PINNACLE WEST CAPITAL CORP annual report, FY2019

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Pinnacle West Capital Corporation (NYSE: PNW) — 2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019; filed February 21, 2020. Pinnacle West is a holding company whose results are driven primarily by regulated Arizona Public Service Company (APS), serving approximately 1.3 million customers. Figures below are in U.S. dollars; financial statements report dollars in thousands unless noted.

Business context and key financial metrics

  • Revenue: Pinnacle West consolidated operating revenue was $3.471 billion, down 6% from $3.691 billion in 2018. Retail electric service represented the large majority of revenue.
  • Earnings: Net income attributable to Pinnacle West common shareholders was $538.3 million, up 5% from $511.0 million. Diluted EPS was $4.77 versus $4.54; dividends declared were $3.04 per share versus $2.87.
  • Operating performance: Operating income was $672.0 million, down from $773.7 million. Operating margin was approximately 19.4%, versus 21.0% in 2018. Lower operating revenue, including customer tax refunds and milder weather, outweighed expense reductions; lower income-tax expense supported net income.
  • APS results: APS revenue was $3.471 billion versus $3.688 billion, operating income $687.0 million versus $829.8 million, and net income attributable to its common shareholder $565.3 million versus $570.3 million. APS’s 2019 income-tax benefit was $9.6 million, compared with tax expense of $144.8 million in 2018.
  • Cash flow: Pinnacle West operating cash flow was $956.7 million, down from $1.277 billion. Investing cash outflow was $1.131 billion, including $1.191 billion of capital expenditures; financing cash inflow was $178.8 million. Year-end cash was $10.3 million.
  • Capital and debt: Total assets were $18.48 billion and total equity $5.55 billion. Long-term debt, including current maturities, had a carrying amount of approximately $5.63 billion; short-term borrowings were $114.7 million. Debt-to-capitalization covenant ratios were 52% at Pinnacle West and 47% at APS, below the 65% limit.
  • Liquidity: At year-end, Pinnacle West had $123 million available under its $200 million revolver; APS had $1.0 billion available under its $1.0 billion revolvers. Management stated that the companies had ample borrowing capacity. APS’s regulatory-order common-equity ratio was 52%, above its 40% minimum.
  • Investment: APS capital expenditures were $1.191 billion in 2019. Forecast APS capital expenditures are $1.331 billion in 2020, $1.650 billion in 2021 and $1.725 billion in 2022, with significant planned spending on renewables and storage.

Material changes versus 2018

  • Pinnacle West common-shareholder earnings rose $27 million, while operating income fell about $102 million and revenue fell about $220 million. The filing attributes earnings improvement primarily to lower operations and maintenance costs and lower income-tax expense, partly offset by lower revenue and pension-related credits.
  • Operating and maintenance expense declined $95 million at Pinnacle West, including lower parent-company public outreach costs, fossil-generation costs and employee-benefit costs. Income-tax expense declined by approximately $150 million.
  • Operating cash flow fell $320 million, reflecting lower cash receipts and higher payments for operations and maintenance, fuel and purchased power, property taxes, interest and pension contributions.
  • APS issued $900 million of senior notes during 2019 at 2.6%, 3.5% and 4.25%, and repaid $500 million of 8.75% notes at maturity. APS also repaid the remaining $150 million of 2.2% notes in January 2020.
  • The Navajo Generating Station ceased operations in November 2019. APS reported $82 million of remaining investment for which it will seek continued rate recovery, plus retirement and closure costs that were still being assessed.
  • The McMicken battery facility experienced a battery-module failure in April 2019. APS’s proposed battery installations and related power-purchase agreements remained subject to investigation results, timing decisions and, for certain agreements, regulatory approval.

Outlook, commentary, risks and contingencies

  • Clean-energy plans: APS set an aspirational goal of 100% clean, carbon-free electricity by 2050; a 2030 target of 65% clean energy, including 45% renewables; and a commitment to end coal-fired generation by 2031. APS said execution depends on regulatory support, customer and sales growth, technology and capital-market access. It planned at least 850 MW of energy storage by 2025, while noting the McMicken event could affect deployment timing.
  • Demand outlook: Management projected customer growth of 1.5%–2.5% annually for 2020–2022 and weather-adjusted retail sales growth averaging 1%–2% annually. Projections exclude potential sales from several new large data centers; management said their demand remained uncertain.
  • Pending rate case: APS requested a $184 million total annual revenue increase, including a $69 million base-rate increase and a net credit of approximately $115 million largely related to tax refunds. The requested average annual bill impact was 5.6% (5.4% for a typical residential customer); APS sought rates effective December 1, 2020. The filing was pending, so the outcome and recoverability were uncertain.
  • Regulatory and customer matters: A summer 2019 residential disconnection moratorium reduced 2019 operating results by approximately $10 million pretax; further effects depend on final rulemaking. APS also identified roughly 13,000 customers potentially affected by an error in its rate-plan comparison tool and was providing refunds and $25 inconvenience payments; the company did not expect a material financial-statement impact, while regulatory and Attorney General reviews continued.
  • Environmental and plant risks: Coal-combustion-residual requirements, groundwater corrective action, wastewater permits, emissions rules and possible early plant retirements could increase costs. APS estimated Four Corners corrective-action and monitoring costs of $10–$15 million over 30 years; the Cholla estimate was not yet clear. APS stated that cost recovery through rates is not assured.
  • Other exposures: Risks include ACC/FERC rate decisions, retail-market restructuring, weather and drought, water access, wildfire, outages, nuclear operations and spent-fuel disposal, cybersecurity, fuel and purchased-power volatility, pension funding, and counterparty or financing risks. The filing described multiple proceedings and contingencies; it did not provide a clear estimate for some potential ultimate costs.
  • Audit and controls: Deloitte issued unqualified opinions on both companies’ financial statements and internal control over financial reporting. Regulatory accounting judgments were identified as a critical audit matter because recovery of deferred costs and regulatory assets depends on future commission decisions.

Important facts for investors to verify

  • Progress and decision timing for APS’s 2019 rate case, including approved revenue, allowed returns and customer bill effects.
  • Whether recovery of APS’s $82 million Navajo Plant investment and remaining closure costs is approved, and the final costs of retirement.
  • Battery-investigation findings, resulting changes to the 850 MW storage plan, project schedules and regulatory approvals.
  • Coal-ash corrective-action requirements and final cost estimates for Cholla and Four Corners, alongside other environmental compliance obligations.
  • Cash flow, borrowing needs and the funding plan for forecast capital spending, while monitoring credit outlooks that were negative at Moody’s and Fitch.
  • Actual customer and electricity-sales growth versus management projections, including the uncertain contribution from large data centers.