Pinnacle West Capital Q4 2021 Earnings Call Transcript

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February 25, 2022

Key Takeaways

  • Rate case outcome in Arizona imposed a lower return on equity and led the company to file appeals, creating near-term regulatory uncertainty.
  • Pinnacle West served over 1.3 million customers, achieving 2.2% retail customer growth and 4.2% weather-normalized sales growth in 2021 driven by residential and commercial demand.
  • Operational reliability was best-in-class with a 94.4% equivalent availability factor for non-nuclear units (only nine startup misses in 5,226 starts) and improved J.D. Power satisfaction scores to top quartiles.
  • Advancing its clean energy transition, the company procured nearly 1,400 MW of renewables toward its goal of 100% carbon-free generation by 2050 and earned EPA A-scores in climate and water security.
  • For 2022, EPS guidance was reset to $3.90–$4.10 (vs. $5.47 in 2021) due to rate case headwinds, inflationary pressures, and ongoing cost management, with all three rating agencies on negative outlook.
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Earnings Conference Call
Pinnacle West Capital Q4 2021
00:00 / 00:00

There are 10 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Pinnacle West Capital Corporation 2021 4th Quarter Earnings Conference Call. At this time, all participants have been placed on a listen only mode and the floor will be opened for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Amanda Ho, Director of IR. Ma'am, the floor is yours. Thank you, Kate.

Speaker 1

I would like to thank everyone for participating in this conference call and webcast to review our Q4 and full year 2021 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Gollner and our CFO, Ted Geisler Barbara Lockwood, Senior Vice President, Public Policy and Jacob Tetlow, Executive Vice President, Operations 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 Actual results may differ materially from expectations.

Speaker 1

Our annual 2021 Form 10 ks was filed this morning. Please refer to that document for forward looking statements, cautionary language as well as the Risk Factors and MD and 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 March 4, 2022. I will now turn the call over to Jeff.

Speaker 2

Great. Thank you, Amanda, and thanks all for joining us today. And looking back on 2021, there are certainly a number of Challenges and setbacks, but also positive accomplishments and successes. Without question, the biggest setback of 2021 was the rate case outcome. Coming out of the rate case, we laid out a comprehensive plan on the 3rd quarter earnings call and we've already begun making progress towards that plan and I'll briefly discuss that.

Speaker 2

I'll also provide an operations update and share some notable successes from our employees in 2021, and then Ted will discuss our 2021 earnings and our forward looking financial expectations. I know we're all tired of talking about the last rate case and how disappointing that outcome was. As you know, the rate case decision makes everything that we're committed to doing more challenging and more costly for a time. Importantly, it's also cast our state in a negative light when it comes to our regulatory environment and our efforts are focused on ways in which the company can support During our Q3 earnings call, we spoke of management actions that we planned on taking, which included the possibility of filing That's not something that we took lightly and I'd emphasize I don't, we don't take pleasure in litigating with the commission. Our number one goal is doing what's right for the people and Prosperity of Arizona, which includes working collaboratively with the commission and building a more constructive relationship.

Speaker 2

However, in this case, we really had no other choice. And in December, we filed a notice of appeal with the Arizona Court of Appeals in parallel with a special action With the Arizona Supreme Court. Although there were 7 other amicus briefs, these are Friends of the Court's briefs filed in support of our special action filing. On February 8, the Supreme Court declined to take jurisdiction of the case. This was not particularly surprising since the We don't know what the final resolution of that case will be.

Speaker 2

However, we look forward to the opportunity to share with the court our arguments and the reasons why we believe Turning to the operations side, although 2021 was extremely challenging, it was not without successes. And I want to start by recognizing our field team's exceptional execution in 2021. We reliably Served our over 1,300,000 customers through the hottest June on record followed by the 3rd wettest monsoon season. Our non nuclear fleet recorded an impressive reliability performance with a summertime equivalent availability factor or EAF of 94.4%. I just want to call out another data point on that non nuclear fleets performance out of 5,226 starts last year, there were only 9 misses.

Speaker 2

And that startup reliability is Impressive and it's important in our participation in the energy and balanced market and in our actions in the broader market in the West and also benefits our customers. Recognizing that creating customer value is inextricably linked to increasing shareholder value, we remain focused on improving the customer experience. Although there's still much work to be done, we're not where we want to be yet. We're making positive progress. Thanks to the hard work of our employees, Our 4th quarter J.

