Pinnacle West Capital Corporation (PNW) CEO Don Brandt on Q3 2018 Results - Earnings Call Transcript

|
About: Pinnacle West Capital Corporation (PNW)
by: SA Transcripts

Pinnacle West Capital Corporation (NYSE:PNW) Q3 Earnings Conference Call November 9, 2018 11:00 AM ET

Executives

Stefanie Layton – Director of Investor Relations

Don Brandt – Chief Executive Officer

Jim Hatfield – Chief Financial Officer

Daniel Froetscher – APS' Executive Vice President of Operations

Barbara Lockwood – APS' Vice President of Regulation

Analysts

Michael Weinstein – Crédit Suisse.

Insoo Kim – Goldman Sachs

Paul Ridzon – KeyBanc

Julien Dumoulin-Smith – Bank of America Merrill Lynch.

Operator

Greetings, and welcome to the Pinnacle West Capital Corporation Third Quarter 2018 Earnings Conference Call [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Stefanie Layton, Director of Investor Relations. Thank you. You may begin.

Stefanie Layton

Thank you, Christine. I would like to thank everyone for participating in this conference call and webcast to review our third quarter earnings, recent developments and operating performance.

Our speakers today will be our Chairman and CEO, Don Brandt; and our CFO, Jim Hatfield. Daniel Froetscher, APS' Executive Vice President of Operations; and Barbara Lockwood, APS’ Vice President of Regulation are also here with us.

First, I need to cover a few details with you. The slides that we will be using our available on our Investor Relations website, along with our earnings release and related information. Note that the slides contain reconciliations of certain non-GAAP financial information. Today’s comments and our slides contain forward-looking statements based on our current expectations and the company assumes no obligation to update these statements.

Because actual results may differ materially from expectations, we caution you not to place undue reliance on these statements. Our third quarter 2018 Form 10-Q was filed this morning. Please refer to that document for forward-looking statements, cautionary language as well as the risk factors and MD&A sections, which identify risks and uncertainties that could cause actual results to differ materially from those contained in our disclosures.

A replay of this call will be available shortly on our website for the next 30 days. It will also be available by telephone through November 15. I will now turn the call over to Don.

Don Brandt

Thank you, Stefanie, and thank you all for joining us today. Throughout this year, our positive customer growth and disciplined cost management continue to support our ability to meet financial commitments. The Pinnacle West Board also displayed confidence in the company’s outlook by approving a 6.1% dividend increase, effective with the December 2018 payment.

Before Jim discusses the detail of our third quarter results and guidance, I’ll provide several updates on recent operational and regulatory developments, including the ballot initiative and certain elections. Our operations team did an excellent job, maintaining the generating fleet and electrical grid again this summer. Our workforce quickly restored service to customers after several storms toppled a combined 451 poles, which is almost as many as the 2016 and 2017 summers combined.

The Palo Verde generating station also performed well, with all 3 units operating at a combined 97.3% capacity. To meet customer demand and increase our clean energy mix, we issued 3 request for proposals this year. We’ve received bids on our request for forest, bioenergy solutions, peaking capacity and energy storage. Our energy storage RFP is particularly noteworthy because it will allow customers to use energy from our existing AZ Sun solar facilities during the peak period after the sun sets. We’re in the process of evaluating the bids and anticipate making our selection for each in the late 2018 or early 2019 timeframe.

Our capital investment program continues to be robust, supporting investments in clean energy resources and maintaining safe and reliable service for our customers. Approximately 51% of our distribution capital investment from 2018 through 2020 will be driven by customer growth. For generation-related investments, the installation of 5 new fast-start flexible generating units at the Ocotillo power plant is on track to be completed in the second quarter 2019.

Turning to our regulatory updates. The hearing for the Four Corners step increase request concluded on September 7. On September 24, the Arizona Corporation Commission staff filed its closing brief, which recommended a $58.5 million step up in revenue compared to our filed request worth $67.5 million increase.

Next, the administrative law judge will issue a recommended opinion in order. The step increase request will then be scheduled for an open meeting and the ACC will issue a decision. APS’ installation of pollution controls at the Four Corners Power Plant is part of our continued investment in a cleaner energy future.

We commissioned the selective catalytic reduction equipment earlier this year and now are achieving an 88% reduction in nitrous oxide emissions. In August, APS filed their second request with the Arizona Corporation Commission to return an additional $86.5 million in tax savings to customers beginning January 1, 2019. If approved, the second layer savings from tax reform will offset the requested Four Corners step increase. The total tax savings for customers, when combined with the first reduction implemented in March of 2018, would be $205.5 million.

