CMS Energy Corporation (CMS) — Q1 2015 Earnings Call Transcript

Good morning and thank you for joining us today. With me are John Russell, President and Chief Executive Officer and Tom Webb, Executive Vice President and Chief Financial Officer. Our earnings news release issued earlier today and the presentation used in this webcast are available on our website. This presentation contains forward-looking statements which are subject to risks and uncertainties. All forward-looking statements should be considered in the context of the risks and other factors detailed in our SEC filings. These factors could cause CMS Energy's and Consumers' results to differ materially. This presentation also includes non-GAAP. A reconciliation of each of these measures to the most directly comparable GAAP measures is included in the appendix, as well as posted in the Investor section of our website. Now let me turn the call over to John.

Thanks, D.V. Good morning, everyone. Thanks for joining us on our first quarter earnings call. I'll begin the presentation with an overview of the quarter, provide an update on energy legislation and turn the call over to Tom to discuss the results and outlook. Then as usual close with Q&A. First quarter adjusted earnings per share were $0.73, down $0.02 compared to last year but up $0.04 or 7% on a weather-adjusted basis. In January our Board approved a 7.4% dividend increase, the ninth consecutive increase in as many years. The new annual dividend of $1.16 per share results in a competitive payout ratio of 62%. Today we're reaffirming our full-year adjusted EPS guidance of $1.86 to $1.89. This reflects our plan to grow 5% to 7% off last year's actual results. Our improved safety performance that began in the second half of last year continued through the first quarter. Compared to last year's first quarter, safety improved 58%. Our electric and gas systems continue to perform well. On the gas side we had record sales in February. Capital investments in our electric system have resulted in improved reliability, the best in 10 years. Customer satisfaction has increased for both electric and gas business customers. And I'll talk more about these results in just a few minutes. We also have a tentative five-year agreement with our union, pending ratification. The mutually beneficial contract will support a high level of customer service and increased investment in the gas business. Here you can get a sense of how we're investing heavily in the gas business. We already have one of the largest natural gas systems in the country and we plan to grow it to better serve our customers. Our 10-year plan calls for almost $6 billion of capital investment. We plan on replacing 800 miles of main, installing nine new compressors and connecting 100,000 new customers. We have another $1 billion of opportunity to grow this plan with more replacements, conversions and supplying natural gas generators. We're able to continue our investment in the gas business as falling natural gas prices create headroom and offset base rate increases. Over the last six years our customer's average bill has been cut by a third, falling from $3 to $2 a day, supported by natural gas fuel costs declining by 50%. We've been able to do this by cycling our gas storage fields and filling them with low-price gas. As you look over the next five years we see customers' prices staying relatively flat as new investment is offset by cost reductions and low natural gas prices. We're in a good position to invest in the gas business, maintain a high level of system performance and deliver increased reliability with lower prices to our customers. We're committed to providing our customers with exceptional value. Our dedication to improving customer satisfaction has moved us from fourth quartile to second quartile for electric and gas business customers and to first quartile for residential customers, a significant improvement over the last five years. In 2016 we anticipate having all four segments in the first quartile, as we continue to focus on customer satisfaction by delivering the quality of service our customers expect. Customer satisfaction is an important element of our breakthrough thinking that leads to predictable and sustainable financial results. As you know, Michigan is currently in the process of updating its energy law. The Governor is focused on adaptability over the long term as Michigan moves away from coal and more towards natural gas generation and renewable energy sources. His vision provides a constructive framework. The Michigan Senate and House are currently developing and debating legislation. The bills we have seen range from full regulation to an increase in the cap. The Governor stated that he would like to see the cap remain unchanged but would require five years of firm forward capacity. He calls this fair choice. We look forward to working with the Governor and legislators on the energy policy and meeting Michigan's long term energy needs. The Governor has established four pillars to make Michigan's energy more adaptable, affordable, reliable and environmentally sound. We support his vision and see many opportunities to achieve the state's energy goals. Our current energy efficiency program is working well and saving customers money. A continuation of this program with revenue recovery and the existing incentives would make the 15% elimination of energy waste attainable. We fully support the Integrated resource plan process that would allow the regulated utilities to determine the most economic capacity plan. By providing our customers with enablers like our smart Energy program they will have more control over their energy usage and save money. Like the Governor we want to see the elimination of subsidies to a fair choice policy or full regulation without mandates and begin to address the looming capacity shortfalls facing the state. MISO continues to predict a capacity shortfall in zone seven, Michigan's Lower Peninsula. We're nearing this reality as coal plants are shut down and excess capacity is eliminated next year. In order to begin addressing this we need a strong and supportive new energy law. The law will help the state meet its goals by eliminating waste, adding renewables and allowing the state to determine its energy future. Now I'll turn the call over to Tom to review the quarter.

