Pinnacle West Capital Corporation (10-Q): Quarter ended June 30, 2016
Pinnacle West is the parent of Arizona Public Service Company (APS), a vertically integrated Arizona electric utility that generates essentially all of Pinnacle West’s revenue and earnings. The filing presents unaudited results for the three and six months ended June 30, 2016, compared with 2015.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Pinnacle West operating revenue | $915.4 million | $890.6 million | $1,592.6 million | $1,561.9 million |
| Pinnacle West operating income | $231.7 million | $232.0 million | $281.9 million | $299.7 million |
| Net income attributable to common shareholders | $121.3 million | $122.9 million | $125.8 million | $139.0 million |
| Diluted EPS | $1.08 | $1.10 | $1.12 | $1.25 |
| APS electric operating revenue | $909.8 million | $889.7 million | $1,586.4 million | $1,560.4 million |
| APS net income attributable to common shareholder | $127.2 million | $125.4 million | $134.4 million | $145.2 million |
For Pinnacle West, operating margin was approximately 25.3% in Q2 2016 versus 26.0% a year earlier, and 17.7% for the first half versus 19.2%. These percentages are calculated from reported operating income and revenue.
- First-half operating cash flow was $422.5 million, up from $394.3 million. Capital expenditures were $731.6 million, versus $531.0 million; investing cash use was $715.5 million.
- At June 30, Pinnacle West had $43.0 million cash, $4.192 billion long-term debt including current maturities, and $64.1 million short-term borrowings. APS had $31.2 million cash and $64.1 million commercial paper outstanding.
- Pinnacle West and APS reported debt-to-capitalization ratios of approximately 49% and 48%, respectively. APS’s regulatory common-equity ratio was 52%, above its 40% minimum requirement. Management said both companies had ample borrowing capacity.
- Pinnacle West declared dividends of $1.25 per share for the first half, compared with $1.19 in 2015; the Board declared a $0.625-per-share dividend payable September 1, 2016.
Changes and drivers versus the prior period
- Q2 common-shareholder net income declined $1.6 million year over year; first-half net income declined $13.3 million. First-half revenue rose, but operating income and earnings fell.
- First-half operations and maintenance expense increased $59 million, mainly from employee benefit costs, fossil generation and planned outages, and transmission, distribution and customer service costs. Interest expense also increased with higher debt balances.
- Higher transmission revenue, weather and customer growth supported results. APS retail customers increased 1.4% and weather-adjusted retail sales rose 0.6% in the first half.
- APS recorded a $12 million write-off of a regulatory asset after FERC denied recovery of a payment related to the Four Corners transmission agreement. The filing identifies the disallowance in its results comparison.
- APS’s reduced System Benefits charge, effective January 2016, is expected to lower annual retail revenue by about $14.6 million, with a corresponding reduction in depreciation and amortization expense.
Outlook, regulatory matters and risks
- APS filed for a $165.9 million annual retail base-rate increase, excluding existing adjustor collections. The requested average annual bill increase is 5.74% (7.96% for a typical residential customer), with requested rates effective July 1, 2017. The ACC outcome is uncertain.
- Management expects APS customer growth of 2.0%–3.0% annually and weather-adjusted retail sales growth of 0.5%–1.5% annually during 2016–2018. The filing does not provide a specific earnings guidance figure.
- Estimated APS capital expenditures are $1.205 billion in 2016, $1.307 billion in 2017 and $1.124 billion in 2018. Management expects capital needs to be funded through operating cash flow and external financing.
- Environmental compliance and coal-plant economics remain significant uncertainties. Estimated APS shares of control costs include about $400 million for Four Corners, up to $200 million for Navajo, and potential Cholla costs; recovery and final obligations depend on regulatory and legal outcomes. Clean Power Plan compliance requirements were stayed pending judicial review.
- Other material matters include the Peabody bankruptcy dispute over the Cholla coal supply agreement, with damages sought unspecified and losses not reasonably estimable; litigation challenging federal approvals for Four Corners; and APS’s appeal of FERC’s denial of the $12 million recovery. Pinnacle West also received two grand jury subpoenas concerning the 2014 Arizona elections and said it was cooperating.
- Additional risks include the pending Arizona Supreme Court review of the System Improvement Benefits decision, which could affect recovery through rate adjustors; potential recovery of the $119 million remaining book value of retired Cholla Unit 2; and nuclear operating, spent-fuel, counterparty and collateral risks.
Important facts for investors to verify
- Progress and final outcome of APS’s retail rate case, including the requested rate increase and proposed recovery mechanisms.
- Whether APS can recover the Four Corners transmission payment and the remaining Cholla Unit 2 investment, and how related regulatory or court decisions affect earnings and cash flows.
- Final environmental compliance requirements, associated capital spending, and any resulting coal-plant operating or retirement decisions.
- Resolution of the Peabody contract dispute and Four Corners litigation, including any potential financial exposure.
- Execution of the substantial capital program while maintaining liquidity, credit metrics, dividend capacity and planned pension contributions.