering project we are now introducing repowering expectations for 2021 and 2022 period of 200 megawatts to 700 megawatts.

Continued cost and technology improvements have supported an expanding opportunity set for both new wind and repowering over time. As a result, we are beginning to evaluate incremental repowering opportunities for beyond 2022. Through the first three quarters of 2020 we have added nearly 4,800 megawatts to our renewables backlog, which now totals more than 15,000 megawatts and is the largest in our history. To reflect the current backlog and strong origination success we are raising the low end of our 2019 through 2022 development expectations to 15,500 megawatts, which is above the midpoint of our original range. And we are increasing the top end of the expectations to reflect the incremental repowering expectations that we added this quarter.

Additionally, with more than 4,000 megawatts of renewables projects already in our backlog for post 2022 we are well positioned to execute on our long-term growth objectives. We continue to believe that by leveraging Energy Resources’ competitive advantages, we can further capitalize on the best renewables development environment in our history going forward.

As we’ve previously discussed, we are optimistic about the potential for green hydrogen to support an emissions-free future. Consistent with our toe in the water approach to new opportunities Energy Resources has developed a pipeline of approximately 50 potential green hydrogen projects spanning the power, transportation and industrial sectors. These projects serve a variety of end uses, and similar to the strategy employed in wind, solar, battery storage and other areas, provide the opportunity to develop early learnings with relatively small investments to set the stage for much larger capital deployment as cost declines and technology improvements are realized. Over the next several quarters we expect to add to this pipeline, while advancing select projects as we position ourselves to continue to be a leader in the decarbonization of the energy sector.

We remain excited about hydrogen’s long-term potential to further support future demand for low-cost renewables, as well as accelerate the decarbonization of transportation fuel and industrial feedstocks. Beyond renewables, we are pleased with the recent progress to resolve the outstanding permit issues required for Mountain Valley Pipeline’s construction. Among other progress since the last earnings call, MVP has received its revised biological opinion, approval of the project’s nationwide 12 permit by the Army Corps of Engineers and a recent order by FERC authorizing forward construction to resume along the majority of the project route.

Following receipt of this approval, MVP resumed construction work across West Virginia and Virginia. Despite the recent progress we were disappointed with the Fourth Circuit Court’s decisions to administratively stay MVP’s nationwide 12 permit. We disagree with the court’s decision and continue to work with our partners to move the project forward. Depending on the outcome of these issues, we continue to target an in-service date of the pipeline for during 2021.

Consistent with our focus on growing our rate-regulated and long-term contracted business operations, during the third quarter NextEra Energy Transmission announced an agreement to acquire Grid Lines, which owns three FERC-regulated transmission utilities spanning six states. Subject to regulatory approvals, the approximately $660 million acquisition, including the assumption of debt is expected to close in 2021, and to be immediately accretive to earnings. The proposed acquisition has strong expansion potential and attractive markets with significant expected renewables growth, and furthers our goal of growing America’s leading competitive transmission company.

Turning now to the consolidated results for NextEra Energy. For the third quarter of 2020 GAAP net income attributable to NextEra Energy was $1.229 billion or $2.50 share.

NextEra Energy’s 2020 third quarter adjusted earnings and adjusted EPS were $1.311 billion and $2.66 per share respectively.

Adjusted earnings from Corporate and Other segment declined $0.10 year-over-year, primarily due to other corporate expenses, which includes interest.

During the quarter NextEra Energy issued $2 billion of equity units as we continue to focus on opportunistic and prudent capital management to enhance the strength of our balance sheet. The equity units will convert to common equity in 2023. And the proceeds are expected to be primarily used to redeem a portion of NextEra Energy’s outstanding hybrid securities and to finance the acquisition of GridLiance and NextEra Energy’s continued renewables expansion.

In addition to the redemption of hybrid securities in the fourth quarter, we are also considering several other potential refinancing activities to take advantage of the low interest rate environment. In total, these initiatives could generate negative adjusted EPS impacts of roughly $0.20 in the fourth quarter before translating to favorable net income contributions in future years and an overall improvement in net present value for our shareholders. Consistent with our efforts to position NextEra Energy well for long-term growth and take advantage of the low interest rate environment, during the quarter, we entered into $2 billion in forward starting interest rate swaps to further support future debt issuances.