Thanks, John. And thanks to each of you for joining our call today. As always, we deeply appreciate your interest in our company and for spending time with us on the call today. For the first quarter, our earnings were $0.73 a share on both a reported and an adjusted basis. This is $0.02 below last year and $0.04 or 7% above last year on a weather-normalized basis. All business units were well ahead of their plans with company results $0.21 better than budget. As you can see here, the first quarter weather-normalized earnings up 7% and another cold winter O&M reinvestment is underway. Even with huge added costs of about $45 million or $0.08 a share associated with longer lives in the new mortality tables and lower discount rates, our continued cost reductions offset this and result in lower costs, down 3% from last year. Our earnings per share forecast is already $0.17 ahead of plan. Please recall last year when we added substantial reliability work and still hit the top end of our 5% to 7% guidance. This year weather has helped $0.14 and our cost reductions, coupled with other improvements, are $0.04 ahead of plan. Reinvestment underway includes increasing utility forestry work and accelerating a planned major outage at DIG from 2016 to 2015. This has the double benefit of pulling ahead the outage cost into 2015 when we have ample room to absorb it and freeing up capacity in what will be a very tight year in 2016. In addition, we plan to increase DIG's capacity by 38 megawatts. This will add further to profitability next year. While we're on the subject of our business at the Dearborn industrial generation facility, here's an update on both capacity and energy. The opportunity to increase capacity-related profits by $20 million to $40 million already has been enhanced. Just recently we added a new nine-year capacity contract at a price that nearly doubled what we had assumed in our forecast. In addition, we're adding a new long term seven-year energy contract for one of our two combined cycle units that could improve profits by more than $5 million a year. This is in progress. The good news here is that we're beginning to realize benefits from the layering in strategy for capacity, as well as energy, enhancing the upside potential at DIG by as much as $25 million to $50 million a year with long term contracts. Patience is paying off. The outlook for our utility service territory in Michigan continues to be healthy. Whether it's building permits, GDP growth, population growth or unemployment, we continue to outperform Michigan overall as well as the U.S. average. First quarter sales were up nicely, continuing to support our outlook for full-year sales increases of 3% for industrial customers and 1% overall. First quarter industrial sales are below the full-year forecast but that's as expected, reflecting a ramp-up at several customers during the year. In fact, the full-year outlook is about 3% but we prefer to keep the forecast at a conservative level. Please remember that our earnings growth is not predicated on sales growth or cost reductions. Upsides from these are intended for our customers. Even without any upside our capital investment over the next 10 years will be 45% greater than the last 10 years. The opportunity to increase that investment by as much as $5 billion to over $20 billion continues to be practical, particularly when many of the investment opportunities can be included without increasing customer bills. There is a lot of work ahead but none of it represents big bets that put the company at risk. Capital spending projects are progressing well. For example, we're 40% through our Smart Energy meter rollout. And this has been a terrific project to re-introduce ourselves with each and every one of our customers. Our environmental spending, primarily to address clean air standards, is 85% complete. We still have work ahead replacing gas mains and distribution systems and we're 15% along the way. We've upgraded compressor stations and we're halfway through the work to replace compressors to maximize efficiency at our gas storage fields. As an LDC, remember, we have the largest storage fields in the nation. And our project to upgrade our pump storage facility at Ludington, the fourth largest in the world, is nearly at the halfway spending mark. This project will provide a 16% improvement to capacity. A lot of our capital investment enables us to reduce O&M costs and these are down 10% since 2006. We will reduce these costs another 7% by 2019. As we switch from coal plants, which require a substantial number of people to run, to gas and wind farms, which require about 10% of the workforce needed to run coal, we'll be reducing our O&M costs by over $30 million. By continuing our program to harden our pole tops we will reduce future storm-related damage and we'll capitalize rather than expense that work. This results in lower O&M costs, spreading costs to our customers over a longer period of time. In addition, natural attrition, a variety of quality-enhancing productivity actions and Smart Energy meters will help us reduce our costs substantially. And that's down 3% last year and 3% more this year. Here is our sensitivity chart that we provide each quarter to assist you with assessing our prospects. We've added capital investment and O&M cost metrics to permit you to assess just how much these opportunities might be worth. And here's our report card for 2015. Obviously with the Arctic blast we're well ahead on earnings. We will, however, work to put this surplus to good use with even more reliability improvements for our utility customers and accelerated outages to enhance our outlook for 2016. You'll note that we've graded ourselves with green checks on all metrics and a double check on earnings per share growth. While we're not increasing our guidance beyond 5% to 7%, I suspect that our performance so far this year, coupled with our track record over the last decade, probably gives you a pretty good sense that we feel pretty comfortable. Continuing our mindset that focuses on customers and investors permits us to perform well. We hope you agree. We're now in our 13th year of premium earnings and dividend growth and we plan to continue this performance for some time. Thank you very much for your interest and your time today. We look forward to taking your questions, so, operator, would you please open the line for questions.

