Earnings Call Transcript - CMS Q1 2024

Operator, Operator

Good morning, everyone, and welcome to the CMS Energy 2024 First Quarter Results. The earnings news release issued earlier today and the presentation used in this webcast are available on CMS Energy's website in the Investor Relations section. This call is being recorded. Just a reminder, there will be a rebroadcast of this conference call today beginning at 12:00 p.m. Eastern Time, running through May 2. This presentation is also being webcast and is available on CMS Energy's website in the Investor Relations section. At this time, I would like to turn the call over to Mr. Jason Shore, Treasurer and Vice President of Investor Relations.

Jason Shore, Treasurer and VP of Investor Relations

Thank you, Drew. Good morning, everyone, and thank you for joining us today. With me are Garrick Rochow, 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. And now I'll turn the call over to Garrick.

Garrick Rochow, President and CEO

Thank you, Jason, and thank you, everyone, for joining us today. CMS Energy, 21 years of consistent industry-leading results. What sets us apart is our performance, and it starts with our investment thesis. It is how we prioritize and focus our work to deliver the service our customers deserve and the financial outcomes you expect. As we look ahead, we see ample investment opportunity over the long term as we lead the clean energy transformation and deliver the critical work needed to improve the reliability and resiliency of our electric and gas systems. This important work is supported by legislation and a constructive regulatory environment, which provides confidence in making required investments to strengthen our system and prepare for a clean energy future. We plan ahead through our electric reliability roadmap, natural gas delivery plan, and our upcoming renewable energy plan, which all provide visibility and transparency, and the work will deliver to keep our systems safe, sound, and clean. At CMS Energy, we work both sides of the equation. We make important investments in our systems, and we work to keep bills affordable. Our CE Way lean operating system helps us improve our performance, increase productivity, and reduce costs in the business. We are hard at work to grow Michigan through economic development, ensuring Michigan thrives well into the future. These efforts are important and help us keep customers' bills affordable. At CMS Energy, we make our investment thesis work year after year, and it continues to set us apart in the industry, delivering results for all our stakeholders. Today, I'm going to share three focus areas that have me excited about our future and give us confidence in our outlook. First, our electric distribution system. As our world becomes more dependent on electricity for business growth, technology advancements, devices, and vehicles, our system needs to be stronger, smarter, and more resilient for our customers. But our vast electric distribution system is aging. It needs to be modernized and strengthened for increasingly severe weather. Over the past five years, we have seen some of the highest wind speeds on record and more frequent storm activity. We have responded to this need through our electric reliability roadmap, currently a five-year $7 billion plan to improve performance and harden our system for the future. The plan utilizes best practices from across the industry, including designing the system with stronger poles, undergrounding, sectionalizing, and further automation. Given the size of our distribution system, 90,000 miles of line, nearly 1,200 substations and a historically lower investment per mile compared to peers, we see a long runway of needed investment. We've incorporated roughly half of the incremental $3 billion you see on Slide 4 into our current capital plan, and you'll start to see this investment show up in our next electric rate case, which we'll file in the second quarter. These important investments will mean fewer and shorter outages for our customers, and we are already seeing meaningful improvements from the investments made over the last few years. The second focus area I want to share is our continued leadership in the transformation to clean energy in the industry. In the past, I have shared our approved plans to eliminate coal in 2025, reduce carbon, grow energy efficiency and build out renewables in pursuit of our net zero target and cleaner air for our customers and our planet. In late 2023, much of our clean energy targets were bolstered by Michigan's new clean energy law. This law is unique in the industry and is good for all stakeholders. It provides us with the opportunity to further reduce our carbon footprint while maintaining resource adequacy, affordable customer bills, and delivering for our investors. On the right side of the slide, you'll see the opportunities ahead as we prepare to meet Michigan's new clean energy law. It supports an accelerated plan with the decarbonization of our system, with an enhanced financial compensation mechanism, which provides a roughly 9% return on clean purchase power agreements. There is also an increased incentive for energy efficiency as we target 60% renewables by 2035 and 100% clean energy by 2040. It gives us important flexibility as we consider how to best meet our customers' needs with renewables across the broad MISO footprint. This mechanism and the flexibility in the law help us balance customer affordability as we work through this transition. For our customers, all this means stronger, more resilient, and cleaner energy. For our investors, an exciting and robust investment runway well into the future. Now let's work the other side of this investment equation. The third focus area that I want to share today is how we are helping Michigan grow and thrive, which is good for our company and our customers. Growth across our service territory is good for Michigan, helps keep bills affordable for our customers, and provides headroom to the investments I just referenced. I'm excited about the growth we need in our state. Michigan has a strong fiber network, access to fresh water, a temperate climate, energy-ready site, and attractive energy rates. In February, we secured a contract with a large data center in the heart of our service territory. The majority of the 230 megawatts of new load is expected to be online by 2026. This is nice load growth. I'm even more excited about the manufacturing load growth we are seeing in Michigan, which is a differentiator for us. Our statewide leadership projects such as Gotion, Hemlock Semiconductor, Ford, and many others continue to drive new and expanding load in our service territory. These projects bring significant jobs, supply chain, commercial growth, housing starts, and broad Michigan investment. The ancillary benefit of manufacturing growth is good for all customers, as it can bolster our confidence in our plan for 2024 and beyond. Our customers thrive when Michigan thrives, and I'm proud of the diversity and quality of new load our leadership is working to bring to the state. Now let's get into the numbers. In the first quarter, we reported adjusted earnings per share of $0.97. Although we experienced a warmer-than-normal winter, the healthy set of countermeasures we deployed in 2023 and our active use of the CE Way continued to benefit us in 2024. We remain confident in this year's guidance and long-term outlook, reaffirming all our financial objectives. Our full-year guidance remains at $3.29 to $3.35 per share with continued confidence toward the high end. Longer term, we continue to guide to the high end of our adjusted EPS growth range of 6% to 8%, which implies and includes 7% to 8%. With that, I'll hand the call over to Rejji.

