Pinnacle West Capital Corporation
Q4 2012 Earnings Call Transcript

Published: 22 Feb 2013

[Operator:]

Greetings, and welcome to the Pinnacle West Capital Corporation 2012 Fourth Quarter and Full Year Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rebecca Hickman, Director of Investor Relations for Pinnacle West Capital Corporation. Thank you. You may begin.

[Rebecca L. Hickman:]

Thank you, Christine. I'd like to thank everyone for participating in this conference call or webcast to review our fourth quarter and full year 2012 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Don Brandt; and our CFO, Jim Hatfield. Jeff Guldner, who is APS Senior Vice President of Customers and Regulation, is also here with us. Before I turn the call over to our speakers, I need to cover a few details with you. First, the slides to which we refer are available on our Investor Relations website, along with our earnings release and related information. Please note that the slides contain reconciliations of certain non-GAAP financial information. Also, all of our references to per-share amounts will be after income taxes and based on diluted shares outstanding. It is my responsibility to advise you that this call and our slides contain forward-looking statements based on 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 2012 Form 10-K 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 on our website for the next 30 days. It will also be available by telephone through March 1. At this point, I'll turn the call over to Don.

[Donald E. Brandt:]

Thanks, Becky, and thank you, all, for joining us today. In 2012, we made progress in a number of key areas as we focused on our core electric utility business. This progress included demonstrating sustained improvement in Arizona's regulatory environment, making strategic capital investments, maintaining operational excellence, strengthening our financial profile and positioning ourselves to benefit from economic recovery in Arizona. Jim and I will provide more information on these areas through our remarks today. Looking first to Arizona regulation. Early last month, the composition of the Arizona Corporation Commission changed as the commissioners elected in November, Bob Stump, Susan Bitter Smith and Bob Burns, were sworn in, and Bob Stump was elected Chairman of the commission. With 2 new members and commissioners Stump, Brenda Burns and Gary Pierce continuing in office, the commission is now comprised of 5 Republicans. In January, the commissioners unanimously approved APS's 2013 Renewable Energy Standard implementation plan. The plan contains steps for continued compliance with the commission's Renewable Energy Standard and other APS commitments while balancing the need to moderate customers' bills and to support renewable energy. Given our history over the past several years, it is indeed a pleasant change for me not to be discussing a pending retail rate case. APS's retail regulatory settlement that became effective July 1, 2012, was progressive and contained broad-ranging benefits for our customers, the communities we serve and our shareholders. Among other things, it provides the financial support APS needs to meet our customers' energy needs while helping to achieve Arizona's energy goals. It also provides a measure of regulatory certainty for both customers and shareholders through at least mid-2016. Third, it allows retail rates to change gradually over time through a number of rate adjustment mechanisms. Moderating rates this way will avoid the need for large base rate increases every several years while allowing reasonable recovery for APS's prudently incurred expenditures. And finally, it allows APS the opportunity to earn a reasonable return on invested common equity during the 4-year settlement period. With that settlement in place, we are continuing to work with the Arizona Corporation Commission and various stakeholders on a collaborative approach to the state's energy future. Our capital investments position us well to reliably serve the needs of APS's electric customers while addressing Arizona's energy goals and environmental compliance. Today, I'll update you on 2 components of our capital expenditure program, the AZ Sun Program and the planned Four Corners acquisition. Our renewable energy initiatives, including the AZ Sun Program, taken together, are an important part of a comprehensive resource plan designed to advance our state's energy future. Through AZ Sun, APS plans to develop and own utility-scale photovoltaic solar plants in Arizona. To date, we have commitments in place for a total of 118 megawatts, with a projected capital investment of $502 million. So far, we have placed 4 plants in commercial operation with a total capacity of 69 megawatts. The latest addition was 19 megawatts at the Chino Valley site in Northern Arizona that went into service on November 26 of last year. Construction and other development activities are currently under way for another 49 megawatts at 2 sites in Southwestern Arizona called Yuma Hills and Hyder. We expect those facilities will go into operation later this year. We are continuing with our plan to acquire Southern California Edison's interest in the Four Corners coal-fired plant in Northwestern New Mexico. The plan has substantial merits, economically, environmentally and socially, and has already been approved by Arizona, California and federal regulators, as well as other government agencies. In mid-December, the Navajo Nation and BHP Billiton, the parent company of the operator of the coal mine serving that plant, announced that they had entered into a memoranda of understanding under which BHP plans to sell the coal mine operation to the Navajo Nation. The Nation would retain BHP as the mine manager and operator until July 2016. It's currently expected that the Navajo Nation Tribal Council will consider approval of their transaction in the second quarter. APS has been negotiating a new coal supply contract for Four Corners. Key terms of the new contract are being finalized by APS, the other Four Corners co-owners and the Navajo Nation. We expect that this agreement would be executed upon completion of negotiations and following the transfer of ownership of the stock of BHP's mine operation subsidiary to a new Navajo Nation commercial entity. We are targeting mid this year to close APS's Four Corners acquisition from Southern California Edison, following satisfactory completion of a new coal supply contract and finalization of other typical closing conditions. Turning now to our operational excellence. Excellence in day-to-day execution remains a top priority. Our performance in 2012 reflected this focus. I'll highlight just a few examples. First, Pinnacle West stock outperformed our industry. We're pleased that our total return to shareholders, comprised of stock price appreciation, plus dividends, was 10.3% for the year, which compares very favorably with U.S. electric utility average of just 0.1%. Second, our industrial safety record is one of our top accomplishments. I am proud to report that in 2012, we had the lowest number of recordable injuries in our company's history, bettering our record performance in 2011. However, every member of our team and I will continue to drive safety performance toward our goal of 0 injuries. Third, our baseload nuclear and coal fleet continues to turn in solid performance. For the full year 2012, our Palo Verde nuclear facility operated at a site average capacity factor above 92%. Palo Verde had its best production year ever, topping its site record from 2011 and generating almost 32 million megawatt hours. Additionally, in 2012, Palo Verde was the top U.S. power producer of any kind for the 21st consecutive year. Furthermore, Palo Verde is the only U.S.-generating facility of any kind to ever exceed 30 million megawatt hours in a single year, and it did so last year for the eighth time. Our fossil plants also have operated well. When appropriate, we took advantage of low near-term natural gas prices by reducing output by our coal plants and increasing gas plant production. And fourth, top tier reliability and other customer-focused efforts allowed APS to again achieve top decile customer satisfaction as evidenced by the company being ranked third highest nationally among 55 large investor-owned electric utilities by J.D. Power and Associates. In addition, APS's system reliability continued to be in the best quartile of our industry on almost every reliability metric. To close my remarks, I'm very pleased with where our company is today and very optimistic about our future. With the retail settlement behind us, we expect we will continue to achieve top-tier performance through our day-to-day focus on excellence and execution, cost management, strategic forward thinking and continuous improvements, areas in which our talented leadership team and workforce perform very well. Now I'll turn the call over to Jim for the financial and economic overview. Jim?

