Pinnacle West Capital Q1 2024 Earnings Call Transcript

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Provided by Quartr
May 2, 2024

There are 7 speakers on the call.

Operator

Good morning, everyone, and welcome to the Pinnacle West Capital Corporation 20 24 First Quarter Earnings Conference Call. At this time, all participants have been placed on a listen only mode, and we will open the floor for your questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Amanda Ho. Ma'am, the floor is yours.

Speaker 1

Thank you, Matthew. Would like to thank everyone for participating in this conference call and webcast to review our Q1 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Goldner and our CFO, Andrew Cooper. Ted Geissler, APF President and Jacob Tetlow, EVP of Operations are also here with us. First, I need to cover a few details with you.

Speaker 1

The slides that we will be using are available on our Investor Relations website along with our earnings release and related information. Today's comments and our slides contain forward looking statements based on current expectations and actual results may differ materially from expectations. Our Q1 2024 Form 10 Q was filed this morning. Please refer to that document for forward looking statements, cautionary language as well as Risk Factors and MD and A section, which identify risks and uncertainties that could cause actual results to differ materially from those contained in our disclosures. A replay of this call will be available shortly on our website for the next 30 days.

Speaker 1

It will also be available by telephone through May 9, 2024. I will now turn the call over to Jeff.

Speaker 2

Thanks, Amanda, and thank you all for joining us today. 2024 started off in line with the financial guidance that we provided on the Q4 call in February. And before Andrew discusses the details of our Q1 results, I'll provide a few updates on our recent operational and on regulatory developments. With the temperatures in Arizona quickly heating up, we're focused on executing our robust summer preparedness program with the resource adequacy continuing to be extremely important as energy demands increase and energy supplies in the Southwest tighten. To serve our customers with top tier reliability, we work year round on operational preparedness, resource planning, procuring sufficient reserve margins, creating customer partnerships to manage peak demand and maintaining a comprehensive fire mitigation program.

Speaker 2

In fact, as we head into the wildfire season, the company is taking further action to protect our customers and our communities from the risk of wildfires. Our comprehensive fire mitigation strategy includes 3 key categories to ensure defense in-depth. First, we have a robust vegetation management program, including creating defensible space around poles and infrastructure and strong coordination with forest management officials around the state. 2nd, we deploy technology that's targeted at managing wildfire risk and that includes weather stations, cameras, remote control sectionalizing devices and advanced risk modeling software. And third, we apply several risk informed operating protocols such as specific requirements for how our crews work safely in fire prone areas, in addition to new protocols such as power safety public safety power shutoffs or PSPSs.

Speaker 2

While PSPS is a new protocol for our program, we've been working on this implementation following last summer and we've partnered with local communities, first responders and state officials to ensure that our customers are informed and know what to expect. We've had community workshops and we've invested a lot in customer and to safeguard the communities that we serve while continuing to learn from operating experience developed throughout our industry. Turning to our operational preparedness, it's extremely important that our generation units are ready for the summer. We're in the final stages of our planned maintenance activities for our thermal units ahead of the summer period to ensure our system is ready to serve. In addition, Palo Verde's Unit 3 is currently in a planned refueling outage that began on April 6th and it's on schedule to return to service in early May.

Speaker 2

Upon the successful completion of the latest refueling outage, all three units are poised to provide around the clock clean energy to help meet the demands of the summer for the entire desert Southwest. I'm also proud to say that we're starting this year, with J. D. Power Residential Customer Satisfaction Survey Scores that place APS within the 1st quartile for overall satisfaction when compared to its large investor owned peers. APS made gains in every category including power quality and reliability, price, corporate citizenship, billing and payment, communications and customer care both digital and phone in the Q1.

Speaker 2

Results like this take the dedication and the commitment of all employees across the company and we look forward to continuing to make improvements for our customers and providing a more frictionless experience. Turning to regulatory, we've successfully implemented the rate case outcome on March 8 for our customers. The commission recently voted to hold a narrow rehearing on our rate cases limited to the grid access charge. That charge is a rate design issue where the commission had increased the revenue allocation to distributed generation solar customers to better align their rates with cost of service. The commission intends, I think, to further examine whether the grid access charge is just and reasonable and will be participating in those proceedings.