Rejji Hayes, Executive Vice President and CFO

Thank you, Garrick, and good morning, everyone. On Slide 7, you'll see our standard waterfall chart, which illustrates the key drivers impacting our financial performance for the quarter and our year-to-go expectation. For clarification purposes, all of the variance analysis herein is in comparison to 2023, both on a first quarter and 9 months to go basis. In summary, through the first quarter of 2024, we delivered adjusted net income of $288 million or $0.97 per share, which compares favorably to the comparable period in 2023 largely due to higher weather-normalized sales and lower service restoration costs, partially offset by mild weather. To elaborate on the impact of weather, we experienced another warm winter in Michigan during the first quarter, which had the second-lowest number of heating degree days in the past 25 years. The warm winter weather resulted in $0.06 per share of negative variance, which appears modest given the historically low number of heating degree days. However, it's important to note that last year's winter was also quite mild. Rate relief net of investment-related expenses resulted in $0.05 per share of positive variance due to constructive outcomes achieved in our recent electric rate case and last year's gas rate case settlement, coupled with residual benefits from our 2023 electric rate case settlement approved last January. From a cost performance perspective, our financials in the first quarter of 2024 were positively impacted by lower operating and maintenance (O&M) expenses, primarily attributable to lower service restoration costs than we experienced last year. Additionally, as Garrick noted, we continue to see benefits from selected cost reduction initiatives implemented in 2023, which have offset modest inflationary trends we've experienced in various cost categories such as wages, and we anticipate this trend to continue over the remainder of the year. Our catch-all category represented by the final bucket in the actual section of the chart shows a healthy pickup of $0.19 per share, largely driven by weather-normalized sales, which contributed almost half of said positive variance, particularly in our residential and commercial customer classes. It's worth noting that the leap year impacts comparability with 2023 for weather-normalized sales, but even absent the effects of the leap year, our residential weather-normalized sales were up about 0.5%, and our commercial customer class was up almost 2.5% versus the prior year, highlighting the continued solid performance of our higher-margin customer classes. Looking ahead, we plan for normal weather, as always, which equates to $0.22 per share of positive variance for the remaining 9 months of the year, given the mild temperatures experienced throughout 2023. From a regulatory perspective, we're assuming $0.18 per share of positive variance, which is largely driven by the constructive electric rate order received from the commission in early March. We also assume a supportive outcome in our pending gas rate case. On the cost side, we anticipate lower overall O&M expenses at the utility driven by usual cost performance fueled by the CE Way and last year's voluntary separation program, among other 2023 cost reduction initiatives that continue to bear fruit. We also assumed lower service restoration costs given last year's record level of storm activity in our service territory. In aggregate, we expect these items to drive $0.09 per share of positive variance for the remaining 9 months of the year. Lastly, in the penultimate bar on the right-hand side, you'll note a significant negative variance which largely consists of the absence of select one-time countermeasures from last year and the usual conservative assumptions around weather-normalized sales and non-utility performance among other items. In aggregate, these assumptions equate to $0.52 to $0.58 per share of negative variance. Slide 8 offers the latest updates on our regulatory forward calendar. As you'll note in the top section, we plan to file a Renewable Energy Plan (REP) by mid-November, which will highlight our strategy for complying with the various renewable energy targets associated with Michigan's new clean energy law. We are excited about the prospects of the new law, which will support our net zero carbon by 2040 goal and look forward to socializing our filing with key stakeholders in the coming months. Once filed, the commission will have 300 days to issue an order, likely in the third quarter of 2025. Therefore, as mentioned during our fourth quarter call, you should expect the 5-year plan to roll out in the first quarter of 2026 to incorporate a greater portion of the financial impacts of the REP. Moving on to our general rate case filings, you can expect our next electric rate case to be filed in the late May to early June timeframe. This filing will incorporate some of the initial spending we've outlined in our 5-year electric reliability roadmap that Garrick touched on earlier. Given the 10-month stipulated period for rate cases in Michigan, we would expect to receive an order from the commission in the first quarter of 2025 and thus, the related financial impact. Lastly, we anticipate an order in our pending gas rate case by mid-October, absent a settlement. While we don't always include a balance sheet update on our formal presentation, it is worth noting that Moody's and Fitch reaffirmed our credit ratings in March and April, respectively, as noted at the bottom of the table on Slide 9. Longer term, we continue to target solid investment-grade credit ratings, and we'll continue to manage our key credit metrics accordingly as we balance the needs of the business. With that, I'll hand it back to Garrick for his final remarks before the Q&A session.