Over the last 20 years, our price increases have been below the rate of inflation. With the rate reductions from tax reform and other price reductions, customer rates will be lower at the end of 2018 than they were at the beginning of the year.

As required by the 2017 rate review decision, each year, the resource comparison proxy must be recalculated to determine the amount new rooftop solar customers will receive for the generation they export back to the grid.

Beginning October 1, 2018, the Arizona Corporation Commission approved a rate of $0.116 per kilowatt hour, which is 10% less than the previous rate of $0.129 per kilowatt hour. This reduction continues to move the amount received by solar customers or excess generation closer to our avoided cost and further mitigates the cost shift between solar and non-solar customers.

Lastly, on October 1, the Arizona Corporation Commission concluded its hearing regarding a customer complaint, alleging the average residential bill increases higher than the average approved from the 2017 rate review order. We’re confident that the rate increase was implemented appropriately and is consistent with the rate review order.

Final briefs in this matter are due on November 16, and a recommended opinion in order will subsequently be issued by the administrative law judge. We anticipate that commissioners will issue a decision in this matter in 2019. As you are aware, Arizona held its midterm elections on November 6. While the Corporation Commission race has not been officially declared, as of this morning, Commissioner Olson and Republican Rodney Glassman are ahead of the Democratic candidates. Commissioners Dunn, Tobin and Burns will continue serving through the remainder of their terms, ending in January 2021.

Importantly, the residents of Arizona voted overwhelmingly to defeat Proposition 127, insuring the energy policy in Arizona will continue to evolve in a thoughtful and constructive manner. With Proposition 127 behind us, we can now work with stakeholders to establish forward-thinking energy policies that move towards an increasingly clean energy mix.

Arizona is number three nationally in solar energy installed, and our APS energy mix is already 50% clean. We’re on the cutting-edge of advanced battery storage technology. Arizona is uniquely positioned to achieve a cleaner energy mix with our abundant solar resource, leadership in advanced technologies and Palo Verde generating station, the largest clean energy generator in the nation.

Additional infrastructure investments will not only support our clean energy focus, they are also necessary to support our robust customer growth. Maricopa County was the fastest growing in the United States the last 2 years in a row. We estimate that 340,000 new customers will move into the APS service territory by 2030, and our customers' energy needs are expected to increase by more than 30% over that same period. Significant investments in new resources, including grid infrastructure, cleaner power generation and advanced energy technologies will be required to support Arizona’s growing economy.

Let me conclude by saying that I’m proud of our team’s commitment to our customers and our community. We not only supported the effort to protect Arizonians, but we also remained focused on our operational performance and delivering on our commitments. Our capital investment opportunities and emphasis on cost management continue to create value for our shareholders.

I’ll now turn the call over to Jim.

Jim Hatfield

Thank you, Don, and thank you, again, everyone for joining us today. This morning, we reported our financial results for the third quarter of 2018. I’ll discuss the details of our financial results, provide an update on the Arizona economy and introduce 2019 guidance.

As shown on Slide 3 of the materials, for the third quarter of 2018, we earned $2.80 per share compared to $2.46 per share in the third quarter of 2017. Slide 4 outlines the variances that drove the change in our quarterly earnings per share. I’ll highlight a few of the key drivers. Adjusted gross margin was up $0.04 per share compared with the third quarter in 2017, supported by favorable weather, the price increase from the 2017 rate review, higher sales and transformation revenue, sales net of energy efficiency and distributed generation were up 1.2% in the quarter, driven by strong commercial sales growth and robust residential customer growth.

The strong commercial sales growth reflects the positive economic trends we have seen in the Metro Phoenix area. Offsetting drivers include the refunds to customers resulting from the federal tax reform, and a shift in the seasonality of revenue resulting from the residential rate design changes approved in the 2017 rate order review.

As previously discussed, the 2017 rate review order established new rate options for customers. The new rate shifted a portion of the revenue previously collected during the summer to non-summer months, better aligning revenue collection with the cost to serve. Looking out to our operating expenses, higher adjusted operating and maintenance expense decreased earnings by $0.12 per share due to a higher cost at APS for transmission, distribution, customer service and information technology. And at the parent company level, for public outreach cost primarily associated with Prop 127.

Depreciation and amortization expenses were higher in the third quarter of 2018 compared to the third quarter of 2017, reducing earnings by $0.08 per share. The increase was primarily related to higher depreciation rates approved in the 2017 rate review order and plant additions.