Finally, in July, as part of its 2020 annual review, Moody’s reduced NextEra Energy’s CFO pre-working capital-to-debt downgrade threshold from 18% to 17%. The favorable adjustment was based on recognition of NextEra Energy’s leading position in the utility and renewable energy sectors and stable cash flow generation profile.

As we announced last month, based on the ongoing strength of the renewables development environment and continued execution across all of our businesses, we increased NextEra Energy’s financial expectations for 2021 and 2022, and extended our long-term growth outlook to 2023.

For 2021, NextEra Energy’s adjusted EPS expectation ranges increased by $0.20, and we now expect adjusted earnings per share to be in the range of $9.60 to $10.15. For 2022 and 2023, we expect to grow 6% to 8% off of the expected increased 2021 adjusted earnings per share. The increased adjusted earnings expectations are supported by what we believe is the most attractive organic investment opportunity set in our industry, largely as a result of the significant renewables investment opportunities that we expect to capitalize on, we now expect our total capital expenditures from 2019 to 2022, to total roughly $60 billion, an increase from the $50 billion to $55 billion range we introduced at the Investor Conference last year.

During the quarter, the Board of NextEra Energy approved a four-for-one common stock split, which is intended to make stock ownership more accessible to a broader base of investors.

Trading will begin on a stock split adjusted basis on October 27. And our fourth quarter and full year 2020 financial results will reflect the post split share count. As a result of the stock split NextEra Energy updated its adjusted EPS ranges to reflect the increase in its – in outstanding shares.

In 2020, the company now expects adjusted earnings per share to be in the range of $2.18 to $2.30. The adjusted EPS ranges for 2021 and beyond are included on the accompanying slide.

from 2018 to 2023, we expect that operating cash flow will grow roughly in line with our adjusted EPS compound annual growth rate range. We also continue to expect to grow our dividends per share at roughly 10% per year through at least 2022 off of the 2020 base. As always, our expectations assume normal weather and operating conditions.

In summary, despite the challenges created by COVID-19 pandemic, NextEra Energy has continued to deliver terrific operational and financial results through the first three quarters of 2020. Based on the resiliency of our underlying businesses and our strong growth prospects, we will be disappointed if we are not able to deliver financial results at or near the top end of our adjusted earnings per share expectations ranges in 2020, 2021, 2022 and now 2023, while at the same time, maintaining our strong credit ratings. We remain intensely focused on execution, and believe NextEra Energy remains well positioned to drive shareholder value in the coming years.

Let me now turn to NextEra Energy Partners. The NextEra Energy Partners portfolio performed well and delivered financial results in line with our expectations. Adjusted EBITDA was down slightly compared to the third quarter of 2019 and cash available for distribution increased 10% versus the prior year comparable quarter.

On a year-to-date basis, adjusted EBITDA and cash available for distribution have increased by 16% and 50% respectively, versus 2019. Yesterday, the NextEra Energy Partners board declared a quarterly distribution of $0.595 per common unit, or $2.38 per common unit on an annualized basis, continuing our track record of growing distributions at the top end of our 12% to 15% per year growth range.

During September, NextEra Energy Partners completed the successful conversion of approximately $300 million of convertible debt into roughly 5.7 million common units. This financing, combined with a related capped call, that NextEra Energy Partners entered into at the time of the debt issuance, generated significant value for LP unitholders.

Following receipt of the capped call settlement, the debt had roughly $0 three-year cumulative cash cost. Relative to issuing equity at the time of the financing, 25% fewer units were issued. And NextEra Energy Partners generated approximately $50 million in cumulative cash savings. The convertible debt financing highlights the value of NextEra Energy Partners, utilizing low-cost financing products to support growth and efficiently issue equity over time. Overall, we are pleased with the year-to-date execution at NextEra Energy Partners and are well positioned to meet our 2020 and longer-term expectations.

