Eversource Energy (ES) — Q2 2018 Earnings Call Transcript

Thank you, Paula. Good morning and thank you for joining us. I'm Jeff Kotkin, Eversource Energy's Vice President for Investor Relations. During this call, we'll be referencing slides that we posted last night on our website. As you can see on Slide 1, some of the statements made during this investor call may be forward-looking as defined within the meaning of the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and are subject to risks and uncertainties which may cause the actual results to differ materially from forecasts and projections. Some of these factors are set forth in the news release issued yesterday. Additional information about the various factors that may cause actual results to differ can be found in our Annual Report on Form 10-K for the year ended December 31, 2017, and on Form 10-Q for the three months ended March 31, 2018. Additionally, our explanation of how and why we use certain non-GAAP measures is contained within our news release and the slides we posted last night, as well as in our most recent 10-K. Speaking today will be Phil Lembo, our Executive Vice President and CFO; joining us by phone for Q&A is Lee Olivier, our Executive Vice President for Enterprise Energy Strategy and Business Development. Also joining us today are Jay Buth, our VP and Controller, and John Moreira, our VP for Financial Planning and Analysis. Now, I will turn to Slide 2 and turn over the call to Phil.

Thank you, Jeff, and this morning I'll summarize our second quarter and year-to-date results. I'll recap recent regulatory proceedings, our updated capital plan, and affirm our long-term growth rate. So overall, we're very pleased with the results through the first six months of the year; our media results are consistent with our expectations and we continue to target full-year EPS of between $3.20 and $3.30 a share. We made good progress on a number of our initiatives and our regulated businesses that will enhance service to customers and support our 5% to 7% long-term EPS growth rate. I'll provide more specifics on those initiatives shortly but I'll start with Slide 2 and a review of our financial results. We earned $0.76 per share in the second quarter of 2018 compared to $0.72 in the second quarter last year. Our electric distribution business earned $0.32 per share in the second quarter of '18 compared with earnings of $0.38 per share in the same quarter of '17. And just a reminder, that historically we reflected both our distribution and our public service of New Hampshire generation in this electric distribution segment, so year-on-year comparisons will be impacted by the divestiture of these assets in January. The quarter decline was expected and primarily due to lower electric distribution margins, as well as the lower generation earnings in New Hampshire generating assets, which also had some higher property tax expenses in the quarter. Together those factors more than offset the benefits of distribution rate adjustments in Connecticut and Massachusetts. The lower distribution margins in Eastern Massachusetts primarily reflect the timing of revenues through NSTAR Electric's new decoupling mechanism that was approved in the recent rate proceeding. This mechanism is more reflective of a seasonal usage pattern in NSTAR Electric's former last state revenue recovery mechanism, which was reflected radically over the years. As a result, compared with past years we'll see higher revenues in the peak usage quarters, in other words, really the third quarter, and lower revenues in the other quarters. So simply put, the electric distribution segment is impacted by the generating asset sale and timing of the new decoupling mechanism, both as expected. Our electric transmission business earned $0.35 per share in the second quarter of '18 compared to $0.30 per share in 2017. Improved results were due largely to increased investment in our transmission facilities. Our natural gas business earned $0.02 per share in the second quarter of '18 compared to about $0.01 to $0.02 a share in the same period of '17. Improved results were due primarily to much colder weather in the month of April resulting in increased heating-related sales at Yankee Gas, which is not yet decoupled. Our new aquarium water company subsidiary earned $0.02 per share in the second quarter, consistent with our expectations. And finally, our parent and other segments earned $0.05 per share in the second quarter of '18 compared with $0.03 in the second quarter of '17. Earnings in both years benefited from investments we've made in certain renewable energy facilities that we've discussed in the past, the impact of which is recorded in the second quarter of each year. Turning to year-to-date results, we earned $1.61 per share in the first half of '18 compared to $1.54 in the first half of '17. Our electric distribution business earned $0.65 per share in the first half of '18 compared with $0.74 per share in the same period last year. Again, lower results were primarily due to our New Hampshire generation event this year, as well as the timing of decoupling revenues versus the previous loss-based revenue methodology. Our electric transmission business earned $0.69 per share in the first half of '18 compared with earnings of $0.60 in the same period of '17. This was also due to a higher level of investment in our transmission facilities. Our natural gas segment earned $0.20 per share in the first half of '18 versus $0.17 in '17, with higher sales resulting from colder weather in the months of January and April. As for our natural gas sales, these were up about 6.6% year-to-date compared with the same period in 2017. Our water distribution business earned $0.03 per share, and our parent and other earned $0.04 per share in the first six months of the year. I should note that the most profitable quarter for water is typically the third quarter since water usage peaks during the summer time period. From results, I'll turn to Slide 3 and some recent regulatory developments. Regulatory decisions for our core business have been constructive and supportive of our utilities' capital plans, designed to meet the ever-increasing expectations of our customers. We've increased the rate of infrastructure investment to modernize our electric grid, enhance electric reliability, accelerate the replacement of older natural gas and water distribution pipes, and increase investments to meet our state's environmental and clean energy goals. On May 1, our Connecticut Light & Power's new three-year rate plan took effect with an initial distribution rate adjustment of about $64 million. Two smaller increases will follow in May of '19 and May 1 of 2020. Additionally, regulators approved the capital tracker for investments in our system above a base amount of $270 million per year, and these investments are aimed at making the grid more resilient, such as smart switches, enhanced tree trimming, upgrades to our poles and their integrity, and substation security. These totaled about $75 million a year, and recovery of these costs associated with these investments will go through the reconciliation mechanism. Currently, a process for identifying top priorities for grid modernization is underway, and we expect to file a separate grid modernization plan before the end of this year. We have not yet reflected any potential Connecticut grid modernization investments in our distribution capital forecast. I believe our proposal could be meaningful as we work to enhance grid animation and two-way communications with our customers about real-time grid conditions, as well as consider investments in electric vehicle infrastructure and battery storage. Shortly after we wrapped up our CL&P rate review in Connecticut this spring, we filed our first Yankee Gas rate case in about eight years. Hearings in the case are scheduled to begin this month with the draft decision due on November 14 and a final decision on December 5. The new rates would take effect in January of 2019. The rate application includes a proposal for revenue decoupling, which we expect to implement since Yankee Gas is the only one of the Connecticut utilities without a decoupling rate structure. We've also proposed to increase capital expenditures, particularly investments related to replacing our cast iron and unprotected steel pipes. The acceleration of these important capital projects will provide great service reliability and safety, as well as continuing to improve the performance of leak-prone infrastructure. Fuel leaks are harmful to the environment and will help to lower O&M costs, ultimately benefiting customers. In our rate application, we highlighted the significant improvement in key performance metrics over the past four years with no increase in base distribution rates. This includes a 45% reduction in Class 2 leaks since 2014; additionally, Yankee Gas's actual non-fuel O&M in 2017 was 3% lower than it was seven years earlier in 2010, another excellent story for customers. Turning from Connecticut to Massachusetts, we continue to move forward with resiliency investments at NSTAR Electric. This past spring, the DPU approved $133 million of additional grid modernization investments for NSTAR Electric over the next three years. This is in addition to the $100 million authorized by the DPU in 2017 for two battery storage initiatives and initial electric vehicle infrastructure. As a result, we'll be investing a total of $233 million in grid modernization projects, which will be recovered through a capital cost recovery mechanism. In addition, the DPU instructed NSTAR Electric to file a three-year rate plan for continued grid modernization efforts for the years 2021 