Pension and other postretirement benefits, nonservice credits, increased pretax income by approximately $6 million or $0.04 per share in the third quarter. The increase was primarily related to higher market returns in the adoption of a new pension and OPEB accounting guidance for 2018.

Lastly, the refunded customers resulting from federal tax reform was positively offset by a lower effective tax rate. The net impact of pivotal corporate tax cuts in the quarter was of $0.14 per share benefit to net income.

Turning now to the Arizona’s economy, customer growth and sales growth. Metro Phoenix continues to show strong job growth and has consistently been above the national average, as shown in the top panel of Slide 5.

Through August, employment in the Metro Phoenix area increased 3.1% compared to 1.6% of the entire U.S. Job growth is particularly strong in the construction sector. A sign of strength in the areas commercial and residential real estate markets. Construction employment has increased by 10.4% versus 2017. We expect a continuation of business expansion and the related job growth to continue to support commercial development.

The Metro Phoenix residential real estate market has also continued its upward postrecession trend as shown in the lower panel of Slide 5. In 2018, we expect a total of 30,000 housing permits, an increase of about 4,200 compared to 2017, driven by single-family permits. We believe that solid job and income growth and relatively low mortgage rates should allow the Metro Phoenix housing market and economy more generally to continue to expand faster than the national average. Reflecting this steady improvement in economic conditions, APS' retail customer base grew 1.6% in the third quarter of 2018. We expect this growth rate will continue to accelerate in response to the economic growth trends I just discussed.

Importantly, the long-term fundamentals supporting future population, job growth and economic development in Arizona appear to be in place, and we believe Phoenix should remain one of the country’s fastest-growing large metropolitan areas. As I mentioned earlier, net sales were up 1.2% in the quarter. Commercial and industrial sales increased 2.3% over the third quarter of 2017, reflecting the positive economic growth trends we have seen in the region.

Finally, I will review our financing activity, earnings guidance and financial outlook. On August 9, 2018, APS issued $300 million of 30-year 4.20% unsecured senior notes. The proceeds were used to repay commercial paper borrowings. Overall, our balance sheet and liquidity remained strong. At the end of the quarter, Pinnacle West had approximately $128 million of short-term debt outstanding. Later this year, we expect to infuse up to $150 million of equity capital from Pinnacle West into APS.

Turning to guidance, as shown on Slide 6, we continue to expect Pinnacle West consolidated earnings for 2018 will be in the range of $435 million to $455 per share. While we benefited from a hot September, we also had a very mild October. We expect October weather will negatively impact the full year 2018 earnings by approximately $0.10 to $0.15 per share. Offsetting updates to our 2018 guidance can be found on the appendix to our slides.

Before I introduce 2019 guidance, I would like to confirm that we do not intend to file a rate review request in 2019. As a reminder, the 2017 rate review order prohibited APS from filing a new general rate review before June 1, 2019. After reviewing our financial expectations, we have determined that filling our rate review in mid-2020 will meet our financial objectives. In preparation for this filing, we expect to keep our capital structure similar to the level approved in our last rate review.

Continuing with guidance, we’re introducing 2019 guidance of $4.75 to $4.95 per share. Positive drivers for 2019 include the anticipated Four Corners' SCR revenue increase, higher weather normalized sales, higher transmission revenue, flat to lower interest expense and lower operating and maintenance expenses, primarily due to lower planned outages in our continued cost management.

We expect these drivers to be partially offset by higher D&A related to more plant in service, higher property taxes and lower AFUDC. We estimated effective tax rate of 10% for 2019 reflects the amortization of $71 million of excess deferred taxes associated with the second team filing. The decrease in the effective tax rate is offset by the proposed $86.5 million refund to customers, which is also part of the second team filing.

Our 2019 capital expenditure forecast remains at $1.15 billion. We will provide updates to our CapEx forecast and rate base on our fourth quarter call. A complete list of key factors and assumptions underlying our 2018 and 2019 guidance is in the appendix to our slides.

Our rate base growth outlook remains at 6% to 7% through 2020. And we still expect to achieve a weather-normalized annual consolidated and return on average common equity of more than 9.5% over the same period.

As we have said, our earnings are not linear and will fluctuate from year-to-year. However, over the long term, the opportunity to lead Arizona to a cleaner energy future positions us well to continue our track record of success.

This concludes our prepared remarks. I’ll now turn the call over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Michael Weinstein with Crédit Suisse. Please proceed with your question.

