PINNACLE WEST CAPITAL CORP quarterly report, Q2 FY2018

Business context and reporting period

Pinnacle West Capital Corporation (Pinnacle West) filed this unaudited combined Form 10-Q for the quarter and six months ended June 30, 2018. Its regulated electric utility subsidiary, Arizona Public Service Company (APS), generates substantially all Pinnacle West revenue and earnings. Comparisons below are with 2017 periods unless noted.

Financial performance and position

Amounts are in millions of dollars, except per-share data and where noted.

• Revenue increased 3.1% in Q2 and 2.7% in the first half. Q2 operating margin fell to about 24.9% from 31.5%; the first-half margin fell to about 16.4% from 22.5%.
• First-half operating cash flow improved by $105.2 million, while capital spending remained substantial. Cash flow less capital expenditures was negative by approximately $284 million.
• At June 30, cash was $3.8 million. Consolidated short-term borrowings were $616.2 million, current long-term debt maturities were $600 million, and long-term debt was $4.19 billion. Including short-term borrowings and current maturities, debt was approximately $5.41 billion, versus $4.97 billion at December 31, 2017.
• APS reported a 53% common-equity ratio under the ACC definition, above its 40% minimum. Its $1 billion revolving facilities were undrawn at quarter-end, while $500 million of commercial paper was outstanding. Pinnacle West had $30 million of commercial paper and $86 million outstanding under its 364-day facility. Credit facilities were renewed or replaced in June and July.
• Common dividends declared were $1.39 per share for the first half, compared with $1.31 a year earlier. A $0.695-per-share dividend was declared in June, payable September 4, 2018.

Material changes and drivers

• First-half common-shareholder earnings declined $20.8 million. Management attributed the decrease principally to higher operations and maintenance costs, planned generation outages, higher depreciation and adverse weather; higher revenues from the 2017 rate settlement and transmission partially offset these effects.
• Operations and maintenance expense rose $83 million for the first half, including increased fossil-generation outage costs, renewable-program costs, public outreach and transmission and customer-service costs. Depreciation and taxes other than income taxes also increased.
• Federal tax reform reduced the corporate tax rate to 21%. APS implemented a $119.1 million annual retail-rate reduction through customer bill credits beginning in March 2018. Lower income-tax expense helped earnings, while lower rates reduced revenue.
• APS completed a 28-day, 13-hour Palo Verde refueling outage in April, the shortest in the station’s history. First-half weather-adjusted retail electricity sales fell 0.7%, despite 1.6% customer growth.

Outlook, risks and unusual items

• Management projected 2018 customer growth of 1.5%–2.5%, averaging 2%–3% during 2018–2020. Weather-adjusted retail sales were projected to rise 0%–1% in 2018 and average 0.5%–1.5% growth during 2018–2020. These are operating projections, not earnings guidance; the filing provides no specific earnings-per-share guidance.
• APS estimated capital expenditures of $1.181 billion in 2018, $1.153 billion in 2019 and $1.211 billion in 2020, to be funded through operating cash and external financing as needed.
• A proposed Arizona ballot measure would require 50% renewable energy by 2030, excluding nuclear. APS estimated it could require more than 5,500 MW of additional resources and over $10 billion of incremental investment; management said customer bills in 2030 could be double current levels. Signature verification and litigation over the submission remained pending.
• APS considered it probable that the Navajo Generating Station would close in December 2019. Its remaining book investment was $92 million; recovery of this regulatory asset and retirement costs depends on regulatory treatment. Cholla Unit 2-related costs of $97 million were also subject to rate recovery. Four Corners environmental compliance, coal supply and related regulatory proceedings remain relevant risks.
• On June 29, APS settled a Four Corners coal-supply arbitration for $45 million, of which APS’s share was approximately $34 million. Separately, NTEC purchased 4CA’s 7% Four Corners interest for approximately $70 million; the sale closed July 3, after quarter-end, with payment over four years. Pinnacle West guaranteed certain obligations associated with the sale.
• Other uncertainties include rate-case appeals and customer complaints, pending renewable-energy rules, environmental and water requirements, nuclear waste disposal, and the ability to recover costs through regulated rates. Management cautioned that actual results may differ materially from forward-looking statements.

Important facts for investors to verify

• Whether higher operating and outage costs persist, and whether revenue growth can offset expense and depreciation increases.
• Actual customer and weather-adjusted sales growth versus management’s projections, including the effects of conservation and distributed generation.
• ACC and other regulatory outcomes affecting tax refunds, rate recovery, renewable programs, and the Navajo and Cholla plant balances.
• The ballot initiative’s status and potential effect on APS’s generation plans, investment needs and customer rates.
• Funding of the capital program and debt maturities, alongside liquidity and credit-facility capacity.
• Collection of the Four Corners sale proceeds and the scope and exposure of Pinnacle West’s related guarantees.