CMS Energy Corporation (CMS) — Q1 2016 Earnings Call Transcript

Good morning everyone and thank you for joining us today. With me are John Russell, President and Chief Executive Officer; Patti Poppe, Senior Vice President of Distribution Operations, Engineering and Transmission and Incoming CEO; and Tom Webb, Executive Vice President and Chief Financial Officer. This presentation contains forward-looking statements which are subject to risks and uncertainties. Please refer to our SEC filings for more information regarding the risks and other factors that could cause our actual results to differ materially. This presentation also includes non-GAAP measures. Reconciliations of these measures to the most directly comparable GAAP measures are included in the appendix and also posted on our website. Now let me turn the call over to John.

Thanks DV. Good morning everyone. Thanks for joining us on our first quarter earnings call. I will begin the presentation with a review of our first quarter and operating performances before turning the call over to Patti to discuss our capital investment plan and cost reduction initiatives. Then, Tom will provide the financial results and outlook, and we will close with Q&A. First quarter earnings were $0.59 per share, down $0.14 from a year ago. Weather was the primary factor. The mild weather that began last October continued through March, resulting in the second warmest winter on record. On a weather-normalized basis, first quarter earnings were up $0.12 or 20% compared to last year and, as you would expect, we've already taken steps to mitigate the unfavorable weather impacts. In time we will talk more about our plans later. But today we are reaffirming our full-year earnings guidance of $1.99 to $2.02 a share. Earlier this month we retired seven coal plants totaling 950MW, bringing our capacity mix to less than 25% coal. Our regular and routine rate case strategy remains on track. Last week the commission approved a gas rate case settlement for $40 million, using the previously approved return on equity when required. We filed an electric rate case on the 1st of March for $225 million and plan to self-implement later this year. We continue to operate with a constructive energy law; the framework allows for fair and timely regulatory treatment. If the law is updated, we see this as being incrementally positive to our customers. With the recent coal plant closures, we are proud of the fact that we have reduced the most coal capacity of any investor-owned utility. The gas-fired Jackson generating station and new wind farms have been added to our portfolio, making our capacity mix more sustainable. Additionally, we continue to offer energy efficiency programs which reduced demand 1% annually. This strategy puts us in a good position to meet future carbon reduction requirements and, as I always enjoy saying, the air is cleaner today in Michigan than it's ever been in my lifetime. Our regulatory track record is among the best in the nation. Over the last five years we have filed gas and electric cases to recover capital investments and pass along O&M savings to our customers. This has been the foundation of our sustainable business model for the past decade. In some years ago, our O&M reductions fully offset our capital investment needs, and we were able to avoid three rate cases. During this time, the ROE has remained unchanged at a competitive 10.3% for gas and electric. The latest gas rate case was the fourth consecutive one that we have settled dating back to 2011. The current energy law in Michigan is working well. It allows us to execute our business plan while making needed infrastructure investments and providing energy savings programs to our customers. However, the law still requires that 99.98% of our customers subsidize about 300 large customers. This is simply not fair. We believe that updates to the law would be beneficial to our customers by securing reliable capacity and reducing rates. This is an opportunity for our legislators and we will work with them on constructive updates. Whether or not the legislators decide to act, we will continue our plan with the current law in place and move to 6% to 8% earnings growth for 2017 and beyond. There are many external factors that can affect our operational and financial results, but we work through everything and work with everyone. We remain focused on delivering the consistent and predictable results that you have come to expect. It has been an honor and a privilege for me to lead the team that has delivered these results over the past six years. I believe the company is better today than it has ever been, both financially and operationally, with a very bright future. Now, let me turn the call over to Patti who will lead the execution of our model.