Michael Weinstein

Hi good morning guys. Hi I’m maybe we could just start and talk a bit about the process going forward now that Prop 127 is defeated. What can we expect to see going into next year and maybe then later this year in terms of kind of a collaborative process of some kind of stakeholder review of options going forward?

Don Brandt

Well, I think, Michael, it remains to be seen exactly what that process looks like. As you know, and we’ve talked about Commissioner Tobin has a docket open on 80% claim by 2050. A lot of things are also been attached to the docket. And so the exact way forward is sort of unknown at the moment. It would be our intent to participate in that docket and all of those factors. But we’ll have to wait and see where it ultimately goes from a timing and outcome perspective.

Michael Weinstein

Do you expect to have something, I guess, solidified by the time you file your next draft IRP?

Jim Hatfield

Draft IRP is in April. So not sure we would be able to go fully through a process at that point. I think our – remains to be seen exactly how the RFP unfolds. That’s one of the sections in a 80 by 50 is reviewing how we go forward on the IRP. So again, it remains to be seen.

Daniel Froetscher

Yes, it’s Daniel. I think the timing of the informal docket on the energy modernization plan is a little bit ambiguous. And therefore, as it relates to flanging up with the preliminary IRP, we can’t make that call. I think Don put out a press release here a couple of days ago, post-127 bill indicating that we’re going to build on the coalition that works on Prop 127, in terms of trying to shape and formulate what a cleaner energy future looks like for Arizona. So we’ll continue to engage in that space.

Michael Weinstein

Great. Just one final question, I’ll let other people get on. The weather-normalized retail electric sales volume that you’re assuming for 2019 guidance is still the 0 to 1% range. Now for the three-year period, it’s a little higher than that. I’m just wondering at what point does that three-year forecast kind of roll into those one-year forecasts?

Jim Hatfield

Well, I think what we’re seeing is a continual gradual improvement in the overall economy. And exactly when our three-year period rolls into the higher remains to be seen. But I think we saw this quarter sort of the example of a improved economy, and we have a site to a pipeline of a lot of projects in West Phoenix as well, which will continue to build that momentum.

Michael Weinstein

Okay thanks a lot nice job and guidance and congratulations on winning your argument against Prop 127. Thank you.

Jim Hatfield

Thanks Michael.

Operator

Our next question comes from the line of Insoo Kim with Goldman Sachs. Please proceed with your question

Insoo Kim

Hai good morning guys. As you prepare for the 2020 rate case, would any potential equity issuance to boost the equity layer likely be done sometime in 2020 in the early half of the year? And have you also considered whether potentially a fuller sale was as an option given where your stock is trading at the current moment?

Jim Hatfield

So last year, we injected $150 million from Pinnacle into APS. We expect to do some more here in 2019. Any additional equity that we’ll need can be handled through a draft type of program. And we’re not contemplating a fuller sale at the moment. It won’t – certainly won’t be a lot of additional equity, we’ll need to raise through a dividend or reinvestment.

Insoo Kim

Understood. And turning to the renewable discussions going forward. Given the uncertain timelines to when the final RPF standards or the IRP will take place. Do you not see any meaningful tick in renewable investments until maybe 2021 at the earliest? Or could you see some meaningful amounts in 2020, especially to take advantage of some tax benefits?

Jim Hatfield

Well, look, we’re obviously cognizant of the ITC and the timetable there. I think from a renewable right now, nothing planned. Don referred to the battery IRP, which – how the prices tick out, and we’re on discussions now. It would be attached to our utility of solar, be able to – when we have the negative pricing peak the batteries, should be able to provide peaking power later in the day. I think we have to see how this conversation unfolds over the near term before we think about any large-scale renewable bill. At this time, that obviously continues to change as we talk to customers and other things.

Insoo Kim

Thanks a lot.

Operator

Our next question comes from the line of Paul Ridzon with KeyBanc. Please proceed with your question

Paul Ridzon

You touched on it earlier. But as you look at Tobin’s proposal of 80 by 50, is that workable? Or do we get into cost pressures under that plan?

Jim Hatfield

Well, I – well, the – there’s a – Prop 127 was a constitutional amendment that was just a rigid. And it was irrespective of cost. I think the value of a commission-driven processes is, you think about claim, you think about reliability, but you also think about affordability. And so that will be a key gauging factor as we move forward will be what can customers afford. And we’re very cognizant of that from a – as we think about CapEx and other things. It’s always how much is this going to cost customers and we’re very mindful of that.

