Pinnacle West Capital Corporation (NYSE:PNW) Q3 2023 Earnings Call Transcript

Pinnacle West Capital Corporation (NYSE:PNW) Q3 2023 Earnings Call Transcript November 2, 2023

Pinnacle West Capital Corporation beats earnings expectations. Reported EPS is $3.5, expectations were $3.33.

Operator: Good day, everyone. And welcome to the Pinnacle West Capital Corporation 2023 Third Quarter Earnings Conference Call [Operator Instructions]. It is now my pleasure to turn the floor over to your host, Amanda Ho. Ma’am, the floor is yours.

Amanda Ho: Thank you, Matthew. I would like to thank everyone for participating in this conference call and webcast to review our third quarter 2023 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Guldner; and our CFO, Andrew Cooper. Ted Geisler, APS’ President; Jacob Tetlow, Executive Vice President of Operations; and Jose Esparza, Senior Vice President of Public Policy, are also here with us. First, I need to cover a few details with you. The slides that we will be using are available on our Investor Relations, along with our earnings release and related information. Today’s comments and our slides contain forward-looking statements based on current expectations, and actual results may differ rely from expectations.

Our third quarter 2023 Form 10-Q was filed this morning. Please refer to that document for forward-looking statements, cautionary language as well as 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 Web site for the next 30 days. It will also be available by telephone through November 9, 2023, and I will now turn the call over to Jeff.

Jeff Guldner: Great. Thanks, Amanda, and thank you all for joining us today. We continue to execute well on our operations performance and financial management. As part of my operations update, I’ll share with you our success in managing through a record breaking summer in the valley and reliably serving our customers when they needed us the most. I’ll also provide an update on our pending rate case and other regulatory filings. As Andrew will explain our earnings expectations for the year on track to meet our guidance range that we recently updated in the second quarter. First, I want to recognize our operations and field teams for doing an exceptional job maintaining reliable service for our customers this summer. July was just one day short of an entire month of 110-plus degrees and August did not provide much repreve.

We ended the summer with 55 days of 110-plus degrees and 36 days of overnight lows above 90 degrees. During this period, our generation fleet performed extremely well and was available when our customers critically needed the power. Our careful long term planning for resource adequacy, combined with equipment maintenance programs and innovative customer demand side programs proved beneficial throughout the summer. APS set five new peak demand records during the month of July, ultimately reaching 8,162 megawatts on July 15. That figure’s over 500 megawatts higher than our last peak demand that was set in August of 2020. Our baseload and fast-ramping assets, including Four Corners, [Indiscernible] and Palo Verde all performed well. Our nonnuclear generation fleet’s equivalent availability factor, which is the percentage of time that a generation units available and ready to perform when called upon was 93.4% from June through September.

In addition, we were extremely pleased to have our Agave solar facilities and our AZ Sun batteries online and available to serve customers. Finally, Palo Verde generating station’s capacity factor for the same time frame was 99%. With the successful completion of the summer run, Palo Verde Unit 1 has entered its planned refueling outage on October 7th. Not only were our generation plants there when we needed them our customers were as well. Customers participating in APS’ Cool Rewards program helped create grid capacity while earning bill credits for voluntarily reducing their energy use. A community of more than 58,000 customers and about 80,000 of smart thermostats created a virtual power plant to save energy during the peak hours of the summer.

This year, participating customers conserved a record 135 megawatts of power, the equivalent of a peaking unit. APS’ Cool Rewards is the cornerstone of our virtual power plant, which is rapidly approaching 200 megawatts in participation and will be an important part of our long term resource planning strategy. We’ll continue to expand this resource and these important partnerships with our customers as we continue our journey to 100% clean and carbon-free electricity by 2050. Long term planning has been key to providing reliable service. In fact, we just filed our Integrated Resource Plan or IRP with the Arizona Corporation Commission yesterday, outlining our resource needs for the next 15 years. We’re expecting strong customer and demand growth during this period and have outlined the resources necessary to maintain affordable and reliable service for our customers.