Speaker 2

Additionally, the Commission has turned its focus to the regulatory lag docket. The first workshop was held on March 19th with multiple stakeholders presenting a variety of options on how to holistically address regulatory lag and interested parties have been invited to file written comments into the docket and the commission has voiced their intent of having further workshops that will be noticed in the future. We look forward to continuing to work with the commission and with other stakeholders on addressing regulatory lag in Arizona. Although 2024 is off to a solid start, we know we have much to do still and we look forward to continue to execute on our priorities throughout the year. And with that, I'll turn the call over to Andrew.

Speaker 3

Thank you, Jeff, and thanks again to everyone for joining us today. This morning, we reported our Q1 2024 financial results. I will review those results and provide additional details on weather, sales and guidance. In the Q1 of 2024, we achieved earnings of $0.15 per share compared to a loss of $0.03 per share in the Q1 of 2023. This improvement was driven by several key factors: the sale of Bright Canyon Energy, the implementation of new rates on March 8, along with increases in adjuster revenues, and finally, robust customer and sales growth.

Speaker 3

These positive impacts were partially offset by milder year over year weather and increases in interest expense, depreciation and amortization and O and M. The Bright Canyon Energy transaction provided a one time benefit of $0.15 per share this quarter. This follows the initial phase of the sale completed in the Q3 of last year. In addition, as Jeff mentioned, we successfully implemented new rates for our customers in March and are seeing a benefit from these new revenues. Turning to weather, although conditions in the 1st 3 months of this year were normal, we experienced a drag of $0.07 per share year over year.

Speaker 3

This drag can be attributed to the exceptionally cold start in 2023, which was one of the coldest in the Phoenix metro area since 1979 and to March 2023 being the coldest March in over 3 decades. Customer growth for the quarter came in as expected at 1.8% and consistent with our guidance range of 1.5% to 2.5%. Our weather normalized sales growth came in at 5.9% for the quarter, driven by robust C and I growth. Because Q1 is historically a smaller quarter for the company, we are still expecting our weather normalized sales growth to come in within our existing guidance range of 2% to 4% for the year. Arizona's economy remains a diverse growth and investments hub.

Speaker 3

A prime example of this vibrant economic activity is Taiwan Semiconductor, which recently announced a $25,000,000,000 increase to their previously announced $40,000,000,000 investments in Arizona for a total of $65,000,000,000 TSMC announced plans to build a 3rd facility by the end of the decade and the facilities are now expected to employ more than 6,000 workers of which TSMC has already hired over 2,000. In addition, there continues to be sustained interest for additional data center and manufacturing development within our service territory. Although these developments are outside of our current 3 year sales growth guidance, they represent significant long term opportunities for earnings growth and the potential for enhanced cost efficiency for all our customers. Residential growth in our region has been consistently strong. Maricopa County was recognized by the U.

Speaker 3

S. Census Bureau as the 4th largest growing county in the nation in 2023 welcoming over 30,000 new residents. This ongoing influx of residents underscores the need for continuous investment in our infrastructure to ensure reliable service for all our customers. Our current capital expenditure and financing plans are designed to meet these expanding demands effectively. O and M was a slight drag compared to Q1 2023.

Speaker 3

The effect was less than expected, primarily due to delays in procuring essential materials needed for planned maintenance work at our power plants. These delays are expected to shift the timing of certain costs from 1st to 2nd quarter. Despite ongoing inflationary pressures and the costs associated with supporting our expanding customer base, we remain committed to our 2024 O and M guidance, which is a year over year reduction in core expense. Interest expense was higher this quarter compared to the Q1 of last year, driven by increased interest rates and higher debt balances, and we continue to monitor the actions of the Federal Reserve. In addition, our depreciation and amortization expense is higher as 1 of 2 large planned information technology projects went into service this quarter.

Speaker 3

These projects are extremely important to make sure we have updated systems and the tools necessary to reliably serve our customers. Due to the shorter depreciation schedule for IT projects, we expect these expenses to create meaningful drag throughout the year and have already accounted for them in our annual guidance. After the constructive rate case outcome, we successfully completed our planned equity offering of about $750,000,000 of common stock in a forward sale. We will determine the most opportune time to settle the forward sale agreements and invest the funds into the utility to maintain a healthy and sustainable capital structure. In addition, the rating agencies have completed their reviews of our ratings and importantly, all three rating agencies have resolved our outlook from negative to stable.