Now, let’s look at the detailed results. Third quarter adjusted EBITDA was $312 million, a decline of approximately 1% year-over-year. Cash available for distribution was $162 million, up approximately 10% from the prior-year comparable quarter. new projects added $24 million of adjusted EBITDA and $16 million of cash available for distribution. Adjusted EBITDA from the existing assets declined year-over-year as lower wind resource was partially offset by growth at the Texas pipelines as a result of the expansion project going into service.

Wind resource was 96% of long-term average versus a particularly strong 107% in the third quarter of 2019. cash available for distribution from existing projects benefited from a reduction in debt service payments, primarily as a result of the retirement of outstanding notes at our Genesis project and receipt of higher year-over-year PAYGO payments. The reduction in project level debt service was partially offset by higher corporate level interest expense. As a reminder, these results include the impact of IDR fees, which we treat as an operating expense. The additional details are shown on the accompanying slide.

We are pleased to announce that NextEra Energy Partners has successfully completed its first two organic growth investments ahead of schedule and on budget. The repowering of the 175 megawatt Northern Colorado wind project was recently placed into service. The repowering provides multiple benefits to NextEra Energy Partners, including increased production, an uplift in project cash flow, a longer asset life and lower O&M costs. The remaining 100 megawatts of wind repowering, remains on track to be in service later this year.

Additionally, during the quarter, the backup compression capacity on the Texas pipelines also reached commercial operation. The expansion opportunity is supported by a long-term contract and is expected to deliver attractive returns to LP unitholders. The ability to complete these projects as planned, despite the challenges created by the pandemic is a testament to the best-in-class engineering and construction team that NextEra Energy partners is able to leverage to execute its organic investments. We continue to expect to execute on additional attractive organic growth opportunities as the NextEra Energy Partners portfolio further expands.

Let me now turn to NextEra Energy Partners’ expectations, which remain unchanged. NextEra Energy Partners continues to expect December 31, 2020 run rate for adjusted EBITDA to be in a range of $1.225 billion to $1.4 billion, and cash available for distribution to be in a range of $560 million to $640 million, reflecting calendar year 2021 expectations for the portfolio at year-end 2020.

As a reminder, our expectations include the impact of anticipated IDR fees, as we treat these as an operating expense. NextEra Energy Partners is also considering several potential refinancing activities to take advantage of the low interest rate environment. If pursued, these initiatives could generate costs in the fourth quarter, before translating to favorable cash available for distribution contributions in future years and an overall improvement in net present value for our unitholders.

From a base of NextEra Energy Partners’ fourth quarter 2019 distribution per common unit at an annualized rate of $2.14, we continue to see 12% to 15% per year growth in LP distributions as being a reasonable range of expectations through at least 2024. We expect the annualized rate of the fourth quarter 2020 distribution that is payable on February 2021, to be in a range of $2.40 to $2.46 per common unit.

We continue to expect to achieve NextEra Energy Partners’ 2020 distribution growth objectives, while maintaining a trailing 12-month payout ratio of approximately 70% highlighting the significant flexibility we believe NextEra Energy Partners has going forward. as we previously discussed, while we continue to be opportunistic, NextEra Energy Partners’ favorable position should give it flexibility to achieve its long-term distribution growth objectives, without the need to make any acquisitions until 2022. As always, our expectations assume normal weather and operating conditions.

We are pleased with a strong year-to-date performance in NextEra Energy Partners and continue to believe it offers a compelling investor value proposition going forward. with significant expected long-term renewables growth combined with the strength of NextEra Energy Partners existing portfolio and continued access to low-cost sources of capital, we believe NextEra Energy Partners is uniquely positioned to take advantage of the disruptive factors reshaping the energy industry.

NextEra Energy Partners continues to maintain flexibility to grow in three ways; through our great organic growth, third-party acquisitions or through acquisition from NextEra Energy resources, unparalleled portfolio of renewables projects that now totals roughly 28 gigawatts, including signed backlog. These factors provide us with as much confidence in NextEra Energy Partners’ long-term future as we have ever had. We look forward to delivering on that potential in the coming years.