We anticipate that a variety of resource types will be important in serving this period of robust customer growth and look forward to partnering with customers, developers and stakeholders on bringing these technologies online. While the IRP does not specify ownership, we are committed to continuing our competitive all-source RFP process, which will yield a blend of PPA and ownership projects. The IRP includes a variety of scenarios but our preferred scenario identifies a diverse blend of technologies to secure a reliable grid while maintaining a strong focus on customer affordability. And this scenario also achieves our clean energy goals of 65% carbon free by 2030. With the extreme weather that we experienced each summer remains as important as ever to continue assisting our communities through our heat release support programs, APS partners with local community organizations to aid the state’s most vulnerable populations.

This support includes a collaboration with the foundation for senior living, offering emergency repair/replacement of AC systems during the hot summer months; the Salvation Army’s network of 18 cooling and hydration stations across Arizona; an emergency shelter and homeless prevention program in partnership with St. Vincent de Paul; and a new partnership with Salary 211 and Lyft to provide eligible Arizonans with free rides to cooling shelters. These are just a few examples of our efforts to collaborate for the benefit of our customers and communities, and I’m pleased to share that APS was recently recognized with the innovative Corporate Philanthropy Award by the Phoenix Business Journal for these partnerships and programs aimed at providing heat relief to vulnerable individuals and customers.

I’m also happy to share that we’ve completed our labor negotiations with our local IBEW and have a newly ratified agreement in effect. We worked hard to build a collaborative relationship with our labor union employees. And I’m grateful that we’ve been able to reach an agreement that allows us to continue to serve our customers and retain top talent. Finally, our customer care center was ranked as the top care center amongst our peers so far through the third quarter of this year as rated by our customers in the J.D. Power electric customer satisfaction study. And overall, our customer satisfaction is rated by customers through J.D. Power remains strong. I’m extremely proud of our employees, our progress so far and look forward to closing out the year strong.

Turning to our rate case. After 24 days of hearings, we wrapped up on October 3rd, and the parties are now in the briefing period, initial briefs are due November 6th with replied reach due November 21st. We expect the administrative law judge to issue her recommended opinion in order later this year, possibly early next year, with it being placed on an open meeting agenda shortly thereafter. We look forward to completing our rate case in a constructive manner while securing the cost recovery that’s necessary to enable continued growth of our electric grid and to support Arizona’s growing economy. As we look to wrap up 2023, our focus and priorities remain on executing our mission of providing clean, reliable and affordable service to our customers.

I want to thank you all for your time today, and I’ll turn it over to Andrew.

Andrew Cooper: Thank you, Jeff, and thanks again to everyone for joining us. Earlier today, we released our third quarter 2023 financial results. I will review those results, which were positively impacted by weather, and provide additional detail on the various drivers for the quarter. We earned $3.50 per share this quarter, an increase of $0.62 compared to the third quarter last year. As Jeff mentioned, we experienced record breaking summer heat. So weather was by far the large driver for the higher year-over-year results. In fact, the number of residential cooling degree days, which is a utilities measure of the effects of weather, increased more than 28% over the same period a year ago and were 32% higher than historical 10 year averages.

Residential coin degree days for the month of July were the highest of any year since data tracking began in 1974, and August recorded the second highest cooling degree days for the month behind only August of 2020. This resulted in a $0.38 benefit from weather versus third quarter last year, which itself was slightly warmer than normal. Favorable surcharge income through both our LFCR and the new surcharge related to the 2019 rate case appeal outcome, income tax items and other net were also positive drivers, partially offset by higher interest, higher depreciation and amortization and lower pension and OPEB nonservice credits. Our income tax benefit is largely due to the timing of certain tax items being recognized through the effective tax rate.

Q3 income taxes were also favorably impacted by the investment tax credit amortization from our Arizona Sun battery facilities and production tax credits from our Agave solar facilities. Turning to customer growth in the third quarter. It came in at 2%, which is right at the midpoint of our 1.5% to 2.5% guidance range. Arizona remains an attractive destination for population migration and for economic development. APS was honored in the September issue of Site Selection Magazine as one of the top utilities in economic development based on corporate end user project investments and affiliated job creation. Our weather normalized sales growth was flat in the third quarter compared to last year. For the quarter, residential sales were down 1.9% on lower weather normalized customer usage, but our strong C&I sales growth continued coming in at 2.2% for the quarter and is now at 2.8% through three quarters year-to-date.

