Earnings Call: Q3 2016

Nov 4, 2016

Good day, and welcome to the Duke Energy Third Quarter Earnings Call. Today's conference is being recorded. At this time, I would like to turn the call over to Mr. Mike Callahan. Please go ahead, sir. Thank you, Rachel. Good morning, everyone, and thank you for joining Duke Energy's Q3 2016 earnings review and business update. Leading our call today is Lynn Good, Chairman, President and CEO along with Steve Young, Executive Vice President and Chief Financial Officer. Today's discussion will include forward looking information and the use of non GAAP financial measures. Slide 2 presents the Safe Harbor statement, which accompanies our presentation materials. A reconciliation of non GAAP financial measures can be found on duke energy.com and in today's materials. Please note the appendix for today's presentation includes supplemental information and additional disclosures. As summarized on Slide 3, Lynn will cover the key milestones we reached in the quarter as we near the completion of our portfolio transition and provide a brief overview of our new business segments. She will also discuss our Q3 financial and operational highlights and provide an update on our growth initiatives. Steve will then provide an overview of our Q3 financial results and load growth trends as well as an update on regulatory activity. He will also provide insight into our expectations for 2017 before closing with our key investor considerations. With that, I'll turn the call over to Lynn. Good morning, everyone, and thank you for joining us today. We had a strong Q3 at Duke Energy, delivering very solid financial results and demonstrating significant progress in the execution of our business portfolio transition. We closed the Piedmont Natural Gas acquisition and we also announced the sale of our Latin American assets. This transition of our business portfolio strengthens our franchise of high quality, stable and growing energy infrastructure businesses. Starting on Slide 4, let me begin with our business portfolio transition. On October 3, we closed the Piedmont Natural Gas acquisition following approval by the North Carolina Utilities Commission. We're delighted to bring Piedmont's industry leading expertise into our company as we expand our natural gas platform, supporting our transition to a lower carbon future and growing investments in important natural gas infrastructure. We've worked with and admired Piedmont for many years and our post closing integration efforts are well underway. In addition, on October 10th, we announced agreements with China 3 Gorges Corporation and I2G Capital to sell our Latin American generation assets. China 3 Gorges will buy our assets in Brazil for approximately $1,200,000,000 including the assumption of debt. We expect to complete the transaction in 2 to 4 months once we receive required approvals in Brazil and China. We're making good progress. In fact, this morning, the Brazilian antitrust agency preliminarily approved the transaction without any restrictions. This begins a 15 day statutory objection period and if no objections are filed, the approval will become final. Iceweared Capital will buy our remaining assets in South and Central America and a separate transaction also valued at approximately $1,200,000,000 We expect to close this transaction within the next 3 to 5 months. The proceeds available will be used to reduce Duke Energy Holding Company debt. Steve will discuss additional implications from the transaction in a moment. Both of these announcements demonstrate our commitment to deliver more predictable growth in earnings and cash flows. I'm proud of our team for the extensive work on these transactions as well as the continued dedication of our employees at Duke Energy International who have managed the business very well throughout the process. We look forward to a timely close as we exit our Latin American generation business and we're pleased to welcome the Piedmont employees to Duke Energy. Turning to Slide 5, consistent with the transition of the portfolio, Today, we are announcing the realignment of our Financial Reporting segment structure beginning with our 4th quarter results. Prospectively, we will discuss performance for 3 primary business segments: Electric Utilities and Infrastructure, Gas Utilities and Infrastructure and Commercial Renewables. Electric Utilities and Infrastructure will be comprised of our regulated electric utilities in the Carolinas, Florida and the Midwest. This segment will also include our commercial transmission investments. As previously noted, Frank Yoho will lead our Gas Utilities and Infrastructure business, which will contain Piedmont, our local gas distribution companies in Ohio and Kentucky, and our gas pipeline investments, such as Atlantic Coast Pipeline, Sable Trail, Constitution and Piedmont's existing joint venture investments. With the realignment of our business, commercial renewables will become its own segment. Meanwhile, other will continue to include holding company interest expense and our captive insurance results. Other will also begin to include our national methanol equity investment in the 4th quarter. With of the Latin American Generation Business, the balance of the International segment will be classified as discontinued operations starting in the 4th quarter of 2016. We will continue to report the earnings of this business and adjusted earnings per share until closing. Turning to Slide 6, let me update you on our strong financial results for the quarter. We announced 3rd quarter 2016 adjusted earnings per share of $1.68 an increase of $0.21 from the prior year. We generated higher adjusted earnings with strong results at our regulated utilities due to