CMS Energy Corporation (CMS) — Q3 2017 Earnings Call Transcript

Good morning and thank you for joining us today. With me are Patti Poppe, President and Chief Executive Officer; and Rejji Hayes, 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 posted on our website. Now I will turn the call over to Patti.

Thank you, Sri. Good morning, everyone. We are happy to have you with us. I know that we saw many of you at our Investor Day on September 25th and we'll see many of you at EEI, so I'll be brief this morning. But we do have a few updates to share, including our results for the quarter, and not to worry, we have another exciting story of the month. Rejji will walk you through the financial results and our outlook. We're happy to announce that for the first nine months of 2017 we reported $1.66 of adjusted EPS. On a weather normalized basis, this is up 8% from last year. Despite challenging weather and storms throughout the year, we are well on track to meet our guidance, and we're raising the bottom end of our full-year guidance from $2.14 to $2.15 per share. Our top end remains unchanged at $2.18 per share. We're also introducing 2018 full-year guidance of $2.29 to $2.33 per share, which implies another year of 6% to 8% annual growth. Now this is a good opportunity for me to remind you what we mean when we say 6% to 8%. For 14 years in a row, we have delivered 7%, so it would be easy to assume that when we moved from 5% to 7% to 6% to 8% we meant to imply 8%. What we actually signaled is our confidence in 7%, and frankly, we took 5% off the table. Our self-funding model and our adaptability under a variety of changing conditions each year puts us in a unique position to deliver sustainable 6% to 8% annual growth. This is why we have confidence in the midpoint of our range. In years where we have particularly strong performance and don't have higher priorities for reinvestment, we could go to the high end. However, our bias is to reinvest in the business and to stack the deck for next year and deliver our growth trajectory for longer. We know it is both our growth rate and the consistency of it that is valued. To that end, we remain unwavering in our commitment to the triple bottom line. Our focus on people, planet, and profit, underpinned by our performance, will deliver the consistent and sustainable results that you have come to expect. When we say people, we are referring to our customers, our co-workers, our communities, and of course, our investors. Driving economic development in Michigan is a great way to enable growth and to serve the people of Michigan. We know that when Michigan wins, our business wins. It’s a competitive environment and these large site selection efforts and Michigan is winning. In part, due to the speed of our in-house economic development team which has identified 23 energy-ready sites so that when a company wants to locate here we can quickly help them find a site that's available and best suited to their needs. For example, we were pleased that when Lear Corporation, a large auto supplier, was looking for a place to locate a new manufacturing facility, we were ready. As a result, Lear recently announced plans to invest in a new plant in Flint, a community we are proud to serve. This is another win for Michigan, creating approximately 450 new jobs. Turning to the planet, we're thrilled with the response to our renewable tariff. This program allows us to partner with our large business customers to meet their commitment to renewable energy at a very competitive price. We're already looking for ways to expand this program to keep up with our customers' demand and partner with them to protect the planet. Finally, our commitment to people and the planet can't be fulfilled without the critical capital that you all have provided. We know that pensioners, retirees, and individuals have entrusted you with their life savings to invest in safe and reliable places. We want you to count on us to be just that sort of place. Therefore, we are equally committed to delivering consistent and predictable financial results. We continue to progress on the regulatory agenda and look for ways to support longer-term planning. The 2016 energy law creates a framework for the governor's long-term energy plan and our commission has been systematically implementing the different elements of it. For example, we'll be filing our integrated resource plan required by the new law next year. Combined with the commission's ordered 5-year electric distribution plan, we'll be providing a vivid picture of future replacements, upgrades, and enhancements to our large and aging electric supply and distribution system in partnership with the commission and its staff, yielding more transparency and regulatory certainty going forward. Our rate cases remain on track. Our gas rate case was approved at $29 million and it included an expanded $18 million capital tracking mechanism. We plan to file our upcoming gas case in the next couple of weeks. Our new electric rates were self-implemented at $130 million on October 1st. We expect a final order in March of 2018. These rate cases enable the infrastructure improvement that delivers real value to our customers and reflect the cost savings that help reduce the price of that infrastructure. One way we are driving our ongoing cost savings is through the implementation of the Consumers Energy Way, our lean operating system. Most of the coverage about the Consumers Energy Way has been about the benefits of those cost savings. My story for this month, however, demonstrates the power of the CE Way to not only reduce costs through waste elimination, but also to enable better system performance and areas like electric reliability to the benefit of our customers. You know, we've been in business for 130 years, and yet, we still find things we can improve every single day. About a year ago, we realized that our approach to improving reliability was just not working as fast as we wanted, so we stepped back and leveraged our CE Way playbook; we tackled the systemic issue in a whole new way. The results speak for themselves. In spite of challenging weather and storm activity, we had our best system reliability ever recorded this quarter. Our talented team tackled the problem through the use of data and applied problem-solving techniques, and as a result, we improved the prioritization of capital investments on our worst-performing circuits, which we actually call our Dirty Thirty. We had more targeted tree trimming and realized that we could effectively engineer animal mitigation at our substations. Yes, the CE Way even helps us protect our local wildlife. This coordinated effort resulted in a 40% improvement in reliability for this quarter versus our last 10-year average. Every dollar we spend is more effective. The waste is eliminated, and our customers have a better experience. I am sure this sounds simplistic, but when we apply the CE Way every day all across our system in big and small ways, we fuel our simple but powerful business model, which is higher value at lower cost, built on our consistent past and yielding a sustainable future that you and your clients can count on. Now I'll turn the call over to Rejji.