Due to the weaker weather normalized residential sales, we are adjusting our sales growth guidance for the year to 1% to 3% while keeping our long term sales growth guidance at 4.5% to 6.5%. Turning to O&M. This quarter came in slightly lower than last year. However, we continue to see pressures in O&M, both from inflation as well as increases in costs incurred to serve the significant growth in our service territory. We continue to look for opportunities to reduce risk and find efficiencies that keep our costs low and maintain customer rate affordability. We raised our O&M guidance last quarter and are reaffirming it now while continuing to target O&M permit what hour declines over the long term. Interest expense remains a drag on earnings as the Federal Reserve continues to combat inflation through higher rates, and they have signaled that higher rates will likely persist.

This is expected to impact future debt financings and refinancings. With that said, I will note we only have a single fixed rate maturity of $250 million in 2024 and we will continue to closely monitor our financing needs. Recently, our Board approved a 1.7% increase in our quarterly dividend. We are proud to continue our track record of steady dividend growth and are confident in our intention to grow back into our 65% to 75% dividend payout ratio target over the long term. Turning to CapEx. We have raised our guidance for 2023 from $1.67 billion to $1.8 billion. This increase is due to distribution investments needed to serve our growing service territory and generation investments to support the reliability of our fleet. This higher CapEx level also includes increases in transmission spend as we continue to make key investments in our FERC jurisdictional high voltage system.

We now expect 2023 transmission capital within our regulated footprint at a spend level nearly 50% higher than last year. Finally, I’d like to reiterate the impact weather has had on our financial outlook for the year. Taking both the mild spring weather of the second quarter and extremely hot summer weather of the third quarter into consideration, we continue to guide to our $4.10 to $4.30 per share earnings guidance range for the year. With our rate case hearings concluded, we look forward to continuing to execute on our strategy as we await the issuance of the recommended opinion order and the final decision. This concludes our prepared remarks. I will now turn the call back over to the operator for questions.

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Q&A Session

Operator: [Operator Instructions]. Your first question is coming from Shar Pourreza from Guggenheim Partners.

Shar Pourreza: So Jeff, the TransCanyon win under the DOE program, and obviously, it’s a large line, it’s 114 miles, Utah to Nevada. Can you just talk about any timing, scale, next steps and sort of how to think about opportunities like that relative to the current CapEx guidance? And there’s obviously other needs in the region. So curious, are you seeing more announcements like this.

Jeff Guldner: I think that was one of three announcements that was made by the DOE, and there’s another one that’s in the region here that we’re not out with. But that one — this line, as you know, is a joint project that we’ve been working on for a while with Berkshire Hathaway. This DOE announcement is essentially a derisking opportunity. So it’s certainly positive for the project, but that project is still quite a ways out. It is core to our business and that it’s transmission. But given that this is at an unregulated affiliate at TransCanyon, it would be more project financed. And so it is a little different than the core transmission at the utility that we’re talking about, which is, again, where we tend to look mostly at the investment opportunities, but certainly something that we want to continue to look at. But it is a ways out.

Shar Pourreza: And then obviously, just quickly the jump in the CapEx is notable, and you raised it somewhat obviously at the tail end of the year. Could we see similar increases to ’24 and ’25 CapEx and future updates, or was this year’s increase a one-off? You’re still kind of projecting similar rate base right now in the ’25 time frame. So I guess how do we think about the cadence.

Andrew Cooper: Yes, so we did raise CapEx for the year by $130 million. And this was really looking at the needs for the year, independent of any potential rate case outcome and how generation could be addressed under a tracker. There were needs around the existing fleet, and we identified those. On the distribution side, we continue to see customer growth and frankly, some of the equipment that we need to acquire to serve that growth costing more in the current environment. I’d say the area that really — we’re not going to be able to provide an update on CapEx out past this year until after we get through the rate case. But I’d say the one trend that I think is critical to highlight, when you think about where the real transmission opportunities begin for us, it’s within our regulated footprint.