Speaker 3

Moody's and Fitch downgraded Pinnacle West ratings by 1 notch with Moody's downgrading APS ratings 1 notch as well and we are now similarly rated by all three agencies. We continue to focus on reducing regulatory lag and sustaining our targeted cash flow metrics with adequate cushion to maintain solid investment grade credit ratings for the benefit of our customers. Finally, we are reaffirming all other guidance provided on the Q4 call and look forward to continuing to execute our strategy and reliably serving our customers as we head into the upcoming summer season. This concludes our prepared remarks. I will now turn the call back over to the operator for questions.

Operator

Certainly. Everyone at this time will be conducting a question and answer session. Your line is live.

Speaker 4

Hi, good morning team. This is Faye for Nick today. And thank you for taking my questions. Sure. Good morning, Nick.

Speaker 4

So first, I guess on rate case timing, as we have more time to digest the latest rate case outcome back in February, since the last quarterly update. Can you maybe discuss, some of your latest thoughts on SRB capital deployment and how should it possibly accelerate in the coming years deeper in the plan?

Speaker 3

Sure, Faye. Thanks for the question. Yes, so we continue to work through our competitive RFP process and that's really the basis for us putting projects through the SRB. We had a 1,000 Megawatt RFP in 2023 and we're negotiating projects that are coming out of that right now. And so there's a healthy pipeline of projects really across a diverse set of fuels, renewable and gas as well that we're looking at that would qualify.

Speaker 3

Our Q4 deck included some illustrative projects that we expect could meet the criteria for the SRB and we feel good about those projects being part of the plan certainly at least some of them. And our CapEx for the next 3 years that you see does include some probability weighted capital on the generation side related to those projects. Ultimately, the RFPs will determine the results, but the projects that we laid out at Q4 represent potentially up to 40 plus percent of the megawatts that we need to procure based on our IRP over the next few years. So there's a really substantial opportunity there. Of course, our number one goal is reliability and cost for customers.

Speaker 3

But ultimately, between this RFP and future RFPs, and there will be future RFPs given the substantial need to meet customer growth demands over the next few years, We're confident that there'll be opportunities for us to participate. And then of course with the SRB, the opportunity to substantially reduce the lag on beginning to recover on those investments becomes much shorter. So opportunities ahead, as we have projects that come forward, we will certainly update you on the status of them.

Speaker 4

Great. Thanks, Andrew, for all the colors. That's really helpful. And maybe I can just turn to financing a little bit. As you've done the equity deal and remove this financing overhang post the constructive rate outcome, can you just maybe discuss as we evolve from the last quarter, your latest thinking on the remaining Pinnacle capital of $400,000,000 with ATM and hybrid extra disposal.

Speaker 4

Has any thinking on this change since the equity deal also given all the S and P positive revision on the credit outlook, how does that affect your thinking and confidence in the debt and hybrid market? Thanks.

Speaker 3

Sure, Fay. So as I mentioned earlier, we're really pleased to be able to execute on the foundational discrete block equity that we needed to ensure that we're maintaining a balanced healthy capital structure down at the utility. And so as

Speaker 2

we go through and you've got kind of

Speaker 3

the 3 year capital financing plan in front of you, as we go through the out years of that plan, given the capital needs that we have today and ensuring a balanced capital structure down at the utility, There is, as you pointed out, an unidentified external financing need of an incremental $400,000,000 from the parent. Over the next couple of years, we'll continue to monitor the different markets available to us to meet that need. The base case tends to be something like an ATM because that matches up well to deploying capital and then investing the proceeds into the utility. And so that would sort of be where we would start. But what's motivating us most of all is maintaining a balanced capital structure down to utility as we look at the capital plan over the next few years, Being judicious about the amount of parent company debt and to your point, there are securities sort of in between debt and common that we will continue to look at as potential opportunities as well.

Speaker 3

We were really pleased to see all of the ratings be returned to stable across all three agencies. The agencies feel comfortable with the amount of holding company debt that we do have, but we do want to continue to be judicious about it and make sure that we're managing to the right cash flow metrics so that we stay in that target range of 14% to 16% FFO to debt.

