CMS Energy Corporation (CMS) — Q3 2016 Earnings Call Transcript

Good morning and thank you for joining us today. With me are Patti Poppe, President and Chief Executive Officer; 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. Reconciliation of these measures to most directly comparable GAAP measures are included in the appendix and posted on our website. Now I'll turn the call over to Patti.

Thanks, Sri. Good morning, everyone; thanks for joining us on our third quarter earnings call. For those of you who have not yet met Sri, he is our new Treasurer and Vice President of IR. Sri has been with CMS for a couple of years and we're excited to have him in his new role. I'll begin the presentation with an update to earnings and describe our simple but powerful model. Tom will then provide the detailed financial results and outlook, and we'll finish with some Q&A. We're happy to report adjusted earnings for the first three quarters are up $0.22, and we have narrowed our guidance to the high end of our forecasted range of $2 to $2.02 or 6% to 7% over last year's performance. As a reminder, we previously announced our long-term adjusted EPS guidance of 6% to 8%, and we're introducing today specific 2017 earnings guidance of $2.13 to $2.17 a share. It was a strong quarter, and that sets us up for a strong finish to 2016. That strong finish will be led by our continued implementation of the Consumers Energy way. We're proud of our consistent financial performance. My coworkers are motivated to serve our families, friends, and neighbors. There are many times, however, when those same coworkers, in spite of their best efforts, are unable to serve our customers to our desired standard. Many of our processes are burdened with waste that goes unchecked, and the CE way is simply a lean operations model focused squarely on business results through customer-focused standards, implemented by enabled employees working within well-designed and standard processes in a mindset that every day there's an opportunity for continuous improvement. Completing our work safely with high quality, low cost, and on time will deliver the same consistent results for customers and investors that we have had for over a decade. As a result of our efforts, I am more confident than ever in our ability to deliver our simple but powerful model. We have depth in our organic capital plan. I have yet to attend a meeting where we have trouble identifying opportunities to invest. We have a long shopping list with many investments that improve safety, reliability, affordability, and our customers' experience. Nothing new here. We will tackle the structural costs with these smart investments, good business decision-making, and continuous process improvement. We plan conservatively for sales growth, and we don't dilute our earnings per equity. All of this adds up to a sustainable model that enables investment while keeping our rates affordable. Like I said, our shopping list is long, and we're not making any big bets to fill out the plan. We have a large electric distribution system. It's made up of over 70,000 miles of conductor and 1200 substations that all need to be upgraded and maintained. We have a lot of work to do just to modernize our grid, starting with completing our electric smart meter installations in 2017. We continue to increase our gas investments. I'd like to remind people that we have a great gas business, where smart investments yield real returns for our customers. We still have to say no to projects because we can't spend more than our customers can afford. Our generation fleet continues to evolve in small bites, with incremental renewables, capacity upgrades, and coal to gas conversions. These are all small bets that add real value, cost savings, cleaner energy, and reliability for our customers. Future PPA replacements could even potentially allow for additional investment without affecting customers' bills. The ability to pay is always our limiting factor, which is why we're so focused on sustainable and structural cost reductions. It is not easy to be the leader of the pack on cost reduction year over year over year; however, that is our ambition. Let me remind you that many of our previous decisions were structural, permanent, and have many years of favorable impact. For example, our conversion to defined contribution plans significantly reduced our long-term liabilities. Each year, as my coworkers retire and are replaced by a new workforce, we save about 1.6% of the previous year's O&M before we tackle a single work process improvement with the CE way. We have a lot more gas pedal in waste elimination that results in real cost savings. Those cost savings then allow us to focus on making our prices competitive so that we can continue to be part of the Michigan growth story. We're seeing positive momentum, cooperation, and success stories related to our customers' growth and economic development in our service territory. We're bullish on Michigan. The more we improve our business model, the more companies and their employees will choose Michigan as a place to locate or grow their businesses. And the stats don't lie. Michigan is growing faster than the U.S. average. Grand Rapids, the heart of our electric territory, is going faster than the Michigan average. We feel great about being part of that success today and into the future. And still, we plan conservatively for load growth. As we continue to maximize customer value with a strong investment portfolio to drive waste out of our operations and to let customer affordability be our throttle, we will continue to deliver high-end and quality earnings growth. Our constructive relationships with our state policymakers, legislators, and regulators are based on keeping our promise to perform and to care for our customers and communities. Performance is power. When we perform at best-in-class levels, we can earn the trust and admiration and deliver hometown service for our customers. Day in and day out, you and our customers can count on us. Now I'll turn the call over to Tom.