So I wanted to first dig into the Michigan side of the equation. In terms of the fair choice on the cap, what percent of your customers as you understand the current proposal, would come back to you versus opt to choose the five-year capacity compliance mechanisms?

Currently, Julien, the proposal is still in its early stages. The Governor wants to ensure that our existing utility customers do not have to subsidize the capacity needed for retail open access customers. If the proposal is implemented as he envisions, these customers would need to demonstrate a firm capacity five years ahead, relieving us of the responsibility to supply that capacity. The situation will depend on market conditions. At present, we have about 300 retail open access customers, which represents approximately 0.2% of our total customers. It's difficult to determine the specifics of their contracts or the current market dynamics. However, based on some recent capacity auction results from the MISO market, it appears that deregulated states have slightly higher rates compared to regulated ones, so it will ultimately be their decision to find the best deal available.

And let me just add one thought, Julien, and I'm not sure your question was going this way, but what we've experienced in the past is when the market changes, which this could be a part of, we saw about 80% to 90% of that load come back over a period of time say a year or two years. This could be a little different depending on the duration of their contracts as John just said, but I think the economics will push them our way along with the potential policy change.

Excellent and then looking at the DIG site of the equation in terms of adding the 38 megawatt what's the timing and cost of that by chance?

Will remember we just described that pull ahead. In our presentation today where we were telling you that we're taking an outage that we plan to take in 2016 actually in the fall of 2015 so will have that in place this year that 38 megawatts in that cost of about $8 million to $9 million is part of that pull ahead which includes that upgrade and you won't see that repeated of course in 2016. So the money is being invested this year about 8 million to 9 million for the outage and the upgrade altogether with the benefit accruing to us next year.

And then the new contract on the nine-year capacity deal that’s annualized at that same rate every year?

That's correct.

What kind of customer is it just by chance?

Well because as you noticed I mentioned we’re in the progress of doing that I don't want to mention the customer's name, I don't think that would be appropriate. You wouldn't be surprised about who that customer is and the duration that we're looking at here on this contract will probably be about seven years.