In summary, we continue to believe that both NextEra Energy and NextEra Energy Partners have some of the best opportunity sets and execution track records in the industry and we remain as enthusiastic as ever about our future prospects.

That concludes our prepared remarks. And with that, we will open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Steve Fleishman of Wolfe Research. Please go ahead.

Steve Fleishman

Hello. Thank you. I guess, two questions; first of all, the – does the backlog increase that you announced today include the NiSource NIPSCO projects that were just announced this morning or would those be additive?

John Ketchum

Steve, this is John Ketchum. Yes, it does include the NiSource projects.

Steve Fleishman

Okay. And then second question would just be this will probably be the last time we hear from you before the election results. So just maybe, one more time. Could you just talk about in the event that Biden wins the election, thoughts on what that could mean for renewables opportunity? And also thoughts on how NextEra is positioned for any tax reform changes. Thanks.

Rebecca Kujawa

Thanks, Steve. As you well know and kind of consistent with our history, we focus on analyzing a variety of impacts and one of our key focus for going into the election is to ensure that we’re well positioned to be successful regardless of the outcome. And looking back in the last couple of years, obviously, we’ve done quite well across all of our businesses in the environment that we’ve been in.

So, should Trump win a second term, we would expect to continue our strong momentum and continued focus on our strategies and execution on them. If Biden is the new President, he has clearly made clear across this platform, across the Democratic platform that they had strong support for renewables. To date, their plan is more focused on broad goals as opposed to specific plans for how they would get there, but we could easily see, whether it’s extension of incentives, focus on storage, potentially focus on hydrogen, et cetera, to further accelerate the expansion of renewables across the U.S. beyond the already strong demand that we’re seeing, that’s clearly based on the economic value of renewables relative to the alternatives.

As it relates to tax reform, obviously, that’s part of some of the things that Biden has been talking about. It certainly could be on the agenda. I think there’s a question as to whether or not it would be one of the first things that a new administration would want to focus on, particularly as we will likely find ourselves still in recovery mode from the pandemic and we will evaluate, as there’s – if there are more details and as there are more details, we’ll evaluate the overall impacts.

If you look at the prior tax reform as an example, clearly, a change in the tax rate, an increase in the tax rate, as Biden has talked about, would have some negative adjusted earnings impacts, positive cash impacts, all else being equal. But we need to think about, one, the details of any policies that they put forward; but two, together with the other things that would come along with the new Biden administration, including the strong demand for renewables that we would expect. So more to come as we learn more and, obviously, the results from the actual election unfold.

Steve Fleishman

Great. Thank you.

Rebecca Kujawa

Thanks, Steve.

Operator

Our next question comes from Julien Dumoulin-Smith of Bank of America. Please go ahead.

Julien Dumoulin-Smith

Good morning to you. Thanks for the time. Appreciate it. If I can follow-up on a couple of things here. First; transmission, you guys did this interesting announcement in the quarter. How does that enable a further expansion of potentially larger-scale projects? And how does that complement essentially larger-scale renewable ambitions you might have across the core Midwest territories that they serve today?

Rebecca Kujawa

Yes, Julien. thanks for the question. We are thrilled with the acquisition, of course, subject to approvals of GridLiance, and it is the three different transmission companies across six states, where their existing assets are located. First, there are investment opportunities in those existing investments that we have – that we would have in GridLiance. But it also positions us to have a seat at the table in these regional ISOs as they contemplate new transmission projects. And obviously, GridLiance would seek to compete effectively for those opportunities. The comment around renewables is that as we think about a broad and substantial expansion of renewables across the U.S., it becomes important and increasingly so over time, to continue to invest in the transmission grid across the U.S.

So, we want to be a part of that solution and capitalize on those investment opportunities via our competitive transmission business, but also, we’ll depend on that in order to realize the significant expansion of renewables over time. So, it’s both an enabler and an investment opportunity from our perspective.