Thanks, Patti. Third quarter results, at $0.67, were up $0.14 compared with a year ago. Adjusted to exclude the cost of our voluntary separation program, results were $0.70, or up $0.17. In either case, this is substantially better than our original plan, even as it reflects meaningful O&M reinvestment permitted by cost reductions ahead of plan and the warm, muggy summer. Now for the first nine months overall, our GAAP earnings were $1.70 per share, up $0.19 from last year. Adjusted for the VSP cost, results were $1.73, up $0.22, or 23% on a weather-normalized basis. As you can see here again, our performance in the first nine months is $0.22 better than last year. Adverse weather hurt $0.10. We blew away our 5% to 7% EPS growth target, growing more than 10%, including the mild winter weather. Improvements included benefit savings, lower uncollectible accounts, cold plant closures, hole-top hardening, higher demand, and productivity at dig, to name just a few of the areas. Looking ahead into the fourth quarter, if the weather is just normal, we will accomplish a nice uptick of $0.13 compared with 2015. And as you know, we already have a head start on the fourth quarter, with cost reductions well ahead of plan. We also have an electric rate case underway, and that was self-implemented at $170 million on September 1. We filed a gas rate case last August which will support 2017. We have plenty of room for reinvesting O&M for our customers this year and we raised our 2016 guidance to the high end of our 5% to 7% range. This has become an investor-favorite slide, where we show our projected earnings per share growth for the full year, and this is as the year progresses. During the first quarter, mild winter weather and abnormal storms reduced earnings per share by $0.13, but in a very short period of time, we were right back on track for our adjusted earnings growth at 5% to 7%. You can see the improvements that offset the abnormal weather with no impact on customers. We're well ahead of our guidance, and as always, are putting the upside to work for customers by improving reliability, pulling ahead work from next year, as well as pre-funding debt maturities. We will deliver consistent, peer-leading earnings per share growth. We beat guidance and delivered 7% adjusted earnings growth for almost 15 years. Here is a picture of that track record. It shows how we consistently offset bad news and put good news to use for our customers without compromising predictable earnings growth of 7% each and every year. Over the last three years, favorable weather and cost reductions in excess of our plan generated room to reinvest $0.25 billion for our customers. That’s a big number. We put these savings to work in many beneficial ways. By this year, we're 20% ahead of our plan. Our customers and investors really will benefit. In addition to our cost performance, our conservative view of sales growth, and our ability to avoid diluted equities, we still have other attractive upsides. As you can see in this slide, continued layering in of energy and capacity sales could enable us to increase our profitability by $20 million to $40 million at our Dearborn industrial generation operations. Recent capacity sales have exceeded $4 a kilowatt month. This is a nice insurance policy for our utility if it needs more capacity and a catalyst for new growth. To help you with your own assessment of our future performance, here is our standard profit and cash flow sensitivity slide. Recall the impacts from many legislative changes are not in our plan. Interest rate shifts, up or down, largely offset at our Company as changes in debt cost offset changes in discount rates on our pension plans. We believe in no big bets and strong risk mitigation. Here is our report card. For 2016, we're right on course to achieve our plans for capital investment, a high-quality balance sheet, competitive customer prices, a robust dividend payout, and strong operating cash flow. We're well ahead of our adjusted earnings per share growth in the 5% to 7% range, therefore, we raised guidance to the high end. We have introduced specific guidance for 2017 at $2.13 to $2.17, up 6% to 8% for this year. Count on another strong year, our 15th in a row, with high-end predictable earnings, cash flow, and dividend growth. This is my 57th CMS quarterly call in a row, maybe my voice is wearing out, but I have been sharing with you the results of a great team delivering consistent industry-leading earnings per share growth for over 14 years. We intend to continue this next year and for a long time. Our earnings and dividend growth continue at a predictable high pace every year, no matter what is happening in the economy, the weather, politics or succession planning. Thank you for your interest and your support. Patti and I would be delighted to take your questions. So Tracy, would you be kind enough to open the telephone lines? Thank you.