Speaker 2

D. Power overall residential customer satisfaction score jumped 1 quartile compared to the year prior Among large investor owned utilities in the U. S, we had year over year improvements in several key areas that are important to our customers, Including power quality and reliability, billing and payment and customer call center performance. In fact, our customer ratings Put us in the top decile nationally for Perfect Power and the 2nd quartile nationally for our telephone customer care. APS was also named a 2021 Business Customer Champion by Escalent, which recognized the company as one of the top performing electric utilities in the nation for business customer scores and brand trust, product experience, service satisfaction and customer effort.

Speaker 2

In addition, we continue to make progress on the ESG front. On January 22, we celebrated 2 years since announcing our goal to reach 100 percent clean carbon free energy by 2,050. Over the past 2 years, we've procured nearly 1400 megawatts of clean energy resources. These substantial investments are not only vital to our Transition away from coal and into a clean energy future, but there are essential resources designed to help us keep pace with Arizona's tremendous growth At the same time, the capacity markets are tightening across the entire West. And finally, I want to highlight 3 awards We received in 2021 that recognize our commitment in the ESG space.

Speaker 2

First, APS was honored with by the EPA with the Energy for leadership in corporate sustainability with A- scores for both climate change and water security. That's significant because Pinnacle West is one of only 2 North American Electric Utility Companies to achieve leadership scores in these areas. Finally, the 2021 Inclusive Workplace Award, a Joint recognition from the Diversity Leadership Alliance and the Arizona Society Human Resources Management acknowledging our efforts to create a diverse and inclusive environment for our employees. I'm extremely proud of the progress that our company continues to make And engagement, enhancing our regulatory relationships and continued execution of our clean energy commitment. I want to once again recognize the near term headwinds that were created by the unfavorable rate case outcome and how challenging it will make 2022.

Speaker 2

But we believe in our ability to provide long term value to both customers and shareholders. We look forward to executing our plan and Our proven cost management efforts all against the backdrop of Arizona's incredible economic expansion. So again, thank you all for joining us today and I'll turn the call over to Ted.

Speaker 3

Thank you, Jeff, and thanks again everyone for joining us today. This morning, we reported our Q4 and full year financial results for 2021 and updated our outlook for 2022. As you can see, 2021 was better than anticipated, primarily due to stronger sales growth in the 4th quarter. While 2021 resulted in a solid year, this does not mitigate our outlook for 2022 and the reality that we remain in a financial reset as a result of the recent rate case outcome. Before I review the details of our full year 2021 results, I'll briefly discuss some key factors from the 4th quarter, which are shown on Slide 4.

Speaker 3

Our performance was strong in the 4th quarter as we earned $0.24 per share compared to a loss of $0.17 per share in the Q4 of 2020. Keep in mind, we had 2 unique items in 2020 that did not repeat last year, our settlement with the Arizona Attorney General's Office and the company funded portion of the Kohl community transition payment. Both were booked in the Q4 of 2020, resulting in a year over year benefit. Mild weather was a factor again this quarter, but was largely offset by higher sales and usage, which came in well above prior expectations, largely due to strong residential growth and the continued expansion of our commercial customer segment. Turning now to our full year results for 2021.

Speaker 3

We earned $5.47 per share compared to $4.87 per share in 2020. Looking at Slide 5, I'll review some key factors of these results. In gross margin, weather was unfavorable by $0.76 compared to the prior period. As you may recall, 2020 had the hottest summer on record, whereas weather in 2021 was slightly below normal. Continued strong sales and usage was a $0.51 benefit.

Speaker 3

The 2021 guidance established on our Q3 call assumed weather normalized sales growth of 3.5%. However, We experienced a much stronger 4th quarter than anticipated with weather normalized sales growth of 6.7%, resulting in full year weather normalized sales growth of 4.2%. Our year over year retail customer growth ended strong at 2.2%. For 2021, employment in Metro Phoenix increased 4% compared to a national average of 2.8%. In November, Arizona also achieved an important milestone.

Speaker 3

Employment recovered to pre pandemic levels, a milestone reached by only 3 other states. In addition, Arizona was once again the 3rd fastest growing state in the U. S. Last year. As a result of this robust population growth, Maricopa County Residential Housing Permits had their strongest year since 2005, finishing with just over 43,000 permits.

Speaker 3

We are investing heavily to support this level of growth, which is beneficial to our customers and the entire state. However, we must be able to receive constructive regulatory recovery in a timely manner to continue to support this level of growth. Now turning to our 2022 outlook. As we shared last quarter, we reset our financial targets has now come from the recent rate case decision. The majority of what we shared last quarter has not materially changed, but I will discuss a few updates, which result in a slight increase to our 2022 guidance range, now projected to be $3.90 to $4.10 per share.