Paul Ridzon

So this proposal has some off ramps?

Jim Hatfield

Well, yes. The thing about it is, as you sort of bill as you go forward, and so they come up with a prescriptive plan today that says, this is what we’re going to do, and that’s a value of a more of a commission-driven process.

Paul Ridzon

And Jim, just a clarification that the inter-quarter tax items will be net neutral from the calendar year?

Jim Hatfield

Correct. But we haven’t applied in the appendix, it sort of shows how that’s been laid out over the course of the year.

Paul Ridzon

Great thank you.

Jim Hatfield

Thanks Paul.

Operator

Our next question comes from the line of Andrew Levy with ExodusPoint. Please proceed with your questions.

Unidentified Analyst

Just two questions. One, just on the CapEx post-2020. This $1.2 billion level that you’ve kind of been averaging, should we just assume – you haven’t given guidance yet on that. That’s kind of like your sweet spot CapEx level, and then anything that would occur on the renewable side as far as any type of new initiatives would be incremental?

Jim Hatfield

Well, certainly, as we look out over our CapEx forecast. I can’t. I won’t comment specifically about 2021 beyond. But as we look at things, for example, battery storage on our 6 megawatts, will that be supplemented in our base CapEx plan?

And so don’t know how that takes out. That could be incremental, renewables could be incremental, electric vehicle infrastructure could be incremental. We filed four pilots in the 2018 DSM plan, and we’re waiting to get that from the commission. So how it plays out and when, it’s sort of TBD. But we feel good about our fundamental ability to continue to grow rate base and keep it cost affordable to customers.

Unidentified Analyst

That sounds good. And then when do we get a refresh on the CapEx?

Jim Hatfield

We’ll do rate base in CapEx in our year-end call, and they’ll be – 2021 CapEx will be in the 10-K.

Unidentified Analyst

Got it. And then one last question just on the 2019 guidance because I think there was a little confusion. But I think if I heard you correctly, there was an offset. So the lower tax rate is offset by a customer credit? Is that what you were saying?

Jim Hatfield

Yes.

Unidentified Analyst

Okay. And that’s why you have a lower tax rate, I guess, right?

Jim Hatfield

Correct. Right.

Unidentified Analyst

Okay perfect thank you guys.

Jim Hatfield

Thank you.

Operator

Our next question comes from the line of Julien Dumoulin-Smith with Bank of America Merrill Lynch. Please proceed with your questions.

Julien Dumoulin-Smith

Hi good morning guys. So I just wanted to follow-up a little bit on the composition of the CapEx here quarter-over-quarter. Roughly the same magnitude of capital here, but just shifting around the bucket. Can you talk a little bit about the two buckets? The traditional gen and the clean gen? And what’s shifting that around? I suppose why – perhaps to start with the why, why the downtick in traditional gen?

Jim Hatfield

Well – go ahead.

Daniel Froetscher

Excuse me, Julien, it’s Daniel. So the downtick in the traditional gen is reflective of the completion of the SCR projects, and a different outage plan for 2019 going forward in terms of number of majors and minors so on and so forth. The uptick in clean gen is a reflection of Palo Verde Generating Station fuel, the clean battery technologies that Jim mentioned, that won’t be determined, if you will, until we settle and make our decision relative to the three RFPs that are out there.

But we certainly anticipate some level of investment in that space. And we’ve got a segment with our residential low and moderate income customer base, a program called community solar, within which we are installing and rate basing residential distributed generation rooftop solar on customer rooftops. That’s a multi-year program.

Julien Dumoulin-Smith

Got it. And maybe to clarify that. The traditional gen, is this the – probably a new lower level on a consistent basis? Or for the 2019 and 2020 this $100 million-ish type number, is that probably just a transient based on outages, et cetera?

Daniel Froetscher

No. It’s a – major outages at our power plants are cyclical in nature. Certain work is every 3 to 4 years. Certain work is every six to eight years. So this is just a reflection of the normal cyclical nature, if you will, of our major and minor outs.

Julien Dumoulin-Smith

Got it. Excellent. And just to clarify on the capital recovery piece or that the clean gen uptick, is that fairly straightforward in the context of the next case?

Jim Hatfield

Well, we’re recovering the residential through the res surcharge currently. The rest will be just included for recovery on our next rate case.

Julien Dumoulin-Smith

Thank you very much all the best.

Operator

We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Stefanie Layton

Thank you all for joining us today. This concludes our call.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.