It's Julien. Just a couple of questions, can you go over a little bit of what the pull forward poor opportunities for the $0.15 you kind of delayed here. Just give us a little bit of the flavor of each one of those in terms of what they mean in terms of the timing perspective recognition in '17 onward and then I have a follow-up in some policies.

Absolutely. What Julien is talking about, if you have all the slides handy, it was slide number 12. The slide I called an investor favorite, I know it's my favorite. I just got that curve in it with the little blue box in it, that blue box in terms of what are some of the pull aheads. Those are traditional things that we do; if we can take work from next year and pull it into this year, it makes the job we have to do next year easier. Some examples are there are some small outages that we are able to pull ahead, a little bit of tree trimming got pulled ahead during the course of the year, things that improve reliability and help us be a better company for our customers. The next item listed there is called debt pre-funding. I think everybody knows we're cautious that we go out and pre-fund our parent debt at least two years in advance to ensure that if there was a nightmarish scenario of 2007 or 2008 proportions, we would not have any exposure in the capital markets. This is simply pulling ahead some debt that will mature, potentially when it's economic, doing a little more financing for that. It's a little bit of bad news for this year, so it's one of those choices that helps you in the next year or two. There is a list at the bottom that talks about operations and quality. There are many things that we can do to be better for our customers that aren't necessarily in our rate cases and not necessarily in our basic plans, but we will do those. I will just give you one example; Patti has talked and I have talked about the Consumers Energy way. Sometimes, it takes a little bit of money to bring in the talent to help you make these changes in your processes to implement better ways of doing things. This gives us a little more resource to do this work even sooner than planned so that we can get ahead of the game that improves on our quality, delivery, cost, and makes us a healthier, better company for you, but more importantly, for our customers. The last is about how much money we can put into our company foundation and to low-income funds to help customers and the people of Michigan. In some years, even though we have been strained, where we have a very big storm at the end of the year, we may not have as many resources to put towards that, but other years we have an opportunity to catch up a little bit and put more money into the foundation. That gives you a little bit of sense on the things we are able to adjust in order to influence growth in the 6% to 8% zone, which is an important commitment for us.

Absolutely. Just real quickly, can you elaborate a little bit on what your thoughts and expectations coming out of this Michigan deal are? Certainly, we heard from your peers yesterday, but we want to get your view and specifically can you comment on what kind of rate, what's the ballpark, and to the extent that the rate may be higher than what you are seeing out there in MISO capacity. Would that also bode well for your pricing on your big assets, at least the ones folks might want to contract with local merchant assets instead of paying the capacity charge under that construct?

There are a lot of things in-flight with the MISO filing and what the implications are. So I'll try to break it down a little bit and then answer your question completely. First of all, MISO is filing for somewhere around November 1. This opportunity for a three-year forward-looking auction is important for Michigan given our hybrid regulatory construct. Their filing has a provision for a prevailing state compensation mechanism, which the State works with MISO to establish in order for the state to have an alternative in the event that a forward auction shows a shortfall. In that case, it would default to a point that would set the price. So to your question on prices, yes, capacity prices would go up with the auction, but if Michigan faces a shortfall, they implement a mechanism which requires alternative energy suppliers to show that they have contracted capacity for the subsequent three planning years, and then their customers pay a capacity charge that the regulators will have the authority to set. This protects our bundled customers because we know that we will have adequate supply to serve our customers. Let Tom address the implications for DIG related to that MISO auction.

