威斯康辛能源 (WEC) 2017 Q2 法說會逐字稿

Good afternoon, and welcome to WEC Energy Group's Conference Call for Second Quarter 2017 Results. This call is being recorded for rebroadcast. (Operator Instructions)

Before the conference call begins, I remind you that all statements in the presentation, other than historical facts, are forward-looking statements that involve risk and uncertainties that are subject to change at any time. Such statements are based on management's expectations at the time they are made. In addition to the assumptions and other factors referred to in connection with the statements, factors described in WEC Energy Group's latest Form 10-K and subsequent reports filed with the Securities and Exchange Commission could cause actual results to differ materially from those contemplated. During the discussion, referenced earnings per share will be based on diluted earnings per share unless otherwise noted.

After the presentation, the conference will be open to analysts for questions and answers. In conjunction with this call, a package of detailed financial information is posted at Wecenergygroup.com. A replay will be available approximately 2 hours after the conclusion of this call.

And now it is my pleasure to introduce Mr. Allen Leverett, President and Chief Executive Officer of WEC Energy Group.

Good afternoon, everyone. Thank you for joining us today as we review our results for the second quarter. I want to start by introducing the members of our team who are here with me today: Scott Lauber, our Chief Financial Officer; Jim Schubilske, our Treasurer; Susan Martin, General Counsel; Bill Guc, Controller; and finally, Beth Straka, our Senior Vice President of Corporate Communications and Investor Relations.

Now as you saw this morning, we reported second quarter 2017 earnings per share of $0.63. Effective cost controls and warmer than normal June weather contributed to a solid second quarter. Scott will provide more detail in a moment. We are affirming our current 2017 guidance of $3.06 per share to $3.12 per share with an expectation of being in the upper end of the range. This is in line with our expected long-term earnings per share growth of 5% to 7%.

Now I would like to update you on our major investments and several developments on the regulatory front. On June 30, we closed the acquisition of Bluewater Natural Gas Holding after the Wisconsin Public Service Commission approved the investment. This $230 million investment in natural gas storage will provide approximately 1/3 of the current storage needs of our Wisconsin natural gas distribution companies. Bluewater will have a long-term service agreement with each of these 3 companies. The earnings and risk profile from this investment are expected to be essentially the same as if the storage was owned by our local gas distribution companies. I believe this investment will bring very meaningful benefits to our customers.

You may recall on April 4, we filed a proposed settlement agreement with the Public Service Commission of Wisconsin. Now under the terms of this settlement, the currently approved base rates for all of our Wisconsin utilities would be frozen for 2018 and 2019. This would make a total of 4 years that base rates will be flat and essentially gives our customers price certainty through 2019. The settlement also requires that we continue to manage our costs aggressively.

Under the proposed agreement, the current earning sharing mechanisms would be extended through 2019 at Wisconsin Electric and at Wisconsin Gas. In addition, a similar mechanism would be put in place for 2018 and 2019 at Wisconsin Public Service. There would be equal sharing between customers and shareholders of the first 50 basis points of earnings above Wisconsin Public Service's allowed return on equity of 10%. All earnings above 10.5% would go back to benefit customers.

As part of the agreement, we are looking to expand and make permanent some electric pricing options for our large electric customers. These options have helped many of our customers reduce their energy costs, grow their businesses and create more than 2,000 jobs. These changes will allow us to retain an effective economic development tool and avoid a price increase for customers whose current pricing options would expire under existing terms. The settlement has the support of a broad cross-section of our industrial and commercial customers. In addition, state legislative leaders are supportive.

The commission began consideration of the proposed settlement on April 20. Then on May 25, Wisconsin Commission staff issued a schedule outlining the key dates. On July 19th, the Wisconsin Commission staff issued a memorandum in response to our proposed rate freeze settlement. Staff's review confirmed an electric revenue deficiency, and thus in my view, demonstrated that the settlement we arrived at with our customers remains in the best interest of all of our customers. However, the staff proposed a wide range of conditions to the settlement. Unfortunately, none of these conditions are acceptable to us.

