Pinnacle West Capital Corporation (NYSE:PNW) Q2 2023 Earnings Call Transcript

Pinnacle West Capital Corporation (NYSE:PNW) Q2 2023 Earnings Call Transcript August 3, 2023

Pinnacle West Capital Corporation misses on earnings expectations. Reported EPS is $0.94 EPS, expectations were $1.19.

Operator: Good day, everyone, and welcome to the Pinnacle West Capital Corporation 2023 Second Quarter Earnings Conference Call. At this time all participants have been placed on a listen-only mode. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Amanda Ho. Ma’am, the floor is yours.

Amanda Ho: Thank you, Matthew. I would like to thank everyone for participating in this conference call and webcast to review our second quarter 2023 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Guldner; and our CFO, Andrew Cooper. Ted Geisler, APS’ President; and Jacob Tetlow, Executive Vice President of Operations; and Jose Esparza, Senior Vice President, Public Policy, are also here with us. First, I need to cover a few details with you. 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 second quarter 2023 Form 10-Q was filed this morning. Please refer to that document for forward-looking statements, cautionary language as well as the risk factors and MD&A sections 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. It will also be available by telephone through August 10, 2023. I will now turn the call over to Jeff.

Jeff Guldner: Great. Thanks, Amanda. Thank you all for joining us today. Although our second quarter financials were negatively impacted by significantly mild weather in June, as well as higher operating expenses, we have updated our full year 2023 guidance to take into account the settlement that was reached between APS and the commission on the SCR matter. Before Andrew goes through the details of our second quarter results and updates to our 2023 full year guidance, I’ll just provide a few updates on recent operational and regulatory developments. Starting with operations. As we progress through the summer season, I’m very proud to say that our team continues to excel in delivering reliable service to our customers. The Palo Verde Generating Station successfully completed its planned refueling and maintenance outage for Unit 1 on May 13.

Additionally, we commissioned the remaining 60 megawatts of energy storage at our AZ Sun sites. So that totals now 201 megawatts of APS-owned storage installed this year and 150 megawatts of APS-owned solar at the Agave Solar facility. These are all valuable resources to help serve our customers through the summer season. In fact, while the second quarter was marked by extremely mild weather, as I think all of you probably know, July certainly heated up. Our robust planning, resource procurement efforts and our dedicated team have allowed us to provide exceptional service to our customers throughout this unprecedented heat wave. Phoenix experienced a record number of consecutive days of over 110 degrees, shattering prior records for daytime highs for evening lows for days over 110 degrees, and the APS team served its customers with top-tier reliability throughout it all.

In fact, we broke our previous peak demand record multiple times this July, reaching a new all-time record on July 20 at nearly 8,200 megawatts. That’s a 500-megawatt increase compared to our prior record that was set in 2020. I want to recognize our operators and our field teams for doing such an exceptional job in making sure that customers continue to have reliable service through this unrelenting heat. As you know, APS plans years in advance to continue serving customers with reliable and affordable energy, our resource planners secure a diverse energy mix to meet demand like solar and wind power, battery energy storage and our APS operated Palo Verde Generating Station, which is still the largest nuclear plant in the U.S. and the country’s largest producer of clean energy.

When temperatures caused demand to increase, APS’ strength and resilience comes from using flexible resources like natural gas to keep homes and businesses cool over long stretches of extreme heat. Another important tool that I want to highlight and that we utilize is our Cool Rewards demand response program. It’s in its fifth year of operation. That program essentially operates as a virtual power plant where our customers provide over 110 megawatts of flexible clean capacity. The program connects nearly 80,000 APS customers with smart thermostat technology that helps them save money while also playing an integral role in conserving energy when the demand on the electric grid is its highest. This partnership helps us to ensure reliable, uninterrupted service to our customers on the hottest Arizona days, while also assisting us on our journey to 100% clean in carbon-free electricity by 2050.

So you can see we’ve taken all of the above approach to provide the most affordable and reliable service when our customers need us the most. And as part of our vigorous planning, we recently issued an all-source RFP for another 1,000 megawatts to be online between 2026 and 2028. We’re seeking the best combination of resources to serve our customers reliable – reliably while not sacrificing affordability and continuing to build towards our clean energy future. Additionally, we continue to remain focused on providing exceptional customer service. Our J.D. Power, JDP residential rankings for overall customer satisfaction have steadily improved over the past two years. And I’m proud to share that the latest JDP residential 2023 second quarter results have placed us back in the first quartile compared to our peers.

APS is the strongest performing drivers in the latest survey where customer care, both phone and digital power quality and reliability and corporate citizenship. We’ve made remarkable progress over the past few years moving from fourth quartile to first and that progress would not have happened without the dedication and commitment of our hard-working employees across the company. I look forward to continuing to provide exemplary service to our customers in the future. Turning to our regulatory updates. Last quarter, I spoke about the appeal of our last rate case and the favorable Court of Appeals decision. The commission directed its legal staff to enter into negotiations with the company. And in June, we reached an agreement with the commission legal staff on how to implement that decision.