Thank you, John, for your leadership and all your contributions to our company throughout your career. CMS Energy is significantly better since you became CEO and President, improving by approximately $8 billion under your leadership, which reflects your commitment to leaving things better than you found them. We're optimistic about our future thanks to our capital investment in our gas and electric utility. Over the next decade, we plan to invest $17 billion, which is a 60% increase compared to previous years. Each project is evaluated to ensure it adds value for our customers. This value comes in the form of customer service, cost reduction, increased productivity, and cleaner energy, with many investments improving multiple areas. For instance, our electric infrastructure investments reduce outages, enhancing the customer experience and lowering costs. Our customers can effortlessly activate services online, and due to our smart energy and smart meter upgrades, we can turn on power remotely without dispatching a truck. This streamlines the customer experience and reduces operating costs. Our Smart Energy program exemplifies how major capital investments benefit our customers in terms of service quality and costs. Ongoing savings also stem from proactively replacing old gas lines, mitigating unexpected maintenance costs and disruptions. Upgrading gas compression and utilizing field technology enable a more efficient workforce and fewer unanticipated expenses. As we transition from coal to gas and increase our renewable energy investments, we consistently show our customers that CMS Energy is a responsible steward of our Great Lakes state. This model has proven effective for over a decade, delivering results that will continue into the future with our range of self-funded organic capital projects, complemented by numerous cost reduction opportunities. In a diverse economy, this strategy is particularly effective, especially as we maintain our focus on cost reductions, a strength we have demonstrated year after year. This allows us to create capital expenditure headroom while committing to keeping base rate increases below inflation. Cost reductions remain a vital part of our self-funded model; we include all data without adjusting for inflation or external factors, averaging 3% savings over recent years with a clear plan to achieve another 6% in savings over the next two years. When asked about sustaining our performance, I see great potential. Our total operating and maintenance cost per customer is competitive, yet we still see room for improvement in our distribution metrics, where we're currently in the third quartile. With distribution accounting for a third of our total expenses, opportunities for enhancement abound. For instance, we only achieve plan adherence about 70% of the time at job sites, suggesting potential for improvement in material ordering, equipment availability, and crew alignment. By focusing on waste reduction and enhancing first-time quality and standardization, we can lower expenses. We are initiating a company-wide improvement effort, generating real savings daily. This commitment to first-time quality acts as a value creation strategy, enabling ongoing cost reductions while targeting 6% to 8% EPS growth in the coming years, all while enhancing affordability and customer experience. I see opportunities throughout the company, and we have a strong foundation for developing innovative, cost-effective ways to serve our customers. I feel both realistic and optimistic about our future at CMS. Now, let me hand over the call to Tom.

Thank you, Patti. Thank you everyone for being with us today on this busy day. This is my 54th quarterly call regarding CMS earnings and, as expected, there are no surprises. Our first quarter earnings have decreased by $0.14, which we attribute to the colder winter from last year and the milder weather this year. When adjusting for weather, our 2016 earnings show an increase of $0.12 or 20%. All operations, including the gas and electric utilities, enterprises, as well as interest and others, performed at or better than our plans for 2015. The waterfall chart illustrates the unfavorable comparison between 2016 and 2015 weather. Our operations are performing significantly better than anticipated, which helps counterbalance the weather challenges faced in the first quarter of 2016. Looking back nine months, if we had experienced normal weather, we would be $0.16 ahead of 2015, which was characterized by milder conditions. Ongoing cost reductions keep us on track for earnings per share growth of 5% to 7%. The earnings-per-share forecast curve from last year indicates that we successfully reinvested $38 million back into the business for our customers, primarily due to better-than-expected cost reductions and the cold winter of 2014-2015. Towards the end of the year, we saw the warm winter of 2015-2016 begin, but we fully offset this to achieve our 13th consecutive year of consistent EPS growth at 7%. This slide includes our forecast for EPS growth in 2016, and as mentioned, the adverse weather impact in 2016 has been completely offset. The winter of 2015-2016 was the second warmest recorded. Nonetheless, it hasn't limited our ability to achieve 5% to 7% growth without compromising customer service. For instance, we enhanced cost reductions by adjusting for normal changes due to milder weather, such as fewer uncollectible accounts because customer bills were lower. In late December, with cash flow from 2015 being better than anticipated, we made a pension contribution that improved profits by two cents for 2016. Furthermore, the improvement program correlates to the capitalization of our hardworking initiatives, which is $0.03 better than we planned. We also implemented a new strategy for applying interest rates to determine costs related to pension and healthcare obligations. This adjustment was worth a nickel, enabled by a favorable SEC interpretation of a proposal by AT&T last year. The new PBO weighted application of interest rates reduces volatility and improved our earnings for 2016. Each year of pension obligations is discounted according to its yield curve rate as if it were its own separate pension plan, rather than using an average interest rate across the board. This new method reduces interest costs in the near term while being somewhat offset by higher costs in later years. The benefit is particularly pronounced for our defined benefits program, which we closed about a decade ago. We greatly appreciate lower volatility at CMS. This new method provided a five-cent earnings improvement per share in 2016, helping to alleviate the impact of unusual weather. Our EPS curve over the past couple of years reveals that although every year varies, we consistently achieve 7% EPS growth by effectively managing the business for our customers and investors. Over the past three years, we've reinvested $238 million into enhancements for our customers, with half stemming from favorable weather and the other half from cost savings exceeding our expectations. This is significant: we've reinvested $238 million in O&M for our customers while maintaining 7% earnings growth. Many of you are aware of the recent one-year MISO capacity auction for Zone 7, where capacity costs were set at $2.19 per kilowatt month, significantly lower than the cost of building new facilities. However, this had little direct impact on our business operating out of the Dearborn Industrial Generation facility. The majority of our 2017 contracts were established before the auction, and new contracts finalized by March contributed an additional $50 million to our profitability for 2017, raising our projected profit to $35 million, a nice boost towards our growth guidance of 6% to 8% for the year. We still have external opportunities for 2018 and beyond, with 25% of the big energy and 50% to 90% of capacity available depending on the year. The results from the MISO capacity auction were pushing close to a dollar higher, encouraging bilateral customers to pay a bit more to mitigate their risks. As reflected in our sensitivity table shared each quarter, we are managing risks effectively and have robust mitigation strategies in place. Last month saw Fitch upgrade our utility rating by two notches and our parent rating by one notch. Moody's has also placed both the utility and parent ratings on a positive outlook, which is reassuring as the agencies recognize the strength of our balance sheet and business model. For the year, we have met or exceeded all our financial targets, including investments, cash flow, customer pricing, dividends, and EPS growth. We anticipate another strong performance this year as our business model continues to be effective, self-funding the majority of our capital investments to benefit customers, with minimal rate increases that align with inflation. This model emphasizes decision-making that serves both customers and investors, ensuring sustainability and allowing us to maintain a consistent high-performance track record for almost 15 years. Patti and I look forward to continuing this successful journey together, and John, it's been a pleasure working alongside you for six years on these calls with undoubtedly the best CEO in the business.