Looking forward from today, comments to the staff memo are due on August 2. Reply comments are due on August 8. We expect the commission to make a decision on the proposed settlement in the late August to September time frame. Should the commission reject the proposed settlement, I expect we will file a traditional rate case.

In Michigan, our proceeding to obtain regulatory approval for the construction of new gas-fired generation in the Upper Peninsula is progressing well. We anticipate receiving Michigan Commission approval within the 270-day statutory deadline which ends on October 27. In addition, we have received all local approvals needed to accommodate the project. If approved by the Michigan Commission, we expect this to be a $265 million investment.

Turning to Illinois. We continue to make progress on the Peoples Gas system modernization program. This program is designed to make our gas distribution system in Chicago safer, more reliable and less expensive to maintain. Consistent with our plan, we expect to invest $300 million in the program this year.

Now a reminder on our dividend. On January 19, our board declared a quarterly cash dividend of $0.52 per share, which is an increase of $0.025 or 5.1% over the previous quarterly dividend level. This represents a compound annual growth rate of 6.6% from the 2015 fourth quarter level. Our annualized dividend level stands at $2.08 per share. We continue to target a payout ratio of 65% to 70% of earnings. And given that we are right in this range now, I expect our dividend growth will continue to be in line with our earnings per share growth.

Finally, here in Wisconsin, we're seeing some promising economic activity. The state's per capita real GDP has grown faster than the U.S. average. Wisconsin's unemployment rate fell to 3.1% in May, the lowest it has been since 1999, and well below the U.S. average of 4.3%. In Southeastern Wisconsin in particular, there are a number of active ongoing projects.

Now with some additional details on our first quarter results and the financial outlook, here's Scott Lauber, our Chief Financial Officer.

Thank you, Allen. Our 2017 second quarter earnings increased to $0.63 per share from $0.57 per share in the second quarter of 2016. Effective cost controls continue to have a positive impact on earnings. We exceeded our guidance for the second quarter, which, as you recall, was $0.56 to $0.60 per share. Lower-than-expected costs at our Illinois utilities and warmer-than-normal June weather contributed to these results.

The earnings package placed on our website this morning includes a comparison of second quarter and year-to-date 2017 and 2016 results. My focus will be on the quarter, beginning with operating income by segment and then other income, interest expense and income taxes.

Referring to Page 7 of the earnings packet, our consolidated operating income for the second quarter of 2017 was $362.2 million as compared to $332.1 million in the second quarter of 2016, an increase of $30.1 million.

Starting with the Wisconsin segment, operating income in the second quarter increased $8.9 million from the second quarter of 2016. On the favorable side, operation and maintenance expense was $29.1 million lower. This was largely offset by lower customer usage related to mild weather conditions in April and May.

In the second quarter of 2017, our Illinois segment recognized operating income increase of $18.8 million compared to the second quarter of 2016. The increase was primarily driven by reduced operations and maintenance expense and continued investment in the gas system modernization program.

Operating income in our Other States segment improved $2.4 million related to lower operations and maintenance expense resulting from cost control measures.

Following last month's acquisition of Bluewater Natural Gas Holding, our We Power segment was renamed the non-utility energy segment. For the second quarter, operating income at the non-utility energy segment was up $4.6 million. This increase reflects the additional investment at our Power the Future plants since in the second quarter of 2016. Beginning in the third quarter of 2017, this segment also will include the results of Bluewater. The operating loss at our corporate and other segment was $6.2 million for the second quarter of 2017, an increase of $4.6 million compared to the second quarter of last year. Taking the changes of these segments together, we arrive at $30.1 million increase in operating income.

During the second quarter of 2017, earnings from our equity investment in American Transmission Company totaled $41.8 million, an increase of $10.9 million compared to the same period of the prior year. Recall that in the second quarter of 2016, we recognized lower earnings from ATC as a result of the ALJ recommendation related to the FERC ROE reviews.

Other income net decreased by $19.3 million quarter-over-quarter. Driving the decrease was a $19.6 million gain recognized in the second quarter of 2016 from the sale of the chilled water generation and distribution assets of Wisvest. Interest expense increased $1.8 million quarter-over-quarter, driven by lower capitalized interest.