Julien Dumoulin-Smith

Thank you. Perhaps, if I can pivot over to the more strategic side of the equation here and perhaps I’ll frame it this way. So, you all have recently received greater latitude when it comes to your debt metrics on an FFO to debt basis from the agencies. Can you talk about how you might receive yet further latitude as you think about the percent regulated the business needs to get to, to unlock yet for lower metrics, if that makes sense? And perhaps in tandem with that, might you expose your latest thought process on strategic thinking from here beyond, perhaps some of the comments you previously provided to the extent relevant.

Rebecca Kujawa

Yes, of course. So, a strong balance sheet is incredibly important to us. And one of the things that we spend a lot of time talking with the agencies about is how strong a cash flow generation profile all of the businesses have, how diverse in a variety of metrics, including geography, technology, customers, et cetera, and how that profile compares very favorably to other peers in the industry and their own respective cash profiles.

So, we did realize the improvement in downgrade thresholds, specifically at Moody’s this period that 18% to 17% downgrade threshold improvement and we’ll continue discussing with the agencies about the high-quality characteristics of our cash flows and seek improvements in additional flexibility as appropriate. There is the opportunity to have extensive dialogues with the agencies around potential regulated M&A. So any time, we do contemplate transactions; we have those conversations to evaluate whether or not the profile of the cash flow generation changes such that it would move those metrics. And as we have those dialogues and have those conversations with respect to potential M&A, we factor those in to any deal transaction economics. It remains incredibly important to us to be able to maintain consistency with our objectives around M&A, which is that they’re value accretive from an earnings perspective. They also are in strong regulatory environments and create opportunities for us to invest capital. But being accretive is incredibly important to us.

As you know, when we think about metrics, there are quite a number of ways to think about the balance of our business between the competitive generation business and regulated. And one of the key ways that we continue to maintain that balance is through capital recycling. And that’s one of the reasons why NextEra Energy finds value in its long-term relationship with NextEra Energy Partners, is the clear ability to recycle capital in a very efficient way with NextEra Energy Partners.

Julien Dumoulin-Smith

Got it. But there’s no specific percent regulated that you want to achieve to get that number down to 16% or 15%, right?

Rebecca Kujawa

No. We’re not prescriptive about a specific balance. We think about a variety of factors when we think about what’s the optimal balance of our business and there’s not one answer at a given point in time. And certainly, that can be influenced over time as things change and our perspective and the agency’s perspective changes.

Julien Dumoulin-Smith

Excellent. Thank you, all. Best of luck.

Rebecca Kujawa

Thank, Julien.

Operator

Our next question comes from Shar Pourreza of Guggenheim Partners. Please go ahead.

Shar Pourreza

Hi, good morning, guys.

Rebecca Kujawa

Good morning.

Shar Pourreza

Just a quick follow-up on Julien’s question. And it’s really bent on sort of that mix. Obviously, FPL and Gulf are posting very solid regulatory capital deployment, but the NEER development platform keeps signing contracts. And as you guys sort of highlighted that the backlog is now larger than the existing portfolio. So, curious on how we should sort of think about the growth trajectory of NEER as we’re sort of thinking about a mix. I mean, is 70%/30%, Rebecca, no longer relevant on what you sort of target there? Have you sort of sanitized the additional growth opportunities with NEER with the rating agencies?

And then how do you sort of stay within a potential mix? Obviously, recycling capital into NEP is an option, but that has a lot of constraints and limits. Slowing down NEER likely isn’t an option. So really is the path of least resistance, more regulated acquisitions. So maybe, if you could just drill down a little bit further into the prior question?

Rebecca Kujawa

Thanks, Shar. And then I certainly appreciate the premise of the question, which is, we have terrific organic growth prospects at both the regulated utilities and in the competitive energy business. One of the things that we think is really important from the competitive side of the business is so long as we can find projects that are attractive, that have attractive returns. We don’t want our teams to be capital constrained because we believe that these are very strong value-accretive project investment opportunities for our shareholders. So, we set them off and hope that they can find all of the best projects and that we can secure the wins and build those projects.