Garrick Rochow, President and CEO

Thank you, Rejji. Our simple investment thesis is how we run our business and provides us with confidence for a strong outlook this year and beyond. 21 years of consistent industry-leading financial performance serve as proof, regardless of conditions, no excuses, just results. With that, Drew, please open the lines for Q&A.

Operator, Operator

Our first question today comes from Shahriar Pourreza from Guggenheim Partners.

Shahriar Pourreza, Analyst

I guess, firstly, just given you have an upcoming electric case. How are you thinking about any kind of incremental construct improvements there? Would you kind of seek an expanded IRM framework? Do you need to address any kind of rate design issues with C&I rates, especially as you're trying to accommodate new load like data center growth, especially just trying to balance that customer rate impact?

Garrick Rochow, President and CEO

Shahriar, you want me to get into rate design? Everyone's going to fall asleep on this call if I go into rate design. Let me start with the fundamentals of this electric case, as this is really important. You've heard me speak repeatedly about the importance of improving reliability. We've seen higher wind speeds and more frequent storm activity. This is our focus as a company: how we improve reliability and the longer-term resiliency of our electric system. You can also hear that from the commissioners; they're very clear about that expectation. So I would say there's really good alignment there, and this reliability roadmap does just that. It's aimed at those important capital improvements. There's some O&M work associated with that as well. These are best practices in the industry, which we're deploying across our system and will provide meaningful benefits for our customers. Additionally, we're focused on the affordability aspect. It's great to invest the capital, but we also have to pay attention to affordability for our customers. So that's driven down unit costs through the CE Way, and there are various cost offsets; there's a range of actions we're undertaking to ensure this next electric rate case delivers for our customers in terms of improved reliability and cost offsetting. So those are the fundamentals of the case. We're going to explore different mechanisms in that case. As I shared previously, I would anticipate we again take advantage of our infrastructure recovery mechanism supported in the last case. We'll look at a storm recovery mechanism. We've utilized that in previous cases and will continue to explore that opportunity as well. Longer term, we'll file this in late May or early June. I feel confident about what we're assembling based on the important merits of the case that will improve reliability while balancing the significant components of affordability.

