Earnings Call Transcript - EVRG Q1 2023

Operator, Operator

Good day and thank you for standing by. Welcome to the Q1 2023 Evergy Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during this session, you will need to press star-one-one on your telephone. Please be advised that today's conference call is being recorded. I would now like to turn the conference over to your speaker for today. Peter Flynn, you may go ahead.

Peter Flynn, Speaker

Thank you, Lisa, and good morning, everyone. Welcome to Evergy's first-quarter 2023 earnings conference call. Our webcast slides and supplemental financial information are available on our Investor Relations website at investors.evergy.com. Today's discussion will include forward-looking information. Slide 2 and the disclosures in our SEC filings contain a list of some of the factors that could cause future results to differ materially from our expectations. They also include additional information on our non-GAAP financial measures. Joining us on today's call are David Campbell, President and Chief Executive Officer; and Kirk Andrews, Executive Vice President and Chief Financial Officer. David will cover our first-quarter highlights provide regulatory and legislative updates and discuss our ESG progress. Kirk will cover in more detail the first quarter results, retail sales trends, and our financial outlook for the year. Other members of management are with us and will be available during the question-and-answer portion of the call. I will now turn the call over to David.

David Campbell, CEO

Thanks, Pete, and good morning, everyone. I'll begin on Slide 5, and I'm pleased to report that Evergy had a solid first quarter as we delivered adjusted earnings of $0.59 per share compared to $0.56 per share a year ago. The increase was driven by weather-normalized sales growth, transmission margin, and lower O&M expenses, partially offset by the impact of a mild winter, an increase in depreciation and amortization, and higher interest expense. Kirk will discuss these earnings drivers in more detail in a few minutes. In 2022, we achieved our historically best safety year, and I'm pleased to report that our OSHA recordables and days away and restricted time events are trending favorably relative to those '22 results through the first quarter of this year. These improvements are a testament to the work of the entire Evergy team. I'd like to thank my fellow employees for their unwavering commitment to safety. With the solid start to the year, we are reaffirming our 2023 adjusted EPS guidance range of $3.55 to $3.75 per share as well as our target long-term annual adjusted EPS growth target of 6% to 8% from 2021 to 2025. On Slide 6 and 7, I'll discuss our recently filed Kansas rate reviews, beginning with Kansas Central on Slide 6. On April 25, we filed an application requesting a $204 million revenue increase, premised on a 10.25% return on equity, a 52% equity ratio, and a projected $6 billion rate base as of the proposed June 30, 2023 true update. As shown on Slide 7, in Kansas Metro, we requested a $14 million revenue increase, premised on a 10.25% return on equity, a 52% equity ratio, and a projected $2.6 million rate base as of the proposed June 30 true update. We believe these rate requests are straightforward and reflect the communications we've had with our Kansas regulators and stakeholders in workshops and other settings over the past few years. The principal items include recovery and return on our grid modernization and infrastructure investments since our last rate reviews in 2018 as well as passing on to our customers the benefits of the substantial cost savings we've achieved since the merger that formed Evergy five years ago. Across our two Kansas jurisdictions, these cost savings reduced the combined revenue increase request by 37%. We are pleased that the hard work of the Evergy team resulted in cost savings that are significantly higher than projected during the merger approval process. These efforts have been a major contributor to successfully advancing our regional rate competitiveness. Since the end of 2017, our rates in Kansas have remained virtually flat, while our regional peers have, on average, increased their rates by double digits, and cumulative inflation has been over 20%. As a reminder, Kansas rate cases run on an eight-month schedule, so new rates will go into effect by year-end 2023. We'll provide an updated time line when a procedural schedule has been issued. We look forward to working with our regulators and stakeholders over the coming months to achieve a constructive outcome for our Kansas customers and communities. Moving on to Slide 8. I'll provide an update on our other regulatory and legislative priorities. In Kansas, Governor Kelly signed House Bill 2225 into law in April and will become effective in 2024. The bill includes a provision that matches the return on equity for our locally planned FERC transition projects to the return on equity established by the state for our other infrastructure investments. This law applies specifically to current and future transmission projects that are not subject to notifications to construct from the Southwest Power Pool. HB 2225 keeps our transmission delivery charge rider mechanism, or TDC, unchanged and fully intact. This bill provides savings to customers and was a product of constructive dialogue with Kansas regulators, legislators, and other stakeholders. In Missouri, the order approving our request to securitize extraordinary costs from Winter Storm Uri is in the state of appellate process. We believe the commission's decision in support of securitization is well supported by the record. As a reminder, we will complete the securitization financing after the appeal plays out, but incremental carrying costs incurred prior to approval will ultimately be recovered when we issue the debt. We anticipate resolution later this year. On the legislative side, we're tracking the progress of Senate Bill 275 in Missouri, which would create a state and local sales tax exemption for the production of electricity. If signed into law, these savings will be passed on to customers and our next Missouri rate case. This bill has passed out of the Senate and is currently awaiting debate on the House floor. Other bills relating to the energy sector may also receive attention this month. For example, the build it enhances state oversight of transmission and improves the consistency of transmission operations and planning, referred to in shorthand as right of first refusal legislation, continues to be an area of focus. The benefits of this legislation are reflected by similar laws that are in effect in the majority of states across our region. However, as the Missouri legislative session is scheduled to adjourn on May 12, timing is tight, and we expect that the discussion of ROFR and other energy-related bills may continue into next year. As a final note on Slide 8, we remain on track to file our annual integrated resource plan updates in both Kansas and Missouri by mid-June. This year's IRP updates will include significant changes in assumptions, most notably updated cost estimates for new generation as well as substantial subsidies in the Federal Inflation Reduction Act for carbon-free resources. Moving to Slide 9. I'll profile another element of our corporate strategy related to environmental, social, and governance measures. We continue to enhance our ESG practices and disclosures, and our efforts have been recognized and reflected in significant improvements in third-party ESG ratings for Evergy. For example, Slide 9 profiles the comprehensive progress that we've made in the ESG ratings provided by ISS and by S&P Global's corporate sustainability assessment. From a disclosure perspective, 2022 marked the first year Evergy completed full CDP climate and water security questionnaires, as well as the global reporting initiative report. We've also joined the Electric Power Research Institute's Climate Ready Initiative, a research partnership aimed at developing a collective approach to identifying and managing physical climate risks. Over time, we expect this effort to support the optimization of our grid investment priorities, utilizing a common framework around cost-benefit analysis, risk mitigation, and adaptation strategies. Finally, we continue to integrate climate-related risks into our enterprise risk management system. This is the best practice, which will allow us to identify and mitigate the impact of current and future risks in our business, enhancing our ability to provide safe, reliable, and affordable power. I'll conclude my remarks with Slide 10, which highlights the core tenets of our strategy: affordability, reliability, and sustainability. On the affordability front, advancing regional rate competitiveness is one of our primary objectives. Since 2017, we have reduced rates by 0.8% across our service territories, while regional rates have risen by double digits, and inflation rose 20% over the same time period. The impact of these efforts is reflected by ongoing wins in our region and economic development. And while we're pleased by our progress in improving regional rate competitiveness and keeping our rate trajectory far below the rate of inflation, affordability will always be an area of focus. We target top-tier performance and reliability, customer service, and generation through modernization of our transmission and distribution lines, investing in smart grid technology, and developing systems capabilities that meet customer needs and enable increasingly active customer engagement with their electric service. Reliability also encompasses operational excellence in our generation fleet, leveraging the skills and capabilities of our high-performing team and important assets like our Wolf Creek nuclear plant. Reliability is all the more important given the increasingly central role that electricity plays in so many aspects of daily life. We recognize the responsibility that comes with our role, and we embrace the challenge of delivering power at the cost and service level that our customers expect and demand. With respect to sustainability, we continue to advance the transition of our generation fleet, a process that has been underway for two decades. Since 2005, we reduced carbon emissions by nearly half while reducing sulfur dioxide and NOx emissions by 98% and 88%, respectively. Additionally, nearly half of the energy that we generated for our retail customers came from carbon-free resources in 2022. Our mission is to empower a better future, and our vision is to lead the responsible energy transition in our region, always with an eye on affordability, reliability, and sustainability. And with that, I will now turn the call over to Kirk.

