WEC ENERGY GROUP, INC. quarterly report, Q2 FY2017

WEC Energy Group, Inc. — Q2 2017 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2017; unaudited. WEC serves approximately 1.6 million electric and 2.8 million natural gas customers and owns approximately 60% of American Transmission Company (ATC).

Financial results and position

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Operating revenue	$1,631.5 million	$1,602.0 million	$3,936.0 million	$3,796.8 million
Operating income	$362.2 million	$332.1 million	$979.5 million	$921.4 million
Net income attributable to common shareholders	$199.1 million	$181.4 million	$555.7 million	$527.6 million
Diluted EPS	$0.63	$0.57	$1.75	$1.66

For the first six months, operating margin was approximately 24.9% of revenue, versus 24.3% in 2016. The company’s electric and natural gas margin measures are non-GAAP measures.
Q2 earnings improved by $17.7 million. Key contributors were higher Illinois operating income (+$18.8 million), higher ATC equity earnings (+$10.9 million), Wisconsin operating income growth (+$8.9 million), and a lower effective tax rate. Lower other income, primarily because 2016 included a $19.6 million Wisvest sale gain, partly offset these gains.
Six-month earnings rose $28.1 million. Higher Illinois operating income (+$37.2 million) and ATC earnings (+$14.3 million) were partly offset by $36.3 million lower other income, including the absence of 2016 gains on a debt repurchase and asset sale.
Six-month operating cash flow was $1,268.0 million, compared with $1,224.1 million. Capital expenditures were $790.0 million, versus $618.7 million; investing cash outflow was $1,023.9 million. Cash ended at $36.5 million.
At June 30, total debt was $10,282.9 million and debt-to-total capitalization was 52.8% (51.5% on management’s adjusted basis). Cash was $36.5 million; short-term debt was $774.8 million. Available capacity under credit facilities was $1,683.9 million.
Current liabilities exceeded current assets by $1,007.6 million. Management said credit lines and capital-market access were adequate to support liquidity.
Common dividends were $0.52 per share for Q2; the board declared another $0.52 quarterly dividend payable September 1, 2017.

Material developments and outlook

WEC completed its $226 million acquisition of Bluewater on June 30. The Michigan gas-storage facilities are expected to provide about one-third of Wisconsin utilities’ current storage needs; $4.9 million of acquisition costs were accrued.
Management forecast 2017 capital expenditures of $2,182.2 million and estimated regulated utility capital spending of $9.5–$10.0 billion over five years, excluding ATC. It expected approximately $226 million of ATC capital contributions from 2017 through 2019.
Management expected the 2017 annual effective tax rate to be 37%–38%. The filing provides no clear consolidated earnings or EPS guidance.
Wisconsin utilities proposed freezing electric and gas base rates through 2019 under a settlement, with a final PSCW order expected in Q3 2017; rejection could lead to a traditional rate case. WEC also agreed to earnings sharing above authorized returns under the proposal.
UMERC proposed approximately 180 MW of natural-gas generation costing about $265 million ($275 million including AFUDC), subject to regulatory approvals. Commercial operation was expected in 2019 and could enable PIPP retirement by 2020.
WEC estimated $80–$110 million for wastewater-treatment and bottom-ash system work to comply with the steam-electric effluent rule; compliance deadlines were under review and some were stayed. The company said other cited air- and water-quality rules were not expected to require significant compliance costs, though some impacts remained undetermined.
In July 2017, Moody’s downgraded certain utility subsidiaries from A1 to A2 and changed the outlook on WEC Energy Group and certain affiliates from stable to negative. Management did not expect a material effect on market access.

Risks, contingencies, and unusual items

Results are seasonal and sensitive to weather, customer usage, commodity prices, outages, and operating costs. Warmer weather and lower retail use reduced Wisconsin margins; cost reductions and regulated investment helped offset the impact.
Regulatory recovery is a key risk. PGL’s QIP rider reconciliations remained pending, and the filing said recovery of all costs in open years could not be assured. Recovery of deferred ReACT costs also requires future approval.
ATC’s lower FERC-authorized return on equity is expected to reduce future equity earnings and distributions; a second ROE complaint remained unresolved.
Environmental remediation reserves for manufactured-gas-plant sites were $622.4 million, with related regulatory assets of $683.8 million. Management said regulators historically permitted recovery of incurred costs, but future costs depend on investigation, remediation, and regulatory requirements.
Other exposures include long-term purchase obligations of $12,065.4 million, environmental compliance, litigation, commodity and credit risks, and potential collateral requirements after specified credit-rating downgrades. Management believed pending ordinary-course legal matters would not materially affect results.
Unusual accounting item: adoption of share-based payment guidance resulted in a $15.7 million cumulative-effect increase to retained earnings; excess tax benefits also contributed to the lower 2017 tax rate.

Investor verification priorities

Track the PSCW decision on the proposed 2018–2019 rate freeze and earnings-sharing terms.
Review outcomes of PGL QIP reconciliations and the potential recoverability of deferred regulatory costs.
Confirm UMERC project approvals, final cost allocation, construction progress, and PIPP retirement timing.
Monitor FERC action and appeals on ATC ROE complaints and the resulting effect on WEC’s earnings and distributions.
Assess environmental compliance cost estimates, particularly the $80–$110 million wastewater and ash-handling program, and remediation reserve adequacy.
Reassess liquidity, debt costs, and financing access in light of the current-liability deficit and July 2017 Moody’s actions.