through 2023. We expect to file that plan sometime in 2020. Turning to Slide 4, I just want to pause a minute to discuss our capital forecast. Every year around this time, we commence our process for updating our long-term operating and capital plan. This effort concludes at the end of the year with the subsequent year's operating plan, the earnings guidance that we've provided to you in February, as well as the long-term capital investment forecast we include in our 10-K. Since we published our most recent forecast, we've seen continued focus by state energy policymakers to enhance the electric grid, accelerate the replacement of aging infrastructure, and construct facilities to meet the growing customer needs. We will provide you with a full update again in February, but this time we believe that our capital expenditures in the next three years, specifically the period 2019 through 2021, will increase by a total of $600 million. This brings our total core business CapEx to $7.1 billion from the previous estimate of $6.5 billion. This incremental capital will be split between $300 million for electric transmission, $200 million for electric distribution, and $100 million for natural gas distribution infrastructure investments, all to benefit our customers. The primary driver of this increased level of expenditure will be investments in resiliency and reliability that will allow us to continue to enhance our customers' experience. And as I said, this $600 million expected increase in CapEx does not include any potential initiatives that may emerge from the grid modernization reviews in Connecticut or Massachusetts. In our electric operations, we need to accelerate resiliency investments; this was underscored by the very harsh March and May weather we referenced in our news release. To be more specific, on the electric transmission system we now plan to accelerate the upgrades of aging wooden transmission structures and expect to replace thousands of them with new steel poles over the next several years. We're also focused on upgrades to certain substation equipment. On the electric distribution side, we're seeing additional customer growth in the immediate Boston and Cambridge area, which is resulting in the need to upgrade several key substations to accommodate this ever-increasing demand. On the natural gas side, most of the additional spending is at NSTAR Gas as we accelerate the replacement of lead-prone, bare steel, cast iron, and unprotected steel pipe, which accounts for about 33% of our mains. We are now also planning additional upgrades at our Hopkinton LNG facility, which is critical to maintaining adequate supplies of natural gas for our customers during extended cold spells like those our region experienced this past winter. At this time we're not anticipating incremental investments in our water segment beyond what we disclosed in February, and Slide 5 shows that our current forecast envisions average annual rate base growth for Aquarion of greater than 7% through 2021 compared with about 3% during periods prior to our acquisition. Regarding our capital expenditure revisions, the $600 million investment along with our typical cost management practices will enhance customer experience through better reliability and service. We are optimistic about reaching our long-term earnings growth target around the midpoint of the 5% to 7% growth range, independent of the Northern Pass access or offshore wind initiatives, as well as any share buybacks. To clarify, if we effectively execute our current capital plan and continue to manage our operating and maintenance costs as we have successfully done in the past, we can achieve earnings growth in the middle of our 5% to 7% projected earnings per share growth rate, even without the larger projects. Additionally, our forecast does not take into account the possibility of adopting widespread advanced metering technology in our states, which would give customers better capabilities for managing their energy usage and might require significant capital investment. Earlier this year, Massachusetts regulators indicated that it wasn't yet the right time to implement advanced metering technology, but they committed to reviewing it as a potential solution for grid modernization goals and plan to initiate a project to explore the next steps for cost-effective rollout. Furthermore, Connecticut regulators are currently evaluating advanced metering components as part of their ongoing grid modernization review. As we have done previously, we will present an updated year-by-year capital investment forecast when we release our year-end results in February. We are confident in our capability to operate, maintain, and invest in our core business to deliver reliable, cost-effective, and technologically advanced service that nearly 4 million customers expect and deserve from us.