[James R. Hatfield:]

Thank you, Don. Today, I will discuss the following topics

[Operator:]

[Operator Instructions] Our first question comes from the line of Kevin Cole with Crédit Suisse.

[Kevin Cole:]

[indiscernible] I guess a broad question about 2013 guidance. I just have a tough time keeping my numbers down towards the mid-point, given that I really only see upward movement given the rate case, the TCA, the LFCR true-up, Four Corners and the assumption of normal weather. Is there any unknown risk that maybe I'm just not seeing that could possibly get you towards the bottom end of your guidance range?

[James R. Hatfield:]

No. I think we've laid out our story pretty effectively. Just a couple points, Kevin. One, we performed very well in 2012 and was able to get to top end of our guidance. We set our guidance range last November, and we got a lot to execute throughout the year. And it's a little early to be changing guidance when we have all summer ahead of us, which is really where we make our money.

[Kevin Cole:]

So I guess weather aside, I should -- if I just assume normal weather, I should be towards the top end?

[James R. Hatfield:]

I always plan to be in the middle of the range.

[Operator:]

Our next question comes from the line of Neil Mehta with Goldman Sachs.

[Neil Mehta:]

So I'm taking a look at the appendices here, and there are some moving pieces in the guidance relative to the Analyst Day. Gross margin was down, but it looks like O&M operating expenses offset those, as well as interest. Can you talk about some of the assumptions that drove the changes to the appendix?

[James R. Hatfield:]

Yes, it's really just the delay in the Four Corners transaction. Assuming a mid-year close, in the 6-month or short rate cycle, as opposed to getting the rate increase July 1, '13, it will be more like January 1, '14. So it really reflects nothing but Four Corners. Nothing else has really changed.

[Neil Mehta:]

Got it. And then I wanted to confirm. On bonus depreciation, the number, Jim, you cited was $400 million to $500 million?

