Pinnacle West Capital Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; filed November 3, 2016. Pinnacle West is a holding company whose results are generated essentially entirely by regulated Arizona Public Service Company (APS), an electric utility. Figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions where appropriate.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Operating revenue | $1,166.9m | $1,199.1m | $2,759.5m | $2,761.0m |
| Operating income | $451.3m | $445.1m | $733.2m | $744.8m |
| Net income attributable to common shareholders | $263.0m | $257.1m | $388.8m | $396.1m |
| Diluted EPS | $2.35 | $2.30 | $3.47 | $3.55 |
| Operating margin (operating income / revenue) | 38.7% | 37.1% | 26.6% | 27.0% |
- Q3 revenue declined 2.7% year over year, while common-shareholder net income rose 2.3%. Management attributed the approximately $6m earnings increase mainly to lower operations and maintenance (O&M) costs and higher lost-fixed-cost recovery, partly offset by milder weather.
- Nine-month revenue was essentially flat; common-shareholder net income fell 1.9%. O&M rose $56.7m, including higher employee-benefit, transmission and distribution, customer-service, and planned fossil-plant outage costs. Higher retail transmission revenue, customer growth, and lost-fixed-cost recovery partly offset the increase.
- Fuel and purchased-power expense declined year over year in both periods. Nine-month operating income decreased 1.6%; diluted EPS declined from $3.55 to $3.47. Dividends declared were $1.25 per share for the first nine months, versus $1.19 in 2015.
Cash flow, debt, and liquidity
- For the first nine months, Pinnacle West generated $765.1m of operating cash flow, versus $821.4m a year earlier. Capital expenditures were $1,014.9m, up from $778.7m; investing cash use was $1,010.5m. Financing provided $254.2m, and cash ended at $48.3m.
- At September 30, Pinnacle West reported $4,279.5m of short-term borrowings, current maturities, and long-term debt, compared with $3,820.0m at December 31, 2015. APS reported $4,120.5m on the same basis. These are overlapping consolidated and subsidiary figures, not amounts to add together.
- Pinnacle West had $117.3m of short-term borrowings, including $34m under a new 364-day facility; it had no borrowings under its $200m revolving facility. APS had $83m of commercial paper outstanding and no borrowings under its $1bn revolving facilities. The companies reported covenant debt-to-capitalization ratios of approximately 48% and 47%, respectively; APS also met its 40% minimum common-equity-ratio requirement.
- APS operating cash flow was $766.3m, versus $832.0m; capital expenditures were $992.7m. APS cash declined to $8.0m from $22.1m at year-end. Management said capital needs would be funded with operating cash and external financing as needed and described borrowing capacity as ample.
- APS issued $350m of 3.75% senior notes due 2046 and $250m of 2.55% notes due 2026, while repaying $250m of 6.25% notes at maturity and redeeming certain pollution-control bonds.
Outlook, regulatory matters, and risks
- Management estimated APS customer growth of 2.0%–3.0% annually and weather-adjusted retail electricity sales growth of 0.5%–1.5% annually for 2016–2018. These are estimates, not earnings guidance. The filing cites potential annual net-income sensitivity of up to $10m from typical economic or weather variations, with extreme weather historically causing larger swings.
- Estimated APS capital expenditures were $1.233bn in 2016, $1.337bn in 2017, and $1.124bn in 2018, excluding certain 4CA Four Corners expenditures. Bonus depreciation was expected to provide $375m–$425m of cash-tax benefits over three years.
- APS’s June 2016 rate-case application seeks a $165.9m annual base-rate increase, with a requested effective date of July 1, 2017. The application estimates average annual bill increases of 5.74% overall and 7.96% for a typical residential customer. The outcome is uncertain; hearings were scheduled to begin in March 2017.
- FERC denied recovery of a $12m regulatory asset related to the Four Corners transmission agreement; APS recorded a write-off in Q2 and requested rehearing. The filing also describes a challenge to the ACC’s Four Corners rate adjustment, and an environmental lawsuit concerning federal approvals for continued Four Corners operations.
- Environmental obligations could require significant spending. APS estimated its share of Four Corners pollution controls at about $400m, Navajo Plant upgrades at up to $200m, and CCR compliance at about $15m for Four Corners and $5m–$40m for Cholla, plus about $1m for Navajo. Clean Power Plan requirements were stayed pending judicial review; eventual compliance costs remain uncertain and could be material under some outcomes.
- Other notable matters include Peabody Energy’s bankruptcy-related claim against APS and PacifiCorp for substantial, unspecified damages; a U.S. Attorney grand jury investigation seeking election-related records; and subpoenas issued by an Arizona Corporation Commissioner concerning company expenditures. The company says it cannot predict the outcomes of these matters.
- APS began participating in the California ISO Energy Imbalance Market on October 1, 2016 and expected potential fuel-cost and operating benefits. On October 20, the Pinnacle West board declared a $0.655-per-share dividend, raising the indicated annual rate from $2.50 to $2.62.
Most important facts for investors to verify
- Progress and final terms of APS’s rate case, including approved revenue recovery and customer rate design.
- Actual capital spending, funding needs, and debt growth relative to the three-year investment plan.
- Cost recovery and timing for Four Corners, Ocotillo, coal-plant environmental work, and other regulatory assets.
- Developments in the Peabody claim, U.S. Attorney investigation, and commissioner subpoenas, including any quantified financial exposure.
- Whether earnings trends improve as higher O&M costs, weather variability, and customer growth affect results.