That concludes my remarks. As Jeff mentioned, Lee is offsite this morning but joining for the Q&A, and I'll turn the call back to Jeff. And I'll turn the call back to Paula just to remind you how to enter questions.

Our first question this morning is from Sharp of Guggenheim.

So just a couple of questions on CapEx here. So obviously, somewhat of a healthy jump in CapEx; just as far as we think about recognition, should we assume the spend was sort of incremental to plan or more sort of a pull forward of spend?

No, this is incremental to plan. As I said, we identified a lot of this just as a result of the harsh winter and the storms that occurred in the region over the first part of the year that really highlighted the need for incremental investment in our infrastructure.

And then obviously, you've displayed a very strong level of confidence in sort of your growth trajectory without these binary risky projects. Is there any reason why we shouldn't assume sort of that same level of confidence as we move beyond your current trajectory of 2021?

There is no reason you shouldn't expect the same level of confidence.

And then finally, regarding the grid modification, you are currently at the midpoint of your range in terms of your base spending. As you consider the grid modification, assuming a normal or base outcome, will that be sufficient to reach the top end of your range, or does it primarily support remaining at the midpoint?

It's challenging to make predictions because the legal processes in Connecticut are just beginning, similar to a smaller case in New Hampshire, and they are all in the early stages. Additionally, we are beyond our current grid modernization plan in Massachusetts, as I mentioned we are preparing to file another three-year plan, but that won't happen for another year. Therefore, it would be difficult to anticipate how much or what types of initiatives we are expected to concentrate on; I need more clarity before I can provide a specific point in the range.

And then just on buybacks; just obviously given the higher capital outlook today and then sort of incremental upside we're going to likely see around grid mod. Are buybacks sort of off the table at this point?

Well, as I mentioned, our growth rate and the confidence we have in the mid-range of that growth rate do not consider any share repurchases.

Our next question is from Angie from Macquarie.

Two questions: the updated growth plan appears robust, and in that context, could you discuss your ongoing interest in water M&A? Also, regarding projects like Northern Pass and offshore wind, should we expect you to continue working on these, or have they been completely canceled? Thank you.

Yes, on the second point, it's certainly activities that are ongoing on the project in terms of either siting or analysis to position us for success in the future; but as I said, there is nothing in the existing forecast period for significant investments or projects in that time period. In terms of water, again, we're interested in pursuing the Connecticut water transaction; we feel that we have a superior and compelling proposal that benefits customers, our communities, shareholders, and employees. It's really highly complementary, and it's located in a territory we're familiar with. We feel that the transaction will be accretive in the first year of any kind of transaction; so that's the transaction that we're interested in at this time.

I mean that transaction still has to be EPS accretive in the first full year after the closing, right? So this is basically the flexibility across any potential high offers for Connecticut water that it has to be accretive?

That is correct; we believe our proposal is a full and fair proposal, and it must be accretive in the first year.

And lastly on Aquarion; so the 7% rate base growth is actually already pretty healthy but when can we expect any updates to your growth plan for that business?

I expect that we will incorporate this into our regular operating and capital plan update, and if there are any changes or updates, we will share that information in February when we provide our full update.

Next question is from Mike Weinstein from Credit Suisse.

It's actually Shank for Mike. I just wanted to see if any update is on the full ROE complaint at this point given the recent commission of departure?

Unfortunately, there is no update at this time; really we're in the same situation that we were at the end of the first quarter.

Can you remind us about the work in Connecticut? You just mentioned a couple of filings and that they are expected in the second half of this year, and are these all recovered through the writers' mechanism?

Yes, a few things that I mentioned that are going on in the regulatory arena in Connecticut as we filed for new rates at our Yankee Gas subsidiary, which is the first time in seven years. So that process is ongoing; I also discussed in Connecticut that there is a grid modernization initiative, and this has been initiated by the Connecticut regulator to look at what types of activities in terms of resiliency and other clean energy objectives could be implemented in the state. That process would be ongoing through this year and possibly concluding this year or early next.

Next question is from Praful Mehta from Citi.

Thank you for the clarity on the capital expenditures; it was very helpful to understand the organic plans for them. I have a question regarding whether this indicates a real change in strategy for pursuing growth, especially considering the challenges you've faced with larger projects. Should we now anticipate that most of your growth will come from more stable, internally driven projects, with the possibility of pursuing larger projects outside your five to seven-year outlook? Is that how we should view this long term?