Naturally, the more people have to turn to find those resources, they can’t get a free ride. They must secure their capacity, and there are only so many places to get capacity in zone seven and nearby zones. This could help in and fits in with why we set this layering in strategy. We try not to be too greedy, thinking that if we stay out of capacity markets, we can get everything at peak price. We're trying to layer it in. Recently, we layered in a little more good news, where we did some capacity sales above $4 a kilowatt month; that is an opportunity. But don't forget, DIG can also be a backup to our own utility needs for capacity, which is another reason we haven’t committed all of it so far.

Julien, I would just add one more implication for the utility in the event of this implementation. If the alternative energy supplier can't secure additional capacity, then it defaults to the utility, and the regulators can direct the utility to build out that capacity, and those charges will be assigned to the alternative energy suppliers. The timing of all this; the filing for MISO is in November of this year. We think there won't be a final ruling from FERC until 2017, which implies that it won’t be available at the earliest until the 2018 auction for the 20/21/22 planning years. So there is a lot of time and many changes that can happen. I will reiterate that our CapEx forward plans do not require this MISO provision to be in place. Our plans are solid with or without either the energy law or the MISO tariff approval.

So just to be clear, your base plan and the growth rate don’t necessarily rely on or expect significant improvement in financial performance as DIG. So when I look at slide 14, did the potential theoretical expansion in revenues not necessarily enable you to achieve your growth targets, correct?

It definitely is not. What you see in yellow on that slide shows all the ability to create more headroom. We do not need any of that to meet our growth targets starting next year at 6% to 8%.

Great. Can I go a little further afield and ask a question regarding the Palisades nuclear contract? It strikes me that at the time the contract was signed, power prices were at a totally different level than they are today. It seems like MISO power prices are lower than what you are going to pay for the power from that asset. Is there a theoretical scenario where it would be in the best interest of the customers to restructure or buy out that contract?

You are always very good with your analysis, but this is a subject that we can't discuss today, and I hope you can appreciate that.

Looking at the weather-normalized electric sales through the nine months, it appears they are up 0.5%. Does the 1% target for the year still look good? Or what should we be assuming now for the year?

Real good, it really does look good. I know you can see the pieces. When you look at the pieces, I call residential up 0.5 point, commercial down 0.5 point for the year to date September. I call that flat. I just wash those out. Even though net, those numbers were positive to earnings. You’ll see the industrial side is up about 2%. We see good information flowing through production plans for the rest of the year. We are quite comfortable assuming that residential and commercial will still be flat. We are not going to predict 0.1 or 0.2 or 0.3 up or down, either way. We still think the industrial side is going to be up about 2.5%, giving us a good 1% growth.

Separately, when you benchmark your costs versus your peer group, where do you think you are? Are you in the top quartile, the second quartile?

Yes, I would say, Ali, in total costs, we are in the top quartile. The structural changes we've made place us in that position. However, the big opportunity is in our distribution operations, where both gas and electric are still in the middle of the pack. Our pursuit of both a great customer experience and low cost structure is where we feel a lot of our headroom exists. That's why we're working hard on process improvements.

I see. Last question. Regarding the investment recovery mechanism, previously the staff and the Commission have not been supportive of that. Any sign that this time around they are thinking differently?

We have had good fortune with our gas-enhanced infrastructure replacement program, which is essentially an investment recovery mechanism on our gas business. I think that has earned some trust and respect with the Commission. They seem more open to it. Their bigger concern is infrastructure reliability in the state post-Flint. The Commission is adamant that they will not allow another infrastructure crisis related to the utilities, making the conditions more amenable for these investment recovery mechanisms. They do prefer annual rate cases to see and share cost savings, so I think it is an opportunity to grow investment recovery mechanisms, but not necessarily a flat rider on capital where we don't have to go in for rate cases.

I was wondering, when you talk about the play between the cost savings that you guys are realizing in a big way and being able to keep customer bills either low or from rising faster, I wonder if you could give a sense of how much of that cost savings you are seeing right now, that $0.32 from the nine months or even the future cost savings would go back to that customer, i.e., through lower bills or through slower rising bills?