Speaker 4

No, that's great. Thanks for all the colors here. I'll leave it here. Appreciate it.

Speaker 2

Thanks, Matt.

Operator

Thank you. Your next question is coming from Shahriar Pourreza from Guggenheim Partners. Your line is live.

Speaker 2

Hi, guys. It's Jameson Ward on for Shar. How are you? Hey, good, Jameson. How are you?

Speaker 2

Doing well. Thanks. Thanks for taking our questions. Just got a couple for you here. First, on sales growth, you're obviously fortunate to have a fairly diverse mix of industries driving your long term retail sales growth forecast.

Speaker 2

Could you remind us how much of the large C and I load that you're currently seeing is from data centers like in 2024? And then whether you're expecting the level of contribution to your annual load growth from data centers to increase between now and 2026 and then as well through the rest of the decade?

Speaker 3

Sure, James. It's Andrew. I'll start. So in the near term, that 5.9% sales growth that we saw for the quarter, we felt really pleased with and it did represent fundamentally a lot of the large high low factor C and I customers. And it was a mix of the ramp up of the Taiwan Semiconductor ecosystem of them and their suppliers and downstream vendors, as well as the ramp up of some of the existing data center customers that we've had come online over the last couple of years.

Speaker 3

In the near term, because Thomas Semiconductor is such a large component of our sales growth and as you said, the diverse set of industrial and manufacturing customers that we're having come in. Their ramp really continues throughout this year until they reach full production next year. And then the their downstream folks and their upstream supply chain kind of in parallel. So in the latter part of our forecast, there is a lot more from the manufacturing side. In the near term, it's a little bit more data centers.

Speaker 3

And you have to remember that for us, data centers have been customers that we've been dealing with for a very long time. Phoenix market has been a big data center market for a while. So we're comfortable with the ramps of these customers, the capacity that they're asking for in the near term. It's really that longer term 25 when TSMC's first phase goes full production and then into the out years of the plan when Fab 2 and Fab 3 go full production, where some of that manufacturing growth really takes over the plan. If you look at our IRP over the decade, it's roughly half and half from advanced manufacturing and data centers.

Speaker 3

And it's probably a good way to think about it. There's certainly more demand out there on both sides than it's represented in that IRP. But ultimately in terms of the customers we could serve on the pace of infrastructure build out. That's roughly the balance.

Speaker 2

That's perfect. Very clear and appreciated. Thank you for that. And then second, on the regulatory leg docket, which of course you guys already touched on. So following the March workshop, which I'm sure a lot of us tuned into and noting the yet to be scheduled additional workshops, which you already mentioned, could you give us your high level sense of where the proceeding currently stands in terms of the timeline overall until we could see an alternative rate making approach being adopted by the commission and actually available for you to use in rate cases?

Speaker 2

And also, are there any expected key milestones we should be watching for? And that's

Speaker 3

it for

Speaker 4

you. Yes.

Speaker 2

Jamieson, this is Jeff. I think the next one to watch for is the June open meeting is likely where they're going to have further discussion. I think there was some thought it might go on the May open meeting. I think it's more likely now on the June meeting. That will be important because I think that's where you'll see the commissioners discuss the process going forward and potentially give some more color on the timeline.

Speaker 2

I do think there's an interest. I mean, I think it was constructive in the conversation just in terms of what they were talking about because it was not only around the potential for a forward test year, which is kind of intuitively what a lot of people think about as the an example of a rate structure or a construct that can address regulatory lag, but also more into other concepts like formula rates, which is what we use at FERC, obviously, and additional conversation from experts who have worked with these kind of programs. And so the content seems to be moving in the right direction. The schedule is being developed. I do think there's a desire to continue to move this forward promptly.

Speaker 2

And so the one of the things we'll be watching for is how the process unfolds. I know at some point they'll have a conversation on whether there's rulemaking or policy statement. If you think back to our decoupling workshops years ago, that ended up in a policy statement as opposed to a rule. And so then the policy statement just goes out and then the utilities can implement that when they file rate cases. So we'll be watching for all that.

Speaker 2

I expect you'll see a little bit more probably in the next quarter, but the next key milestone is likely that June open meeting to watch where they talk through process. Thank you very much, Jeff. Much appreciated.