Turning now to consolidated income taxes. We still expect our effective tax rate will be between 37% and 38% this year. However, our effective tax rate in the second quarter was down 1.8% when compared to the same period last year, due largely to the settlement of several items.

Combining all of these items brings us to earnings of $199.1 million or $0.63 per share for the second quarter of 2017 compared to $181.4 million or $0.57 per share for the second quarter of 2016.

Net cash provided by operating activities increased $43.9 million during the 6 months ended June 30, 2017, compared to the same period in the prior year. A reduction in the working capital and higher operating income were partially offset by $100 million contribution to the pension plan in January 2017.

Looking at the cash flow statement on Page 6 of the earnings package. Our capital expenditures totaled $790 million in the first half of 2017, a $171.3 million increase compared to the first half of 2016 as we continue to invest in our core infrastructure. I want to remind you, we also invested $230 million through our acquisition of Bluewater, however, this investment is identified as a separate line in the cash flow statement.

Our adjusted debt-to-capital ratio was 51.5% at the end of June, a decrease from the 51.9% adjusted debt-to-capital ratio at the end of last year. Our calculation continues to treat half the WEC Energy Group 2007 series A junior subordinated notes as common equity. We are using cash to satisfy any shares required for our 401(k) plans, options and other programs. Going forward, we do not expect to issue any additional shares.

We've paid $328.3 million in common dividends during the first 6 months of 2017, an increase of $15.9 million over the same period last year. Higher dividends were driven by the 5.1% increase in the dividend rate compared to the first half of 2016.

Moving to sales. We continue to see customer growth across our system. At the end of June, our utilities were serving approximately 9,000 more electric and 13,000 more natural gas customers than they did the same time a year ago. Retail, electric and natural gas sales volumes are shown on a comparative basis on Page 11 and 12 of the earnings package, respectively.

On a year-to-date basis, weather-normalized sales are adjusted to factor out the effects of leap year in 2016. Overall normalized sales results for natural gas were above our expectation and retail electric sales were slightly below our expectations.

Turning now to our earnings forecast. As Allen mentioned, we are affirming our 2017 earnings guidance of $3.06 a share to $3.12 a share with an expectation of being in the upper end of the range. This projection assumes normal weather for the remainder of the year.

Finally, I'd like to address the third quarter earnings per share guidance. As a reminder, during last year's third quarter, we earned $0.68 per share. This included $0.01 of acquisition costs to arrive at adjusted earnings of $0.69 per share. Earnings that quarter were primarily driven by weather that was 43% warmer than normal in Southeastern Wisconsin and related positive fuel recoveries that were partially offset by the Wisconsin sharing mechanisms. These items add approximately $0.07 to the quarter of 2016 to arrive at a base of $0.62 per share. Taking these into account, we expect our third quarter 2017 earnings per share to be in the range of $0.63 to $0.67 per share. This assumes normal weather for the rest of the quarter.

With that, I'll turn things back to Allen.

Thank you, Scott. Operator, we're now ready for the question-and-answer portion of our conference call.

(Operator Instructions) Your first question comes from Greg Gordon with Evercore ISI.

I just want to understand sort of procedurally, what the potential scenarios are at the commission with regard to the staff suggestions, right? So they basically said, a, approve the deal as filed, which is clearly your preference. Another one is reject it and have them file the case, which is obvious, pretty obvious. But the third path is not so clear to me. If the commission were to say, "We accept the settlement but impose the conditions that the staff had opined to be implemented." At that point, could you say, "We'd rather file a rate case," or would you be then compelled to accept that decision?

Well, we would not be compelled to accept the decision. So maybe to state for everybody on the call to make sure they understand your question. So basically, you have a scenario, Greg, where the commission says, "Well, all right, we accept the settlement subject to the addition of some or all of the conditions that the commission staff proposed." So that's the hypothetical scenario. Well, in that scenario, given the way the settlement was structured, it's not severable. So if it's not accepted in whole, well, the settlement basically falls away unless we and the other parties who came up with the settlement, unless we all agree to a different set of conditions. So we wouldn't be compelled, Greg, in the scenario you lay out, to accept that modified settlement, if you will. And as I described in the opening remarks, the next step would be we'd file a general rate case.