100%. Here’s the point behind that. In the short period where we might have a cost reduction this year that clearly impacts our business and results, we look for those annual rate cases that Patti discussed. It's key to collect on the capital investment for our customers, but it’s also our mechanism to return that money with O&M cost reductions. The lag is just from the time until the next rate case. We aim to keep base rates growth around or below the rate of inflation, lets say 2%. If we can stay under that 2%, it means our base rates are effectively going down in real terms. That is our goal, and we are constantly doing that work.

Yes, absolutely.

Can you give your view of what is happening in the legislature and what we can expect before year end?

You bet. As I am sure you have seen in the press recently, the Michigan Chamber has now endorsed the bill package, allowing for more momentum. There has been a compromise on the renewable portfolio standard at 15% for 2021 which has brought more Democrats on board, creating quite a bit of momentum. However, we have seen momentum before, so we are cautiously optimistic. Arlan Meekhof, the Majority Senate Leader, and Mike Nofs, the Energy Chair out of the Senate, are working hard toward a vote post-election. With the proper momentum and a good vote count, they might take that vote and potentially move it into the House. There are many factors that would need to come together. With bipartisan support and the assistance of the Michigan Chamber, it is more likely than ever, but I still put odds around 50-50 that it gets done before year end. Our plan doesn't require this law, but we think it is good policy for Michigan. It's important for energy resources to be transparent and allocate costs fairly for new and additional capacities.

And have all the compromises that have been made vetted with the governor and is he still okay with it?

Yes, the administration has been very supportive. They are concerned about resource adequacy in Michigan, particularly for the power provided by alternative energy suppliers. They have frustration regarding the transparency of the source of that power. The administration, the Commission, and the utilities want to ensure transparency and adequate supply for the whole state. We know we have adequate supply for our customers, and we want to make sure that the alternative energy suppliers also have adequate supply for their customers.

Most of my questions have been asked and answered. But, I am just curious regarding Senate Bill 437 that was just referenced, will that change your capital budget, either by size or by mix of investments?

We don't think so. Our CapEx plan continues to emphasize smaller investments. We want to ensure we're building for necessary load and maintaining a diverse portfolio that can adjust as load shifts, allowing us to make quicker, smaller bets rather than long-term big bets. Nothing in the provisions of the law would change that strategy.

What was the reason you can't discuss Palisades?

Usually when you make a no comment answer, that's it. It is simply one of those subjects that we cannot discuss.

And then, on a bigger picture, if the Palisades contract was ceased, how many megawatts would that be?

I think about 800 megawatts.

One of the opportunities would be to replace that power with your own generation? Or with a DIG or what would be the strategy and opportunity for CMS?

It’s an exciting time because we have many smaller-bet options that can provide for a diverse portfolio for serving our customers. This also frees up investment room in our electric distribution system and our gas business where we have significant requirements. Our strategy allows us to balance our approach currently.

I just wanted to follow up on the MISO capacity scheme. If an alternative energy provider doesn't buy capacity on its own, would they be assessed the capacity charge for buying it from you or other utilities?

It would work as a charge assessed to the customer of the alternative energy supplier, not the energy supplier themselves.

Okay, that answers my question. And the second question is regarding the transmission discussion with MISO and the governor about bringing in Canadian power to Michigan as a means of lowering prices. Do you have any thoughts on that?

The MISO study requested by the state has several components, including the feasibility of connecting the Upper Peninsula to Sault Ste. Marie and Ontario. They are looking at various ways to better serve the Upper Peninsula. We participate by providing energy expertise and insights, but the MISO study will help frame the situation. When complete, we will look at the available options.

I recently saw someone's planning a large gas plant in Michigan right on the Indiana border. Do you have any thoughts on that?

I don't know who you’re talking about, but people are constantly exploring where to build. Without specifics, I will verify after the call and share relevant information if we find any substance regarding that.

Great, thank you. Thanks for listening to our call today, everyone. We appreciate your interest and definitely appreciate your ownership. Tom and I look forward to seeing many of you at EEI in just a couple of weeks.