The joint resolution was then approved at the June open meeting, and it created a court resolution surcharge that started on July 1. We’re pleased that we were able to reach an agreement with the commission in a reasonable and expeditious manner to resolve this issue. And as I’ve mentioned previously, the Four Corners Power Plant is a critically important reliability asset for the entire Southwest. And the investment in SCRs was required to keep that plant running under federal law. Andrew will address the financial impacts from this decision here in a few minutes. On our rate case, we are almost done with all rounds of written testimony. Our rejoinder testimony is due tomorrow. The hearing is scheduled to begin on August 10. And we look forward to working through that process and resolving this rate case in a timely and constructive manner.

We made solid progress through the first half of this year, improving our customer experience, enhancing our stakeholder relationships and executing on our regulatory matters. There is certainly more work to do, but I think this is a good opportunity to acknowledge the team’s dedication and early accomplishments here in 2023. And with that, I’ll turn the call over to Andrew.

Andrew Cooper: Thank you, Jeff, and thanks again to everyone for joining us today. This morning, we released our second quarter 2023 financial results. I will first review those results, which were negatively impacted by extremely mild weather and provide some additional details on the various drivers for the quarter. I will also provide an update to full year 2023 guidance. We earned $0.94 per share this quarter, down $0.51 compared to the second quarter last year. Weather, specifically during the month of June, was the primary driver for the lower year-over-year results. June of 2023 was the mildest since 2009 with an average daily temperature slightly below 90 degrees. This resulted in a $0.25 year-over-year drag from weather compared to Q2 last year, which was – which notably included an above average contribution from June 2022’s hot weather.

Higher O&M, interest expense and depreciation and amortization and lower pension and OPEB non-service credits were other negative drivers, partially offset by higher transmission revenues and LFCR revenues. O&M was $0.21 higher year-over-year or $0.14, excluding RES and DSM. We have experienced year-over-year increases to most of our O&M categories due to inflation and high customer growth. We have seen inflationary impacts in areas, including chemicals, materials, insurance and wage rates. Of the $0.14 Q2 headwind, O&M associated with our generation fleet constitutes $0.10. And for the first half of the year, generation fleet O&M has been a $0.21 drag. Prioritizing the needs of our generation fleet to ensure reliability for customers has been essential to our summer preparedness strategy.

The importance of this prioritization was as clear as ever as our team successfully ran our fleet during the month of July. In addition, as Jeff mentioned, July weather was record-breaking. And similar to past years, the weather benefits have allowed us to flex up to derisk future spending. Based on the O&M trends we are seeing, we are increasing our O&M guidance range for 2023 to $915 million to $935 million. Importantly, even with this update, we anticipate our O&M per megawatt hour to be flat to last year, and we maintain our goal of declining O&M per megawatt hour into the future. We continue to look for opportunities to create efficiencies, reduce risk and keep our costs low to maintain affordable rates for our customers. Turning now to customer growth, we continue to be in line with expectations.

Customer growth remains at 2% for the second quarter. The fundamentals for customer growth remains strong in our service territory, and Arizona continues to be a popular migration destination. Redfin.com noted in May that Phoenix Lebination in housing markets its users were most interested in moving into. The cost of living in Arizona and the Phoenix Metro area still compare favorably to many Western markets. So, we continue to project steady population growth and corresponding APS customer growth largely driven by net migration. However, weather normalized sales growth for the quarter was 0.1% compared to last year. Although we continue to see steady C&I sales growth, which came in at 2.2% for the second quarter this year versus last year.

Overall sales growth has been slower than originally anticipated. We continue to monitor our extra high load factor customers as they ramp up. And in fact, Taiwan Semiconductor recently announced a delay in the opening of their first chip factory. With the flat year-over-year sales growth in the quarter and slower ramp-up of these larger customers, we are revising our sales growth guidance range to 2% to 4% for 2023. Because sales from these larger customers contribute a lower margin, the change to our sales growth guidance has a disproportionately smaller impact to earnings expectations. Over the longer term, we continue to forecast a strong contribution to sales growth from advanced manufacturing and other large customers though the variable remains the speed of their ramp-up.

Turning to our 2023 guidance for EPS, with the approval by the commission of the joint resolution of the 2019 rate case appeal, on July 1, we began collecting a corresponding surcharge with an annualized impact of approximately $52.5 million. This surcharge includes both a prospective and historical portion and is collected through a per kilowatt hour charge. Taking all financial drivers into account, including this additional revenue, July temperatures but normalized weather thereafter, anticipated lower sales growth and the higher O&M trends mentioned earlier, we now expect our new EPS guidance range to be $4.10 to $4.30 per share for the year. We look forward to continuing to execute on our strategy and on the next phases of our pending rate case process.

