Dividend Sleuthing: Pinnacle West Capital Corporation

Summary

• Pinnacle West is a utility holding company for its principal subsidiary, Arizona Public Service, which provides electric service to 1.3 million customers, including the city of Phoenix.
• The company has a Standard & Poor's credit rating of A-, has raised the dividend for 9 consecutive years, with a 7/30/21 dividend yield of 3.97%.
• Pinnacle West has a 29% interest in Palo Verde, the nation's largest nuclear power plant, which it operates and which provides 23% of its energy source mix.
• The company expects renewables (including "demand side management") to grow from 27% to between 56-67% by 2035.
• Looking for a helping hand in the market? Members of Margin of Safety Investing get exclusive ideas and guidance to navigate any climate. Learn More »

Jeff Topping/Getty Images News

Introduction

Pinnacle West Capital Corporation (NYSE:PNW) is an electric utility holding company whose main subsidiary is Arizona Public Service, providing electric service to 1.3 million customers in Arizona, including the city of Phoenix. APS operates and co-owns (29%) the Palo Verde Generating Station, which provides 1,146 megawatts (18.7%) of ASP's 6,121 MW electric generation capacity. APS owns 245 MW of solar capacity and over 1,000 MW of contracted solar energy through power purchase agreements (per PNW's 2020 Annual Report).

In Q1 2021, PNW reported earnings of $35.6 million, or $.32 per share, compared to $30.0 million, or $.27 per share in Q1 2020. For the full year 2020, PNW reported earnings of $550.6 million, or $4.87 per share, compared with $538.3 million, or $4.77 per share in 2019.

The company will issue 2021 earnings guidance in an investor presentation after a decision is made in the current pending rate case. At that time, PNW expects to announce an equity offering of $300 to $400 million.

The company's goals for growing renewable energy are depicted below:

From PNW 2020 Corporate Responsibility Report

Strengths

PNW operates in an "Average" regulatory region. Arizona's allowed return on equity of 9.10% is slightly lower than the national average of 9.32% (per George Fisher). Arizona has strong population and business growth.

From PNW March 2021 Investor Presentation

A PNW strength is management's commitment to a clean energy future. Jeffrey B. Guldner, 54, with PNW since 2014 and CEO since 2019, said "the biggest benefit that comes from retiring ... a coal asset is that you save the fuel cost and you move into more zero marginal cost resources....(eliminating) the carrying cost of the asset."

The Palo Verde nuclear plant was commissioned in 1985. It is the largest US producer of carbon-free energy.

Weaknesses

PNW does not have a strong history of good customer relationships. CEO Guldner has learned some difficult lessons through a settlement with Arizona's Attorney General to refund $24 million to 225,000 APS customers.

Arizona's summer disconnect moratorium, plus a COVID-19 disconnect moratorium, will negatively impact PNW's pretax 2021 operating results by $20 to $30 million, according to CFO Ted Geisler in the Q1 earnings call.

To enhance customer relationships, the company is implementing several "Demand Side Management" strategies to provide customers flexibility in managing their energy consumption.

Opportunities

In January 2020, PNW announced its goal to be carbon-free power producer by 2050, including a carbon-free transportation fleet. In the 2020 Q4 earnings call, CFO Geisler said the company's goal is to average 300 MW to 500 MW annually of new renewable energy sources between now and 2030 "to achieve our goal of 65% clean with 45% renewables."

In 2020, PNW added 141 MW of solar battery storage and has an all-source request for proposal for 400 to 600 MW of capacity resources and a renewable energy RFP for 600 to 800 MW.

From 2021 Q1 Earnings Call Presentation

On May 5, 2021, the Utilities Division of the Arizona Corporation Commission rejected by a 3-2 vote a proposed Advanced Energy Mechanism "to recover capital carrying costs and expense associated with the clean energy investments necessary for a clean energy future." PNW says this will not impact its 2050 goal of 100% clean energy.

PNW is ramping up a customer advisory board as it implements a project to simply customer bills and programs like "Cool Rewards" (44,000 connected smart thermostats) and expansion of the company's microgrid offerings.

Threats

APS is the largest stakeholder (29.1%) in the Palo Verde nuclear plant, followed by the Salt River Project (17.5%) and five other partners.

From the Salt River Project

This major asset is a strength but also a threat because of the risks of a radiation mishap, terrorist attack or natural disaster, as well as the long-term uncertainty of nuclear energy.