It's not the same counterparty to the nine-year capacity as the seven-year.

So you're working your way into a name, but the answer is no and that's probably as far as I should go.

John just going back to the legislation conversation, I guess which bills are most consistent with what the governor has on offer right now and how organized the legislature is to get this done in a timely fashion?

I'll start with the last first the timing of this, I mean the Governor has targeted it for June. I think it's possible but it's pretty aggressive. And I think that's going to be dependent primarily on a non-related topic which is a ballot proposal to improve the roads in Michigan. If that doesn't get passed I think the legislators are going to be more focused on the budget than energy for maybe the summer. So expected to be done by year-end but it may not be done by the middle of the year. And as far as where the bills are, they are pretty much across the board. The house is full regulation, the bill has been set and the house is full regulation. The Senate has two bills, one is to increase the cap and one is to ensure that the customers who are on retail open access have a one-time shot at going to the market and they can't come back. So when you look at how that is and what I mentioned earlier about where the Governor is, it looks like the top end of this or the worst-case scenario would be 10% with a firm capacity position that they have to disclose to a regulator going forward. And maybe the best case for us would be full regulation but I don't think it would happen all at once and maybe Julian's question kind of related to that is that I think we would see this come back. Tom mentioned we saw a big jump the last time we went through this but it's going to take time. I don't think it's going to be all at once because I believe and I don't have the data for this but the contracts that the third parties enter into with our customers for retail open access probably have a duration of a year or two. So I don't think any legislation would stop those contracts from being in effect.

John, beyond the choice issues where do you think things settle out on renewables and is there going to be a window where the increase renewable standard and you guys have a bigger stake of that or how do you think that part's going to play into the legislation as well?

Yes, I believe this will become part of an Integrated Resource Plan. The trend seems to be leaning towards incorporating it into an IRP rather than mandating a specific percentage. The focus will likely be on establishing a long-term plan, possibly over the next ten years, allowing for adjustments on a multi-year basis as needed. Specifically, considering the significant drop in gas prices over the last five years, if we had created an Integrated Resource Plan a decade ago, gas might not have been a favored option. However, with current gas prices, it is now a preferred choice. Therefore, we need to embrace adaptability, as the Governor emphasizes, in response to evolving technologies and fluctuating commodity prices. This will enable us to amend the long-term plan, secure regulatory agreements, and progress with that type of energy generation. Additionally, it will include renewable energy and energy optimization. The Integrated Resource Plan will address not only supply but also the means of acquiring that supply, the chosen fuel sources, and how we optimize energy usage. I appreciate that this approach will demonstrate the most economically viable plan, ultimately benefiting our customers.

I just wanted to circle back to the commentary on capacity, so I'm looking at page 14. So you're saying you were at less than $0.50 capacity that your forecast is that you're currently expecting to earn around $2 in capacity? Or did you say that you’ve come in based on this new capacity contract ahead of the forecast on this page.

That's right. So when you're looking at the bar that has below it $2.00 that's our old forecast and then on the little box on the right side you'll see near-term. We're looking at numbers around $4.50 and that's our reference to doubling for that similar period. And over the long term we're looking at if you average it over the whole period around $3.30 so that gives you some benchmarks. To your specific question we've got $2.00 in our numbers but you can see we’re about to revise those and go up.

Okay, during what forecast period do we estimate an increase from $2.00 to $4.50 and an average of $3.30?

$4.50 would be near-term, so you're going to look at the next couple of years. In the long term is over a nine-year outlook.

The $8 million you're investing at DIG this year is an unregulated asset. Is that going to be capitalized or will it be considered operating and maintenance expenses?

Just think of that as a regular non-utility business. So the part that’s capitalized is capitalized and the part that’s expense is expense in the project. Just try not to think utility for a minute and it will look very normal that way. The bulk of it candidly is going to be expensed, that goes in for this year but as you can see we have plenty of room to put it in.