warmer summer weather and our continued commitment to cost management and operational excellence. As a result of the strong results through the 1st 3 quarters of the year, we are trending toward the high end of our original 2016 adjusted diluted EPS guidance range of $4.50 to $4.70 per share. This excludes costs associated with Hurricane Matthew. Turning to Slide 7, we're continuing to move forward and deliver strong results on our $30,000,000,000 growth capital plan. This plan aligns with our vision to invest capital in smarter energy solutions that generate cleaner energy and modernize the grid, creating value for customers and delivering earnings and dividend growth for our shareholders. Here are a few updates. Site preparation activities are underway on our nearly $1,000,000,000 Western Carolinas modernization project, with plant construction anticipated to begin in early 2017. This project allows us to retire our Asheville coal units early, build cleaner natural gas units and install renewable energy on the site. The project is on track to be completed by late 2019. In September, we worked with the Indiana office of the Utility Consumer Council to develop a plan to modernize and upgrade the Markland Hydro Station. This multiyear effort will increase the output of the nearly 50 year old facility, producing low cost, carbon free electricity for Indiana residents for years to come. For the agreement, the approximately $150,000,000 investment in related expenses will be recovered through the recently approved renewable energy rider. Last week, we issued an RFP for 400 megawatts of renewable energy in our Duke Energy Carolina service territory. This furthers our efforts to provide renewable energy to our customers. Proposed projects must be in operation by December 31, 2018. Also in North Carolina, we recently filed for a Certificate of Public Convenience and Necessity or CPCN for our Duke University combined heat and power project. The project will consist of a natural gas fired generator that also provides steam service to the campus and lowers the university's carbon dioxide emissions by 25%. Combined heat and power projects represent an attractive energy solution that could benefit many of our universities and other large industrial customers in the years to come. Shifting to our natural gas infrastructure investments, we continue to make investments in integrity management programs within our local distribution companies and advanced construction of our pipeline projects. Let me briefly update you on Stable Trail, Atlanta Coast Pipeline and Constitution. Construction on Since our last earnings call, we received FERC Since our last earnings call, we received FERC's notice of schedule for the Atlantic Coast Pipeline. Based on this schedule, we expect to receive the final FERC certificate and begin construction in the 3rd or Q4 of 2017. This schedule moves our expected in service date to the second half of twenty nineteen. In September, the project partners announced the selection of Spring Ridge Constructors as the lead construction contractor, representing a significant milestone for the pipeline. This firm is a joint venture of forward leading U. S. Natural gas pipeline construction companies with extensive experience in similar projects. As you recall, we have now added Piedmont's 24% stake in the Constitution pipeline to our portfolio. FERC approved this project in December of 2014. However, in April of 2016, the New York Department of Environmental Conservation, DEC, refused to grant the project's water quality certificate. In response, the project filed lawsuits with the U. S. Court of Appeals for the 2nd Circuit and the U. S. District Court of Northern New York seeking to overturn DEC's action. Both of these lawsuits continue to progress with oral arguments before the U. S. Court of Appeals scheduled for November 16th, and we expect a decision in this case by mid-twenty 17. We continue to believe that the business case for this pipeline is compelling as the Northeast lacks adequate access to low cost supplies of natural gas that this pipeline provides. Before I turn it over to Steve, I'd like to highlight on Slide 8 several of our recent operational accomplishments made possible by the dedication of our employees. As many of you know, we managed through 2 major hurricanes this fall. After Hurricane Hermine hit the Southeast in early September, our team restored power quickly and safely for more than 200,000 Florida customers and 150,000 Carolinas customers. Then Hurricane Matthew, a historic storm swept through our Florida and Carolina service territories in October. The storm tragically resulted in multiple fatalities and widespread flooding, impacting many of our customers across the Carolinas. The flooding, wind and rain caused extensive damage to our energy system leaving more than 1,700,000 customers without power. Piedmont's infrastructure experienced minimal damage. In terms of customer outages, Hurricane Matthew is the 5th worst storm to hit the combined Duke Energy Carolinas, Duke Energy Progress service area with damage similar in scale to Hurricane Floyd in 1999 and Hurricane Hugo in 1989. In response, we mobilized more than 10,000 workers to rebuild the system and restore power for our customers. We continue to work with the hardest hit areas as they look to recover and rebuild. I'm extremely proud of our employees and their unwavering commitment to serving our communities. Given the magnitude of the storm, we intend to request a deferral of incremental costs and we'll ask that they be considered as part of our next base rate cases for Duke Energy Progress, where the majority of damage occurred. Our current estimate of incremental cost is approximately $200,000,000 We are still in the process of refining this preliminary cost estimate. Moving to our generation fleet results in the quarter, our fleet responded well to the hot summer weather. Our nuclear units at Catawba and Maguire set new generation records and our Edwardsport plant set a new station record for generation in the quarter. Also in the 3rd quarter, Duke Energy was named to the Dow Jones Sustainability North America Index for the 11th consecutive year. This consistent run demonstrates the effectiveness of our sustainability, economic, environmental and social efforts. This is a significant achievement earned by the entire company. In addition, we were named a Site Selection Magazine's annual list of top 10 Utilities in Economic Development for the 12th consecutive year, another example of our focus on developing our communities and growing our customer base. Through September, our economic development efforts have yielded almost $3,000,000,000 of investment in more than 10,000 jobs across our service territory. In conclusion, I'm very pleased with our progress on the transition of the portfolio and in delivering strong financial results in the quarter and building momentum for a strong finish to 2016. We are advancing our strategic capital investments and maintaining our focus on operational excellence and value to our customers. Our portfolio of businesses is well positioned to deliver strong, predictable earnings and cash flows to our investors. Now let me turn the call over to Steve. Thanks, Lynn. Today, I will walk you through the key drivers from the Q3 as well as provide updates on the current retail volume trends within our service territories and regulatory activity underway in our jurisdictions. I'll close with a look ahead to 2017 and our key investor considerations. I'll start with the quarterly results on Slide 9 and discuss our adjusted earnings per share variances compared to the prior year quarter. For more detailed information on segment variances versus last year and a reconciliation of reported results to adjusted results, please refer to the supporting materials that accompany today's press release and presentation. As a reminder, this is the last quarter for our existing segment structure. We began managing the business under new segments at the beginning of Q4 upon the completion of the Piedmont acquisition. On a reported or GAAP basis, 2016 Q3 earnings per share were 1.70 dollars compared to $1.35 last year. 3rd quarter adjusted diluted earnings per share were 1.68 dollars compared to $1.47 in the Q3 of 2015. Regulated utilities quarterly adjusted results increased by $0.34 per share quarter over quarter. This strong performance was primarily driven by warmer weather across all of our service territories, which added $0.14 We also recognized a lower effective tax rate, primarily due to prior year tax adjustments, which contributed to an $0.08 increase. Higher revenues from energy efficiency riders in the Carolinas and grid investment riders in Ohio continue to be favorable drivers of earnings, adding $0.05 to results for the quarter. Weather normal retail volumes also added 0 point 0 $4 with growth primarily in the Carolinas Florida. I'll discuss those details in a moment. Finally, our cost management efforts across the business provided a $0.02 uplift despite additional storm cost in the Q3. Our ongoing commitment to managing O and M costs and finding efficiencies throughout our business positions us to achieve our goal of maintaining a flat O and M cost structure through 2020. Commercial portfolio results increased by $0.02 per share in the Q3. The higher results were largely driven by additional wind and solar facilities placed online this year and more favorable wind resources throughout the summer months. Moving on, other was down 0.14 dollars for the quarter, largely driven by a higher effective tax rate due to prior year tax benefits and a current year unfavorable audit settlement. These unfavorable tax items offset the favorable tax variance in the regulated utilities segment. For the year, we continue to expect a total company adjusted effective tax rate of approximately 31% compared to our original expectation of 32% to 33%. This is primarily due to the favorable tax benefit realized at international in the Q1. Our first three quarters have been strong, reflecting favorable weather and strong execution on the part of our team. As we look to the Q4, I would like to share a few considerations. 1st, Piedmont will contribute 0 point 0 $3 to 0 point 0 $5 in the 4th quarter. In regulated utilities, we have taken the opportunity to replan some of our O and M work, including advancing a fossil plant outage and some distribution projects into the Q4. In addition, the prior year results included a favorable Ohio regulatory settlement. Meanwhile, at Commercial Renewables, we expect a relatively flat quarter compared to the prior year. And for the segment to finish below original expectations for the full year. Market returns continue to decline, and we remain disciplined on renewables capital deployment. With our strong year to date results through the Q3 and our expectations for the 4th quarter, we are trending toward the high end of our original guidance range, excluding costs associated with Hurricane Matthew. Moving on to Slide 10, let's review our retail customer volume trends. On a rolling 12 month basis, weather normalized retail load was 0.6% through the 3rd quarter and continues to track our long term expectations for approximately 0.5% load growth. Overall, we are pleased with the strength of our residential volumes, which continue to grow at 1.1 percent over the last 12 months. A strong 1.4% annual increase in the number of new