Thank you, Patti, and good morning everyone. We know how busy this time of the year is for the investment community, and as such, we greatly appreciate your interest in our company. As posted earlier this morning, we reported $0.61 earnings per share on a GAAP basis for the third quarter and $0.62 per share on an adjusted basis. Our third-quarter results are down $0.08 from last year, largely due to continued mild weather. However, on a weather-normalized basis, adjusted EPS for the quarter was up 7% year-over-year. Year-to-date, we reported per-share earnings per share of $1.65 on a GAAP basis and $1.66 on an adjusted basis, which is down $0.07 from the prior year due to mild weather and significant storm activity, but up 8% year-over-year on a weather-normalized basis. We remain quite pleased with our performance to date, which is $0.16 per share ahead of plan, largely due to favorable sales mix and strong cost performance. We're well on track to meet our annual financial objectives, and as a result, as Patti highlighted, we decided to raise the low end of our 2017 EPS guidance range, so our revised range is now $2.15 to $2.18 per share. As you can see on the waterfall chart on Slide eight, weather and storms have negatively impacted our year-to-date results by $0.24 per share. As noted, we have largely offset those impacts through strong cost performance and a favorable sales mix, coupled with rate relief and our performance at enterprises, which positions us well for the fourth quarter. As we look ahead to the remainder of the year, you'll note that the regulatory outcomes achieved this year, including the aforementioned electric rate case self-implementation of $130 million provided $0.08 of pickup relative to last year, which gets us over a third of the way home. As we've discussed in the past, in the fourth quarter of 2016, we took on a number of discretionary reinvestment activities which equated to $0.14 per share in aggregate that we do not need to replicate this year. But some of those two factors alone put us within the implied range for required EPS outperformance versus Q4 of 2016 to meet our revised 2017 EPS guidance range. Consequently, we have a great deal of optionality in the final months of the year to manage weather uncertainty and/or reinvestment in the business to support our future financial and operational objectives. Our 2017 EPS outlook curve on Slide nine embodies our efforts to date, and the good financial flexibility that we have going into the fourth quarter. As you'll note, weather and storms have affected us in every quarter this year. And every quarter, we've responded with sound operational and financial planning to stay on course to meet our financial objectives while delivering a world-class customer experience. As mentioned, favorable sales mix has been helpful to date, and we have supplemented that with strong cost performance, including lower than planned financing costs, higher energy efficiency incentives, and strong property and income tax planning. As always, every year offers varying levels of uncertainty such as weather and storm activity, but we have always managed to work and driven cost savings to position ourselves well to deliver another year of consistent financial performance. As Patti noted, our bias is to reinvest in the business, to stack the deck for the next year, and we are cautiously optimistic about our ability to do so again this year. In order to stay on this path over the long term, we remain focused on executing on our capital plan utility going forward while self-funding roughly 70% of that rate-based growth. This approach minimizes customer rate impact and allows us to grow at 6% to 8% annually. This simple, but unique, business model has driven our historical success and offers a sustainable plan to deliver the triple bottom line in the years to come. At our Investor Day, we highlighted the current customer investment plan at $18 billion over 10 years. We also reiterated the incremental $7 billion of customer investment opportunities which are evenly split between infrastructure and supply investments. We have a relatively large and old system, and our proposed investments would improve system reliability and safety to the benefit of our customers and investors. We will look to execute on these incremental opportunities over time, assuming we can continue to identify cost savings opportunities to fund such investments. As we've said in the past, our key constraint is customer affordability and we do not intend to compromise that principle going forward. To that end, in order to fund our robust capital plan, we will continue to identify savings opportunities within our cost structure. We've emphasized operational and maintenance as a key component of our cost reduction strategy in the past and we'll continue to do so. But operational and maintenance only represents about $1 billion of roughly $5 billion cost structure, so we don't limit our thinking to just operational and maintenance. For example, future expirations of above market Power Purchase Agreements will reduce fuel and power supply costs, and our clean and lean capital investment philosophy will prioritize modular investments to reduce costs and allow us to adapt to changing load patterns. Through the CE Way, we will identify process improvements and efficiencies to eliminate waste and we'll couple that with good business decisions such as attrition management to reduce future operational and maintenance costs. We will also always seek opportunistic, non-operating savings on our balance sheet or through good tax planning to supplement our operational efforts as we've done for the past several years. These are just a few examples that would enable us to reduce costs well into the future for our customers and create headroom for future investments. Moving to operating cash flow, we have generated approximately $1.2 billion year-to-date and we feel good about our ability to deliver approximately $1.65 billion for the full year with steady growth thereafter. As a reminder, our cash flow generation coupled with strong tax planning will enable us to fund our capital plan cost-efficiently by avoiding black equity issuances. On Slide 14, we show our historical EPS trajectory for the past few years and where we're headed. And it should come as no surprise that our guidance is consistent with the past and reflects our long-term growth aspirations. As we've done in the past, we've raised the bottom end of this year's guidance and initiated next year's base in the midpoint. As you know, we grow up our actual results without adjusting for things like weather, or rebasing off a prior midpoint. Needless to say, we've been on the steady climb for more than a decade and we plan to continue to deliver well into the future. In closing, as we look ahead, we see a number of customer investments and cost reduction opportunities that will enable us to continue to deliver the triple bottom line of people, planet, and profit underpinned by performance. And with that, we would like to open it up for Q&A.