As you know, a significant amount of the value creation of developing renewables projects and owning and operating them long-term is in that development process, constructing them and beginning and putting them into operations. So, if we can continue to do that with value-accretive projects, and to the extent that we want to manage a balance of the mix of business across the different companies. We will take advantage of that capital recycling as one of the best ways and most value-accretive ways for NextEra Energy shareholders to recycle capital either to NextEra Energy Partners or potentially even to other third parties depending on market characteristics at the time. So, I think we’ve got a lot of levers. And again, most importantly, in a terrific position of win-win of having a lot of places to place our capital and, obviously, we’re pleased with raising our capital investment ranges for the four-year period.

Shar Pourreza

So just a follow-up. So that 70%/30% regulated non-utility mix, should we sort of just move away from that sort of target that we’ve discussed in the past?

Rebecca Kujawa

Shar, I think the key takeaway is there’s not a specific number that is the right number. And we’ll be – we think about it in a variety of different ways over time. And there are a variety of levers that we can utilize to maintain a balance, but we’re not prescriptive on a specific number that it needs to be.

Shar Pourreza

Got it. Got it. And then just on the battery side, you obviously added 594 megawatts, which includes a single 325, four-hour project. Can you sort of just maybe talk about the economics of storage you’re seeing, especially with the four hours project? Just maybe from an LCOE perspective, and with the current backlog of storage opportunities, is four hours of storage sort of that peak capability? Or are you seeing some longer storage opportunities?

Rebecca Kujawa

Well, let me take that last part first. I don’t know that there’s a constraint or a peak capability of storage. There are clearly a variety of storage solutions that could make sense in a given application. What our energy resources team is largely focused on is providing solutions that our customers want to buy, that solve our customers’ needs. And most recently, four-hour storage has been very attractive and particularly interesting to our customers. So, we have sold quite a number of four-hour storage projects. From a return standpoint, these storage facilities are often sold together with other renewables projects, specifically other solar projects, and we found the returns to be very attractive, comparable to solar and wind project returns on an overall basis.

John Ketchum

Yes. And Shar, this is John Ketchum. I have a couple of things that I would add to that are: One, remember, there are three ways that we really look to grow the storage business. One is pairing it with solar. The second are trifecta opportunities that we’ve advertised in the past that we’ve been successful executing on, combining storage with wind and with solar. If we were able to get – ever to get a stand-alone storage ITC, obviously, that would help what is the largest wind portfolio in North America. And then the stand-alone opportunities along the lines of what we’re able to advertise today.

So, when you combine those three potential opportunity sets, we have a significant growth opportunity in storage. You see that in our 2021 CapEx plan, that is over $1 billion in storage. Nobody has the existing fleet that we have. And so the opportunity to pair storage at existing solar facilities, existing wind facilities and then look for stand-alone opportunities, I think, puts us in a different class, just based on the existing operating fleet that we have. And then as you think about batteries going forward, four-hour duration may make sense in certain markets, two hours in others. But in two to three years, we could be moving to solid-state batteries, which could also provide longer duration, more efficient at a reduced cost. And then hydrogen certainly is a long-term alternative. We mentioned the 50 pilot projects today in electricity, in transportation and industrial applications.

So, we see hydrogen as really a long-term solution, particularly if we end up in 100% decarbonized energy policy by 2035, where hydrogen could really be the solution for that last 10% to 15% where it gets very expensive to do with batteries, much cheaper and more manageable to do with hydrogen.

Shar Pourreza

Terrific guys. Thank you very much.

Rebecca Kujawa

Thank you.

Operator

Our next question comes from Michael Lapides of Goldman Sachs. Please go ahead.

Michael Lapides

Hey, guys. Thank you for taking my questions. On the renewable front, it seems that after years of not really doing a lot, that pretty much every regulated investor-owned utility has its own renewable growth strategy and rate base. Can you talk about – now the broader market has massive tailwinds? But can you talk about how that move by the regulated IOUs is impacting the competitive dynamic for people developing, especially all given your scale, renewables on the non-regulated side of the business. Like how does that just kind of flow-through or impact the market dynamic?