This concludes our prepared remarks. I will now turn the call back over to the operator for questions.

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Q&A Session

Operator: Certainly. [Operator Instructions] Your first question is coming from Julien Dumoulin-Smith from Bank of America. Your line is live.

Dariusz Lozny: Hey guys, good morning. This is Dariuzs on for Julian. Thank you for taking the question. Just wanted to start off on the rate case if I could. Staff obviously came out with a recent round of testimony and specifically, the generation rider that you’ve proposed and revised during the course of the rate case. Just wondering if you could comment on staff views there. And in the event that, that rider isn’t ultimately supported by the commission in this rate case outcome, how that might affect your procurement/capital strategy going forward?

Jeff Guldner: Yes, hi Dariusz. This is Jeff. Let me start with kind of the context of the rider. It came up in the Tucson Electric rate case ultimately didn’t make it into the administrative law judges’ recommendation. That case is going to open meeting here pretty quickly. We have filed it and we’re going to continue to advocate for it because we think it’s an appropriate way of addressing regulatory lag. And you can see with just the growth that we’re seeing, the need for that additional generation and need to have that balance between not just PPAs, but some that we can more directly control and really control the deployment of that capital. That as well as the ability to find a mechanism that we can flow through the production tax credits is going to be important.

So we think there is good reasons to continue to advocate for it. I think what you’re seeing that is still modestly encouraging is that there is an interest from staff in understanding the value and the concept. And so that’s really what the hearing process, I think, is going to give us an opportunity to do is to advocate and explain why this makes sense in the context of where we are. And I’d be more concerned if it was pretty just a flat no, we’re not interested. And I think you can see from the testimony from the dialogue in the Tucson case that there is an interest in understanding it. We’re not quite there yet, and I hope that we’ll have an opportunity at hearing to really explain why we see significant value moving forward with this and not just coming back in which is your other alternative is you come right back in another rate case pretty quickly if there’s not a way to address this kind of – the regulatory lag that comes from getting those plants into service, but not into rates efficiently.

Andrew, you want to talk maybe on the capital?

Andrew Cooper: Sure, Dariusz, it’s Andrew. To date, going back to the last rate case, we’ve been reluctant to bring forward our projects that have been cost competitive with the market because of the question around recovery. And the SRB, as Jeff talked about, really would be an important tool to help us think about taking what’s been less than maybe 20% of the megawatts that we’ve been procuring over the last couple of years and increase that number. Ultimately, we’re going to make the investments that we need to make for reliability. And the two projects that are in our post-test year plant that relate to our generation fleet, Jeff talked about, those were commissioned this summer, our [indiscernible] solar project as well as the batteries at our AZ Sun sites.

Those were projects that were commissioned for this summer, and those were really critical. And as some of the developers we work with have supply chain delays and some of those challenges, our ability to deliver, I think, has been highlighted through those post tester plants. So we will continue to look at ways to reduce lag and ultimately make the decisions that we need to make around capital from our perspective to make sure that we’re delivering each summer as we’ve seen these increasing peak demand numbers.

Dariusz Lozny: Great. Thank you for that detail. I appreciate that. One more, if I could. I just wanted to come back to the generation related O&M spending that Andrew highlighted in the opening remarks. Specifically, how do you see that shaping up for the back half of the year, just given the amount that you have to run the generation resources, obviously, during this extremely hot weather. Do you anticipate that there’s sort of some additional catch-up O&M, if you will, in the latter part of the year? And then related, assuming the weather normalizes in 2024 or thereafter, do you see that as an opportunity to flex down that O&M in future periods.

Andrew Cooper: Yes, Dariusz. So, taking the first part of that. So, the guidance range that we updated today incorporate anticipated O&M kind of across the year. And so we’ve seen in the first half of the year absolutely the generation fleet. And from this July, there’ll certainly be continued needs. And so we’ve anticipated those. And frankly, have in part used the benefit of July weather to look at the rest of the year and think about what are the needs we have and where are the pressure points? And if weather were to continue to be a factor for the rest of the year, absolutely making sure that we could generate support the generation fleet, both Palo Verde as well as our traditional fleet. It’s definitely part of the calculus.

And so then when you think about weather for the rest of the year, post July, which we’ve incorporated at this point and has been part of strategically thinking about O&M. Every year, at the end of the summer, we look at our O&M opportunity set and risk set for the remainder of the year and into the next calendar year and think about where we could flex our muscle around pull forward derisking. And so we’ll do that to the upside and downside as the year goes on. We’re comfortable with the new O&M range that we’ve set out based on where we are, the decisions we’ve made, effectively, conversations that we normally have in October once you’ve looked at the full summer, we’re making those earlier. So, we’re comfortable with the range that we’re in.

And certainly, as we have weather, as we have continued wear and tear on our generation fleet, we’ve accommodated that within the current range.