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Spark Energy To Pull Back From "Low Margin" Larger C&I Business

Spark Expects Opportunities For Small Tuck-In Acquisitions To Increase From Shake-Out From Winter Volatility, Says Getting Calls From Potential Sellers

May 11, 2018

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Reporting by Paul Ring • ring@energychoicematters.com

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As a result of the negative financial impact that extreme cold weather during the first quarter of 2018 had on the business (see story here), Spark Energy said during an earnings call that it will pull back from the low margin larger C&I business, particularly in the Northeast and New England

Discussing the factors that led to the negative impact on financial results from the first quarter weather, Nathan Kroeker, Spark Energy’s President and Chief Executive Officer, noted that, "Weather forecasts leading up to the cold spell were all indicating warmer-than-normal weather, and so we were hedged accordingly."

"The weather forecast suddenly flipped right before Christmas, and when the storm became apparent, we were forced to buy incremental supply in the day-ahead markets at prices well above normal," Kroeker said

"Due to the credit requirements from the ISOs, we were also forced to purchase physical power at significant premiums in order to stay within our credit limits," Kroeker said

Spark CFO Robert Lane noted that this winter Spark purchased a number of physical positions and hedges that were at higher prices than the company would have expected to pay had it not been constrained by the collateral requirements of the ISOs.

"While margins were negatively impacted by the high prices we paid to supply power in January, this has no effect on the overall health and long-term outlook of the business," Kroeker said

"We have taken several steps to ensure that the impact of any such future weather anomaly will be less severe, were something similar to happen again," Kroeker said

"First, we expect to not renew the majority of our larger, low-margin C&I business, instead focusing more on adding higher-margin mass-market RCEs, both residential and small commercial," Kroeker said

"In addition, we have been using more physical hedges instead of financial hedges, which both lowers our collateral requirements with the ISOs, and puts us in a more favorable credit position with our counterparties during price spikes," Kroeker said

"As a result of these efforts, investors should expect to see longer-term unit margins increase, as we refocus on our mass-market business, which we expect to have a long-term positive effect on adjusted EBITDA," Kroeker said

Spark's current volumes are 52% residential and 48% commercial. As a result of moving away from low-margin large C&I service, specifically in the Northeast and New England, where Spark has constraints, the company aims to shift volumes to 60% residential, 40% commercial, or even 70% residential/30% commercial over the next couple of years.

Kroeker said that Spark's corporate development team continues to explore opportunities for tuck-in acquisitions or books of customers, noting that it has received inquiries from suppliers looking to sell as a result of first quarter volatility

"We're starting to see a little bit of it [weather-driven acquisition opportunities] now," Kroeker said. "If you think back to the polar vortex, it took about a year before those things really started to get active on the market. I think a lot of the small players think, 'Oh, I can manage through this, and I'm going to be fine' and they have a sleeve provider that kind of carries them along for a little while and eventually they just get tired of it and will decide to sell the business. We've had a few inbound calls already and I would anticipate that activity to pick up, just like it did in 2014, which is why I said, from our standpoint, if I can do tuck-in deals or small acquisitions like that, those are relatively straight-forward for us to do. And we're going to be focused on that if those opportunities are out there."

Kroeker also said that Spark continues to cut costs, and further said that it is moving forward with additional measures, which include consolidating brands in certain markets, consolidating billing systems, and automating a number of manual processes, each of which it expects to result in additional cost savings.

Providing more color on the events leading to the negative impact during the first quarter, Kroeker said:

"This was a perfect storm. We had a significant amount of growth in our C&I business late in 2017. So all of that load was coming on flow [in] December and January right as prices were spiking from this cold weather. Just those two facts alone would have resulted in a bad week or a bad month, because we would have just been out in the market forced to pay for day-ahead power. Because of our balance sheet constraints, collateral constraints, we actually went out and bought physical instead of financial, and we also went out and hedged balance-of-quarter and balance-of-year, in order to mitigate some of those short-term collateral requirements to the ISO ... So, it really was a perfect storm of those three events coming together at the same time in order to create this issue for us. And like I said, that was an extreme weather event. It was exacerbated by our balance sheet and by the significant C&I growth. I think if you don't have the C&I growth or you have a bigger balance sheet, a weather event like this would have been significantly less harmful to us. So we're taking proactive steps as we talked about to reduce kind of our focus on that large C&I. We've already taken steps to increase the balance sheet, [we] have a significant amount of more availability now than we did at the time. So, I feel like we're taking the steps to where we will not be in that situation again."

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