Yes, our primary focus has always been on delivering excellent service to our customers and successfully operating and growing our core business. While there are strategic projects linked to energy policies that arise in various states from time to time, our main emphasis remains on effectively managing our core business and providing exceptional service.

And I guess in the context of those strategic initiatives on the offshore wind side; as of now you've not had the RFPs going your way, where do you see the gap from your perspective in terms of the offshore wind opportunities and where do you think it takes? Do you actually see this as a big opportunity, an upside opportunity for your growth story longer term, or how do you kind of see that offshore wind thing?

Yes, we anticipate that over the next seven to eight years, there could be between 5,000 to 7,000 megawatts of additional offshore wind capacity in the region. We believe that long-term, offshore wind will become a significant part of the bulk power supply in New England. In Massachusetts, there is an additional 800 megawatts approved, which we expect will be operational early next year. We plan to be involved in that. The Massachusetts legislature is also considering a bill to authorize another 1,600 megawatts of offshore wind, indicating a strong potential for growth in this area. Recently, a zero-carbon RFP was released in Connecticut, allowing for 12 terawatts of clean energy, which could include Class 1 energy as well as existing nuclear and hydro. We see this as an opportunity for offshore wind to participate, alongside initiatives in New Hampshire for around 2,400 megawatts of offshore wind, with the first 800 megawatts expected to come online by late this year or early 2019. Therefore, we view offshore wind as a significant investment opportunity. Although we were not successful in the Massachusetts RFP, we submitted a strong bid in collaboration with a top offshore wind builder. We have consistently stated that we will not compromise our company's earnings in pursuit of winning contracts. Our bid was designed to align with our risk-adjusted returns similar to our transmission projects. While others may have chosen to pursue lower returns, our goal is not just to win contracts but to create shareholder value by partnering with capable companies to ensure timely and budget-friendly project delivery to customers.

Next question is from Paul Patterson from Glenrock.

I apologize if I missed this, crazy morning; but the Massachusetts legislation that I think passed yesterday?

Yes.

Then net metering, I think that was taken out? It wasn't taken out, excuse me, well, the provision was left in that; so if it took out how the DPU treat, could you go over that a little bit in just how you see impacting it?

To be honest, I think they finished at about one o'clock this morning, so some of the information is filtering out today. But I think the overall assessment is that what came out of the legislature is kind of neutral; I think there is nothing in it that is really problematic or from that standpoint. There are some increases in RPS provisions, but some of the other details we still have to go through line-by-line to assess what's in there.

Could you provide an update on what the normalized numbers are for the first half of this year and what you project them to be for the 2019 through 2021 period?

Before I answer that, I will mention that most of our subsidiaries are now decoupled. Yankee Gas will also be decoupled when it completes the current rate proceeding. Consequently, public service in New Hampshire is the only subsidiary that remains not decoupled. This means that weather impacts are diminishing; for 2019, I expect minimal impact since we will have fully decoupled rates across our companies. Specifically addressing your question, for the quarter, weather normalized sales in the electric business were down about 1.5%, while year-to-date gas weather normalized sales were up just over 10% and 8.3% year-to-date.

When discussing the future outlook, I recognize that you are mostly decoupled. However, I'm curious about the overall demand picture and would like to understand your perspective on the underlying fundamentals of electric demand over the next three years. Do you have insights on this?

Yes, I'll begin by stating that we are the leading utility in the U.S. and top-rated for our energy efficiency programs. Our efforts in energy efficiency have significantly reduced energy demand and peak demand on the system. Our programs effectively assist customers in lowering their energy costs, which includes reducing REIT demand. Regarding the overall outlook, we anticipate that sales in our region will remain flat over the next few years. In the Boston area, as you may have noticed with all the construction, we expect specific areas to experience growth. The best way to view this is through our capital plan, which identifies these growth pockets that will need investment. Overall, while there is growth in the system, certain sections of the city are expanding considerably and will necessitate further investment. Now, let’s discuss the areas of growth we’ve identified.