Hey good morning. Congrats on impressive results given the weather and everything.

Good morning, Julien.

Good morning.

Excellent. So a quick question, perhaps starting a little bit bigger picture here. You talked about the IRP coming up here, you also have in your slides talk of a kind of a gradual coal evolution in the plan and ops of 21% to 15%. Can you talk about how the IRP might reconcile against the Slide 15 here and what you talked about in terms of future coal capacity in the portfolio?

Yes, it actually will provide a lot of visibility to that, Julien. We're really excited about having the IRP available to us. It provides a framework and certainly so as we make those long-term transitions, we are able to have alignment with our commissions and make good decisions together about balancing a variety of factors; fuel diversity, cost for customers, how we want to fulfill the RPS standards, how much energy efficiency and demand response we want. In fact, our IRP looks like it's going to have 47 different model runs that we're undertaking right now, as we speak. And so it's a complex set of variables and we're excited about what the opportunities will be provided and the transparency and frankly regulatory certainty that will be a result of it.

Got it. If I can delve... oh sorry, please go for it Rejji.

Julien, this is Rejji. The only thing I would add is, as you look at Slide 15 and that coal capacity from 21% to 15%, one of the underlying assumptions is the conversion of the Filer City plant at enterprises. And so we're planning to convert that from coal to natural gas, so basically going from 60 megawatts of coal to about 225 megawatts of natural gas. That is in the regulatory process and it's trending well. So that is one component of the road to get from 21% to 15%.

