Earnings Call Transcript - BKH Q2 2021

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Black Hills Corporation Second Quarter 2021 Earnings Conference Call. My name is Sara and I'll be your coordinator for today. At this time all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. Operator provided instructions. As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Jerome Nichols, Director of Investor Relations at Black Hills Corporation. Please proceed, sir.

Jerome Nichols, Director of Investor Relations

Thank you. And good morning, everyone. Welcome to Black Hills Corporation's second quarter 2021 earnings conference call. You can find our earnings release and materials for our call this morning at our website at www.blackhillscorp.com under the Investor Relations heading. Leading our quarterly earnings discussion today are Linn Evans, President and Chief Executive Officer; and Rich Kinzley, Senior Vice President and Chief Financial Officer. During our earnings discussion today, some of the comments we make may contain forward-looking statements as defined by the Securities and Exchange Commission and there are a number of uncertainties inherent in such comments. Although we believe that our expectations and beliefs are based on reasonable assumptions, actual results may differ materially. We direct you to our earnings release, Slide 2 of the investor presentation on our website and our most recent Form 10-K and Form 10-Q filed with the Securities and Exchange Commission for a list of some of the factors that could cause future results to differ materially from our expectations. I will now turn the call over to Linn Evans.

Linn Evans, President and Chief Executive Officer

Thank you, Jerome. Good morning, everyone and thank you for joining us today. I’ll begin on Slide 4, which lists our key achievements during the second quarter. Our team delivered strong financial results with earnings up 21% compared to last year. We also delivered solid operational performance with strong execution of our capital plan. And we made excellent progress in our regulatory initiatives, including Storm Uri expense recovery actions. After safety, one of our key operational priorities is providing reliable and resilient service to our customers. During the record-breaking heat in June across the Western United States, the Black Hills team and our electric systems and generating fleet performed exceptionally well. This was our second consecutive quarter that included extreme weather events, and our energy delivery systems performed as designed. During both quarters, our diverse mix of power generation resources, and our reliable and dispatchable generation capacity allowed us to serve customers and avoid rolling blackouts and other emergency actions that were required in other parts of the country. The Black Hills team continued to execute our capital investment plan to maintain our enviable reliability and system resiliency, and to serve our growing communities. We're on track to deploy up to $647 million of capital for the year. And we continue to evaluate and develop new opportunities beyond 2021. On the regulatory front, we had a very productive quarter. As we said we would do, we filed rate reviews in Colorado, Iowa and Kansas. In Colorado, we recently received approval for a new safety-focused investment rider for our gas utility. And on June 30, we submitted our electric integrated resource plan for our South Dakota and Wyoming utilities which I will discuss in more detail in a moment. Rich will cover regulatory activity in more detail in his update. Slide 5 lays out our financial outlook. We affirmed our 2021 earnings guidance based on strong second quarter financial performance. We also maintained our 2022 earnings guidance range. We are targeting 5% to 7% earnings growth for 2023 through 2025 and at least 5% annual dividend growth. Our growth plan is shown on Slide 6. We continue to plan for capital investments of more than $3 billion through 2025. We expect earnings growth to be driven by our robust capital plan to serve customers, incremental project opportunities, and other earnings drivers that add margin with little or no capital investment. In our electric utilities business, we are evaluating our transmission needs to develop expanded access to power markets and to cost-effectively serve loads across our electric utilities. We also see opportunity to serve growing load in our prime data center market in Cheyenne, Wyoming. We look forward to engaging our regulators regarding these potential transmission opportunities. Our initial modeling leads us to believe interconnecting our three electric systems and expanding power market access would benefit our customers and shareholders while also supporting our long-term emissions reduction goals. In