PUBLIC SERVICE ENTERPRISE GROUP INC quarterly report, Q2 FY2013

Business context and reporting period

Public Service Enterprise Group Incorporated (PSEG) filed this unaudited combined Form 10-Q for the quarter and six months ended June 30, 2013. PSEG is a New Jersey energy holding company; its principal businesses are wholesale generation and energy supply through PSEG Power, and regulated electric transmission and electric and gas distribution through PSE&G. Unless noted otherwise, financial amounts below are in millions of dollars.

Financial performance and position

Second-quarter operating margin was approximately 26.5%, compared with 20.6% a year earlier; first-half operating margin was approximately 24.0%, versus 24.4%. The quarter’s earnings increase was principally driven by improved mark-to-market results and higher transmission revenues. First-half earnings declined despite modest revenue growth, reflecting weaker Power results and the absence of prior-year tax benefits.

• Segment earnings: Power earned $204 in the quarter versus $104 in 2012, but $341 for the half versus $357. PSE&G earned $121 versus $101 in the quarter and $300 versus $298 for the half. Energy Holdings earned $4 in the quarter and first half, compared with $2 and $42, respectively.
• Cash flow and investment: First-half operating cash flow was $1,343. Capital additions to property, plant and equipment were $1,406, up from $1,280; investing cash outflow was $1,379. Cash and equivalents fell to $164 from $379 at year-end 2012. Common dividends paid were $364.
• Debt and liquidity: Long-term debt in capitalization was $7,442, compared with $6,687 at December 31, 2012; current maturities included $576 of long-term debt and $232 of VIE securitization debt. Commercial paper and loans were $157. PSEG reported $4,300 of credit facilities, with $3,971 available. Total assets were $32,059 and total capitalization was $18,539.
• Dividends: The quarterly dividend paid was $0.36 per share, versus $0.355 a year earlier. The board declared $0.36 per share for the third quarter; PSEG indicated an annual dividend of $1.44.

Material changes versus the prior comparable period

• Second-quarter net income rose $122, while first-half net income fell $51. Power’s second-quarter improvement reflected higher mark-to-market gains and capacity revenues; its first-half decline reflected lower electricity pricing and volumes and mark-to-market losses.
• PSE&G’s first-half earnings were essentially flat. Transmission revenues rose with increased investment, offset by higher operating and depreciation costs and higher income tax expense.
• The 2012 first-half comparison benefited from a $71 net tax-expense reduction associated with IRS settlements of leveraged-lease audits. Its absence contributed to the higher 2013 first-half tax expense and lower comparative earnings.
• Non-trading mark-to-market results were an important swing factor: after-tax gains were $80 in Q2 2013 versus losses of $10 in Q2 2012, but first-half results were losses of $25 versus gains of $42.

Outlook, commentary, risks and unusual items

• Management provided no specific full-year earnings guidance in the supplied filing text. It said operating cash flow, cash on hand and financing were expected to fund capital expenditures and dividends, and expected to fund the proposed Energy Strong program with internally generated cash and external debt.
• Base capital investment was projected at approximately $6.4 billion for 2013–2015: $2.54 billion in 2013, $2.17 billion in 2014 and $1.64 billion in 2015. PSE&G’s plan includes transmission, distribution and solar investment. The proposed Energy Strong program would invest $3.9 billion over ten years, including $2.6 billion sought for an initial five-year period; regulatory approval remained pending.
• Superstorm Sandy restoration costs were estimated at approximately $426 in total, including $364 for Power and $62 for PSE&G. Power recorded $50 of storm-related expense in the first half of 2013; PSEG had recorded $50 of insurance advances, but additional recoveries and their timing were uncertain. PSEG and its subsidiaries sued insurers over policy interpretation.
• Environmental exposure includes PSE&G’s former manufactured-gas-plant remediation estimate of $491–$578 through 2021; the company recorded the low end, $491, with a corresponding regulatory asset. PSEG could not estimate its share of potential Passaic River and related claims. Potential cooling-water intake requirements could require material spending; an older Salem cooling-tower estimate put PSEG Power’s share at approximately $575, and this was not included in forecast capital spending.
• Power’s leveraged-lease exposure includes coal plants leased to GenOn REMA and Midwest Generation. Midwest Generation’s parent and affiliate were in Chapter 11 proceedings; lease assumption/rejection deadlines were extended to September 30, 2013, with partial monthly payments during the extension. Management noted potential impairment, recovery and cash-tax risks if counterparties default or assets are foreclosed.
• Regulatory and market risks include wholesale power and capacity prices, subsidized generation and market design, environmental and nuclear rules, timely rate recovery, construction delays, commodity prices, counterparty credit and weather. The 2016–2017 PJM capacity auction cleared 8,637 MW of Power capacity at an average $166 per MW-day.
• Other developments: Energy Holdings sold commercial-office investments for $41, recognizing a $6 after-tax gain. PSEG was preparing to begin managing LIPA’s transmission and distribution system in 2014, while a revised contract and related approvals remained uncertain.

Most important facts for investors to verify

• Whether Power’s volatile mark-to-market gains and losses reverse or persist, and how wholesale prices, capacity revenues and generation volumes affect earnings.
• Progress on BPU approval and rate recovery for Energy Strong, storm costs and planned transmission and solar investments; compare actual capital spending with the disclosed plan.
• Actual insurance recoveries and the outcome of the Superstorm Sandy coverage litigation.
• Developments in cooling-water, emissions and nuclear requirements, and any resulting capital costs or operating restrictions.
• Credit and lease developments involving GenOn REMA and Midwest Generation, including payment performance and lease decisions.
• Cash generation, debt issuance and maturities, available credit capacity, and the sustainability of dividends alongside the investment program.