Pinnacle West Capital Corporation (PNW) — Q2 2023 Form 10-Q
Business context and reporting period. The quarter and six months ended June 30, 2023. Pinnacle West is an Arizona utility holding company whose results are principally driven by regulated subsidiary Arizona Public Service Company (APS), serving approximately 1.4 million retail customers. Figures below are consolidated Pinnacle West amounts unless identified as APS; dollar amounts are in millions.
Financial performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Operating revenue | $1,121.7 | $1,061.7 | $2,066.7 | $1,845.2 |
| Operating income | $183.3 | $223.1 | $234.0 | $277.6 |
| Net income attributable to common shareholders | $106.7 | $164.3 | $103.4 | $181.3 |
| Diluted EPS | $0.94 | $1.45 | $0.91 | $1.60 |
| Net cash from operating activities | Not separately presented | Not separately presented | $437.6 | $588.3 |
| Capital expenditures | Not separately presented | Not separately presented | $918.2 | $843.2 |
- Revenue rose 5.7% in Q2 and 12.0% in the first half, while common-shareholder net income fell 35% and 43%, respectively. Higher fuel and purchased-power costs largely flowed through regulatory recovery mechanisms; operating and maintenance expense, interest expense, depreciation, and lower pension-related credits weighed on earnings.
- Operating margin was approximately 16.3% in Q2 versus 21.0% a year earlier, and 11.3% for the first half versus 15.0%. These are calculated as operating income divided by operating revenue.
- First-half operating cash flow decreased $150 million year over year, principally due to higher fuel and purchased-power, operating and maintenance, interest, and other cash costs, partly offset by higher customer receipts. Investing outflows increased $90 million, chiefly from capital spending.
- At June 30, Pinnacle West had $7.7 million of cash and approximately $8.8 billion of short- and long-term debt, including current maturities. Total equity was $6.1 billion. APS had $3.8 million of cash and approximately $7.6 billion of debt. Management stated that both companies had ample borrowing capacity under committed facilities.
Material changes and financial position
- Pinnacle West’s first-half net income attributable to common shareholders declined $77.9 million. Management attributed the decrease primarily to higher operations and maintenance expense, interest charges, depreciation and amortization, and lower pension and other postretirement non-service credits.
- Interest expense, net of construction allowances, increased $20 million in Q2 and $34 million in the first half, primarily due to higher debt balances and interest rates.
- Capital expenditures were $918 million for the first half. APS’s estimated capital expenditures are $1.67 billion in 2023, $1.80 billion in 2024, and $1.85 billion in 2025.
- APS issued $500 million of 5.55% senior notes due 2033 in June; proceeds were used to repay commercial paper and for general purposes. Pinnacle West replaced its $200 million revolver with a facility maturing in 2028; APS established a $1.25 billion revolver maturing in 2028. Neither had borrowings under its revolver at quarter-end. APS had $285 million of commercial paper outstanding.
- Debt-to-capitalization ratios were approximately 60% for Pinnacle West and 52% for APS, below the 65% covenant maximum. APS’s ACC-defined common equity ratio was 48%, above the 40% minimum.
- Credit ratings for both companies carried negative outlooks as of July 27, 2023. Management said it believed available liquidity could address a potential downgrade.
Outlook, commentary, risks and contingencies
- APS projected weather-adjusted retail sales growth of 2.0%–4.0% for 2023 and average annual growth of 4.5%–6.5% through 2025. Management lowered the 2023 outlook versus its prior update due mainly to slower data-center growth and delays at large manufacturing facilities. Customer growth was projected at 1.5%–2.5% annually through 2025.
- APS reported unprecedented requests from extra-large commercial users that exceed available generation and transmission capacity in the Southwest for the foreseeable future. It told prospective customers without existing commitments it could not currently commit to their projects.
- APS’s pending 2022 retail rate case seeks a net $460 million annual base-rate increase, initially equivalent to a 13.6% average customer bill increase. APS later reduced its requested revenue increase to $383.1 million; ACC Staff’s updated recommendation was $281.9 million, while RUCO maintained an $84.9 million recommendation. APS requested rates effective December 1, 2023; the outcome remained uncertain.
- A June 2023 ACC-approved resolution addressed the prior rate case, allowing recovery of $215.5 million of Four Corners emissions-control costs, reversing a return-on-equity penalty, and providing for recovery of $59.6 million of lost revenue. The resolution took effect July 1, 2023; the Sierra Club sought rehearing.
- APS’s 2023 power supply adjustor rate took effect in March at $0.019074 per kWh, designed to reduce the under-collected balance toward zero over 24 months. Fuel and purchased-power regulatory assets remained substantial at $433 million at June 30.
- APS’s clean-energy goals include 65% clean energy by 2030, exit from coal-fired generation by 2031, and an aspiration for 100% clean, carbon-free electricity by 2050. These plans depend on regulatory support, resource development, technology, and access to capital. APS expects to issue an all-source RFP seeking about 1,000 MW of reliable capacity, including at least 700 MW of renewables.
- Key risks include inflation and supply constraints, extreme heat and other weather, fuel and power-market volatility, rate recovery and regulatory decisions, interest rates and capital-market access, reliability and outages, and environmental compliance. Proposed federal carbon and coal-ash rules could increase costs; ultimate requirements and rate recovery are uncertain.
- Fuel and purchased-power and purchase-obligation commitments increased $5.5 billion from the 2022 Form 10-K, primarily due to new purchased-power and energy-storage commitments, partly offset by termination of a contract. Approximately $4.3 billion relates to purchased-power lease contracts. APS also disclosed $6.3 billion of expected fixed consideration for executed energy-storage arrangements not yet commenced.
- Unusual estimates and exposures include a $36 million increase in Cholla asset-retirement obligations and a $13 million decrease in the Four Corners estimate during the first half. A Palo Verde sale-leaseback event under specified circumstances could require payments of approximately $324 million beginning in 2023, up to $501 million over the lease terms; APS considered the triggering events unlikely.
Investor verification priorities
- Track the final ACC decision, timing, and customer impact in APS’s 2022 rate case, including the treatment of the power supply adjustor and post-test-year investments.
- Monitor whether revenue growth and customer demand—particularly from data centers and manufacturers—translate into earnings and can be served with available generation and transmission.
- Reconcile fuel-cost recovery and the $433 million deferred fuel and purchased-power regulatory asset with future customer collections and cash flow.
- Assess debt growth, borrowing costs, capital spending, liquidity, and the negative credit-rating outlooks against operating cash generation.
- Follow environmental rulemaking, coal-plant retirement and remediation costs, and unresolved legal or regulatory proceedings for changes to estimated obligations or recoverability.