customers drives this growth. Utility sponsored energy efficiency programs and more efficient building codes and standards continue to partially offset this customer growth. Recently, we have seen the decline in usage per customer begin to level out a bit. Looking forward, positive trends in new job and wage growth as well as a recovery in housing are positive signs for continued residential growth. Moving to the customer class. We experienced an increase of 0.4% over the rolling 12 months, an improvement compared to last quarter. Commercial usage is slowly improving across our jurisdictions as non manufacturing employment improves and office vacancies continue to decline, even with new office space being added. These improvements are somewhat offset by commercial businesses supporting manufacturing. In addition, we continue to see declines in the government and education sectors, especially in the Midwest. In the industrial class, we see growth of 0.2% on a rolling 12 month basis. Industries that support construction and automotive continue to show resilience. However, the metals industry is once again experiencing declines. We will closely monitor economic conditions and our customer usage patterns throughout the remainder of the year and into 2017. Moving to Slide 11. Let me take a moment to discuss the status of the DEP South Carolina rate case. In October, we reached a constructive settlement with the Office of Regulatory Staff and other key intervening parties. The settlement was reviewed by the Public Service Commission of South Carolina during a hearing earlier this week. The major components of the settlement were largely consistent with our initial filing. We requested a $79,000,000 increase with an allowed ROE of 10.75 percent and equity structure of 53 percent and a rate base of $1,300,000,000 Our significant energy infrastructure investments were the key drivers for the proposed increase. The settlement provides for a 50 $6,000,000 revenue increase and an allowed ROE of 10.1%. We also agreed to a 53% equity structure and a $1,300,000,000 rate base. If the settlement is approved as filed, new rates are expected to be effective in January 2017. Customer rates will be implemented over a 2 year period. In year 1, customer bills will increase by $38,000,000 and step up to $56,000,000 in year 2. DEP will reduce its cost of removable liability by $18,000,000 in year 1 to provide a neutral earnings impact to the company in the 1st year of rate implementation. Based on the settlement, coal ash costs that we had incurred will be recovered with a return over a 15 year amortization period, and we agreed to defer any future rate cases to 2019. This settlement is an important milestone, and we expect an order from the commission in the coming weeks. With the transition in our business portfolio, I want to provide you some broad parameters for 2017 on Slide 12. Consistent with past practice, we will provide guidance for 2017, including 5 year capital plans during our February earnings call. We anticipate growth in the core businesses, electric and gas infrastructure and commercial renewables, of about 5% off of the 4 point 3 zero dollars midpoint of our 2016 adjusted earnings per share guidance range. Accretion from Piedmont is expected to be 0 point We will provide additional perspective on growth capital in all of our segments in February. International results through closing, use of sales proceeds and National Methanol are expected to contribute between $0.10 $0.15 per share in 2017. National Methanol will move to other and contribute $0.05 per share based on prevailing Brent crude oil prices and our ongoing ownership percentage, which is expected to step down in 2017. The use of proceeds from the sale of our Latin American generation assets of $1,700,000,000 to $1,900,000,000 will displace future financings at the holding company and will also contribute about $0.05 per share based on current interest rates. We estimate 1st quarter operating results from our international business could also add up to $0.05 per share of earnings, depending upon the timing of the close. We look forward to further discussion of 2017 and beyond in February. I'll close with Slide 13. Duke Energy has tremendous scale, offering an attractive investor value proposition, which includes balanced growth in earnings and reliable dividends over time. Within months, we expect to complete our multiyear portfolio transition, affirming our commitment to provide low risk, high quality earnings and cash flows and supporting our long term growth projections. We will continue to invest in cleaner energy resources, modernize the energy grid and build our natural gas platform and provide enhanced services for our customers. With that, let's open the line for your questions. We'll take our first question from Michael Weinstein with Credit Suisse. Hi, guys. Good morning, Michael. Good morning. Good morning. Could you discuss in a little more detail the I think you said that there was the results from commercial renewables was not as what you expected. I was wondering if you could discuss some of the issues surrounding that. Michael, I would direct you to Slide 16 of the deck, which gives you a comparison of where we are for year to date results against original expectations. CEC Commercial has delivered about $65,000,000 of net income against our original expectations of $140,000,000 dollars We are not expecting that we'll deliver $140,000,000 for 'sixteen. Some of that shortfall will be the result of lesser capital deployment. As Steve mentioned, returns have been very market driven, so great for customers, but low for investors. And then we continue to expect to be slightly behind on wind and solar resources as a