TXNM ENERGY INC quarterly report, Q2 FY2014

Business context and reporting period

PNM Resources, Inc. (PNMR; identified in the filing as the parent of PNM and Texas-New Mexico Power Company, or TNMP) filed this unaudited combined Form 10-Q for the quarter and six months ended June 30, 2014. The two regulated electric utilities serve approximately 749,000 customers and end-users in New Mexico and Texas. Results are seasonal and interim results are not necessarily indicative of the full year.

Financial performance and position

Amounts below are in millions of dollars except per-share data; comparisons are with 2013.

PNMR’s operating margin (operating income divided by revenue) was approximately 20.6% in Q2 and 17.8% for the first half, versus 22.4% and 19.3%, respectively, in 2013. For the six months, operating cash flow was $123.8 million, down from $159.9 million; investing cash outflow was $151.1 million, and financing cash inflow was $36.9 million. Cash at June 30 was $12.1 million.

At June 30, PNMR reported short-term debt of $105.0 million, current long-term debt of $158.1 million, and long-term debt of $1,717.2 million. Current assets were $446.8 million and current liabilities $486.9 million. Total equity was $1,772.8 million. The filing reported $771.8 million of consolidated revolving-facility availability at July 25, 2014, including facility availability after letters of credit and borrowings.

Material changes versus the prior comparable period

• PNMR’s first-half revenue increased $9.8 million, but operating income fell $8.5 million. Higher operating costs and depreciation more than offset revenue growth.
• PNMR-attributable earnings and EPS rose in both periods despite lower operating income. Management cited lower 2013 tax-related charges, including state tax-credit impairments and a New Mexico tax-rate change, as well as other segment movements. First-half 2014 earnings also included a $1.3 million PNM tax expense related to an IRS settlement, partly offset at the parent level.
• PNM’s first-half operating income declined $14.4 million and segment earnings declined $9.6 million. Lower weather-normalized retail load, milder weather, higher costs, and unfavorable mark-to-market hedge comparisons weighed on results.
• TNMP’s first-half segment earnings increased $4.2 million, supported by transmission-rate increases, customer growth, and lower operating expenses. Revenue increases also included pass-through third-party transmission costs, which did not increase margin.
• First-half operating cash flow declined primarily because tax refunds were $92.9 million lower than in 2013; lower pension and OPEB contributions and nonrecurrence of certain customer refunds partly offset the decline.

Outlook, management commentary, risks, and unusual items

• Management projected total 2014–2018 capital requirements of $2.57 billion, including construction expenditures and dividends, and anticipated a need for additional long-term financing through debt refinancing, new debt, and/or equity. It believed operating cash generation, credit arrangements, and capital-market access would be sufficient, while noting market-access risks.
• PNMR’s stated long-term dividend payout target is 50%–60% of ongoing earnings; management expected above-average dividend growth in the near term. Ongoing earnings is a non-GAAP measure.
• The central regulatory and capital uncertainty is the proposed San Juan Generating Station (SJGS) plan: retire Units 2 and 3 by the end of 2017, install SNCR controls on Units 1 and 4, and develop replacement resources. EPA’s final action on the revised state plan was expected around September 2014; NMPRC action was then sought by February 2015. The plan and ownership restructuring remained subject to regulatory approvals and definitive agreements.
• If the revised SJGS plan fails, the existing federal implementation plan calls for SCR controls on all four units by September 2016. PNM estimated those controls could cost $824–$910 million for the station, compared with its estimated share of approximately $82 million for the proposed SNCR and related controls on Units 1 and 4. Failure to meet compliance requirements could disrupt plant operations and require replacement power; cost recovery and timing are uncertain.
• PNM’s planned SJGS replacement resources included a 177 MW gas-fired source and 40 MW of solar, with estimated costs of approximately $268.3 million. A non-binding ownership proposal would have PNM acquire an additional 132 MW in Unit 4 without an initial purchase cost, but with higher future capital and operating-cost shares.
• PNM closed its purchase of the Delta generating facility on July 17, 2014, after quarter-end, paying $22.8 million and retiring $14.6 million of project debt. PNM also intended to purchase 50% of the Valencia plant, but price and other conditions remained unresolved; completion was uncertain.
• Other exposures include pending environmental regulation and litigation, coal-supply and mine-reclamation costs, drought and water availability, nuclear spent-fuel disposal, commodity and counterparty risks, and potential pension-cost increases. The filing states known lawsuits, environmental costs, and commitments were not expected to materially affect financial condition, results, or cash flows, but outcomes may differ and some losses cannot be estimated.
• PNM reported lower weather-normalized retail load, while TNMP reported growth. PNM’s Gallup wholesale power contract ended June 29, 2014 after Gallup selected another supplier, removing a recurring customer relationship.

Important facts for investors to verify

• Whether EPA and the NMPRC approve the revised SJGS plan, and whether SJGS participants complete binding ownership and cost-sharing agreements.
• Final SJGS and Four Corners compliance requirements, total project costs, replacement-power costs, and the extent and timing of recovery from customers.
• PNM’s ability to sustain earnings amid lower New Mexico load and the loss of the Gallup contract, and TNMP’s ability to maintain rate-driven growth.
• Funding needs and debt maturities, including $158.1 million of long-term debt classified as current at June 30, 2014, and reliance on future capital-market access.
• Resolution of the Valencia purchase conditions and the financial effects of the post-quarter Delta acquisition.
• Potential effects of environmental, water, fuel, pension, and legal contingencies that management says remain uncertain.