Pinnacle West Capital Corporation (10-Q) — Q1 2016
Reporting period: Three months ended March 31, 2016; unaudited. Pinnacle West is the parent of Arizona Public Service Company (APS), a regulated electric utility serving most of Arizona. APS accounts for essentially all of Pinnacle West’s revenue and earnings. Dollar amounts below are in millions unless stated otherwise.
Financial results
| Metric | Pinnacle West Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Operating revenue | $677.2 | $671.2 | +0.9% |
| Operating income | $50.2 | $67.7 | −25.9% |
| Operating margin | 7.4% | 10.1% | −2.7 percentage points |
| Net income attributable to common shareholders | $4.5 | $16.1 | −72.4% |
| Diluted EPS | $0.04 | $0.14 | Down |
| Cash from operations | $144.2 | $144.1 | Approximately unchanged |
| Capital expenditures | $378.5 | $251.0 | +$127.5 |
- Net income attributable to APS’s common shareholder was $7.3 million, compared with $19.9 million a year earlier. APS revenue was $676.6 million versus $670.7 million.
- Operating and maintenance expense rose $28 million, principally from $15 million of higher fossil-generation costs, including planned outages, and $10 million of higher employee-benefit costs, primarily stock compensation. Higher revenue less fuel and purchased-power expense added $8 million, partly offsetting the expense increase.
- Investing cash outflow was $372.3 million; financing provided $203.1 million. Cash declined $25.0 million to $14.5 million. Capital expenditures exceeded operating cash flow by approximately $234 million.
- At March 31, Pinnacle West reported $261.8 million of short-term borrowings, $357.6 million of current long-term debt maturities, and $3.46 billion of long-term debt excluding current maturities. APS had $4.9 million cash and $261.8 million of commercial paper outstanding. APS’s $1 billion revolving facilities had no borrowings outstanding; Pinnacle West’s $200 million facility was also undrawn.
- Pinnacle West current assets were $826.0 million versus current liabilities of $1.59 billion. Management stated that both companies had ample borrowing capacity and expected capital needs to be funded with operating cash and external financing as needed.
- APS’s ACC-defined common equity ratio was 55%, above its 40% minimum. Debt-to-capitalization covenant ratios were approximately 48% for Pinnacle West and 47% for APS, below the 65% maximum.
Outlook, regulation and key risks
- APS planned to file a retail rate case in June 2016, seeking proposed rates effective July 2017. The amount had not yet been determined. Issues expected to include rate design, recovery or deferral of Ocotillo and environmental costs, post-test-year plant, and changes to cost-recovery mechanisms.
- Management projected average annual customer growth of 2.0%–3.0% and weather-adjusted retail electricity sales growth of 0.5%–1.5% for 2016–2018. No earnings guidance was provided. Management noted that typical weather or economic variations can affect annual net income by up to about $10 million; extreme weather has historically produced variations exceeding $20 million.
- Estimated APS capital expenditures were $1.205 billion in 2016, $1.285 billion in 2017 and $1.124 billion in 2018. The 2016–2018 bonus-depreciation extension was expected to generate $375–$425 million of cash-tax benefits, accelerating tax benefits otherwise realized over a longer period and reducing rate base.
- APS made $60 million of voluntary pension contributions year-to-date and expected voluntary contributions of up to $300 million in 2016–2018. Minimum required pension contributions were zero for the next three years.
- Material uncertainties include the pending Arizona Supreme Court review of a utility rate-adjustor decision, which could affect recovery of costs between rate cases; the pending $46.4 million 2016 lost-fixed-cost recovery request; and appeals relating to Four Corners rate treatment and environmental approvals.
- Environmental compliance could require substantial investment: APS estimated its share of Four Corners regional-haze controls at about $400 million, Navajo Plant upgrades at up to about $200 million, and Cholla controls at about $100 million if required. Clean Power Plan obligations were stayed pending judicial review; management said costs under a mass-based compliance approach could be material. Recovery of compliance costs through rates is not assured.
- Other notable exposures include the $121 million Cholla Unit 2 regulatory asset, whose recovery depends on ACC approval, and potential APS collateral needs of $133.7 million under derivative credit triggers plus approximately $153 million under certain energy-related contracts if ratings fell below investment grade. The filing also reports nuclear-insurance assessments and environmental litigation; outcomes and ultimate costs are uncertain.
- Subsequent to quarter-end, APS entered a $100 million, three-year term loan on April 22, 2016 to refinance short-term indebtedness. Pinnacle West declared a $0.625-per-share dividend payable June 1, 2016.
Most important facts for investors to verify
- Whether the planned APS rate case is filed, the requested increase and rate-design changes, and the ACC’s timetable and decisions.
- Whether the Supreme Court and other regulatory proceedings alter APS’s ability to recover costs through adjustors or future rates.
- Actual 2016 capital spending, funding mix, commercial-paper balances and available liquidity as major projects proceed.
- Whether higher operating and maintenance costs persist, and whether customer and sales growth meet management’s projections.
- Environmental-rule and litigation outcomes, potential coal-plant investment or retirement decisions, and recoverability of related assets and costs.
- Developments in pension funding, derivative collateral exposure, and the outstanding lost-fixed-cost recovery request.