PPL Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. The filing also covers PPL Electric, LG&E and KU Energy, LG&E, and KU. PPL’s businesses are regulated electric and gas utilities in the U.K. and U.S.; its competitive generation business was spun off in June 2015.
Financial performance
Amounts below are in millions of dollars, except per-share data. Q2 compares with the three months ended June 30, 2015; year-to-date (YTD) compares the six months ended June 30.
| Metric | Q2 2016 | Q2 2015 | YTD 2016 | YTD 2015 |
|---|---|---|---|---|
| Revenue | $1,785 | $1,781 | $3,796 | $4,011 |
| Operating income | $725 | $638 | $1,548 | $1,528 |
| Continuing-operations income after tax | $483 | $250 | $964 | $802 |
| Net income (loss) | $483 | $(757) | $964 | $(110) |
| Diluted EPS from continuing operations | $0.71 | $0.37 | $1.41 | $1.19 |
| Diluted EPS, total | $0.71 | $(1.13) | $1.41 | $(0.17) |
Operating margin was approximately 40.6% in Q2 2016 versus 35.8% in Q2 2015, and 40.8% YTD versus 38.1% YTD 2015. These are calculated from reported operating income and revenue. PPL’s non-GAAP earnings from ongoing operations were $380 million in Q2, up from $329 million, and $838 million YTD, down from $848 million.
- Cash flow: YTD operating cash flow from continuing operations was $1,170 million, compared with $970 million. Capital expenditures were $1,346 million, versus $1,679 million; operating cash flow less capital expenditures was therefore negative $176 million, compared with negative $709 million. Dividends paid were $513 million.
- Debt and liquidity: At June 30, cash was $492 million, down from $836 million at year-end 2015. Balance-sheet short-term debt, current maturities, and long-term debt totaled approximately $20.0 billion, versus $20.0 billion at year-end. PPL reported $2.042 billion of unused U.S. credit-facility capacity and approximately $1.1 billion of unused U.K. facility capacity; these facilities also support commercial paper programs.
- Subsidiaries: YTD net income increased at PPL Electric ($173 million versus $136 million) and LKE ($204 million versus $177 million). LKE operating cash flow fell to $506 million from $703 million.
Material changes and drivers
- Revenue was nearly flat in Q2 but declined $215 million YTD. Lower U.K. revenue, a stronger prior-year currency comparison, and lower weather-driven volumes contributed; lower fuel and energy costs also reduced related recoveries.
- Reported net income comparisons are heavily affected by the 2015 PPL Energy Supply spinoff: 2015 included a $879 million spinoff loss and discontinued-operations losses of $1,007 million in Q2 and $912 million YTD. The 2016 continuing-operations comparison is more informative.
- Q2 2016 U.K. segment reported earnings included a $104 million after-tax unrealized foreign-currency hedge gain; the YTD amount was $128 million. Excluding special items, U.K. ongoing earnings were $241 million in Q2 (versus $243 million) and $506 million YTD (versus $579 million).
- U.S. regulated earnings benefited from higher Pennsylvania distribution rates effective January 2016 and Kentucky base-rate increases effective July 2015. Milder weather reduced YTD volumes. Higher depreciation and interest expense partly offset these gains.
Outlook, risks, and contingencies
- Management projected higher 2016 reported earnings and higher ongoing earnings than 2015, primarily due to the spinoff comparison and expected growth in Pennsylvania and Kentucky. It expected slightly lower U.K. ongoing earnings, mainly reflecting interest, depreciation, currency, and tax effects. The filing does not provide a clear numeric full-year EPS target.
- The June 23, 2016 U.K. referendum created significant uncertainty. Because WPD results are consolidated on a one-month lag, the post-referendum currency decline was not reflected in June 30 results. At the June 30 exchange rate, PPL estimated an additional $499 million translation loss in other comprehensive income. In Q3, PPL received approximately $310 million from settling 2017–2018 earnings hedges and entered new hedges; management said the settlement would not materially affect earnings.
- Environmental compliance is a major capital and regulatory exposure. Estimated coal-ash compliance projects were approximately $316 million for LG&E and $678 million for KU in the rate-case applications; related estimates elsewhere in the filing were $311 million and $661 million, respectively. An August 2016 KPSC order approved most settlement terms and set a 9.8% authorized return on equity for the projects, with recovery beginning on bills rendered from August 31, 2016. Future CCR and wastewater compliance costs could be significant, though management expects applicable costs to be recoverable through rates.
- Other material uncertainties include Clean Power Plan litigation and potential effects on Kentucky generation, an EPA notice alleging sulfuric-acid-mist violations at LG&E’s Mill Creek plant, environmental claims and permit proceedings, and the pending LG&E gas-franchise award. The filing says outcomes or potential impacts cannot be predicted for several matters.
- Management identified weather, fuel and commodity costs, operating performance and outages, rate-case outcomes and cost recovery, environmental regulation, credit and capital-market conditions, counterparty risk, and foreign-exchange movements among key risks. PPL also disclosed tax risk associated with the 2015 spinoff and the proposed Talen Energy merger.
Investor verification priorities
- Reconcile reported earnings with ongoing earnings, especially U.K. currency-hedge gains and the 2015 spinoff-related comparison.
- Track sterling exchange rates, the replacement hedges’ economics, and the effect of currency translation on U.K. assets, debt, and earnings.
- Confirm the timing, approved cost recovery, and actual spending for CCR and other environmental projects, alongside potential Clean Power Plan and wastewater requirements.
- Monitor cash generation against capital spending and dividends, debt maturities, and available committed liquidity.
- Follow the EPA notice and environmental litigation, the gas-franchise process, and whether the Talen merger could affect the tax-free treatment of the 2015 spinoff.