Got it. Can you elaborate a little bit just on what the timing of that transition is as well, and how you think about that? And maybe perhaps, So you can tell what may not necessarily be finalized, what the key variable you all are thinking about in that transition there?

Yes, I would say the timing is over the 10-year period we are considering for these transitions. With 22% of our energy coming from coal, we are already among the lowest in the country, and we feel good about that. Maintaining fuel diversity at our sites is a key aspect of our strategy, which we will incorporate into our planning. We anticipate the results of our modeling will help us determine the optimal timing for utilizing or transitioning those plants. We have already made several environmental upgrades at those facilities, equipping them with best-in-class environmental controls. Therefore, rushing any additional retirements may not be necessary, although there is a natural end-of-life for those plants within the cycle. We will consider this in our Integrated Resource Plan and engage with all our key stakeholders, both internal and external.

And just a quick one on the numbers here, obviously, you've done very well on cost management and some of the recovery factors on slide 9 there again this year. Since you've launched 2018 guidance, might you be able to elaborate a little bit on some of the key factors we should be thinking about in the year-over-year comparison in that range? What are perhaps some of the known variables that you might be thinking about or leveraged, as we say, in cost management next year? Is there anything that you can kind of say today that we should be paying attention to as we think about that plan?

Yes, so we offer a couple of thoughts. And so when we talk about particularly operational and maintenance cost-reduction opportunities, we've talked in the past about the very nice annuity that we've gotten through attrition management over the years. And so that has been something that we've said has been a benefit in the past and should be an ongoing benefit in the years to come. So specifically on average, we've got about 350 to 400 employees who turn over, who are on defined benefit plans, which obviously are not as cost-effective as defined contribution plans and we froze those plans in their early thoughts. And so now when we have new employees come in, by definition they are on defined contribution plans. We generally save about $40,000 per FTE when we have turnover between defined benefit plan employees and then defined contribution plan employees coming in. And so if you have $40,000 of savings per FTE and you turnover about 400 employees per year, that generates about $16 million of savings per year. And you think about our cost structure on the operational and maintenance side of about $1 billion, that's about 1.5% savings. That gets us a good portion of the way there. Obviously, we always look to do opportunistic refinancings and so we do have some high coupon bonds in our portfolio that we may look to be opportunistic around. And so that introduces opportunities for savings. And clearly, as mentioned before, we are always looking at tax planning opportunities on the property tax or income tax side. So there's a variety of opportunities we look for. And then also as I mentioned, because we're in reinvestment mode for the fourth quarter, this is the time of the year where we look for pull-aheads and if there are operational-related expenses that we have currently forecasted in 2018 that we can pull forward because we're trending well this year, we'll look to do that as well. So that's a small list of the opportunities that we have before us, Julien.

And Julien, I'll add just a couple more points to emphasize that there are plenty of opportunities. The CE Way is taking shape, and we are discovering operational savings throughout the organization. Our adoption of technology, transitioning from traditional phone calls to digital channels, represents fundamental cost savings and reductions. What you are hearing from Rejji and me, as well as from everyone on the call, is that we have the luxury of focus. Our business model is straightforward; we are not making significant bets on large outcomes but rather engaging in a series of small, focused efforts that enable us to deliver consistently. Consistency is something we know you expect from us, and we are excited about the wide range of opportunities that lie ahead.

Julien, I want to mention that for the first nine months of the year, weather and storms have impacted us by about $0.24. We do not plan for such extreme weather or storm activities. In a typical year, we believe this would provide a positive advantage as we move into 2018.

Excellent. Just a quick clarification, since you mentioned the tax item, can you describe the $0.05 benefit related to the third quarter on Slide 2?

Yes, happy to provide some color on that. So the $0.05 benefit realized in Q3, that's largely attributable to a reduction in deferred income taxes associated with electric sales into MISO.

Got it. Okay. Fair enough. Thank you very much for the detail.

Thank you.

Hi, guys.

Hey, Michael, how are you?

I wanted to follow up on some of Julien's questions. Regarding the $7 billion opportunity for CapEx, you mentioned that half of it is related to distribution transmission supply. I understand that the supply issue will likely be addressed in the IRP. However, on the T&D side, how do you see the timeline for incorporating that into the official $18 billion forecast? This would represent part of the plan moving forward rather than just an opportunity.

