PUBLIC SERVICE ENTERPRISE GROUP INC quarterly report, Q1 FY2012

Business context and reporting period

Public Service Enterprise Group Incorporated (PSEG) filed this unaudited Form 10-Q for the three months ended March 31, 2012, with 2011 as the comparable quarter. PSEG operates wholesale energy supplier PSEG Power, regulated New Jersey utility PSE&G, and Energy Holdings, which includes leveraged leases and other investments. Unless noted, amounts below are in millions of dollars.

Financial results and position

• Energy costs fell to $1,179 from $1,563, while operating and maintenance expense declined modestly to $628 from $651. Interest expense was $101, down from $127. Continuing-operations margin was approximately 17.1% versus 13.8% in Q1 2011.
• Investing cash outflow was $706, chiefly reflecting $687 of property, plant and equipment additions; financing cash outflow was $285, including $179 of common dividends. Dividends paid per share were $0.3550 versus $0.3425.
• Reported long-term debt, including securitization and project-level non-recourse debt, totaled $7,259; current long-term and securitization debt totaled $719, with $29 of commercial paper and loans. PSEG reported $4,300 of credit facilities, $4,081 available liquidity, and more than $900 of cash on hand in its outlook discussion.
• Segment earnings: Power $253 (prior-year continuing operations $298), PSE&G $197 (up from $163), and Energy Holdings $40 (up from a $3 loss). The filing attributes much of the improvement in PSE&G and Energy Holdings earnings to the IRS settlement.

Material changes versus the prior comparable period

• Revenue declined 14%, while operating income fell 9%. Management cited lower wholesale electricity and natural-gas prices, reduced volumes, warmer winter weather, customer migration from BGS supply, and lower capacity and operating-reserve revenues.
• Continuing-operations income rose $31, but net income fell $33 because Q1 2011 included $64 of discontinued-operations income, including the gain on sale of a Texas generating plant. Q1 2012 diluted EPS from continuing operations improved to $0.97 from $0.91.
• Non-trading mark-to-market results were a $52 after-tax gain versus $4 in Q1 2011; NDT Fund income was $5 versus $27. PSEG reported lower income-tax expense, principally related to settling IRS audits.
• Operating cash flow increased $46. Capital expenditures rose $190, and cash increased $97 during the quarter. PSE&G operating cash flow improved; Power’s declined.

Outlook, management commentary, risks and unusual items

• Management identified continued low electricity and gas prices, uncertain economic recovery, regulatory and environmental changes, PJM capacity-market outcomes, and challenges to competitive wholesale markets as key concerns. It cited strong operating performance: nuclear capacity factor was 98%; generation volume was 13.1 TWh, about 6% below the prior-year quarter, primarily due to warmer weather.
• PSEG expects more than $6.7 billion of capital spending over the next three years, over 75% at PSE&G. Projects depend on approvals and execution; Susquehanna-Roseland transmission construction has faced delays, with further delay possible. Management said capital requirements are expected to be funded through internally generated cash and external debt; no specific earnings guidance is provided in the supplied filing text.
• IRS settlements concluded audits for tax years 1997–2006. The agreements produced an approximately $70 net decrease in PSEG income-tax expense after existing reserves. Cash timing remains uncertain: the filing describes approximately $600 of tax and interest due for 2004–2006, approximately $670 expected in refunds for 2007–2010, and a possible $100 cash tax saving from an accrued-interest deduction. Refund processing could take years.
• PSE&G recorded a $625 environmental liability and matching regulatory asset for former manufactured-gas-plant remediation; the estimated total cost range is $625–$723 through 2021. PSEG could not estimate its share of potential losses for several other river and natural-resource matters.
• Potential environmental compliance costs are material uncertainties. A proposed federal cooling-water rule, if adopted as proposed, could affect most generating stations; an older Salem cooling-tower estimate was about $1 billion total, or approximately $575 for Power’s share. New Jersey NOx rules could require significant controls or retirement of generating units. The filing says the impact of pending requirements is uncertain.
• Energy Holdings’ lease portfolio includes coal facilities leased to financially weak counterparties; the filing notes credit-rating downgrades, environmental litigation, and a planned long-term layup of Shawville units from April 2015. A lessee default, foreclosure, or lease termination could lead to write-offs and cash tax liabilities.
• Power’s outstanding guarantees had a face value of $1,803 and current exposure of $349. A loss of investment-grade status could require additional collateral; the filing estimates $876 under the specified guarantee and credit-facility scenario. Commodity-price and counterparty movements may also affect collateral needs.

Important facts for investors to verify

• How much of earnings improvement reflects recurring operations versus the IRS settlement and volatile mark-to-market and NDT results.
• Whether wholesale prices, customer migration, and lower capacity revenues continue to pressure Power’s earnings and cash generation.
• Timing and cash effects of IRS payments and refunds, including whether refund claims are processed as anticipated.
• Final costs and regulatory recovery for environmental remediation and potential generating-plant compliance upgrades.
• Progress, approvals, budgets, and in-service timing for major transmission, generation, solar, and utility infrastructure projects.
• Credit quality of lease counterparties, guarantee exposure, and potential collateral demands under ratings or market stress.