Pinnacle West Capital Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Pinnacle West is a holding company whose results are driven primarily by Arizona Public Service Company (APS), a regulated electric utility serving much of Arizona. Figures below are consolidated Pinnacle West unless noted.
Financial performance and position
- Quarter: Operating revenue was $878.6 million, up 9.9% from $799.8 million. Operating income was $254.5 million versus $197.0 million; net income attributable to common shareholders was $122.3 million versus $86.7 million. Diluted EPS was $1.11 versus $0.79.
- First six months: Revenue was $1.499 billion, up 3.5%; operating income was $302.5 million versus $232.8 million; common-shareholder net income was $114.1 million versus $71.6 million. Diluted EPS was $1.04 versus $0.65.
- Margins: Calculated operating margin was 29.0% for Q2 versus 24.6% a year earlier, and 20.2% for the first half versus 16.1%. Common-shareholder net margin was 13.9% versus 10.8% for Q2 and 7.6% versus 4.9% for the first half.
- Cash flow: First-half operating cash flow was $458.6 million, up from $436.3 million. Capital expenditures were $424.8 million, compared with $387.3 million; net investing cash outflow was $414.7 million. Cash declined $22.4 million to $11.2 million.
- Debt and liquidity: Long-term debt, including current maturities, was about $3.43 billion at June 30; APS also had $109 million of commercial paper outstanding. Pinnacle West had a $200 million revolving facility with no borrowings; APS had $1 billion of facilities, also with no facility borrowings. APS’s common-equity ratio under the ACC definition was 55%, above its 40% minimum. Consolidated debt-to-capitalization covenant ratios were approximately 48% for Pinnacle West and 47% for APS.
- Dividends: Pinnacle West declared $1.05 per share for Q2 and $1.575 per share for the first half. Its board declared a quarterly dividend of $0.525 per share payable September 4, 2012.
Changes versus the prior comparable periods
- Management attributed Q2’s higher regulated-segment earnings mainly to warmer weather increasing customer usage, lower depreciation following 20-year extensions of Palo Verde’s operating licenses, and lower net interest charges. Higher operations and maintenance expense, mainly stock compensation, partly offset gains.
- First-half results also benefited from lower operations and maintenance expense, including less fossil-fuel plant maintenance and the absence of a prior-year transmission right-of-way settlement cost. Higher property taxes partly offset these improvements.
- APS’s weather-adjusted retail electricity sales declined 0.5% in the first half, despite 0.9% customer growth. Management cited conservation, efficiency programs, and distributed generation.
Outlook, regulatory matters, and risks
- Management expected average annual customer growth of about 2% and weather-adjusted retail sales to remain flat on average during 2012–2015. It noted that weaker Arizona economic conditions or weather variability could change results; typical weather and economic variations could move annual net income by up to $10 million, with extreme weather historically having a larger effect.
- APS’s 2012–2014 estimated capital expenditures were $1.115 billion, $927 million, and $1.057 billion, respectively. These estimates assume the proposed Four Corners transaction closes. APS planned to fund investment with operating cash flow and external financing as needed.
- The ACC approved APS’s rate-case settlement on May 15, with new rates effective July 1, 2012. It provides for zero net base-rate change, combining a $116.3 million non-fuel increase, a $153.1 million fuel-related decrease, and transfer of certain renewable-project recovery to base rates. It authorizes a 10.0% return on common equity and generally bars a new general rate case filing before May 31, 2015.
- APS issued $325 million of 4.50% senior notes due 2042 and used the proceeds with other funds toward repayment of $375 million of 6.50% notes that matured in March 2012.
- APS’s proposed purchase of SCE’s Four Corners Units 4 and 5 interest for $294 million remained subject to approvals and other conditions. If completed, APS planned to close Units 1–3. A proposed EPA rule could require about $182 million of additional emissions controls at Cholla; this amount was not in the current environmental expenditure estimates.
- Other material exposures include fuel and purchased-power costs, regulatory recovery, nuclear operations and spent-fuel disposal, water availability, environmental requirements, and litigation. The filing describes potential NERC penalties related to the 2011 Southwest outage but says impacts could not be predicted; APS’s motion to dismiss a related amended complaint was granted July 27, 2012. APS said it could not estimate a reasonably possible loss range for the Four Corners Clean Air Act case.
- SunCor filed for bankruptcy in February 2012 to liquidate; management did not expect a material impact on Pinnacle West. APS discontinued cash-flow hedge accounting for most contracts from June 1, 2012, following changes to PSA recovery; substantially all relevant unrealized derivative gains and losses are deferred for future rate treatment rather than immediately affecting earnings.
Most important facts for investors to verify
- Whether higher earnings persist when weather is less favorable, given the role of warmer weather in Q2 results and flat expected weather-adjusted sales.
- Execution and funding of the capital program, including the Four Corners purchase, required approvals, and any additional environmental-control costs.
- Whether the new rate settlement and PSA mechanisms deliver timely recovery of operating, fuel, transmission, renewable, and environmental costs.
- Liquidity and debt-service capacity given low cash balances, planned capital spending, pension contributions, and possible collateral needs after a credit downgrade.
- Developments in nuclear, water, environmental, and litigation matters; the filing does not quantify all potential outcomes.