addition, we're exploring the potential for responsibly adding more renewable generation and pursuing additional renewable natural gas projects across our agriculture-heavy service territories. We currently have a long list of potential renewable natural gas interconnect projects. And while our existing RNG business is relatively modest, RNG represents an interesting sustainability and perhaps longer-term financial opportunity. We're very optimistic about population migration into our service territories. Both our electric and gas utility service territories are seeing accelerating customer growth, and we continue to see evidence affirming customer growth trends. As we noted in our press release yesterday, we set new all-time load peaks in July at our South Dakota and Wyoming electric utilities. Finally, we're advancing our culture to be better every day through cultivating innovative solutions, leveraging technologies and data analytics, and encouraging our team to find ways to serve our customers with more efficient and effective processes. Before I leave this slide, let me point out that we typically refresh our five-year capital plan during our third quarter earnings release in November. Then at our year-end earnings release we add a year to maintain a five-year capital forecast. Moving to Slide 7, as I said earlier, on June 30, we submitted our integrated resource plan for electric systems in South Dakota and Wyoming. The resource plan modeled a variety of scenarios with the objective of accomplishing four goals. First, serve our growing customer demand for electricity. Second, utilize resources that are cost effective. Third, maintain strong reliability. And finally, achieve our environmental goals as set forth in our ESG initiatives. Our preferred plan proposes to add 100 megawatts of new renewable generation, evaluate the addition of up to 20 megawatts of battery storage to help maintain reliability, and evaluate and develop new transmission opportunities. In addition, the plan proposes to convert our 90 megawatt Neil Simpson II coal-fired power plant to natural gas in 2025 at the end of its engineered life. This option helps provide system resiliency, demonstrates our continued support of a locally based energy economy and supports our emission reduction goals. In addition to our resource plan, we're supporting research to advance emissions-reducing technologies. The funding for a feasibility study for a hydrogen pilot project we propose was recently approved by the Wyoming Energy Authority and the University of Wyoming Energy Research Council. The feasibility study will examine the viability of using hydrogen and natural gas generation. We’re also supporting the University of Wyoming's research program for turbine firing technologies that would further reduce emissions. As these technologies advance, future options for our generation resources will only continue to expand and in turn allow us to continue to cost-effectively and responsibly reduce our emissions. Specifics about the pilot project and the associated capital necessary to execute our recently submitted resource plan are still in the early stages of evaluation. As we work with regulators through the review of the resource plan and gain greater clarity on project specifics, we will provide estimates on potential incremental additions to our capital plan. Any new generation investment would be incremental to our current capital plan. We have included some transmission investment in our existing capital forecast, but there may be incremental opportunities. Moving to Slide 8, we continue to make progress from an environmental, social and governance or ESG perspective. We're taking a responsible approach to reducing our emissions with goals to reduce emissions intensity for our electric operations by 40% by 2030 and 70% by 2040 from a 2005 baseline. For our gas utilities, we're targeting a 50% reduction by 2035 and have voluntarily committed to reducing methane emissions with our participation in the EPA Methane Challenge and the ONE Future Coalition. We have a legacy of prioritizing ESG issues and we're working to holistically communicate that story as we continually enhance our disclosures. During August, we will publish new disclosures for the Sustainability Accounting Standards Board and the natural gas sustainability initiative. We will also soon publish our 2020 Corporate Sustainability Report and updated AGA and EEI quantitative reports. I encourage you to visit our investor website and review these materials once they are published. And finally on Slide 9, we're well positioned as an integrated utility with a strong long-term growth outlook, we are executing our customer focus strategy and are confident in our future. I'll now turn it over to Rich for the financial update. Rich.