Speaker 3

We have updated Slide 6 to illustrate 2021 full year results of $5.47 per share compared to the midpoint of our new 2022 guidance range. In addition to increased sales, we plan to continue our track record of disciplined cost management to reduce O and M in 2022. However, we are not immune to inflationary pressures and recognize this will be more challenging than in years past. As you can see, we are still targeting a meaningful reduction in cost Compared to 2021 as we remain laser focused on cost management through our Lean Sigma initiatives. Just as we shared in the 3rd quarter, We continue to anticipate strong customer and sales growth in the range of 1.5% to 2.5% for 2022.

Speaker 3

While the total range has not changed, Given the stronger growth in the 4th quarter, we have revised our residential growth projections higher, which is partially offset by slower growth in our commercial and industrial segments due to expansion delays. Sales growth through 2024 remains the same as we guided last quarter, 3.5% to 4.5%, and we remain confident in the long term developments in our service territory. Finally, we've also updated our interest expense net of AFUDC to reflect higher interest rates and updated timing of debt issuances. The remaining aspects of our financial outlook remain consistent with our guidance provided last quarter, and we are committed to executing our plan through this reset period. We continue to benefit from a solid balance sheet Despite recent downgrades by all 3 rating agencies after the rate case decision.

Speaker 3

That said, we do remain on negative outlooks and we'll continue to provide updates as we move through the year. Meanwhile, we're focused on building an exceptional experience for our existing customers, rapidly expanding the grid for our incoming customers and delivering long term value for our shareholders. This concludes our prepared remarks. I'll now turn the call back over to the operator for questions.

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. We do ask that if you are listening via speakerphone to please pick up your handset for optimum sound quality. Our first question today is coming from Shahriar Pourreza at Guggenheim Partners. Your line is live.

Operator

You may begin.

Speaker 4

Hey, good morning guys.

Speaker 3

Hey, Shar. Good morning, Shar.

Speaker 5

So just a couple of quick ones here. Jeff, clearly, you've got healthy customer growth and load growth that's Kind of even stronger than that, which is great. I guess the concern here with us is with some of the disallowances Related to generation expenses in the last case, it seems like a possibility exists for all this pace of growth to actually be a bad thing if you're underfunded as we think about Integrating and servicing all this incremental demand safely. Can we just maybe get your thoughts here as we think about the upcoming rate case In light of the stronger than expected backdrop you're presenting today?

Speaker 2

Yes. Shar, that's a I mean, it's a great question because it really highlights, I think that the disconnect that we've got to work on between now and filing an x-ray case and then prosecuting that case Of the challenges you just identified, which is we're in one of the highest growth, if not the highest growth service territory in the country, which means that we're spending more capital, we're investing more than we've ever done in the history of the company. And yet in the last rate case, We received the lowest return on equity of basically any utility in the country and those 2 just don't they don't gel together. I mean That's the disconnect that we have to work with our regulators to help make sure that they understand that the challenges we have, the need to access capital markets, The need to maintain positive credit ratings is critical for us to be able to meet this growth. And with the Tightening capacity markets in the West as we invest in new technologies, again, you can look at that risk profile as you just suggested and say that suggests The need for a higher return on equity than if it was just pipes and poles and wires.

Speaker 2

And so that environment that we're in, which is driving significant capital investment by us and need to access those financial markets requires that regulatory support And at least a healthy return on equity and cost recovery structure because we've got to be able to recover the cost of those investments and not turn that growth into a negative. So I think that's a good observation.

Speaker 3

Yes. Shahriar, this is Ted. I'll just add to that That we fully recognize that the sales growth customer growth is tremendous in our service territory. We've said that for a long time and the fundamentals are coming through as predicted. We also recognize that, that growth is only as good as our ability to recover the costs and investments needed to support that growth.

Speaker 3

And so that's certainly a key focus for us as we Look forward to continue to work with stakeholders and our regulators. Rates are lower today. The average bill is lower today than it was in the 2017 outcome of that last rate case. So We think we've got the ability to be able to recover these costs and still focus on affordability for our customers.

Speaker 5

Got it. And then, lastly is, I mean, obviously, we've noticed a few pieces of legislation in the state, which seem to be focused on Improving the construct in various ways like maybe enhanced oversight, and dealing sort of with the ACC, which is obviously a welcome surprise for some of us, right? How are you thinking about the legislature's increased interest and Maybe activity around establishing more effective rate making and any specific bills we should be monitoring at this point?