Operator

Thank you. Your next

Speaker 5

Going back to the financing plan, you sized the $400,000,000 of additional equity at 40% of incremental CapEx. Just wondering any incremental spending beyond that going forward, how would you expect to finance that in terms of portion of equity?

Speaker 3

Sure. And going back, Michael, it's Andrew. Certainly, there will be opportunities to look at our capital plan over the next few years. And as we see, for example, what projects come out of our RFPs on the generation side and the pace of execution of our strategic transmission plan, we'll continue to revisit that CapEx forecast. And fundamentally, I think some of the drivers I talked about earlier will determine how we fund that, right?

Speaker 3

We want to make sure that we're staying in the right spot from our cash flow metrics perspective. And there's a numerator question there as well on the debt where we want to make sure that we're reducing regulatory lag through the mechanisms Jeff just talked about to help support those credit metrics. But again, making sure we're being judicious about parent company debt. And so that 40% of incremental CapEx, that paired with retained earnings is the way we would ensure that we maintain that plus whatever incremental modest Pinnacle asset we could take on is the way that we would maintain a balanced capital structure at the utility going forward. So it's probably a good rule of thumb to think about.

Speaker 3

We haven't updated the CapEx plan or the financing plan. So until we do so and look at all the markets available to us, that's everything from all of the debt markets that are available to parents, some of the low cost financing options we've talked in the past in our slides about continuing to look at things like, for example, the DOE lending program and where we can access low cost financing for our customers. But foundationally, I think some modest amounts of equity to make sure that we're keeping a balanced capital structure over time is going to be one of the ways to do it. And we'll continue both for the that $400,000,000 needed, any incremental need to it, continue to look at all those markets.

Speaker 5

Great. Thank you. And then secondly from me, going back to the regulatory lag, your EPS guidance forecast through 'twenty six presumably isn't accounting for any changes in the regulatory docket in terms of test years or formula rates. Just wondering if there's anything you could share about the earned ROE on the ACC rate base that you are assuming in guidance this year and then over the course of 2025 and 2026, presumably it will be somewhat lumpy?

Speaker 3

Yes. And I think one of the things that we're trying to solve for through the regulatory initiatives is that lumpiness and trying to find a way to create a smoother, more predictable stream. We believe we've got substantial customer rate headroom to be able to make the investments we need to make over time. But when we're dependent on step function kind of rate relief to recover on them, that's really the challenge we're trying to address. We've talked pretty openly about the regulatory lag that we're seeing given the historical test year construct that we're living under and the test year in the rate case that we just concluded and put rates into effect in March, those costs go back to the middle of 2021 before inflation was really starting to pick up and we're starting to see an increase in interest rates as well.

Speaker 3

And so we are in that period right now where there is that drift around our ability to earn close to our actual ROE. While we haven't disclosed a specific number, as we go through time and look at costs that go back to 2021, 2022, that definitely increases. We feel very positive about the impact that the SRB can have on creating smoothness and reducing lag. If you look back to what we said in Q4 about the types of projects, there's RFPs nearly yearly at this point and opportunities for us to put forward cost competitive projects that we're building ourselves. And so between generation and transmission, 30%, 40% of our capital it will now have trackers and give us much smoother, more predictable recovery.

Speaker 3

So it really comes down to those operating costs, the income statement costs, O and M depreciation, etcetera. And then, any of the distribution capital that's not picked up by sales growth that we need to focus on. And that's really the focus of these regulatory initiatives, be it the regulatory lag docket or the timing of our next rate case. And those are really the 2 levers we have besides our continued focus on cost management. Our customer affordability initiatives, our lean operating culture are really the other lever that we have within our control.

Speaker 3

And I think we've demonstrated a pretty strong track record there and we plan for 2024 to reduce our core O and M expense by a couple of percent over the last year even as we still face substantial inflation for goods and services.

Speaker 5

Great. Thanks. And then a quick final one for me. Regarding rooftop solar installations, are you expecting a continued decline in them to trickle down into residential sales growth and then the LFCR mechanism? And just wondering if you have an earnings sensitivity there?