I'll start, and then Rejji may add some additional comments. The commission has requested a five-year distribution plan, and we filed an initial version in August. We are currently receiving feedback and having working sessions with the commission staff. We will submit a final plan in January. A significant part of what the commission is currently leading involves long-term considerations for where the appropriate infrastructure investments should be made. By filling out our Integrated Resource Plan in the spring of next year alongside this T&D distribution, particularly the five-year modernization plan, we will gain a clear understanding of where the investment opportunities lie and achieve alignment with the commission regarding those investments. Given the age, size, and complexity of our system, we face internal competition in deciding how best to allocate funds, as numerous areas within the distribution and supply systems require investment. Additionally, in our extensive gas system, our constraint isn't about available capital but rather the customers' ability to pay. This is why we place such a strong emphasis on minimizing infrastructure costs whenever possible, to provide greater value for each dollar invested. Therefore, with the five-year distribution plan and the IRP together, we will be able to develop that five-year investment strategy in much greater detail and with increased certainty.

Do you think there is a possibility that the $7 billion on opportunities can also be expanded as you work your way through, both this plan and the IRP?

Yes, we do. And again, it's only constrained by customers' ability to pay, so that in the 10-year time horizon, in particular, when we have these Power Purchase Agreements that do peel off and are at the end of their contractual life, that creates some real headroom to make additional investments without raising customers' prices beyond what they can afford. And so that definitely is a key ingredient in our 10-year plan.

Michael, this is Rejji. I would like to add that everything you've mentioned is entirely accurate. To provide some specifics, as you may remember from Investor Day, Garrick discussed in detail the numerous capital investment opportunities available, particularly due to the age of our system. On the electric side, we noted that approximately 75% of our assets were built before 1970, compared to the industry average of about 65%. Additionally, our gas distribution mains are quite old, with many constructed around World War II. This presents substantial opportunities, and based on those calculations, we have opportunities significantly exceeding the $25 billion outlined in our $18 billion 10-year plan, plus an additional $7 billion in upside potential. Therefore, there are numerous avenues for capital investment. As Patti mentioned, the main limitation is affordability, so if we can speed up cost reductions or savings, it will enable us to pursue these additional opportunities.

Right. Makes sense. Thank you very much.

Thanks, Mike.

Good morning, guys.

Good morning, Jonathan.

Good morning, Jonathan.

I was just curious, so again this tax item in the quarter sounds like it was largely to do with cross period, so probably a one-timer, is that fair?

Yes, largely one-timer. There could be a little bit of upside to the tune of about $0.01 in 2018, but largely one-timer.

Rejji, my question is whether you anticipated this situation going into the year or if it was just a matter of timing. If you hadn't received this outcome, how would you feel about the range? What other options could you have explored?

I'll answer the last question first and then address your initial part. We're confident in our ability to meet our financial goals for the fourth quarter and the full year, regardless of the tax opportunity. Currently, we're $0.16 ahead of our plan, and even without the tax savings this quarter, we would have still been about $0.10 ahead. While the tax savings were beneficial, they are not our primary focus. We've consistently managed to adapt to unexpected variances like weather and storms, and this situation is simply another example of us identifying cost-saving opportunities. As for the initial part, we've been looking into this deferred income tax reduction opportunity for some time. The legal precedents that emerged recently enabled us to take advantage of it this quarter, and we'll provide more details about this in the upcoming disclosure. This is essentially the reason we decided to capitalize on the opportunity now.

Thank you.

Thank you.

Thank you. Good morning.

Good morning, Ali.

Good morning, Ali.

Good morning. Looking at the data, year-to-date weather normalized electric sales were running behind your full-year target, any insight into that? And does that change your long-term planning for weather normalized sales going forward?