Speaker 2

Yes. Shar, I think you know that there's been some tension between the commission and the legislature for a while and it's important to Remember in Arizona, the commission's authority over rate making is a constitutional authority. So there's not a lot that the legislature As I said, our focus is really on ensuring that we have the dialogue with the stakeholders and with the commission To ensure that the connection between the growth that we're seeing and the need to access the financial markets to support the investment To drive that growth and continue to grow Arizona that we can make that connection and that we can improve the regulatory structure. We've had good examples post test year plan. There's been other mechanisms the commission has adopted that have supported Recovery of investments outside of a purely historical test year rate case.

Speaker 2

And so our focus is really on engaging with the stakeholders of the commission and the commission and the staff to make sure that we're explaining the need that we have And frankly, the challenges that we have going forward.

Speaker 5

Terrific. Thank you guys so much. Appreciate it.

Speaker 2

Yes. Thanks, Shar. Thanks, Shar.

Operator

Thank you. Our next question today is coming from Insoo Kim at Goldman Sachs. Your line is live. You may begin.

Speaker 6

Yes. Thank you. First question, when we think about the unchanged CapEx over the next few years in your plan, obviously, I think There's some level of conservatism there. As we think about this welcome low growth, especially on the residential side, any color on Just on the base level of capital that's needed to service this increasing customer growth, around what level that could potentially layer on going forward?

Speaker 3

Yes. And Sue, good question. And yes, you're right. That's relatively conservative because we put a lot of effort into Prioritizing the projects and investments needed to both maintain reliability in the grid and keep up with customer expansion. And as our customer growth continues to exceed our expectations that puts even more pressure on the capital budget.

Speaker 3

We've got it set at those levels because we are Very focused on trying to maintain affordability for customers and target a reasonable level of future rate increases, Certainly levels that as we said before are at or below inflation. But as customer growth Continues to be robust, that's more and more challenging. So we're still focused on trying to balance The capital budget with affordability, but we'll just continue to monitor that as the service territory expands And as we continue to procure the resources needed to serve that growth in the future.

Speaker 6

Okay. Leave it there. I guess the second question, Jeff, I guess a few months have passed now and You've made it a point to try to engage with various stakeholders as you prepare for this next rate case. Just Some color on how those discussions, if they have happened so far, how they've been and what are some of the key items and focus items that people How are you working on?

Speaker 2

Yes. Insoo, I think it's been constructive and so we have been able to engage and frankly It's been good since we've been ex parte essentially the entire time I've been CEO. And so coming out of ex parte is Important. And again, the conversations are around the discussion we had here on the phone, the importance of The regulatory construct that we have in Arizona given the growth and the transition that's happening around the West in decarbonization. There's also been, I think, good discussions about the current Western market.

Speaker 2

And as you know, we're very tight right now in the West. There's not a lot of excess capacity, and we're going to have challenges moving forward across this entire region of dealing with both the growth, but then also the transition putting significant amounts of battery storage in. And so a lot of this has been just making sure that our point of view on the changes that are happening in the system, the opportunities to expand Western markets, And again, the need to be able to invest to meet the growth is all well understood by all the stakeholders that we work with and by the commission.

Speaker 6

Got it. So we'll see how that translates going forward. Thank you very much. Have a good weekend.

Speaker 4

Yes. Thanks, Insoo.

Operator

Thank you. Our next question today is coming from Paul Patterson at Glenrock Associates. Your line is live. You may begin.

Speaker 4

Hey, good morning guys.

Speaker 2

Hey, Paul.

Speaker 7

Just on the rate case appeal, Are there any key dates we should be looking out for? And in terms of answers questions, in terms of your discussions what have you, Is there any sort of focus on how I guess, how does the timing associated with the new rate case Interact on your expectations for the rate case appeal outcome if you follow me. I mean, are people sort of saying, hey, we want to see how that goes or Is that a gating issue in any way the rate case appeal and the outcome there?

Speaker 2

Yes. No, Paul, I don't think it's a gating issue. In terms of the timeline That happens we do have more clarity now in the sense that there's not a special action. The special action would have had a Quicker clock on it than the Court of Appeals action. The Court of Appeals appeal, if you look at kind of other cases, typically is a year or more.

