PPL Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. PPL is a regulated utility holding company with electricity distribution businesses in the U.K., Pennsylvania and Kentucky, and regulated generation and gas operations in Kentucky. The combined filing also reports PPL Electric, LG&E and KU separately.
Financial performance
- PPL consolidated: Revenue was $1.951 billion, down 3% from $2.011 billion. Operating income was $796 million versus $823 million; net income was $403 million versus $481 million; diluted EPS was $0.59 versus $0.71.
- Other expense was $47 million, compared with $61 million of other income in Q1 2016. The change primarily reflected realized and unrealized foreign-currency hedge results. Management’s non-GAAP earnings from ongoing operations were $425 million ($0.62 per share, per MD&A) versus $458 million ($0.68 per share); these exclude special items, including a $21 million after-tax loss on foreign-currency economic hedges in 2017.
- Segment net income: U.K. Regulated $286 million (2016: $289 million); Kentucky Regulated $95 million ($112 million); Pennsylvania Regulated $79 million ($94 million); Corporate and Other loss $57 million (loss of $14 million).
- Management’s non-GAAP gross margins: U.K. $536 million, down $21 million reported, but up $70 million excluding exchange-rate changes; Kentucky $507 million, down $18 million; Pennsylvania $366 million, up $1 million. These measures are not GAAP operating income.
- Cash flow: Operating cash flow was $135 million, down from $557 million. The principal driver was $520 million of defined-benefit plan funding, versus $123 million in Q1 2016, including $462 million contributed to U.K. pension plans. Capital expenditures for property, plant and equipment were $677 million (2016: $656 million). Ending cash was $409 million.
- Debt and liquidity: At March 31, total debt carrying amount was $18.375 billion, including $1.666 billion of short-term debt; cash was $409 million. Short-term debt increased from $923 million at year-end 2016. PPL reported $2.076 billion of unused U.S. committed credit capacity and $1.419 billion of unused commercial-paper capacity. PPL issued $64 million of U.K. index-linked notes during the quarter and raised $50 million net through its ATM equity program.
- Quarterly dividend declared was $0.395 per share, or $1.58 annualized, compared with $0.38 per share in Q1 2016.
Material changes and management commentary
- Lower U.K. revenue reflected a $96 million unfavorable currency translation effect, partly offset by higher U.K. pricing and volumes. Kentucky revenue and earnings were pressured by milder weather and lower electricity sales volumes. Pennsylvania earnings declined amid higher operating and depreciation costs, despite slightly higher gross margins.
- PPL’s 2017 outlook called for lower U.K. segment net income than 2016, chiefly from a lower assumed pound exchange rate, lower incentive revenues, and higher interest and depreciation expense. Kentucky and Pennsylvania segment net income was projected to be relatively flat year over year. The filing text does not provide a clear consolidated EPS guidance range.
- As of April 20, PPL said budgeted U.K. earnings were 100% hedged for the remainder of 2017 at an average $1.21 per pound, and 99% hedged for 2018 and 2019 at average rates of $1.41 and $1.32, respectively. The U.K.’s March 2017 notice of intent to leave the EU creates uncertainty for exchange rates and the U.K. economy.
- After quarter-end, LG&E and KU filed proposed rate-case settlements providing annual revenue requirement increases of $55 million for KU electricity, $59 million for LG&E electricity and $8 million for LG&E gas, at a proposed 9.75% return on equity. They remained subject to KPSC approval; if approved, rates were expected to take effect July 1, 2017. The agreements withdrew the advanced-metering-system CPCN request.
Risks, contingencies and unusual items
- Significant environmental compliance costs may arise from coal-ash closure, wastewater discharge rules, other permits and litigation. The companies generally expect eligible costs to be recoverable through rates, but recovery and timing are not assured; some compliance costs are not yet fully estimable.
- LG&E faces an EPA notice alleging sulfuric-acid-mist violations at Mill Creek; the outcome and potential costs are uncertain. A separate E.W. Brown water-discharge and coal-waste matter also remained unresolved. The Kentucky Supreme Court upheld the Trimble County discharge permit on April 27, 2017. The Cane Run case was dismissed in its entirety on April 13, subject to appeal or state-court refiling rights.
- LKE disclosed guarantees and indemnities, including up to $301 million of exposure for lease-termination and other divestiture indemnifications. A disputed WKE-related claim remained in litigation; management did not expect outcomes of indemnification matters to cause significant losses above recorded amounts, but ultimate outcomes were uncertain. LG&E and KU also have obligations tied to OVEC debt and potential credit-support actions whose maximum exposure cannot presently be determined.
- Other key sensitivities include weather-driven demand, rate-case outcomes, U.S. tax reform, pension funding and asset values, interest and currency rates, credit access, and regulatory changes affecting the U.K. and U.S. The filing said there were no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether the KPSC approved the LG&E/KU rate-case stipulations and whether the planned July 1, 2017 rate changes took effect.
- How much of the sharp decline in operating cash flow reflects accelerated pension funding, and the expected pension contribution schedule after Q1.
- Whether lower U.K. exchange rates, hedge settlements and hedge mark-to-market volatility affected full-year results relative to management’s outlook.
- Actual U.S. and U.K. borrowing levels, liquidity headroom, and any developments in OVEC-related credit support or WKE indemnification litigation.
- Updated cost estimates, rate-recovery status and legal outcomes for environmental compliance and other contingencies.