And so that additional $55 million that we’re spending on our FERC transmission assets this year, I think is reflective of a trend that we’ve seen over the last few years of continuing to lean in there. There’s a massive need in the transmission system, we have a formula rate and a competitive ROE. And so that’s an area where we’re going to expect to continue to lean in, regardless of rate case outcome and need around CapEx going forward. But the need here was discrete to identify needs in 2023, and we’ll be able to provide an update for ’24 and beyond when we come out of the rate case.

Operator: Your next question is coming from Nicholas Campanella from Barclays.

Nicholas Campanella: So I just wanted to ask on pension. Could you just give us a sense on how that’s performing versus targeted returns year-to-date? And just appreciating that recapture of pension is only partial because of the way that the test year in the rate case is structured. Should we be thinking about a continued benefit or headwind into ’24 here, anything that you could quantify would be helpful as we think the ’24?

Andrew Cooper: So I guess just from the outset, I would say that we’re really committed to a liability driven strategy and I’ve said it many times before. We’re primarily fixed income invested about 80% of our portfolio. And it’s meant to match up the asset and liabilities so that our funded status remains strong, because from an investor value proposition perspective, I think over the long term, having to mitigate through the strategy they need to go out to the market and raise external capital to fund the pension, that is what we do not want to do. And so we’re focused on funded status for that reason. Fixed income returns have continued to be challenged this year. When it comes to 2024, we’re not really in a position today to give an update because we do only revalue the assets and liabilities at the end of the year.

And so as you’ll recall from prior years, we look at actuarial gains and losses relative to the expected return at year end as they’re material, and we measure that through what is known as a corridor test, which is the most common accounting approach among utilities to addressing actuarial gains and losses. And at that point, if it’s material, we would amortize any gain or loss over the life of the plants, which is in the 10 to 12 year range. So too early to look out at 2024. You alluded to the pension expense that was crystallized at the end of ’22 based on market returns last year. And there, we have advocated through the stages of this rate case, including the hearing and we will continue to do so through to the open meeting to ensure that we get appropriate recovery there, consistent with our prior rate case, which in a split test year.

As you noted, it doesn’t necessarily get us recovery on the whole amount, but would average out to give us half of the recovery on that 22 year end impact. So we’ll continue to advocate for that and certainly be able to give you an update when we revalue everything at year end on any impacts from ’23 returns. The one thing I would remind you of is that higher interest rates, while they may impact the value of our bond portfolio have a meaningfully positive impact on service costs, which helps us from an O&M perspective. And you see that in the year-over-year O&M numbers this year. And of course, potentially lead to a higher expected return next year given where yields are. So we look at all the puts and takes around higher interest rates and discount rates at year end and can give you an update at that point.

Nicholas Campanella: And I guess just the IRP, obviously, some big opportunities here, and you’re not making any assumptions on ownership at this point. But can you just give us a flavor of is this spending that could potentially be incorporated in the next five year roll forward, or is it more further looking than that?

Andrew Cooper: What I’d say is that you’ve got our current CapEx forecast for the next three years. We’ll refresh ’24 and ’25 after the case. As the rate case is done, we have better clarity on the SRB mechanism, which we continue to advocate for in this case. The IRP is agnostic. As you said, we’ve got projects in various stages of development in our pipeline and bringing those projects forward will be dependent upon ensuring reliability and diverse group of developers, including ourselves but also whether or not there’s contemporaneous returns. Because of the lumpiness of that CapEx, we want to make sure that we’re going to lean into it that there’s an ability to recover that investment in a timely way.

Operator: Your next question is coming from Julian Dumoulin-Smith from Bank of America.

Julian Dumoulin-Smith: Actually, let me just pick up where Nick left off there on IRP here real quickly. Just obviously, the new data centers growth is pretty impressive here. I just wanted to get a sense of just how firm are some of these industrial manufacturing and data center, data points that you guys are showing here. I mean, obviously, your things are large, or subject to some movements and delays. But how firm in time line is that, are these numbers here in front of us? I’ll leave it open then to you guys.