So the net impact on '16 is an $18 million swing because you're avoiding that capital expense next year and you're picking up the $10 million?

You can do that math that way but I would caution you not to because remember we're taking the good news this year that's happening unrelated to it to fit it in. So your base didn't change. And then next year yes we had planned to spend about $10 million which we won't need to. But if we've got some head room next year what do you think we will do?

Host a big party for analyst.

What's your second choice Paul?

No, we will find a way as you've grown accustomed to see us get in that growth of earnings of 5% to 7% no matter what. If it's easy or hard and I may as well take the question on before it comes. We've got so much work to do on the reliability side in the utility that I would just tell you there will be a time when we won't and maybe the 5% to 7% will drift up a little bit. Again I would get excited about it because we've got plenty of work to do this year and we will have plenty of work to do next year so it's not in that timeframe that you would likely see us change from our guidance of 5% to 7%.

Assuming the contract you're currently negotiating at DIG comes to fruition, what does the free capacity look like over the next several years that is currently unhedged?

Yes. So we'll be for the '17 to '18 planning year a little over 500 megawatts available. And then a little bit better than that, a little higher than that in other words as you go through time. So that's all upside opportunity.

And this is with the new capacity this will be 750 megawatts total?

Well no, we’re actually making two upgrades and the number you will get used to seeing will be 770 megawatts. We had already planned this and had been quietly working on increasing the capacity at DIG this year. This new increase is news because we just authorized it within our company, and it will add an extra 38 megawatts on top of that. So, going from what you’ve seen at 710 in the past, we will go to 770.

Just one more on the Michigan law, the energy efficiency side of things I think you said that you would support it with the continuation of revenue recovery in incentives. How likely is that from some of the proposals that you're hearing around the legislature, is it expected that that will continue as is or are people talking about potentially changing the element of it?

What we're hearing at least right now is I will call revenue certainty the decoupling seems to be optional for the utilities to choose which is fine with us if we choose to do it or don't. The incentives they haven't really dug into the incentives yet, but the argument I think is pretty strong that we make electricity, we deliver electricity, we sell electricity; we should be incented to help our customers understand why we're not trying to do that with energy optimization. So I have a feeling the incentives that they have worked well for us and I expect those to continue but that may be in a regulatory format rather than a legislative format.

Then on doing some more generally the recent MISO capacity auction obviously cleared low but that's obviously in the near term where you don't see that shortfall yet. Have you seen, you’ve talked a quite a bit about your own contracts but maybe more broadly in the bilateral market have you seen any change in the bidding or the asking since that auction?

I believe this topic can be divided into two parts. Firstly, let me share my observations on the bilateral market. From a capacity perspective, the indication we've provided of $4.50 for the near term is a reasonable reflection of our current position. Many are closely monitoring the developments in energy regulations. The capacity to increase supply and the responsibility for doing so will both be beneficial, but while the policy is still being finalized, there is a sense of unease as people try to determine how we will address the significant gap that will arise next spring when we reduce our coal plants by a third. There is considerable speculation in the markets regarding our future direction. The best estimate I can offer for the bilateral market is around $4.50 for the planning year from spring 2016 to spring 2017. You also raised a different point about the near-term capacity market in MISO, and perhaps John can provide more insight on that.

One of the things that we found is, Andrew, we found pretty revealing as we have talked, we expect the capacity prices to rise in Zone 7 next year when we shut down at least our company shuts down a third of its coal capacity. This year I think the news out of the capacity auction was that capacity prices were low as expected except in Zone 4 for which was the one deregulated state and that was Illinois. And the capacity prices there are 50 times higher than in the generally regulated states of the rest of MISO. So that's an interesting time to see this happen when we haven't seen a lot of the capacity come out of the market. And you can rest assured we’re talking to a lot of people here in Michigan about the risks of the volatility of the deregulated market.