Okay. That's what I thought, I just wanted to hear you state that so that it was clear. Because looking at the conditions, they would clearly put -- they seem to, at least some of them, put a lot more pressure on you to control costs by virtue of not allowing you, under certain of those conditions, to continue to defer costs and by reducing the amount you could earn on what are -- on significant regulatory asset balances, right? So it would seem to me that it would, unless you had -- were able to pull off some Herculean effort vis-a-vis cost-cutting, there would be the potential for some significant regulatory lag under that scenario. Is that fair?

I agree with that description.

Your next question comes from Larry Liou with JPMorgan.

Can you just quickly on how you plan to address the ratings pressure at Moody's?

I'll let Scott talk about it. And I think Larry's question is about the recent action that Moody's took and whether we have any actions that we would plan in response to that. Is that fair, Larry?

Yes, exactly.

Yes. So just to remind everyone, Moody's, at our Wisconsin utilities, moved them down 1 notch from A1 to A2. And they described several reasons. And one of them is the recovery of some of the regulatory items and not having riders compared to other jurisdictions. With that, now they've put our holding company on a negative watch or outlook also. We're continuing to monitor our holding company debt to total debt. And that's one of the items, I think they'd like to see that come back a little faster than we've reduced it. However, as we continue to find good investments, such as the Bluewater investment, that will add some stress to the holding company, but it's good for the customers and good for the shareholders as it continues to improve earnings. So we're monitoring that holding company debt, and as you can tell, watching our financials as tight as possible.

Okay. And I guess just on Bluewater. Can you just remind us how you financed the acquisition again?

Yes. So the way it will be financed, Larry, initially, of course, we just take down commercial paper at the holding company to fund the $230 million acquisition price. $115 million, or roughly half of the investment down at the sub, will be equity. And then another $115 million will be nonrecourse debt, meaning nonrecourse to the holding company debt, down at the Bluewater Holding level. And then -- so we'll take $115 million from that financing and pay down some holding company debt. But the holding company is essentially funding its equity contribution, if you will, into the subsidiary with debt up at the holding company.

Your next question comes from Shar Pourreza with Guggenheim Partners.

Just one question. With the Bluewater acquisition, you're kind of sort of chipping away at some incremental growth opportunities that can help you maybe get you above the bottom end of your range. Is there sort of any updates on additional growth opportunities you're kind of working on? Maybe the Arizona opportunities? Or additional storage assets? Anything that could help get you above?

Yes, thanks for the question. And I guess we, in November -- actually early November time frame, probably around the EEI finance conference, we provide a complete update on our 5-year capital plan. So I don't have any an incremental update today, but what I would say is I'm feeling very optimistic about additional opportunities. Some of those kind of in the areas that you were alluding to in your question, in the midstream natural gas assets, where we would purchase assets that we could either financially or physically integrate with our natural gas distribution company. So feel optimistic, but what I'd rather do is really provide a complete update in a 5-year plan in early November.

That's super helpful. Just for -- I think we've talked about sensitivity purposes, roughly what is the capital program, around $1.5 billion over a 5-year period could equate to about 1% incremental growth?

Yes, just to be clear. So if you look over a 5-year plan and you invest $1.6 billion of capital, and let's assume that that's levered 50-50, so 50% equity, 50% debt, and then you earn approximately a 10% return on the equity piece, you're exactly right. That would add 1 percentage point to the 5-year, excuse me, compound annual growth and EPS.

Your next question comes from Paul Ridzon with KeyBanc Capital Markets.

So just, did you book any FERC ROE complaint reserves or refunds in this quarter?

No. It was -- the entry we talked about in the prepared comments was in 2016.

And could you quantify that?

I don't know the exact dollar amount. It had to be around $8 million, I'm assuming, $8 million to $9 million.

Pretax.

Pretax.

Your next question comes from Paul Patterson with Glenrock Associates.

I just wanted to sort of follow up on Paul Ridzon's question there. The ROE, just if you could break it down for me. It seems like the FERC transmission impact seemed a lot more this quarter than last quarter. If you could just walk me through why it's so much more.