Rich Kinzley, Senior Vice President and Chief Financial Officer

Thanks, Linn. And good morning everyone. Slide 11 summarizes earnings per share for the second quarter. We delivered EPS as adjusted of $0.40 compared to $0.33 in Q2 2020, a 21% increase. Overall strong financial results were driven by new rates and rider revenues and recovery of wholesale power margins at our utilities. Higher gross margins were partially offset by increases in O&M, DD&A and interest expense. Weather was not a major driver of earnings during the non-peak second quarter for both our electric and gas utilities. The net benefit to earnings from weather was $0.01 per share compared to normal and $0.01 below the second quarter last year. Slide 12 illustrates the detailed drivers of change in net income quarter-over-quarter. All amounts listed on this slide are after-tax. As I noted on the previous slide, the main drivers compared to last year were $9.2 million of gross margin improvement from new rates and riders and recovery of wholesale power margins at our utilities. O&M increased due to higher employee costs and outside services, planned power plant maintenance-related expenses, and operating expenses for new wind generation. The improvement in other income expense over the prior year was driven by lower retirement benefits service costs and market impacts on non-qualified deferred compensation expense. The additional quarter-over-quarter tax benefits of $4.3 million on the far right of the slide were primarily from two items. First, Nebraska tax cuts and jobs act customer bill credits which reduced gross margins collected from customers and reduced income tax expense by the same amount. And second, increased flow-through tax benefits related to repairs and certain indirect costs. Additional second quarter detail on segment earnings can be found in the appendix. And you can also find additional details on year-over-year changes in gross margin and operating expenses in yesterday's earnings release. As we promised last quarter, we made progress on mitigating winter Storm Uri's impact on earnings. The first quarter net impact from Storm Uri was $12.5 million or $0.15 per share. As we told you then, we planned to offset approximately $0.05 of these costs through regulatory actions and ongoing power marketing opportunities. We delivered $0.03 of the offsets in the second quarter, and we anticipate achieving the other $0.02 through the remainder of the year. And we plan to mitigate the remaining $0.10 net Storm Uri impact through O&M management and other opportunities. Slide 13 shows the details of our recent regulatory activity. In Kansas, we filed our first rate review in more than seven years, including a request to renew our existing five-year system safety and integrity investment rider. In Iowa, we filed our first rate review in more than a decade, including a request for a new system safety and integrity investment rider. And I'll note that in Iowa interim rates took effect in June, and we continue to make progress on a rate review filed for Colorado Gas. We expect all three of these rate reviews to conclude late this year or early next year with new rates effective in Q1 2022. Looking forward, we are tentatively planning to submit rate reviews for Arkansas Gas in the fourth quarter of this year and for Wyoming electric in mid-2022. And as previously noted, we are making progress on our Storm Uri recovery plans; all our recovery applications have been filed, and we already received final approval and commenced recovery in Nebraska and South Dakota, with interim rates in place in Arkansas and Iowa. Slide 14 shows our financial position through the lens of capital structure, credit ratings and financial flexibility. We have a manageable debt maturity profile and are committed to maintaining our solid investment grade credit ratings. At the end of June, we had more than $500 million of available liquidity on our revolving credit facility. And in July, we amended and extended our revolving credit facility with similar terms through July 2026. We expect to finalize our refinancing strategy for the $600 million balance on our term loan in the third quarter. We’re evaluating refinancing options that align with our anticipated recovery period. The weighted average length of recovery requested in our regulatory plans is 3.7 years. New debt and deferred recovery of fuel costs for Storm Uri temporarily increased our debt-to-total capitalization ratio to 62% at the end of March, and it remained at that level at the end of June. As we recover storm costs, repay debt and execute on our equity program, we expect to reduce our debt-to-total capitalization ratio, and we continue to target a debt-to-total cap ratio in the mid-50s. During the second quarter, we issued $40 million through our at-the-market equity offering program. Our equity issuance expectations are still $100 million to $120 million for 2021 and $60 million to $80 million for 2022. Moving to our dividend on Slide 15. In 2020, we proudly marked 50 consecutive years of annual dividend increases, one of the longest track records in our industry. Since 2016, we've increased our dividend at an average annual rate of 6.6%. And looking forward, we anticipate increasing our dividend by more than 5% annually through 2025 while maintaining our 50% to 60% payout target. In closing, we thank you for your interest in Black Hills. We are pleased with our strong second quarter financial results and the progress we made during the quarter on many fronts. We're excited about our growth opportunities with accelerating population migration into our service territories, and many opportunities to continue to develop our strong capital program. We continue to be well positioned both operationally and financially to be ready to serve all our stakeholders. And with that we're available to take your questions.

Operator, Operator

Ladies and gentlemen, we are ready to open the lines for your questions. Operator provided instructions. Please stand by for your first question. Your first question comes from a line of Brian Russo with Sidoti. Your line is now open.

Brian Russo, Analyst (Sidoti)

Hi, good morning.

Linn Evans, President and Chief Executive Officer

Thanks for the question. Brian, this is Linn. We filed the IRP in Wyoming and South Dakota. In South Dakota, it's submitted as information essentially only. In Wyoming, they will have a review and comment period and a review and comment hearing. They don't necessarily approve the IRP. So anything that we would want to do and have suggested in our IRP to add generation, transmission, pipeline, etcetera, each would be pursued through a CPCN request in Wyoming and South Dakota. It's a prudency review, frankly, after it's been constructed. So it's a fairly simple IRP process. Most of the work comes through the CPCN process allowing us to then build those assets, Brian.

Brian Russo, Analyst (Sidoti)

Okay, great. And then the three projects that you outline — the 100 megawatts of renewables, the Simpson coal-to-gas conversion and the battery storage — based on the cost estimates and ranges you provide in the IRP, it looks like it could be anywhere between $125 million to $150 million of possible investment. Is that accurate?