[James R. Hatfield:]

Yes, it's -- impact this year of about somewhere between $50 million and $100 million.

[Operator:]

Our next question comes from the line of Ali Agha with SunTrust Robinson Humphrey.

[Ali Agha:]

The slide where you talked about dividend growth of about 4% expected over the next 3 years or so, Jim, should we assume that, that basically moves in line with EPS growth? Or how should we be thinking about that relative to EPS growth?

[James R. Hatfield:]

Well, what we've been talking about is rate base growth of 6% should lead to net income growth somewhere lower than 6%. And if you will, the dividend growth is sort of the floor, so to speak, on what we think is possible over the next few years.

[Ali Agha:]

Okay. Because, I mean, if EPS growth is any greater than that, then you're implying that your payout ratio would be coming down.

[James R. Hatfield:]

Slightly. Very slightly.

[Ali Agha:]

Okay. And more near term, coming back to '13, the Four Corners delay, the rate increase going into effect, let's say, beginning of '14, if my math is right, it's about $0.07 if you will delay in earnings in '13. And I'm wondering, is that a direct offset to that? Or is that within the band of the range that you've laid out? How should I think about that?

[James R. Hatfield:]

That's within the band of the range that we laid out.

[Ali Agha:]

Okay. But my math makes sense to you?

[James R. Hatfield:]

Yes, it makes sense.

[Ali Agha:]

Okay. And then my last question is, essentially, the load growth assumption that you've made out there, relatively flat going forward, can you remind us the earnings sensitivity to, let's say, a 1% change in load growth?

[James R. Hatfield:]

1% change in customer growth is about $0.10 per share, as a rule of thumb.

[Ali Agha:]

That's customer growth. Should I equate that to sales growth as well, weather-normalized?

[James R. Hatfield:]

Yes.

[Operator:]

Our next question comes from the line of Sarah Akers with Wells Fargo.

[Sarah Akers:]

With the new makeup of the commission, do you think there's any chance that the commission may reconsider the aggressive energy efficiency standards that are currently in place?

[Jeffrey B. Guldner:]

Sarah, this is Jeff Guldner. They are certainly asking questions about the standard. And so one of the discussions we've had at open meetings has been around how you do the performance or how you manage cost effectiveness. And so as they look at that, that has the potential to impact it. There's also some things they are looking at with respect to how large customers, like a mine, is impacted by energy efficiency. So there may be some changes from that, but there's certainly discussion going on.

[Sarah Akers:]

Great. And then are there any other potential regulatory issues or regulatory initiatives on your part that we should keep an eye on over the next 9, 12 months or so?

[James R. Hatfield:]

No, I think probably the biggest thing is -- Sarah, is we have some technical workshops now on the impact of net metering, and that will be ongoing through the first half of the year. Other than that, they're like any commission who's looking at the impact to consumers of everything that's going on.

[Operator:]

Our next question comes from the line of Paul Ridzon with KeyBanc Capital Markets.

[Paul T. Ridzon:]

Jim, could you just repeat something you said around the $1.1 billion of annual CapEx?

[James R. Hatfield:]

Sure.

[Paul T. Ridzon:]

You said 40% had rider recovery and 35% had what?

[James R. Hatfield:]

It's covered by cash from depreciation.

[Operator:]

Our next question comes from the line of Chris Ellinghaus with Williams Capital.

[Christopher R. Ellinghaus:]

Can you give us any detail on what the loss from discontinued operations was in the fourth quarter? That's kind of a more substantial number than normal.

[James R. Hatfield:]

Yes. It's specific to SunCor, and it really is part of the final wind-down through bankruptcy of SunCor.

[Christopher R. Ellinghaus:]

Okay. And as far as the rating changes have transpired over the last couple of years, are you satisfied where you're at now? And I'm really thinking in terms of future equity needs. Do you have greater aspirations for credit ratings? Or can you just give a little color...

[James R. Hatfield:]

No. We obviously always have aspirations for higher credit ratings, but we're very happy the BBB level. It's probably at or slightly above average for the industry as a whole. And with the BBB+, we have more room, so to speak, than we had when we were BBB or BBB-. So certainly would not issue equity with the stated goal of trying to raise the credit rating.

[Operator:]

[Operator Instructions] Our next question comes from the line of Charles Fishman with Morningstar.