Shahriar Pourreza, Analyst

Got it. Perfect. Lastly, as we're thinking about the energy law construct, what are some of the first changes you can implement, especially as we think about the upcoming IRP update? Would you lean more on that FCM construct? Is any of this kind of embedded in your long-range growth guidance?

Garrick Rochow, President and CEO

It's still early days on some of that modeling. We'll file our Renewable Energy Plan (REP) on November 15. As I've mentioned in previous calls, there's a broad spectrum of ownership versus PPAs. PPAs obviously have the opportunity for the financial compensation mechanism, or if you're going to build and own everything, you obviously have the opportunity to earn your ROE. It ranges between those bookends, and I think there's a mix. There are many variables we need to consider that we're modeling out right now, and that's why we're not prepared to share what that looks like, but let me hand it over to Rejji; I know he has some additional thoughts on this.

Rejji Hayes, Executive Vice President and CFO

Thanks for the question. All I would add to Garrick's comments is that in our current 5-year plan, we've incorporated a modest amount of PPAs with the financial compensation mechanism, solely because any PPA put in place after June of this year would be subject to the new FCM, around 9% versus the prior of about 5.5%. We have a portion of that, albeit a small portion, included in this 5-year plan. We've also factored in the enhanced economic incentives associated with energy efficiency flowing through our plan as well. Historically, on the electric side, we've been reducing load by about 2% year-over-year, and prior to the new energy law, we had a 20% incentive on top of that spend. That's now 22.5%, which is an additional source of financial upside embedded into this plan. However, the more expansive opportunities regarding scaling contracts, ownership opportunities, or more specifically rate base opportunities are not incorporated into our 5-year plan and won't be until 2026.

Shahriar Pourreza, Analyst

Okay. Perfect. Appreciate it, Garrick, for the record, your rate design answer was not boring at all.

Operator, Operator

Our next question comes from Nick Campanella from Barclays.

Nicholas Campanella, Analyst

I guess just thinking about other off-site opportunities, can you maybe give us an update on your conversations around DIG and the recontracting opportunity there? And how those discussions have been progressing? Is this something that we can maybe see an update on by year-end, or is it more a '25, '26 item? Maybe just talk about timing there.

Rejji Hayes, Executive Vice President and CFO

Nick, this is Rejji. I appreciate the question. Yes, as we discussed on our fourth quarter call, we still have about 30% to 35% open margin in the outer years of our plan, starting around 2026 or the second half of 2026 going through 2028. We certainly see attractive reverse inquiry for that open margin on the capacity side. We're sold through on the energy side through 2028, but there are still opportunities in the capacity side. We'll be thoughtful. We never get too aggressive in selling down that open margin. We like to have a little bit of optionality, particularly with the attractive technical opportunities we see in Zone 7 with tightening supply and upward pressure on demand. We'll provide an update in our next 5-year plan, as we always do, and I expect we'll begin selling down a portion of the open margin gradually over the coming months and quarters, but we should still have a little open margin as we provide a new 5-year plan in the first quarter next year. I hope that's helpful.

Nicholas Campanella, Analyst

That is helpful. I appreciate that. And I guess thinking about the rate case cadence and outcomes, on the electric side, the last case pursued a fully litigated outcome, but on the gas side, you just received staff testimony. I think, Rejji, I heard you say you'd get an order in the fourth quarter absent a settlement. So just what's your reaction to the staff's starting point here, and what are your thoughts on being able to settle the gas case?

Garrick Rochow, President and CEO

I'd go back, Nick, to the fundamentals of that case, aiming for a safe natural gas system, reducing methane and delivering affordable natural gas to our customers. The balance of that equation involves making investments in the natural gas system, just like we're doing in the electric business while aiming for improved affordability across the gas ranks through unit costs, and by pushing costs down using the CE Way. Those fundamentals remain important. Staff position, I categorize as constructive and a constructive starting point. Once we have that position, we will look for opportunities for settlement. We've successfully worked with several interveners in the past, so I have confidence in the testimony and merits of the case. If we need to go the full distance, we will, and I am optimistic we will achieve constructive outcomes for our customers and stakeholders.