PNW's decision to not issue 2021 earnings guidance until after a pending rate case illustrates the threat of adverse regulatory decisions for a utility.

Climate change, particularly impacting water resources in the southwest, is a threat to the region's population and business growth.

Long-term Business Outlook

Utilities need a growing economy, low cost capital and favorable regulators. The outlook is generally favorable, but with risks. The most successful utilities are integrating renewable and distributed energy and are complementing regulated operations with non-regulated projects that often contracted energy for large businesses and other utilities.

F.A.S.T. Graph

A new (dark red) line has been added to graph the year-end dividend yield. The movement to 12/31/14 from the upper left to the lower right reflects the general trend toward lower rates and PNW's growth.

From F.A.S.T. Graphs

The Dividend

The quarterly dividend is $.83, annualized to $3.32. At a 7/30/21 closing price of $83.55, the yield was 3.97%. The average high yield for the past 5 years was 4.06%, with the highest yield of 5.3% reached in 2020.

Trailing 12-month EPS is $4.93, for a current payout ratio is 67.3%, above the 5-year average of 63.1%. The current P/E is 16.9, based on the EPS of $4.93 and the 7/30/21 closing price of $83.55. The 5-year average P/E was 18.4.

PNW's Q2 earnings call is this week: Thursday, August 5, 2021. Analysts will be eager to hear any updates regarding PNW's pending rate case.

Personal Investment Thesis

Pinnacle West Capital Corporation is 4.3% of my personal 24-stock retirement income portfolio. I use eight factors to rate these companies:

1. S&P Credit Rating. PNW's A- rating scores 3 points on a scale ranging from 9 points for AAA to 1 point for BBB.
2. Consecutive Years of Dividend Increases. I divide this number by 10, so PNW's 9 years equal a score of 0.9. The portfolio range is 0.9 to 6.5.
3. Current Dividend Yield. PNW's $83.55 closing price on 7/30/21 translates to a 3.97% yield. I multiply by 100 for a score of 3.97. The portfolio yields range from 0.60% to 5.21%, so scores for this factor are 0.60 to 5.21.
4. Payout Ratio. I use F.A.S.T. Graphs' earnings estimates. PNW's estimated adjusted EPS is $5.50. The $3.32 dividend is 60.36% of this estimate. A low payout ratio gives more flexibility for dividend growth. I subtract the payout ratio from 100%, which for PNW is 39.64%. I multiply this by 10, giving PNW a 3.96 payout ratio score. Scores for this factor range from 1.62 to 8.59.
5. Five-year Dividend Growth Rate. I use Seeking Alpha's data. To maintain parity with other factors, I multiply the growth rate by 0.5. For example, PNW's 5-year dividend growth rate is 5.84%, or 5.84, which I multiply by 0.5, for a score of 2.92. Scores range from 0.82 to 10.92.
6. The Quant Score from Seeking Alpha. This is "an objective, unemotional evaluation of each stock based on over 100 metrics, such as the company's financial statement, stock price performance, and analysts' estimates of the company's future revenue and earnings, relative to other companies in the stock's sector. The rating is from 1.0 to 5.0, with 1.0 being very bearish and 5.0 being very bullish." For example, PNW's quant score is 2.82.
7. Dividend Safety Score. This is from Simply Safe Dividends, which rates the safety of a company's dividend on a score of 0 to 100, with 50 being average. For parity, I divide the dividend safety score by 10. For example, Pinnacle West's dividend safety score of 92 becomes 9.2.
8. Long-term Debt to Total Capital. I use Seeking Alpha for this metric. Lower is better, (like the payout ratio), so I subtract PNW's 52.82% LT debt from 100%, to get 47.18%. I multiply by 10, giving PNW a score of 4.72.

These eight factors give PNW a combined score of 31.50, which ranks PNW 22nd among the 24 portfolio companies. The three REITs and the three utilities score the lowest, driven by their somewhat lower credit ratings and higher debt.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of PNW either through stock ownership, options, or other derivatives. 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.

This article is for informational purposes only (not a solicitation to buy or sell stocks). Ted is not a registered investment adviser. Kirk Spano is an RIA. Investors should do their own research or consult a financial adviser to determine what investments are appropriate for individual selection. This article expresses my opinions and I cannot guarantee that the information/results will be accurate. Investing in stocks involves risk and could result in losses.