Thank you.

Thank you for being a good friend.

Thank you.

I just had a quick question with the legislation having been introduced into the Senate, is there any read through that maybe some common ground has been found with the Chamber of Commerce and the schools?

I believe the introduction of the bill is a positive development. There have been discussions involving the schools and the chamber regarding support for this bill and similar ones from the House. To clarify, the bills that were introduced include two substitute bills in the Senate Energy Committee yesterday, which focus on previously discussed issues. One aspect involves maintaining the 10% cap on retail open access, while requiring suppliers to have firm forward capacity in Michigan. Additionally, any new ROA customer would incur a capacity charge. While achieving a fully regulated entity would be ideal, this approach seems reasonable. Part of the discussion includes an integrated resource plan that allows for pre-approved generation costs and regulatory changes, which should benefit everyone, including us. The chamber needs to determine its position on these matters. Currently, the system in Michigan is unfair, where 300 of our 1.8 million customers benefit, causing 99.98% of our customers to pay 3% to 4% more to subsidize these customers. I believe what is happening is the right approach, and we need to advance the Senate bill and gather as much support as possible. Regarding schools, only a few participate in choice programs, and the majority do not, resulting in higher costs for them as well. Similarly, for the chamber, only a few customers opt for choice, with most paying more. I hope both organizations will support the right direction on this issue.

I also just wanted to sort of touch base on the legislation. When you have a bunch of people who are subsidized, often they can be pretty effective in blocking things and the legislation hasn't been going as quickly as you might have expected earlier. And I'm just wondering any sense about that? I mean you did sort of address it with Paul Ridzon just now, but how do you guys feel about its chances of passing I guess at this point?

You raise a valid point about those who have subsidies wanting to continue them, and if I were in their position, I would want to continue as well. This has been a struggle. The challenge is that it’s not fair to our customers. As we shut down seven coal plants and faced other closures in Michigan, the results of the MISO auction that Tom mentioned indicate that we may be experiencing capacity constraints. If that happens, we will need to combine new supply with energy efficiency and move forward. Investing in the most capital-intensive industry, which deals with the most volatile product, is difficult when there’s uncertainty. I believe that’s what the legislation aims to address, and it seems Senator's main focus is on ensuring reliability and certainty moving forward. I can't predict whether it will pass, but I am fairly confident it will get through the Senate. However, I think it might be more challenging in the House, which we've seen before, so I don't want to make any predictions at this time. If the legislation passes, it would be beneficial, but I want to stress that we are not relying on any changes for our ten-year or five-year plans. Under Patti's leadership, we are growing the business by 6% to 8%, which is fantastic and not dependent on any legislative changes. If there is a change, it would benefit our customers and could provide some advantages for us, yet our main priority is ensuring fairness for our customers. The issues being discussed in Ohio are a clear example of what we want to avoid in Michigan.

And then just on the pension, what's the full-year impact? I mean just the impact going forward on this $0.05 and what have you? I'm sorry to be so slow on it, but I wasn’t particularly clear.

So the $0.05 is the positive impact from the change in how we calculate the interest on pension and healthcare costs. So I don't want that to sound like it's just a first quarter paper thing; that’s the full-year impact. You still have other impacts and things like remember the discount rate still moves up and down so that could change things next year; it could give you a little good news, little bit of bad news. The $0.05 for that change is the full-year effect. In the future, we will remeasure that each year in January, but what we think we have done is taken volatility out of that particular calculation, but you still could have—I’m going to go on the big side of penny or maybe two up or down, but less than what we’ve looked at in the past.