Then one last one, you made it very, very clear that the upside to DIG should not necessarily drive faster than 7% earnings growth and how the sales growth and cost cutting is not what's driving your plan here. Maybe a different way to ask a question is when you look out in the near or medium-term what's your expectation on customer bills? You talked about the gas side but maybe more on the electric side if you do reinvest a lot of the upside from these various drivers into this system without charging customers for it, is it possible that we will see customer bills on the electric side falling over the next several years?

Let me address that since Tom has already covered some of the details. It's essential to recognize that our capital investment plan is based on several key reasons, and if we can't fulfill those reasons, we won't allocate the capital. First, we need to ensure it delivers value to our customers. Second, it helps us lower fuel costs. Third, it decreases operating and maintenance costs. Lastly, if we have environmental commitments—whether mandated by EPA regulations, state laws, or our own initiatives—we make those investments as well. By investing capital, we provide customers with a better environment, lower bills, and improved reliability, which is our goal. In our current five-year plan with the capital investments we've outlined, we expect to keep customer rates below inflation, and this applies to both electric and gas services. With low gas prices, customers are paying rates similar to what they did in 2001. We have significant leeway, and most fuel costs are favorable. Where we are investing in the electric sector, we are witnessing improvements in reliability and customer satisfaction, as well as a reduction in operating and maintenance costs. Over the last eight years, we have seen a 10% decrease in O&M costs, and we anticipate a 7% reduction in the next five years. This figure accounts for inflation and our legacy costs. We are confident that we are investing the right amount of capital to achieve these goals while keeping bills affordable.

Just a follow-up on the last question and commentary, you mentioned the gas retail rates are expected to be flat over the next few years due to lower gas prices and cost controls but yet your goal is to keep rates at or below the rate of inflation so is there upside investment opportunity in that segment that you guys can capture?

Yes. Definitely. When thinking about that Brian it's the cost the base rate our rate of inflation keep it at the rate of inflation but on one of the slides I showed you can see the increase in investment in the capital in the gas business because of the dramatic decline of the natural gas fuel cost, we’re down about 50% in the fuel cost which provided headroom for us or does provide headroom for us to be able to make additional capital investments while still having the customers' overall bill decline.

Does that imply upside to your current capital budget forecast?

There's opportunity there, I think I stated we've got $1 billion on top of that if we choose to but right now that seems like the right level. The one thing that we're a little pushed against is we hired about 625 people in the gas business over the past three years and we're growing those people I think it's going to be a competitive advantage for us to have people that can install pipe, weld pipe going forward in the future. So as those people develop we may be able to put a little more capital into it but one thing about the gas business is that it's not just plug-and-play; it takes a lot of employees to get that done and what you'll find in some areas contractors are getting a little short now because of the influx in capital. So we made a decision a few years ago to move ahead with our own workforce, worked with our union and we added 625 people to do that which will position us well in the future, and so if there was going to increase, think of it incrementally.

Okay. Understood. And then what customer classes are driving for 3% industrial sales growth forecast?

The situation is best understood as a comprehensive overview of the current landscape. If you're asking about what's expected for the remainder of the year, it's important to note that we saw only a 2% increase in industrial sales and a 1.9% increase in the first quarter. Looking ahead, there are customers with programs who will require more power, which should lead to some growth. We’re also observing increases in sectors like building materials, including cement, which align well with the economic trends we’re noticing. Additionally, there’s a slight uptick in high-tech demands, particularly in the silicon and aluminum industries. All these sectors indicate a need for more resources, which we are prepared to provide, and we are already beginning to see a slight increase. Therefore, our projections suggest that industrial growth could exceed 3%, but we prefer to wait for clearer signs before confirming that figure.

Great. Thank you. Thank you for joining us today. We're off to a good start again this year and we look forward to working with you through the rest of the year and we will put this year's first quarter's good weather to good use for our customers and our investors. So thanks for joining us, I appreciate it.