Rebecca Kujawa

Thanks, Michael. We appreciate the question. Well, let me highlight first and at the risk of sounding a little too flip. We now have a backlog of over 15,000 gigawatts, and we do get a lot of questions about whether or not we’re concerned about the competitive dynamic, but the team is doing pretty well in this dynamic. And keep in mind that we’ve got customer base that’s investor-owned utilities, munis and co-ops and C&I customers. And the dynamics of wanting to build and rate base really are predominantly focused on the investor-owned utility side.

And there are opportunities even within investor-owned utilities to compete effectively for the business and partner with them in many cases to create win-win opportunities for them to get the best built projects for their customers, own some of it in rate base, enable us to operate it in some cases, enable us to power purchase agreement – enter into those power purchase agreements and sell it to them over time. And then, of course, we continue to have strong opportunities to sell under contract to the munis and co-ops and C&I customers. So the outlook is very bright. Our team is doing a terrific job executing, and we’re looking forward to continuing to deliver against those growth opportunities.

John Ketchum

Yes. And just, Michael, picking up on a couple of the comments that Rebecca made. With IOUs, let’s just take a look at what happened with NIPSCO this quarter. If you add on the 400 megawatts of wind that we announced last year, we’re now at 2-gigawatts with just one customer, one investor-owned utility in Indiana, in NIPSCO. So, we still see significant opportunities for investor-owned utility renewable buildout, being able to bring low-cost solutions that combine not only traditional renewables, but with storage applications and then obviously around hydrogen. Munis and co-ops have always been a core part of the business. And then C&I, as Rebecca mentioned at the end, the C&I market is really accelerating. And as ESG has really come into the fold, a lot of the investor pressure that formally nontraditional buyers of renewables are facing from their investor base has really expanded the opportunity set for us to sell many different products to those potential customers.

And one of the things that we’re seeing in the decarbonized U.S. economy is not only the chance to sell renewables, but also to play to our others ranks. So a lot of adjacencies, a lot of adjacencies around clean energy, where we are the natural fit to be a leader in some of those specific markets. And those are some of the things that we are continuing to look at and spending a lot of time as a senior team focusing on.

Michael Lapides

Got it. And if you don’t mind a follow-up on the regulated side. In the event sometime over the next couple of years, there are higher corporate income tax rates and we’ll see, obviously, policy changes and is fluid. How do you think about what that means for the customer, given the cost of service would obviously have to reflect the higher tax rate? But also the excess accumulated deferred federal income taxes that currently is being refunded by many utilities around the country, part of that would actually potentially, I think, reverse.

So it would kind of put on the backs of the customer a decent bit of a rate increase and a little vary by jurisdiction and by utility. How does that impact the dynamic over a multiyear period? Yes, it raises cash flow, but it could also raise the customer bill. And what do you think the opportunity set is for NextEra in terms of either offsetting that impact? Or even improving your competitive position at the utility level relative to some of your peers?

Jim Robo

Hey Michael it’s Jim. Let me take that because we’ve been doing a lot of thinking around, obviously, different scenarios around, obviously, different scenarios around what happens with taxes depending on what happens with the federal elections. Remember, what happened in 2017 around tax reform is that the industry very effectively, I think, came together, and they were really two industries that were carved out for different treatment in the 2017 tax reform scenario. One was real estate, and I’ll let you speculate as to why real estate might have gotten singled out. And the other was the utility sector and the utility sector, I think, was very effective in laying out what the impacts to customers and to balance sheets were around tax reform.

I think to the extent that there is any tax discussion next year. Let’s assume for a minute that Biden wins, I think it’s very – I think it’s – we’re obviously in a scenario planning around both outcomes because I think you can’t really handicap it one way or another right now. The best thinking that we’ve had around this is that in the middle of a pandemic it’s probably not the time to have a tax increase period. And so in terms of the timing around tax reform, I’d be surprised if it was next year, honestly, even in a Biden administration. Who knows, right? I mean that’s a bit of speculation on my part.

But the other thing I think we would be very effective as an industry being able to do is to lay out how any tax increase on utilities is really simply a tax increase on all customers and non- corporations but on everyday Americans. And I think that message will resonate in Washington. And so that’s a message that we, as an industry, haven’t been able to lay out yet, obviously, because it’s premature to do so.

