Pinnacle West Capital Corporation — Q3 2017 Form 10-Q
Business context and period. The filing covers the quarter and nine months ended September 30, 2017. Pinnacle West is a holding company whose principal business is regulated electric utility Arizona Public Service Company (APS), serving most of Arizona. Financial statements are unaudited; amounts below are U.S. dollars.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Pinnacle West operating revenue | $1.183 billion | $1.167 billion | $2.806 billion | $2.759 billion |
| Operating income | $466 million | $451 million | $844 million | $733 million |
| Net income attributable to common shareholders | $276 million | $263 million | $467 million | $389 million |
| Diluted EPS | $2.46 | $2.35 | $4.16 | $3.47 |
| Operating cash flow | Not stated for the quarter | $772 million | $765 million | |
| Capital expenditures | Not stated for the quarter | $1.028 billion | $1.015 billion |
Liquidity and debt. At September 30, consolidated cash was $10.7 million. Short-term borrowings were $131.4 million and long-term debt, including current maturities, totaled approximately $4.698 billion. APS separately reported $31.8 million of commercial paper outstanding, no borrowings under its $1 billion revolving facilities, and approximately $4.573 billion of long-term debt including current maturities. Management described borrowing capacity as ample. APS’s regulatory common-equity ratio was 52%, above its 40% minimum; debt-to-capitalization covenant ratios were 49% for Pinnacle West and 47% for APS, below the 65% limit.
Cash flow and investment. Nine-month operating cash flow slightly exceeded the prior year, while investing cash use rose to $1.040 billion, primarily from higher capital expenditures. Cash from operations did not cover investment spending; financing provided $270 million. Estimated APS capital expenditures are $1.337 billion for 2017, $1.181 billion for 2018, and $1.009 billion for 2019.
Changes versus comparable periods
- Nine-month Pinnacle West common-shareholder income increased $78 million. Management attributed the improvement primarily to higher revenue, including the new retail rate settlement, customer growth and transmission revenue, plus lower operations and maintenance costs; higher depreciation, taxes and interest partly offset gains.
- Q3 common-shareholder income rose $13 million year over year. Higher revenue from the rate settlement and transmission was partly offset by higher depreciation and operating costs.
- Nine-month fuel and purchased-power expense fell to $777 million from $832 million; operations and maintenance declined to $658 million from $703 million. Depreciation and amortization increased to $387 million from $363 million, and interest expense increased to $147 million from $140 million.
- The September 30 cash balance remained low, while receivables and regulatory assets increased from year-end 2016. Capital spending continued to exceed operating cash flow.
Outlook, commentary and risks
- Rates and regulation: The ACC approved APS’s settlement on August 15, with new rates effective August 19, 2017. It provides a net annual base-rate increase of $94.6 million, a 10.0% authorized return on equity, and an estimated average annual customer bill increase of 3.28%. An appeal concerning rate schedules for certain new residential customers remained pending; APS did not expect a material impact. The settlement also provides mechanisms for certain tax, environmental and project-cost adjustments.
- Demand outlook: APS reported weather-adjusted retail sales up 0.1% for the first nine months and customer growth of 1.7%. Management projected 2017 customer growth of 1.5%–2.5% and weather-adjusted sales growth of 0%–1.0%; projections are sensitive to weather, economic activity, conservation and distributed generation.
- Generation and environmental exposure: Management considered it probable the Navajo Generating Station would cease operations in December 2019. APS had reclassified its $102 million remaining investment as a regulatory asset and intends to seek recovery, but a disallowance could adversely affect earnings, cash flow and financial position. Cholla Unit 2’s $109 million net book value and related retirement costs were subject to rate recovery under the settlement. Four Corners pollution controls were estimated to cost APS approximately $400 million for its 63% share.
- Contingencies: APS faced arbitration over an alleged Four Corners coal-purchase shortfall of approximately $30 million for the buyer group, including about $17 million attributable to APS; management did not expect a material financial impact. A separate dispute involved approximately $26 million potentially payable to 4CA by NTEC, including $10 million due at year-end. Environmental compliance and remediation costs, nuclear liabilities, and the outcome of regulatory and legal proceedings remain uncertain.
- Financing and dividends: APS issued $250 million of 4.35% senior notes due 2045 and $300 million of 2.95% senior notes due 2027 during 2017. After quarter-end, Pinnacle West declared a $0.695-per-share dividend payable December 1, 2017, increasing the indicated annual rate to $2.78. Management noted expected cash tax benefits from bonus depreciation of approximately $350–$400 million over three years.
- Other risks: Key exposures include weather and electricity demand, fuel and purchased-power prices, plant reliability, timely recovery of costs in rates, environmental rules, nuclear operations, capital-market access, counterparty credit, and investment performance of pension and decommissioning assets. EPA had proposed repeal of the Clean Power Plan; the regulatory outcome was uncertain.
Investor verification priorities
- Track implementation and any appeal of the 2017 APS rate settlement, including actual revenue and customer impacts.
- Assess the Navajo Plant’s expected 2019 closure, remaining investment recovery, and retirement obligations.
- Compare planned capital expenditures with operating cash generation, borrowing needs and dividend commitments.
- Monitor Four Corners coal-supply arbitration and the collection of amounts due to 4CA.
- Review environmental compliance requirements and potential cost recovery, especially at Four Corners and coal ash facilities.