Operator, Operator

Our next question comes from Jeremy Tonet from JPMorgan.

Jeremy Tonet, Analyst

Just want to dive in, I guess, to the sales outlook. It came in a bit better than expected, I guess, for the first quarter, and for the balance of the year, it looks like that's trending better than expected. Just wondering by customer class if you could dive in a bit more on the drivers that you're seeing that within each class that is leading to this uptick.

Rejji Hayes, Executive Vice President and CFO

Yes. Jeremy, this is Rejji. I appreciate the question. We were pleased with the first quarter performance of non-weather sales. We provided color on that in our earnings digest, which you probably saw. Going through customer classes, we saw residential sales up just under 1.5% versus Q1 of 2023. On the surface, that looks quite good, but it's important to note the leap day in the quarter drove about two-thirds of that. Still, even without the leap day effect, residential sales were up about 0.5%. We see continued upside with the trend of returning to work and facilities. We had conservative assumptions about this return but are noticing greater stickiness with employees retaining what I would describe as a hybrid workforce, which is delivering some surprises on the upside, especially since it represents a higher-margin customer class as well. Our commercial side also performed remarkably well, with nearly a 3.5% increase versus Q1 of 2023; after calculating out the leap year effects, we were still just under 2.5%. Some specific subsectors performed well, including agriculture and mining, which were up around 6.5%. Entertainment also increased by about 3%. We believe this is partially due to more foot traffic in communities as people return to the office more regularly, contributing to businesses like cafes. Regarding industrial customers, if you exclude one low-margin large customer, we were slightly up, at around 20 to 25 basis points. However, accounting for the leap year, you'd see a decline of about 1%. I also want to add that weather-normalized sales inherently include the impact of our efforts to reduce electric load by about 2% each year due to energy efficiency efforts, so these numbers are on a gross basis. Additionally, the weather normalization process is an imperfect science, but we feel good about the economic outlook and remain optimistic about the robust pipeline of opportunities in the industrial sector that should impact our numbers positively in the coming years.

Jeremy Tonet, Analyst

That's very helpful. And maybe just pivoting a bit here, it seems on the side that they lay out, there's a bit of cushion to hitting the guide in '24. Just wondering, how does your confidence level guide at this point put you in position to start thinking about '25? Just wanted to get a sense for how that stands.

Rejji Hayes, Executive Vice President and CFO

Yes. I would say, Jeremy, early days. Obviously, we're delighted that 2024 is not 2023 in that we don't have significant storm activity or mild weather at the start of the year, which we obviously experienced last year. To be clear, we still observed negative variance in terms of weather-related revenue; there's still some work to do. We are actively counter measuring, and we're confident in the outlook, but it’s too early to start thinking about derisking 2025 and beyond.

Operator, Operator

Our next question comes from David Arcaro from Morgan Stanley.

David Arcaro, Analyst

I was wondering what you're seeing in terms of data center demand in the pipeline. Any uptick in further requests to connect beyond the megawatt addition that you called out? And wondering if that customer class would potentially be involved in the voluntary renewables plan. Any upside potential there?

Garrick Rochow, President and CEO

Thanks for your question, David. A couple of things on this. I typically don't like to talk about the pipeline, as it is quite speculative. Many data center companies are testing waters in various utilities, and we typically focus on secured contracts. When we discuss economic development, whether in manufacturing or data centers, we are referring to secured contracts. This particular data center expansion, which we've mentioned, is for 230 megawatts expected to be online by 2025, with most of the load in place by 2026. This highlights our ability to deliver for these customers. Additionally, Michigan has an attractive temperate climate, which is beneficial for heating and cooling loads, alongside abundant freshwater and energy-ready sites with competitive energy rates. There is active consideration within the state legislature regarding a sales and use tax exemption, which passed the House and is now in the Senate for consideration. We believe this exemption should advance, and if it does, it could broaden Michigan's attractiveness to data center businesses. Companies are weighing options to explore Michigan, though it's early in the process since they're evaluating various locations. We are optimistic about tracking this load growth appropriately while balancing the costs associated with it from both energy and capacity perspectives.