So I think a lot of the angst around tax reform, one way or another, is I think a little premature right now. And obviously, we’ll see what happens in the election. But then if Biden does win, then there’s going to be, where does it stand up in the list of policy priorities for the newer administration if there should be one.

Michael Lapides

Got it. Thank you, Jim. Much appreciated.

Operator

Our next question comes from Michael Weinstein of Credit Suisse. Please go ahead.

Michael Weinstein

Hi, guys. A couple of questions on the possibility of higher taxes on the other side of it, wondering if that would potentially reduce your need to use tax equity for projects going forward. And also, I understand as the largest player out there, you guys don’t really ever have a problem attracting tax equity investors. But can you just comment on the status of the tax equity market in general right now? I guess, it’s pretty tight for some of the smaller players. Is that something that could improve under a Democratic administration if the tax rates go up and tax credits are extended, et cetera?

Rebecca Kujawa

Sure. Let me start with this year first. From a tax equity market standpoint, that was one of the things that we and everybody else in the industry, and of course, the tax equity providers were thinking about in the early stages of the pandemic. We have secured all of our tax equity commitments for this year and have already started the dialogues with tax equity partners about our pipeline of projects for next year. And we feel confident about our ability to secure tax equity.

I do think as you go out a year into 2021 and maybe into 2022, it’s certainly possible that the tax equity providers are going to have more limited capacity. And that may affect others further down the chain a little bit smaller or a lot smaller than we are and could be an issue. As it relates to tax reform, it’s – without knowing the details of it and the kind of having more of the specifics, it’s hard to answer the question of whether or not the needle has moved enough to not need tax equity. It also somewhat presumes that there’s an extension of incentives because, obviously, if the incentives phase out like they are currently expected to, there’s a less need for tax equity over time.

And that’s actually one of the things that we’ve highlighted in terms of our future power purchase agreement prices, is optimization around financing, so seeking lower cost source of financing other than tax equity would be a positive. So I think there’s pluses and minuses, puts and takes. What I do feel very comfortable with is the outlook and demand for renewables is really strong, and we’ve continued to realize attractive returns, and we’re excited about keeping – continuing to capitalize on these opportunities.

Michael Weinstein

Great. Great. And also on the wind repowerings, is there – what’s the primary consideration that you’re looking at to increase those numbers as you look at 2021, 2022 and beyond?

Rebecca Kujawa

Yes. I think the key focus there is really the economics of the repowering projects and ensuring that they are attractive returns and meet the requirements from a tax perspective and, obviously, are also something that our customers are interested in. So, we’ve continued those dialogues over time. And as we’ve gotten closer to the time frames in which we would do these repowerings, obviously, the rubber starts to hit the road, and we’ve been able to start to secure some of those and have increased visibility to those incremental investment opportunities, obviously, in that range that we discussed today.

Michael Weinstein

Right. Would an extension of tax credits really allow you to really increase that or increase the opportunities anyway?

Rebecca Kujawa

It’s certainly possible that it could. Again, a little bit subject to the details of what an extension of incentives looks like, and all the other factors that go into whether or not a project is attractive, but absolutely.

Michael Weinstein

One last question. On FERC 2222, it improves the ability of residential solar to sell into grid services. And I’m just wondering, if the value – that value that comes from FERC 2222 makes –changes your mind at all about residential solar, is it possible investment opportunity for next year?

Rebecca Kujawa

We’ve looked at distributed generation investments. Obviously, we have a very strong business on the – more of the commercial and industrial side. We’ve looked at residential over time. But one of the key factors for us is that we’re a significant sized company, and we like to deploy a significant amount of capital, and inevitably, these are much smaller investment opportunities. But we do look at the business over a long period of time. And obviously, we’ll enter it where we think it makes sense. But we’re really focused on kind of a little bit larger scale investment opportunities for the most part.

Michael Weinstein

Okay. Thank you very much.

Rebecca Kujawa

Thank you.

Operator

This concludes our question-and-answer session. The conference has now also concluded. Thank you for attending today’s presentation and you may now disconnect.

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