Pinnacle West Capital Corporation (NYSE: PNW) — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Pinnacle West is a regulated utility holding company whose results are derived primarily from Arizona Public Service Company (APS), serving about 1.3 million retail customers in Arizona. The filing presents separate consolidated statements for Pinnacle West and APS.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Operating revenue | $929.6 million | $869.5 million | $1,591.5 million | $1,610.0 million |
| Operating income | $261.9 million | $196.6 million | $302.3 million | $256.7 million |
| Net income attributable to PNW common shareholders | $193.6 million | $144.1 million | $223.6 million | $162.1 million |
| Diluted EPS | $1.71 | $1.28 | $1.98 | $1.44 |
| Operating margin | 28.2% | 22.6% | 19.0% | 15.9% |
Operating margins are calculated as operating income divided by operating revenue. Q2 revenue rose about 6.9%, while first-half revenue fell about 1.1%. Common-shareholder earnings increased about 34% in Q2 and 38% for the first half.
- Drivers and costs: Management attributed higher earnings chiefly to hotter-than-normal weather versus milder weather in 2019, lower operations and maintenance costs, and higher pension and postretirement non-service credits. Higher income taxes partly offset the Q2 improvement. First-half O&M expense declined $32.5 million, while depreciation and amortization increased $10.5 million.
- Cash flow, first half: Operating cash flow was $369.0 million versus $345.9 million; capital expenditures were $677.0 million versus $541.4 million; investing cash outflow was $652.5 million. Financing provided $280.0 million. Cash ended at $6.8 million, down from $10.3 million at year-end 2019.
- Debt and liquidity: At June 30, PNW reported $5.922 billion of long-term debt and $291.9 million of short-term borrowings; current long-term maturities were zero. Consolidated debt-to-capitalization was about 54%, within the 65% covenant limit. PNW had $41 million of commercial paper outstanding and no revolving-credit borrowings; APS had $220 million of commercial paper outstanding and no revolving-credit borrowings. APS’s defined common-equity ratio was 52%, above its 40% minimum.
- Capital investment and dividends: APS estimated capital expenditures of $1.331 billion in 2020, $1.650 billion in 2021 and $1.725 billion in 2022. PNW declared a quarterly dividend of $0.7825 per share, payable September 1, 2020.
Material changes and outlook
- Weather-normalized retail sales declined 0.3% in the first half year over year. From March 13 through July 28, APS reported a 1% cumulative decline in weather-normalized usage, with residential sales up 4% and commercial and industrial sales down 5%.
- Management projected 2020 customer growth of 1.5%–2.5%, 2020 weather-adjusted retail sales growth of flat to negative 1%, and average annual sales growth of 0.5%–1.5% for 2020–2022. The latter projection excludes weather and the uncertain contribution of new large data centers. Management estimated that a 1% sales variation under normal conditions could change annual net income by about $20 million.
- APS estimated a $20 million–$30 million pretax adverse 2020 earnings impact from customer disconnection suspensions, the summer moratorium and related bad debt expense. Management said the estimate depends on economic and customer assumptions. COVID-related health and safety costs increased first-half O&M expense by about $9 million, and were expected to continue affecting costs.
- APS’s pending 2019 rate case requests a total revenue increase of $184 million, including a $69 million base-rate increase and a net credit of about $115 million, with a requested December 1, 2020 effective date. The hearing was scheduled to begin December 14, 2020; the outcome is uncertain. The ACC also considered allegations that APS was over-earning under its prior rate decision, but took no action to change rates at its June 2020 meeting.
- PNW issued $500 million of 1.3% senior notes due 2025; APS issued $600 million of 3.35% senior notes due 2050. Proceeds were used in part to repay debt and short-term borrowings and fund capital spending. APS’s application to raise its authorized long-term debt limit from $5.9 billion to $7.5 billion remained pending.
- APS reiterated clean-energy ambitions: 65% clean energy by 2030, including 45% renewables, 100% clean, carbon-free electricity by 2050, and an end to coal-fired generation by 2031. These plans depend on regulatory approvals, technology, affordability and reliable replacement resources.
Risks, contingencies and unusual items
- COVID-19 creates uncertain demand, collection, bad-debt, cost, capital-market and operational effects. Commercial paper markets were disrupted in March; the companies drew on revolvers, then repaid those draws after commercial paper access returned in April.
- Regulatory recovery is important to earnings. APS disclosed uncertainty around the pending rate case, Four Corners SCR cost recovery, Navajo Plant and other retired-plant costs, and evolving clean-energy and environmental rules. Failure to recover certain regulatory assets could reduce earnings and asset values.
- The filing identifies potential environmental compliance costs, including coal combustion residual corrective-action requirements, and nuclear risks including spent-fuel disposal uncertainty. Certain ultimate costs cannot yet be reasonably estimated.
- APS’s rate-plan comparison tool may have misdirected customer recommendations during 2019. APS refunded about 13,000 potentially affected customers and paid inconvenience credits; the financial impact was not material. ACC and Arizona Attorney General inquiries remained unresolved.
- APS’s 2020 disconnection suspensions and related bad debt allowance reflect elevated collection risk: the allowance for doubtful accounts rose to $11.6 million from $8.2 million at year-end 2019.
- APS recognized operating lease right-of-use assets of about $554 million at June 30, versus $144 million at year-end 2019, largely reflecting new lease arrangements. The filing also disclosed a potential $63.9 million collateral requirement if specified derivative credit triggers were fully activated, plus about $88 million for certain energy-related non-derivative contracts.
Most important facts for investors to verify
- Whether weather-driven earnings gains persist and how COVID-19 affects sales mix, collections and bad-debt expense.
- The ACC’s decisions and timing on APS’s rate case, over-earning allegations, debt authorization and major cost-recovery proceedings.
- APS’s ability to fund its substantial capital program while maintaining liquidity, credit ratings and covenant compliance.
- Whether clean-energy targets and coal-transition plans can be executed at reasonable cost and with regulatory approval.
- Potential financial exposure from environmental, nuclear, litigation and collateral matters as estimates and proceedings develop.