Business context and reporting period
Pinnacle West Capital Corporation’s Form 10-K covers the fiscal year ended December 31, 2016; it is an annual report, not a standalone fourth-quarter filing. Pinnacle West is a holding company whose revenues and earnings are derived essentially entirely from Arizona Public Service Company (APS), a regulated, vertically integrated electric utility serving approximately 1.2 million Arizona customers. APS owned or leased 6,236 MW of generation capacity.
Financial performance and condition
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Pinnacle West operating revenues | $3.499 billion | $3.495 billion | +0.1% |
| Operating income | $856 million | $855 million | +0.2% |
| Net income attributable to common shareholders | $442 million | $437 million | +1.1% |
| Diluted EPS | $3.95 | $3.92 | +0.8% |
| Operating cash flow | $1.023 billion | $1.094 billion | −6.5% |
| Capital expenditures | $1.275 billion | $1.076 billion | +18.5% |
Operating margin was approximately 24.5% and common-shareholder net margin approximately 12.6%, based on reported revenue and income. APS reported $3.490 billion of electric operating revenue, $618 million of operating income, and $462 million of net income attributable to its common shareholder. Weather-adjusted retail electricity sales were flat year over year; customer count increased 1.4%.
For the fourth quarter, Pinnacle West revenue was $739 million versus $734 million in 2015, and net income attributable to common shareholders was $53 million versus $41 million. Diluted EPS was $0.47 versus $0.37. Results are seasonal, and interim results are not necessarily indicative of a full year.
Cash and cash equivalents were $9 million at year-end, versus $39 million a year earlier. Pinnacle West had $4.02 billion of long-term debt excluding current maturities, $125 million of current maturities, and $177 million of short-term borrowings. Total assets were $16.00 billion and total equity $4.94 billion. Available committed credit facilities were approximately $1.10 billion. Debt-to-capitalization ratios were 48% for Pinnacle West and 47% for APS, below the 65% covenant ceiling; APS’s regulatory common-equity ratio was 54%, above its 40% minimum.
Capital spending exceeded operating cash flow by approximately $252 million. Pinnacle West paid $274 million in common dividends; declared dividends were $2.56 per share for 2016, and the indicated annual dividend was raised to $2.62. Management expects capital expenditures to be funded through operating cash and external financing.
Material changes versus the prior comparable period
- Common-shareholder earnings increased modestly. Management cited higher transmission and retail revenues, partly offset by higher operations and maintenance costs, including transmission, distribution, customer-service, and planned outage expenses.
- Operating cash flow declined $71 million, while cash used for investing increased $186 million, primarily reflecting higher capital expenditures.
- Long-term debt excluding current maturities rose from $3.46 billion to $4.02 billion. APS issued $350 million of 3.75% notes due 2046 and $250 million of 2.55% notes due 2026, among other refinancing actions.
- APS recorded a $12 million write-off after FERC denied recovery of a regulatory asset related to terminating a transmission agreement with Southern California Edison. A separate early adoption of stock-compensation guidance reduced 2016 operations and maintenance expense by $12 million; the filing identifies this as a one-time adjustment.
Outlook, management commentary, risks and contingencies
- No specific earnings or EPS guidance is provided. APS projects weather-adjusted retail sales growth of 0–1.0% in 2017 and an average 0.5–1.5% in 2017–2019; customer growth is projected at 1.5–2.5% in 2017 and 2.0–3.0% on average over 2017–2019.
- APS’s pending Arizona rate case seeks a $165.9 million annual base-rate increase, with a stated average annual bill impact of 5.74% (7.96% for a typical residential customer). Hearings were scheduled for April 2017; the outcome was uncertain. The request includes recovery and rate treatment for major investments, including Ocotillo modernization and Four Corners controls.
- The co-owners voted not to pursue continued operation of the Navajo Generating Station beyond December 2019 under the existing lease. APS’s remaining investment was $108 million at year-end; recovery of that balance and potentially material retirement costs is uncertain. An ACC investigation was opened in February 2017.
- APS’s Cholla Unit 2 closed in 2015; its remaining $116 million book value is recorded as a regulatory asset, and recovery depends on regulatory approval. EPA approved the proposed Cholla emissions-compliance approach in January 2017, subject to publication and possible legal challenge.
- Environmental exposure includes estimated APS costs of approximately $400 million for Four Corners controls and up to $200 million for Navajo Plant upgrades under existing determinations, plus estimated coal-ash compliance costs of $15 million at Four Corners and $5–$40 million at Cholla. Actual requirements and recovery are uncertain. The Clean Power Plan was stayed pending judicial review; a mass-based compliance approach could entail material costs.
- Other significant uncertainties include litigation challenging Four Corners operating approvals; the ongoing federal grand-jury investigation concerning Arizona’s 2014 statewide elections, for which Pinnacle West says it is cooperating; and Commissioner Burns’s requests for company contribution and expenditure records. The companies cannot predict the outcomes.
- Additional risks include rate recovery and regulatory decisions, weather and sales variability, fuel and purchased-power costs, plant outages, water availability, coal economics, nuclear operations and spent-fuel disposal, pension funding, interest rates, credit access, cybersecurity, and counterparty performance. Pinnacle West depends on APS dividends, which are subject to legal, regulatory and financing restrictions.
Important facts for investors to verify
- Progress and final terms of APS’s rate case, including the approved revenue increase, customer bill impacts, and recovery of plant investments and retired-plant costs.
- Plans and cost recovery for the Navajo Plant after 2019, and the final disposition of APS’s $108 million investment and closure obligations.
- Regulatory, court and permitting outcomes affecting Four Corners, Cholla, Clean Power Plan compliance, and coal-ash requirements.
- Whether earnings and cash generation can support the planned capital program, rising debt, and dividend growth while maintaining credit metrics and liquidity.
- Developments in the grand-jury investigation and ACC information requests, and any resulting financial, regulatory or governance consequences.