Next question is from Andy Levy from Exodus Point.

I think I'm all set but just to make sure that I understand; so you're basically saying that you're firmly in the 6% growth range, is that correct?

Yes, in the middle of the 5% to 7%.

So basically 6%, and just understand whether it's the poll replacement or AMI or some other CapEx opportunities that's what would get you above the 6%?

You know, there are a lot of factors; obviously, one of them is control of costs. O&M is the driver of moving in the range one way or the other, and constructive regulatory decisions is another factor that may move you in the range one way or the other. More CapEx is another factor. So there are probably a few factors that could move you around in the range a bit but certainly if there is incremental CapEx that comes out of the grid modernization or dockets I alluded to that could enhance that number, correct.

Next question is from Joe from Avon Capital.

Actually, my offshore wind question has been answered, thank you, Phil. Since I get you here, just a follow-up on Andy's question; just to clarify, on your long-term EPS guidance, the 5% to 7% based on the '17 actual or midpoint of '18 guidance?

No, '17.

Next question is from Julien Dumoulin-Smith.

I would like to follow up on the 6% you mentioned. How do you assess the earned return on equity across the subsidiaries from now until the forecast period, or compared to the baseline year? I’m trying to understand the breakdown between capital and return on equity improvement. Additionally, regarding grid modernization in Connecticut, can you provide insight into the scale of the capital involved, including the low and high points? I realize it's early in the process and challenging to provide commentary, but any additional details would be appreciated.

Regarding the return on equity, we recently completed two constructive rate reviews in Connecticut and Massachusetts for our elective business, which I believe will allow us to earn at the approved returns. In Massachusetts, with NSTAR Electric and CL&P, we have a rate review upcoming at Yankee Gas, where we are currently earning below our allowed return, which necessitates our entry into that process. It's been over seven years since we requested new rates there, so this isn't unexpected. I anticipate that we could see an increase in our allowed return as a result. Similarly, in New Hampshire, we haven't updated our rates and, with our divestiture of generating assets there and a slightly different business model, we are now ready to proceed with a rate review in New Hampshire later this year. This subsidiary is also currently under-earning its allowed return. I expect the uplift in return on equity from these two subsidiaries, while the others are benefiting from recent rate reviews and are expected to earn at or near their allowed return levels. As for grid modernization, it’s difficult to estimate precisely, but it could range from a few hundred million to a higher amount depending on how the regulator chooses to enhance infrastructure or storage technologies. The final amount will depend on the specific initiatives that align with the state’s goals, but I would say it would be at least a few hundred million.

So maybe just to clarify the timing on the grid modernization here in Connecticut relative to your usual planning process; should we be basically interpreting this mid-year update as pretty much a draft version of the 4Q update? So perhaps borrowing a meaningful update in grid modernization in Connecticut should be largely similar, or I don't want to put words in your mouth here either?

No, I don't think you should look at it like that at all. I think that what we've been trying to do over many years is that as new information becomes available to us and we identify changes to our plan that we would let you know; so I would look at this more as an ongoing process that we're just at the beginning stages of. And we still have several months in our operating plan review to go, so I would say that likely, you will see other items included in that by the time we get to February.

I just want to clarify Angie's earlier question about the water side. Specifically, regarding your commitment to a cash and equity deal, does there need to be a stock component? Also, to confirm, it should be accretive in the first full year, regardless of the leverage composition or if it's a share-for-share exchange?

To answer the second part of your question, absolutely. We maintain a disciplined approach to assessing transactions. I could point out previous deals such as Aquarion and NSTAR, all of which were accretive in the first year, and that will be our focus. Shareholders can choose cash or other options in the offer to Connecticut Water at this stage.

And you're committed to keeping that election open?

The poll is on the table, yes.

We don't have any more questions this morning, so we want to thank you very much for joining us. Good luck with the other calls this morning. If you have any follow-up questions, feel free to send me an email or give me a call. Take care. Paula?