[Charles J. Fishman:]

You achieved 9.9% consolidated ROE in 2012. Can I assume that it is likely that will fall to the 9.5% range for '13? And is that -- can I equate that to about the mid-point of your guidance?

[Donald E. Brandt:]

No -- Charles, Don Brandt here. No, I don't think you can equate that or assume that it will fall to 9.5%. As we've communicated in the past, we believe during this period of we're out of the regulatory environment or at least base rate cases, we're looking at greater than a 9.5% return.

[Charles J. Fishman:]

Okay. And then declining as you get farther along in the stay-out or...

[James R. Hatfield:]

Well...

[Donald E. Brandt:]

No, it's -- it will be more than 9.5% each of those years.

[Charles J. Fishman:]

Okay. Okay. And then the -- on the financial outlook, the bullet points you list, I think the second last one with the -- for 2013, the decrease in interest expense, that is all due to the delay in Four Corners?

[James R. Hatfield:]

Yes, primarily.

[Operator:]

Our next question comes from the line of Paul Patterson with Glenrock Associates.

[Paul Patterson:]

The AZ Sun, I'm sorry if I missed this, how many megawatts did you put in 2012? And what's now the forecast for 2013 through 2015?

[James R. Hatfield:]

Well, we have 118 megawatts under development, 69 of which were in service at the end of the year. And we're in development currently of another 49 megawatts, as Don mentioned. And then beyond '13, we'll continue to work on the renewable energy plan, which needs to be approved by the commission.

[Paul Patterson:]

Okay. And then on the -- the retail customer sales growth, it looks like it's 1.5%, and before, it was 1%. But the longer-term growth, you're still sort of projecting 2%.

[James R. Hatfield:]

That's right. And we expect that you'll get acceleration throughout the '13 to '15 period with higher growth at the end to get to an average.

[Paul Patterson:]

That's right. You guys mentioned that last time. Just on the offset, the 2.5% growth offset that you guys are projecting, with renewables, how much is the distributor renewable element of that? I'm sorry. How much of -- I know it's energy conservation and efficiency. But what's the renewable sort of distributed impact on that?

[James R. Hatfield:]

It's about 1%.

[Paul Patterson:]

Okay. And does anything, I mean -- I know that it's early and the previous question on what the ACC is looking into. But is there -- do you have any -- do you guys feel more or less confident about -- or let me put it this way, do you think that there's more upside potential in terms of sales growth, given the tone of conversation and discussion that you're seeing at the ACC versus perhaps last quarter?

[James R. Hatfield:]

No, not where we sit today.

[Operator:]

Our next question comes from the line of Kevin Fallon with SIR Capital Management.

[Kevin Fallon:]

I just had a question on the Four Corners milestones to the transaction actually closing. What are the steps that need to occur between now and when it actually closes?

[Donald E. Brandt:]

Primarily, the transaction between BHP and the Navajo Nation transferring the coal mine -- the coal mine operations.

[Kevin Fallon:]

And they have to reach an agreement first and then there needs to be a vote by the Navajo Nation. Is that correct?

[Donald E. Brandt:]

Essentially. And then the Navajo Nation Council has to approve it.

[Kevin Fallon:]

And after that occurs, does the transaction just consummate at that point? Or is there an incremental step that needs to be done?

[James R. Hatfield:]

We'll need to sign a coal contract with the Nation now that they have the mine, and then it will be normal closing preparation and then closing.

[Kevin Fallon:]

Okay. And once the transaction is actually completed, what's the process that it moves into rate? And, in particular, is it purely a single issue of moving into the rates? Or is there any kind of a reopener or look at earned returns or anything like that?

[James R. Hatfield:]

Well, our settlement kept the docket open for the treatment of Four Corners upon acquisition, and that calls for the deferral during a period of time where we file and get rates into effect. I wouldn't call it a single issue rate case, but there's already been an adjudication of the Four Corners purchase prior to that. So, I mean, it'll be focused on just bringing Four Corners in.

[Kevin Fallon:]

Okay. So as long as your equity ratio and earned returns are in line with expectations, there's no reason to see those being revisited?

[James R. Hatfield:]

I would not think so.

[Kevin Fallon:]

Okay. And just the last thing. Any update on the potential for transmission investments?

[James R. Hatfield:]

Still working on it.

[Operator:]

Ms. Hickman, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

[Rebecca L. Hickman:]

Thank you, Christine. And thank you again for joining us today. As always, if you need further information about our earnings or other information about our company, please contact us. 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.