David Arcaro, Analyst

It does. That's helpful. Are you thinking there could be upside to your long-term load growth expectations, or is it still early?

Garrick Rochow, President and CEO

Between the manufacturing load from this contract and the data center load that's contracted, as Rejji indicated, it's a substantial piece of load growth that's factored into the later years of this 5-year plan, and we're excited about what that means. There's a strong pipeline from both manufacturing and data center sectors. I'd be disappointed if some of those projects in the pipeline did not materialize. The performance-based rates process is progressing in a positive manner. Initially, we proposed close to ten or so metrics, and it's now narrowed down to four metrics that are benchmarkable and feature good standards. There is still more work to do from our perspective, and we filed comments in the February-March timeframe. We anticipate receiving a report from the Michigan Public Service Commission staff in May, and this will shape our next steps. I suggest we might expect two electric rate cases away before we see implementation. This could potentially happen in the next case, but we continue to evaluate the process with the Public Service Commission.

Operator, Operator

Our next question comes from Michael Sullivan from Wolfe.

Michael Sullivan, Analyst

Just sticking with the data center conversation, it sounds like you're optimistic about this legislation, and if that passes, what do you think about the potential for DIG being fully utilized as a behind-the-meter solution for a larger type of data center build-out?

Garrick Rochow, President and CEO

Like Rejji's comments, from an energy and capacity perspective, most of DIG has been allocated at attractive positions, either meeting our expectations or exceeding them. Therefore, unless you go beyond 2028 and into the 2030s, DIG is largely tied up already due to secured commitments associated with attractive tools and bilateral contracts for capacity.

Michael Sullivan, Analyst

Fair enough. That makes sense. On your upcoming audit rate case filing, should we expect a similar response from the Attorney General as we've seen from one of your peers who recently filed?

Garrick Rochow, President and CEO

We have primaries occurring in August, and so early deliberations will commence in June. Political seasons are already heating up in Michigan, and I would anticipate some level of scrutiny. The Attorney General participates in all our cases, which has been standard practice historically. Sometimes this engagement is more evident than others. We stand by the merits of the case, both in our gas case that's underway now and this electric rate case. The team just conducted a walkthrough this week, and I'm proud of the work they've done on it. Our focus is on enhancing reliability, which is the right thing to do; it is also in alignment with the Public Service Commission's objectives. We are also working hard to create affordability. We're skilled in that area through the CE Way, and we've made significant strides in reducing power supply costs and unit costs by effectively executing capital projects. When we find the right balance in these equation components, we can yield positive results. I'm excited about this case, as it certainly marks a step up in capital. There will also be some O&M work centered around reliability, but we have some offsets in place that make this an exciting opportunity for us and ultimately beneficial for our customers and stakeholders.

Operator, Operator

Our final question comes from Andrew Weisel from Scotiabank.

Andrew Weisel, Analyst

Follow up on the rate cases here. Just a couple of follow-ups regarding the rate cases. First, I think you just alluded to the electric side. Should we expect a larger revenue increase request than what we've seen in past filings, in terms of percentage increase to customer bills?

Garrick Rochow, President and CEO

Yes, the short answer is yes. However, the important work from a capital investment perspective relates to reliability, and we've worked to offset some of the O&M costs components in order to strike the right balance. This underscores the significant merits of the case.

Andrew Weisel, Analyst

Very good. On the gas side, I know this case is unique in that there's no ALJ. Does that change the timeline at all, or the potential for settlement? You spoke a bit about settlement, but does the absence of ALJs factor in at all?

Garrick Rochow, President and CEO

No. The team is enthusiastic about the opportunity to come to the table. Now that we understand the staff position and know where the intervenors stand, we are motivated to explore settlement. We've successfully navigated this process in the past with all intervenors and stakeholders, and we will continue to do so. However, I want to reiterate my confidence in the case's merits; if necessary, I will push through to secure a favorable outcome for customers and stakeholders.

Operator, Operator

That concludes the Q&A portion of today's call. I'll now hand back over to Garrick.

Garrick Rochow, President and CEO

Thanks, Drew. I'd like to thank you for joining us today. I look forward to seeing you on the road soon. Take care and stay safe.

Operator, Operator

That concludes today's call. Thank you for your participation. You may now disconnect your lines.