Linn Evans, President and Chief Executive Officer

Yes, each one of these needs to be proven up individually and separately, if you will. None of our current capital forecast includes any generation opportunities in it. So there would be incremental investment to the forecast we put out there thus far, Brian. We have, however, put a little bit of the transmission investment into our capital forecast that would be represented in the IRP. We have pretty good confidence that we'll need to construct that transmission. So we begin to layer it in, but not all of it’s layered in at this point.

Brian Russo, Analyst (Sidoti)

Yes, and a follow-up on transmission — that was a lot of discussion in the IRP about new transmission for reliability, etcetera. Could you just elaborate on that? Is that outside of the preferred plan and more longer term in nature?

Linn Evans, President and Chief Executive Officer

Relative to the longer term in nature, but within the next several years, we have an objective where we could connect our four generation sites in Gillette, Rapid City, Cheyenne, and Pueblo, Colorado. We think by doing that we can lower our cost, improve reliability, improve resiliency. And perhaps most importantly, lower our customers' cost through that and provide us the opportunity to add more renewables in an effective way that would help us with both resiliency and reliability.

Brian Russo, Analyst (Sidoti)

Okay, and regarding the positive customer growth you're seeing, what's driving that growth? In what jurisdictions is that growth concentrated? And when you look at rate cases, is it possible that the load growth in those jurisdictions can allow you to delay rate cases?

Linn Evans, President and Chief Executive Officer

Yes, good question. I'll start high level and ask Rich to fill in some of the figures and numbers. We are seeing nice population growth across our territory. Some areas especially meaningful are Northwest Arkansas, the Front Range of Colorado, and Rapid City. But we're seeing growth across the whole footprint. If you annualize growth for the first six months of this year, it's about double the rate that we were seeing in 2019. So it's been very interesting to watch. We're watching to see how sustainable it is, but it's certainly having an impact on our load. As I said in my comments a few moments ago, we set new peaks in July at both the Wyoming electric and South Dakota electric utilities, and they were significant increases in those peaks by nearly 5% year-over-year. We think what's driving it is largely migration into our service territories as people look for perhaps more rural or smaller communities. Rich, do you want to add to that?

Rich Kinzley, Senior Vice President and Chief Financial Officer

I can add a little color. If you look at our electric utilities, our three electric utilities' historic customer growth has been about 0.8%. We saw that start to accelerate, particularly in 2020. In the first half of this year, the run rate is about 1.6%, so about double what we've seen historically. At the gas utilities, our historic growth is more in the 1% to 1.1% range. We saw that start to pick up last year, and this year the run rate is again about 1.6%. So we're really encouraged with these trends; they appear to have some staying power, time will tell, but certainly looks awfully good right now.

Brian Russo, Analyst (Sidoti)

Okay, great. And then just on the leverage — obviously about 60% now due to the Storm Uri-related debt — how long do you think it'll take you to get back down to the mid-50% range?

Linn Evans, President and Chief Executive Officer

The way we filed the Storm Uri recovery requests comes out to about a 3.7-year weighted average to get those all recovered. It is a little front-end loaded though. So I think assuming approval of all those, which we fully expect, you'll see that start to happen fairly quickly in 2022 and 2023. Prior to Storm Uri, we were targeting being in that mid-50s range in a couple of years; now it's probably going to take more like three to four years to get there given the recovery period of those Uri costs.

Brian Russo, Analyst (Sidoti)

Okay, great. Thank you very much.

Linn Evans, President and Chief Executive Officer

Thank you, Brian.

Operator, Operator

Thank you. Our next question comes from the line of Brandon Lee with Mizuho. Your line is now open.

Brandon Lee, Analyst (Mizuho)

Hey, Linn. Hey, Rich. Quick question, the theme of the quarter has been an acceleration of decarbonization. Is that something that Black Hills is looking into? And if so, can you discuss the opportunities there?

Linn Evans, President and Chief Executive Officer

Yes, we put out some ESG goals that I mentioned in my comments a few moments ago. We're very focused on carbon and greenhouse gas reduction across our regulated utilities, including our natural gas utilities and electric operations. As you heard about our IRP, we are looking to add at least 100 megawatts of renewables to our generation fleet. We're being careful to focus on cost for customers, reliability and resiliency, especially as we see capacity in the West begin to tighten. For example, we're selling power this summer and into the fall in triple-digit prices for peak load periods. Many utilities are relying on energy markets and may not have adequate capacity. We're watching that closely as we make this transition. That's why we're focused on fuel switching with the Neil Simpson II plant and migrating that from coal to natural gas as suggested to the commission. We support the local energy and fuel economy while ensuring resiliency and capacity for events like Storm Uri.