And then just on sales growth, weather adjusted, leap year adjusted, what was it for the quarter?

So our sales on the quarter were flat, but here is what's interesting. When you look at the weather-normalized sales, we actually are showing in our reports, which you can look at attached to the release, that residential and commercial are down about 2%. I will tell you I actually don’t believe that; I don’t think we have weather adjusted year-over-year correctly. Last year the first quarter was very cold and we said our residential and commercial sales were like 2% up. Now we are comparing to that where it was really mild and we’re saying 2% down. What we saw in the second quarter last year was that sort of reversed; it just said oops, your weather calculations aren't too good. I think we probably see that in this year. I hate to dismiss data, but I just don't believe that follow-off in residential and commercial will continue, but I do believe if you look forward think of those as kind of flat. We are not seeing great growth there. It's the industrial side that is interesting; our industrial side was up 5%, and if you take one customer out, we were actually up 9% in the first quarter. So there is a lot of good news in there. The food business was up about 4%, and the plastic sector was up about 4%, transportation up about 7%, packaging up about 10%, and here's something that I really like to see: several of our companies in the building sector were up a lot. The cement side was about 17% so there is a lot going on where we can see the uplift through industrial, but keep in mind we are conservative beasts; we’re still telling you that for the year as we go out we're looking for about 1% growth overall, but I will admit the bulk of that will be on the industrial side.

Could you please provide some insight into your future expectations? We've noticed some improvement in pricing, though it doesn't significantly impact overall results. How do you plan to adjust your expectations moving forward, whether that means maintaining the current approach or altering it? Additionally, how do your existing contracts influence the earnings profile over the coming years? I'll stop there.

Let me take those in a couple of pieces. First of all, we gave you a little bit of good showing that for 2017 the layering, and that’s a good way to think about how these capacity contracts are being put in, a little bit more good news layered in, a little bit more good news layered in with contracts. We are not trying to grab what we think is a peak or rush to anything. We will miss the peak and we will miss the trough, but the layering strategy should give us some good news. So I would say the $35 million number is pretty good for 2017 for the chart we showed you; we still have about 25% of our energy and our capacity available so there are some more upticks that could come from that. Now go to the future. As you look at further in time we have anywhere starting in 2018 out through time and near time 50% to 90% of capacity and still 25% of energy because we have got some nice long-term contracts in place on energy. I don't want to predict how much of the $20 million to $40 million upside will happen, except to say because we layer in, I don't think you should expect the full $40 million. That would be getting to the replacement cost. But on the other hand, I'm not so negative as to say it will only grow by another $20 million. So I think what we're trying to do is give you the zone somewhere in between there that we honestly believe will be achieved depending on the prices and the bilateral demand and what we are able to do as a business.

And to be explicit about your going forward expectations on where these auction results go out, what do you think of these reforms in terms of impacts on pricing?

They are quite complex. Moving forward, MISO will be altering its seasonal auctions to multiyear auctions. I can't predict how that will play out, but we can examine the recent data. The $2.19 per kilowatt month, if the bids are placed correctly along the demand line, stays fairly consistent. With even a slight shift in market demand, it could easily have been over $3. This situation attracts businesses like Tesla and Ferrari, which are looking for ways to manage volatility, willing to pay a premium above the auction prices to safeguard themselves against risks. I see some potential upside from this, and it highlights what John mentioned earlier: the capacity situation for Zone 7 is not very stable. As demand or supply changes, the market could tighten significantly, and while it's difficult to forecast, I suspect that a year from now, the capacity market will be tighter. But that's just my personal view. I'll leave it at that.

And actually that tees pretty well into the next question. I was curious as you think about your portfolio of PPAs including some of the higher-priced PPAs, is there any ability to potentially step in a little bit earlier to try to come to some resolution on bringing down those costs for consumers by extracting yourself from some of those obligations? Specifically Palisade is what I am thinking.

I am shocked. So there is a lot of speculation going on that subject but all I can tell you that’s the sort of thing that we just don't want to comment on. So I just like to leave that open to see what happens. It's very important that the owners control that so we don't want to do any speculation. I hope you will appreciate that.

All right. Let me close it out. First of all, thank you for joining us today. As Tom said, I know it is a very busy reporting day, and this will be a quick call. Also, I want to thank all of you that are on the line right now for all of your help, support, and I will miss all of you as my tenure and as CEO, and Patti will head up and Tom will head up the next call without me. So my thanks to all of you. It has been a great run, and the company is in great hands moving forward. So thank you.