Speaker 2

Not really an earnings sensitivity. I mean, you're watching, obviously, as we continue to work on the structure that Arizona has adopted with the resource comparison proxy processes that steps down, you tend to see a little bit of And then you see you get a better sense of kind of where they level off. So I think we've got the information in the deck. You want to share with Andrew?

Speaker 3

Yes. Yes. No, I would just say that if you look at our sales growth even for the quarter, we continue to see that 1.5% to 2.5% customer growth. A lot of it is offset by just the continued secular trend around energy efficiency and some distributed generation adoption. And we baked that into the plan.

Speaker 3

We expect fairly modest out of that customer growth, expect fairly modest residential sales growth. And certainly, as we continue to monitor the trends around DG, continue to monitor trends around electric vehicles, etcetera, We'll be able to refine that. But effectively, we had that post COVID work from home period where we had a short window of an increase in residential sales growth, substantial increases that were really just a break in what has been a secular trend those residential declines. And ultimately, it goes back to the diversification of our economy and the traction of more residential customers to service territory, where we'll continue to see in our forecast, some modest increases in residential sales and how much DG offsets that is something that we'll just have to continue to monitor.

Speaker 5

Great. Thanks for taking my question.

Operator

Thank you. Your next question is coming from Alex Mortimer from Mizuho. Your line is live.

Speaker 3

Hi, good morning team. Good morning, Alex.

Speaker 6

So industry wide, we're seeing load growth. It seems skew more C and I, obviously, as well in your service territory.

Speaker 2

Do you expect cost of service

Speaker 6

to become a larger point of contention in future regulatory proceedings? And has Arizona taken any steps to address this?

Speaker 2

That's certainly been a topic conversation with the regulators and it is a I think it is something that there's a lot more attention being paid to. One of the things to recognize, if you have the cost of service done right, when you get a higher load factor customer, which is typically a C and I customer, the margin on those customers tends to be lower because you get closer to the actual cost of service, but the fixed costs, the spread of fixed costs and the recovery of fixed costs can actually help the system. And so you just got to be careful that you reflect that in the cost of service in a way that it is appropriately recognizing that. And so in a general concept, the high load factor customers can make the system operate more efficiently. And then you just got to be very careful in how you watch the cost of service.

Speaker 2

So the incremental cost incurred to serve those customers gets allocated appropriately to the cost causers to the customers that are coming on the system. So yes, I think you're going to see more attention paid to cost of service just to make sure that we've got the balance right.

Speaker 6

Understood. Thanks for that. And then just quickly, can you touch on any conversations you've had with either regulators or other stakeholders, either at the national or state level, just surrounding the wildfire issue? And are there any specific goals with these conversations as we see the entire industry and certainly the western part of the country try to work towards a solution?

Speaker 2

Yes. There's extensive conversations that go on in a number of different fronts. And it's not just in the Western U. S. We've seen fire situations coming really all over the country.

Speaker 2

And so these conversations you see, for example, in the some of the wildfire task force groups, you see a lot more Eastern utilities that are participating in what used to just be a conversation among the Western utilities. There's a significant amount of technical work that's being done at EPRI to work through some of the technical solutions on wildfire. There's a significant amount of sharing. I'll call out PG and E, they are remarkably constructive in terms of helping to share work that they're doing. And that's really true for all the utilities in the West.

Speaker 2

And so the California folks have obviously been in the front tip of the spear for this. They're very open about sharing those lessons and what's working for them and what technology solutions are available there. So it's certainly not there's certainly a robust conversation that's happening really at all levels. Regulators are I think very constructive workshops here in Arizona with our regulators and then most importantly with customers, particularly as you start looking at the PSPS type programs, you want to be as far in front of that as you can with customers so that they understand what's going and can take measures to prepare for that. And then there's also conversations happening on the insurance side to try to figure out how do you get better insurance.

Speaker 2

Is there a role for the federal government to play in that? And so I'd say there are a lot of work streams that are all aligning on trying to support the wildfire work that we're all doing.

Speaker 6

Wonderful. Thanks so much and congrats on the great quarter.

Speaker 2

Thanks Alex. Yes. Thanks Alex.

Operator

Thank you. That completes our Q and A session. Everyone, this concludes today's event. You may disconnect at this time and have a wonderful day. Thank you for your participation.

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