PINNACLE WEST CAPITAL CORP quarterly report, Q3 FY2018

Business context and reporting period

Pinnacle West Capital Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018. APS, its regulated Arizona electric utility subsidiary, accounts for essentially all of Pinnacle West’s revenue and earnings. Comparisons below are with the corresponding 2017 periods.

Financial performance and position

For the first nine months, capital expenditures were $898 million, versus $1.028 billion in 2017; investing activities used $913 million. Financing activities provided $5 million, and cash increased by $51 million to $65 million. At September 30, Pinnacle West reported $5.087 billion of long-term debt including current maturities and $128 million of short-term borrowings. APS had $4.789 billion of debt including current maturities. Pinnacle West and APS reported debt-to-capitalization ratios of approximately 50% and 46%, respectively.

APS had $1 billion of revolving credit facilities available, with no commercial paper or facility borrowings outstanding. Pinnacle West had $49 million of commercial paper outstanding and $79 million outstanding under its $150 million revolving facility. Management said both companies had ample borrowing capacity. APS’s common equity ratio was 53%, above its 40% regulatory minimum.

Changes versus the prior comparable period

• Q3 revenue rose while operating income declined; common-shareholder net income and diluted EPS increased. Management attributed the quarterly earnings improvement mainly to weather and lower federal income taxes, net of customer refunds.
• For the nine months, revenue and common-shareholder earnings increased, but operating income fell. Higher base rates and transmission revenue supported results; higher operating and maintenance costs, depreciation, and property taxes weighed on them. Lower income tax expense, primarily from federal tax reform, supported net income.
• Nine-month operating cash flow increased by $188 million, principally reflecting higher operating cash receipts and lower other cash payments, partly offset by higher operations and maintenance payments.
• APS’s fuel and purchased power costs and revenues are affected by the Power Supply Adjustor. Its February 2018 PSA rate increase was capped under the plan; $16.4 million of 2017 costs above the cap was carried forward for the 2019 reset.

Outlook, commentary, and risks

• Management projected APS customer growth of 1.5%–2.5% in 2018 and an average 2%–3% in 2018–2020. Weather-adjusted retail electricity sales were projected to grow 0%–1% in 2018 and average 0.5%–1.5% in 2018–2020. These are operating forecasts, not earnings guidance.
• Estimated APS capital expenditures were $1.206 billion for 2018, $1.153 billion for 2019, and $1.211 billion for 2020. Management expected funding from operating cash and external financing as needed.
• On October 18, 2018, the Board declared a $0.7375-per-share dividend, payable December 3, and increased the indicated annual dividend from $2.78 to $2.95 per share.
• APS expected the Navajo Generating Station to cease operations in December 2019. APS reported $90 million of remaining investment and intends to seek rate recovery; unrecovered costs could adversely affect results. Retirement and closure costs were still being assessed and could be material.
• APS accepted ACC Staff’s recommendation for approximately $58.5 million of annual revenue recovery for Four Corners emissions-control costs; an ACC decision was expected early in Q1 2019. Relevant environmental compliance, coal-plant economics, and cost recovery remain risks.
• APS settled a Four Corners coal-supply arbitration for $45 million, of which APS’s share was approximately $34 million. Separately, 4CA sold its 7% Four Corners interest to NTEC for approximately $70 million, payable over four years; Pinnacle West guaranteed certain NTEC obligations.
• Other uncertainties include challenges to the 2017 rate case, pending tax-savings rate requests, environmental proceedings, commodity and weather volatility, and nuclear operating and insurance exposures. The proposed Arizona renewable-energy ballot initiative was defeated on November 6, 2018, after quarter-end.

Important facts for investors to verify

• Whether operating-cost increases, depreciation, and property taxes continue to outpace rate-related revenue gains, and how seasonal weather affects earnings.
• ACC decisions on the additional $86.5 million tax-savings request and Four Corners SCR recovery, and outcomes of rate-case challenges.
• Rate recovery and retirement costs for the Navajo Generating Station and environmental compliance at APS coal plants.
• Execution of the capital plan, debt refinancing and liquidity needs, and the effects of bonus-depreciation tax rules on cash taxes.
• Cash collection and credit support for the NTEC note receivable and guarantees, and the final financial effects of the coal-supply settlement.