result of what we've seen in weather patterns. So those are the two things I'd point to. Is it that the market for investment has become more competitive than you expected, let's say, a year ago that returns on acquisitions are just smaller than you thought? Or is this more of a weather issue? I think returns are lower, Michael. And I think the other thing to consider for Duke as an investor, we are in an NOL position as a result of bonus depreciation. And so as we look at returns, we consider that the monetization of tax credits needs to reflect when we will be a cash taxpayer. So the DCF of that can challenge our returns. So that's something that we'll continue to monitor as time progresses. We understand the market well. We have great expertise in both based on the returns we're seeing in the market. How long does that NOL position go out to? What do you expect? Currently, we are expecting, assuming there are no further extensions of bonus, that we would come out of the NOL position in 20 19. We would then begin using tax credits, ITC production tax credits. So we would still not be a significant cash taxpayer for a few years after that. But that would that in theory could make the renewables business a little more competitive for you, right? I think as we get closer to that period of tax where we burn off the NOL, that will impact our view of returns, Michael, because the relative value of the tax credits will be greater. We'll take our next question from Ali Agha with SunTrust. Thank you. Good morning. Good morning. Good morning. Good morning. First question, Steve, the proceeds from international sale, as you mentioned, you're going to use to pay off parent debt. Can you remind me, on average, what's the average interest rate on the debt that you're paying off? Well, when we did the calculation there, it came out with roughly $0.05 we're looking at a long term holding company rate, might be in the 3.5 percent to 4% type range of that nature. So that's the basis of what we're looking at. And we bake that into our financing plans and anticipating that to happen. We'll initially take down some bridge facilities of shorter term with the proceeds. Okay. But there's enough that high cost or relatively high cost debt available to get that kind of savings? Well, what I'm speaking about is we've anticipated this and baked it into our financing plans to avoid issuances of holdco debt at that higher level. Yes. So I would just think about it as $1,700,000,000 to $1,900,000,000 of proceeds coming into the holding company. So the average rate that Steve referenced is consistent with that. I see. Then second, the commercial results that you're getting, dollars 65,000,000 year to date or $140,000,000 for the year, I guess, a little lower now, How much of that roughly is the recognition of tax credits? Tax credits are going to be a significant part of those renewable returns. Ali, I don't have an exact number in front of me. We do have a modest amount of contribution in commercial from the pipelines at this point through the Q3. We'll move that to the gas infrastructure segment in the Q4. How would you add it? That's correct. The results for the commercial portfolio reflect small amounts of AFUDC on the pipelines. That will be growing. But right now, it is primarily from the renewables business, and that is heavily driven by the recognition of the tax benefits. Got it. Last question. As you look at this portfolio now post the international sale, and you look at your utility footprint, is everything essentially core as far as Duke is concerned? And related to that, as you're looking at growth over at least the next 3, 4 years, does M and A come back into the mix for you as you're looking to deliver growth for shareholders? So Ali, the businesses that we own coming out of the transition are all core. And I think the strength of the franchises we own in the Southeast, but gas and electric and then a strong position in the Midwest are all core businesses. And we'll be looking to drive growth through investments that build on cleaner forms of generation and strengthening our grid and driving growth and providing value to customers. That'll be job 1 at Duke. I believe M and A represents something that we will continue to look at as opportunities arise. I think we've demonstrated a track record of successful businesses that we own. Thank you. Thank you. We'll take our next question from Maxwell Burke with Citi. So maybe just jumping back to your renewable portfolio. So when you're underwriting these investments, do you generally assume that the PPA cash flows are going to cover the full investment cost? Or do you assume some residual value post PPA in order to recover that investment? We will typically assign some terminal value beyond the contract period. Okay, got it. And maybe just as a follow-up, can you provide any guidance on like how you think about valuation post PPA? Do you make some assumption around recontracting or do you apply a $1 kw multiple or some other method? We look at a variety of things as we think about terminal value, including forward curves, as well as market experience. And so, our contracts are the majority of the value that we're looking at. And so terminal is something we look at a range of possible outcomes. Got it. Thanks. Thank you. It appears there are no further questions at this time. I would like to turn the conference back to Ms. Lynn Good for closing remarks. So thank you everyone for your interest and investment in Duke Energy. We've made tremendous progress this quarter and look forward to seeing many of you in the coming months and at the EEI Financial Conference next week. Thank you. This concludes today's conference. Thank you for your participation.