Brandon Lee, Analyst (Mizuho)

Great. And then just another quick question on your 2022 equity. Can you discuss the timing? Is that going to be front-loaded in the year? Or are you going to be more opportunistic throughout the year?

Linn Evans, President and Chief Executive Officer

Yes, as you saw in our release yesterday, we did $40 million of this year's $100 million to $120 million in the second quarter. So you'd expect the rest of this year to play out through the course of the year on the ATM. For modeling purposes, I would assume kind of an even spread of that equity need next year throughout the year, with no front-end load.

Brandon Lee, Analyst (Mizuho)

Okay, great. That's all I had. Thanks a lot.

Linn Evans, President and Chief Executive Officer

Thanks, Brandon.

Rich Kinzley, Senior Vice President and Chief Financial Officer

Thanks, Brandon.

Operator, Operator

Thank you. Our next question comes from the line of Chris Ellinghaus with Siebert Williams. Your line is open.

Christopher Ellinghaus, Analyst (Siebert Williams)

How are you doing guys?

Linn Evans, President and Chief Executive Officer

Hey, Chris. How are you?

Christopher Ellinghaus, Analyst (Siebert Williams)

The IRP process — what's your expected timeline on approval?

Linn Evans, President and Chief Executive Officer

We don't have an approval process for the IRP itself. We'll have hearings relatively soon to review the IRP, and the recommendations we made will get a chance for the public and intervenors to comment. Then once we're through that process, we'll start filing for CPCN applications. For the generation side, we anticipate going through an RFP to add that generation probably in both South Dakota and Wyoming. We're focused with the commission on the importance of owning capacity, especially in the aftermath of Storm Uri, so the party that has the obligation to serve is running and operating that capacity. We'll work hard to allow ourselves to have as much ownership as possible for the benefit of customers and shareholders. There's still a lot to work through.

Christopher Ellinghaus, Analyst (Siebert Williams)

Rich, at the end of the second quarter, do you have an adjusted debt-to-capital number absent Storm Uri costs recovered so far?

Rich Kinzley, Senior Vice President and Chief Financial Officer

I don't have that off the top of my head, Chris, but I would tell you we probably would have been in the 58% to 59% range.

Christopher Ellinghaus, Analyst (Siebert Williams)

Okay, that's close enough. Can you give me a little color on the decline in the non-utility side for the quarter?

Linn Evans, President and Chief Executive Officer

Yes, the big factor there was at Power Gen. We had planned outages during the quarter when we didn't need the capacity. That's probably the biggest driver. At the coal mine we had a bit of a downtick as well because of planned outages at the coal mine, so we delivered less coal.

Christopher Ellinghaus, Analyst (Siebert Williams)

Okay. You talked a bit about seeing opportunities in RNG. Do you have any sense of when we might hear a bit more detail on your plan there?

Linn Evans, President and Chief Executive Officer

Yes, we're working on RNG opportunities aggressively. We have four projects in place and have been learning from those. We have another 6 to 10 projects currently under negotiation and a longer backlog of possibilities. Our focus so far has been ensuring we can build pipeline and transmission systems to the sources. We serve thousands of miles of pipe across primarily agricultural economies, so we have lots of potential customers. We're still in the early stages and it's relatively expensive at present. We're looking for economic solutions as well as emission-reduction solutions. Over time, as technologies and prices evolve and we get smarter operationally, economics should improve. We have a committed team looking at this carefully and capturing opportunities as quickly as we can.

Christopher Ellinghaus, Analyst (Siebert Williams)

Okay. Thanks for the details. Appreciate it.

Linn Evans, President and Chief Executive Officer

Thank you, Chris.

Operator, Operator

Thank you. With no further questions, I will return the call back to Linn Evans for closing remarks. Please go ahead, sir.

Linn Evans, President and Chief Executive Officer

Well, thank you very much. Let me close by saying thank you for your interest in Black Hills. We're already hard at work on Q3. I greatly appreciate the Black Hills team and how focused we have been on O&M savings, while still hitting our metrics with respect to great customer service and safety. Many thanks to our team. As always, please be safe and stay well. We'll look forward to next quarter. Take care.

Operator, Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.