Speaker 2

The next milestone in that Court of Appeals case is April 11th, and that's when opening briefs are due. And then I think 40 days after that you see responding briefs to it and they're talking about interveners right now. And so that case is going to continue to progress. And so as we file mid year This year, those 2 will overlap certainly, but they're not neither is gating to the other.

Speaker 7

Okay. But we'll probably get a decision It would sound if I'm understanding correctly. On the appeal, we'll probably get a decision before we get to, I don't know, an ALJ or something maybe, or is that the way to maybe think of it or at least in terms of the final outcome on

Speaker 2

Yes, Paul, it's possible. I mean that again, a lot of it depends on the timing. You got 2 different timing variables there. So it's difficult to say How they're going to exactly interface, but if the Court of Appeals came back with a ruling, most likely that's going Be a remand to the commission anyway if the rate case is pending then there's a potential that you could pick that up in the then pending rate case. And so a lot of it's just going to be fluid as both those cases progress.

Speaker 7

Okay. And any sense maybe when oral arguments I assume there's an oral argument situation where the judges ask Would they interact with the litigants? Do we have any sense when that might possibly happen?

Speaker 2

No, I don't we really don't. That's certainly in the case. Okay. And again, we'll keep people posted as the case progresses.

Speaker 7

Okay, awesome. Thanks so much. I really appreciate it.

Speaker 2

Okay. Yes. Thanks, Paul.

Operator

Thank you. Our next question today is coming from Anthony Cardell at Mizuho Group. Your line is live. You may begin.

Speaker 8

Hopefully, 2 easy questions. Just one more housekeeping. In the rate filing that you're planning, I guess, later this year, will you be able to recover the Operating costs associated with the SCRs that were denied from the last rate case, I understand that they limited the return on Investment, but you pick up the are you able to file for the recovery of the operating costs associated with

Speaker 3

Well, Anthony, this is Ted. We don't get into details of the rate case strategy at this time, but we'll be sure to go through those details once we file a case.

Speaker 8

Great. And then lastly, you talked about demand growth in one of the slides you talked about 3.5% to 4.5% growth through 2024. Just curious, we're all looking for as much detail as possible. Just Do you think the build out of the C and I segment slows down post 2024? Or is it a case of just large numbers as the growth just keeps getting bigger and bigger?

Speaker 8

It's harder to stay up On that 3.5% to 4.5% number.

Speaker 3

Yes, fair question, Anthony. It's difficult to I don't predict any more granular than that range beyond 2024. But I will say, if you look at the fundamentals of our service territory For a long period of time in history, we've traditionally always had higher growth compared to Really, most other service territories and the fundamentals that we're seeing right now in our service territories suggest that you're going to continue to have long term Robust growth, whether it be the jobs that are created, the diversification within the economy here, wasn't that long ago we were heavily dependent on Purely construction and tourism, as of right now, manufacturing jobs are actually outpacing construction jobs within the state. So we've got a lot of good trends that suggest to long term growth that could support that level or maybe even higher. But at this point, we're focused on That 3.5% to 4.5% between 2022 and 2024 and we feel confident in that range because we can point to projects

Operator

Thank you. Our next question today is coming from David Peters at Wolfe Research. Your line is live. You may begin.

Speaker 9

Yes. Hey, good afternoon.

Speaker 4

Hey, David.

Speaker 9

Just related to the renewable procurement efforts, You have decent chunks of CapEx for CleanGen each year in your plan. I'm just curious, have you seen any supply chain related issues? Just an update on schedules there would be great. And I guess to the extent that you do have any delays, it sounds like you have enough on your plate to backfill. Anything that might slip, but just wanted

Speaker 7

to double check.

Speaker 3

Yes. Good question, David. We are experiencing delays in certain areas, Whether it be materials or some of the projects that we have procured, we don't believe any are causing any significant impact, But it's really an impact on timing adjusting from 1 month to another within the same year. We don't anticipate any impact on the capital program.

Speaker 9

Great. And then just specific back to the discussions you've had with stakeholders, ahead of the next rate case. I'm just curious if you've had a chance To talk more about the merits of a concurrent recovery mechanism for renewables, just given the aspirations you have in the state, Just curious if you've had any traction on that specifically?

Speaker 2

Yes, that's David, that's certainly part of the conversations that we're having. Again, we're early in that, but that's one of the key areas of focus for us.

Speaker 9

Okay. Thank you.

Speaker 4

Good. Thank you. Thanks, David.

Operator

Thank you. We have no further questions in the queue at this time. This concludes today's event. You may now disconnect and have a wonderful day. We thank you for your participation.

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