Yes, I mean, that's a good question. Last year in the second quarter, the ALJ came out with their decision to -- for their second case, to have the -- FERC ROE was at, for the second case, that 10.2%. Now remember, that's 9.7% plus a 50 basis point adder to 10.2%. And that time then, we looked at the complaint period and took an entry in that quarter to record that reserve to that 10.2%. Since then, in September of last year, the FERC came out with their decision in the first case, that was at a 10.82% ROE, which is a 10.32 plus a 50 basis point adder, so the 10.82%. And since the end of September, we've been booking at that 10.82% until we'll hear on that second complaint. And the second complaint, we're waiting for a quorum now at the FERC. We don't know if it'll be in the second half of the year. But currently, we're booking at the 10.82%. So the main driver, the swing between quarters there was the entry last year to get down to the first reserve needed. And it's maybe a little bit higher, too, because we're booking at a 10.82%. But long term in our financial plan, we talk about a 10.2% long-term outlook for the FERC ROE.

Okay. And then in terms of the lower O&M, I was just wondering if you could break it out a little bit more in Illinois. I apologize if I just missed this, but between that and the continued SMP. And just where the other O&M savings are showing up?

All right. Well I think, let me let Scott maybe give you some color on Illinois, Paul. But maybe just to kind of reground everybody on our O&M plan for the year. So the goal at an enterprise level was to reduce O&M 3% in 2017 as compared to the actual run rate of O&M, controllable O&M, in 2016. And as I look at the Wisconsin utilities for the year, we've got some timing of O&M expenditures that were moved around because we had to respond to the warmer-than-normal weather in the first quarter. There's also going to be some downstream O&M effects of the storms that we had that affected the electric business in Wisconsin in the second quarter. But overall, my expectation is that the Wisconsin utilities will be right on top of that 3%. But in Illinois, we're actually doing better than plan on O&M. So Scott, do you want to give Paul some additional color on that?

Yes. So Illinois, the drivers is -- it's the combination of, like you said, the O&M and the rider. I would say probably about $8 million to $10 million of that variance year-to-date is related to the QIP rider, the capital investment, plus some other riders that are just a pass-through of O&M. But O&M is the major driver in there. That's -- the majority of the remaining of it, I'd say $10 million to $15 million, plus some other lower interest expenses.

Okay. Great. And then just back to the settlement, it seems that when you read the staff, seems to be saying sort of 2 different things. On the one hand, it seems to be saying what you just mentioned, which was that they would calculate -- or they think it's likely that there would be a revenue deficiency. But I guess they also start talking about the ROE and how can that maybe change a few things if that was changed. And then they also discussed the concern that they apparently have about rate increases in the future because of the deferrals. And based on what I'm hearing from what you're saying, it looks like unless the commission is okay with these deferrals growing, that you probably have to go in for a rate case. Is that right?

Well, let's just make sure that we're clear on the financial effect that our proposal would have. Our proposal, if it were -- the settlement, okay, just to be -- so the settlement that we had entered into with our customers, if that were implemented, if you look at the projected balances, you look at where we expect to be at the end of 2017 and look at where we would expect those balances to be at the end of 2019 if they adopted the settlement, I mean, if you look end to end, Paul, we would expect there to be no growth on a net basis in those deferred balances. So we'd sort of be level '19 year-end versus '17 year-end. So we wouldn't have any additional accumulation of balances. And the hope that we have is that with tax reform, that then, you would start having some uplift, if you will, or a cost reduction effectively, that you could use to start managing those balances down. But if you look at during the pendency of the rate freeze period that we proposed in the settlement, there wouldn't be any net growth at all in those balances.

So when the commission staff says that their analysis suggests that the approach that you guys are proposing could result in a new deferred balance, if you were to put that new deferred balance with respect to the legacy deferred balances, for lack of a better term, you'd still basically be net no change in the deferred balance at 2019. Is that correct?

Right. Out to 2019, that's correct.

Yes. I mean, we do have some deferred balances that relate to deferred taxes, but once again, we won't collect that from the customers. We'll collect that when we pay it back to the government, which will be approximately a 50-year period on those taxes.