The quick answer is that we feel like we're trending quite well on a weather normalized basis. As you may recall from our fourth quarter earnings call, we forecasted about 0.5% growth in weather normalized electric sales, which is net of energy efficiency programs. The data shows we're about 40 basis points into that target. What's exceeded our expectations is the performance in the commercial area, which is up about 1.5% year-over-year. Industrial sales, which were down 1% in the first half of the year, are now essentially flat, indicating a turnaround in industrial activity. Residential sales were strong in the first half of the year, up about 0.5%, but are now flat. It's important to note that we had favorable weather in late September, which isn't reflected in our current performance but will show up in October. So, those sales are still forthcoming. We're on track to achieve about 0.5% to 1% growth year-over-year by the end of the year, and the sales mix has been favorable in the first half of the year and continues into Q3. Overall, we're pleased with our performance to date. Is that helpful?

Yes, yes. It is, thank you. And secondly, the last 12 months earned ROEs weather normalized both electric and gas are above your authorized, any concerns with that as you're going through the rate cases or do you think that gets reduced by the future CapEx opportunities?

Yes. That should normalize over time. I think we're maybe 10 to 20 basis points on the electric side above the authorized ROE, and so that's probably has to do a little bit of lag attributable to some of the cost savings, and just not having the opportunity to pass this on as soon as we'd like. But we obviously, as we always do, we pass this on as quickly as we can through the annual rate filings. And on the gas side, I'm sure you noted that we are well below the authorized ROE, and that's because of the loss of self-implementation attributable to the new energy law that was implemented in April of this year. And so again, we expect those to normalize over time and 10 to 20 basis points above the authorized level, we think, again, that will get back to authorized levels fairly very soon.

Thank you.

Thank you.

Good morning. Thank you.

Good morning, Travis.

I was thinking about the regulatory activities. One short-term question, one long-term question, just wondering if you could point out one of the key 2018 regulatory decisions or filings or other activities that might change that guidance range or put you at the top-end or the low end?

We have several significant regulatory outcomes planned for 2018. Regarding our guidance of 6% to 8%, we always adapt to various changing conditions, including regulatory outcomes and politics. This adaptability is a key strength of our business model. As you consider our 2018 guidance, it's important to remember that our strength lies in our straightforward yet powerful business model, which is supported by ongoing cost savings and strong capital expenditures throughout the year. A major advantage of our company is our ability to manage challenges effectively without relying on any single regulatory outcome or project. This flexibility allows us to make necessary adjustments and continue delivering results. For 14 consecutive years, we have achieved 7% EPS growth, and we are confident in our track record and our visibility to continue delivering solid results moving forward.

Okay, and then the long-term question was how sensitive is that long-term growth number to that IRP filing and whatever outcome plus or minus that might come about?

I think, if anything, the IRP provides more certainty to the performance because we'll have more visibility into longer-term planning and be able to do more cost-effective investments and cost-effective generation, which is how our model works. The heart of our model is that our system is large and aging, and we have significant infrastructure replacement upgrades and enhancements required. And so any certainty we can have going forward allows us to most cost-effectively do those upgrades and make the changes necessary. We have a large and aging system between the gas and electric. And so really we look forward to the certainty that the IRP can provide so that we can do really even better planning than we've been able to do in the past.

The only other point I would add is, obviously, the utility drives a good portion, the lion's share of our earnings on an annual basis. But we still have the unregulated businesses as both enterprises and other banks that provide additional levers to risk mitigate our annual plan, and then obviously, we will seek out cost reduction opportunities, either operating or non-operating, to make sure that we can again risk mitigate any unfavorable regulatory outcomes.

Great. Thanks. I appreciate it.

Thank you.

Thanks, Travis.

Hi. Good morning.

Hey, Andrew.

Just real quick, because I've been off and on. Just on this deferred tax item, I don't know if I heard it correctly, but is it what potential that there could be upside to this year's number if you deem to book more of that? Is that...

No, no. We would say the $0.05 of realized benefit in this quarter, that respectively fitting for 2017, and there may be $0.01 of upside next year as I highlighted. But I wouldn't expect anything further beyond that in this fiscal year. Is that helpful?

I initially thought there would be an increase in 2017, which could affect the growth baseline and subsequently change 2018 and 2019. However, I must have misunderstood. Thank you.

Thank you.

Thanks, Andy.

Well, thanks everyone for joining us, and we do look forward to seeing you at EEI, right around the corner.