And is it that what the commission's referring to with respect to -- the staff is referring to when they talk about the results of a new deferred -- in a new deferred balance?

I think that's what they're referring to, is the tax deferred balance.

The next question comes from Dan Jenkins, State of Wisconsin Investment Board.

So first, I just wanted to follow up a little bit on the earlier discussion around the Moody's downgrade. Just wondering, so do you have, say, a ratings target or leverage target for your balance sheet at both the parent and at the utilities, at a point where you manage towards or the -- at what level you would defend the rating?

Yes. When we look at our utilities, we want to keep all the utilities in that single A rated category. So that moves a little bit within the category with Moody's now, and we did try to defend it to keep it up to that level because we know the cheaper interest is always good for our customers. So we like keeping it in that -- at single A rated category. At the holding company, right now, it's on a negative watch. There's potential it could move down a little bit and we're going to continue to monitor that. If it does move down a notch, I mean, that's where we'll really continue to look at our holding company debt and manage that.

Yes. I think one of the focuses, Dan, that we've had for quite a while is managing the percentage that holding company debt represents as a proportion of consolidated debt. And so we're certainly taking a number of actions this year to keep that within the balance that we'd like it to be. We did permanent nonrecourse financings at Michigan Gas Utilities as well as at MERC over in Minnesota at the gas utility there. And I mentioned the financing that we would plan later this year at Bluewater. So I think all of those have been and will be helpful in also managing that holding company debt to consolidated debt percentage within a reasonable range.

Okay. Then I also was wondering, on Page 7 where you show the comparisons from this year to last year, you also had a $4.6 million difference in the corporate and other category. I was wondering if you could give a little more color on what's driving that change.

Yes. There's a lot of little variety of items in that segment there. Just one item, and this is kind of inside baseball, but we have some investments that were at the service company that really belonged more at the utilities. So we put the investments in the utilities versus the service companies. The earnings stayed the same. The capital stayed the same. It's just, once again, it took -- just moved it into the utility where it belongs. Some of those were still there last year at the acquisition. It's just kind the cleanup of what we think is the best way run a service company. So just a variety of little items.

Okay. And then the last question I had is there's been some speculation that, later today, there will be an announcement of a large Foxconn facility in Southeastern Wisconsin. And I don't want you to spill the beans or steal the thunder there, but there's been talk about a site where there was an old Chrysler engine plant or whatever. I just wondered if you could confirm whether that site's in your service territory.

Yes. The site that you're -- that I believe you're referencing is in our service territory. And when I say our service territory, that's the electric service territory for Wisconsin Electric. And I'm sure, Dan, we both read some of the same reports in the press. Certainly, Governor Walker has been in detailed discussions with the senior people at Foxconn. Foxconn has indicated that they will be making a decision soon. But at this point, they haven't made a formal announcement. But what I would say, Dan, the investment that's being discussed would be quite significant for the economy here in Wisconsin.

(Operator Instructions) Your next question comes from Joe Zuho with Avon Capital Advisors.

It's actually Andrew Levi or Andy Levi. Okay, real quick. because I know everybody wants to get off the call, I'll fire the last question. So just to understand, you were very clear on the settlement, it's all or nothing. But I had just one question on that. Have you spoken to the people or the other organizations that are in the settlement with you? Are they on the same page there? Or is there a little bit of wiggle room between you and the settlement parties and the commission?

We have had, Andy. From time to time, we've had discussions, sort of updates, if you will, with the other parties to the settlement. And they really have the same view that I have. This is a settlement that -- it was highly negotiated between the folks in the settlement. And it's not severable. I mean, they view it as a package and we view it as a package, Andy.

Okay. So it really is all or nothing.

Well, we have a package that we and our customers think are in the best of interest of all of the customers. So I mean, I think it's -- as constructed, it's a very, very good package. So I would be hopeful that the commissioners would agree with my assessment of it.

And there are no further questions at this time.

Well, that concludes our conference call for today. Thank you for participating. If you have more questions, please contact Beth Straka. Her number here in Milwaukee is (414) 221-4639. Thank you.