Kirk Andrews, CFO

Thanks, David, and good morning, everyone. Turning to Slide 12, I'll start with a review of our results for the quarter. For the first quarter of 2023, Evergy delivered adjusted earnings of $136 million or $0.59 per share, that's compared to $130 million or $0.56 per share in the first quarter of 2022. As shown on the slide from left to right, the year-over-year increase in first-quarter adjusted EPS was driven by the following. First, mild winter weather resulted in an approximate 11% decrease in heating degree days compared to last year, driving a $0.08 decrease in EPS. The strong weather-normalized demand of 2.1%, driven by the residential and commercial sectors, contributed $0.04 per share. Higher transmission margins resulting from our ongoing investments to enhance our transmission infrastructure drove a $0.02 increase. A $36 million decrease in O&M drove a positive $0.12 variance year-over-year. This was partially the result of timing of O&M expenditures within 2023. The net impact of higher depreciation and amortization was $0.07 for the quarter, which includes the offsetting impact of new retail rates. Proceeds from company-owned life insurance contributed $0.04 during the quarter. And the combination of higher interest expense and lower AFUDC drove a $0.13 decrease, with interest expense representing $0.11 of that variance. The increase in interest expense reflects the lower rate environment in early 2022, and we expect rate-driven variances to decrease in magnitude as we move through the year, consistent with the assumptions in our guidance. And finally, other items, both positive and negative, drove a net increase of $0.09, which was primarily driven by other income and income tax-related items. Turning to Slide 13, I'll provide a brief update on our recent sales trends. On the left side of the slide, you'll see that total retail sales increased 2.1% over the first quarter of 2022, driven primarily by increases in both residential and commercial usage. The decrease in industrial demand is primarily attributable to two refining customers, one of which experienced a high demand a year ago, and the other offline this past quarter due to a planned outage. Excluding these two customers, however, remaining industrial weather-normalized demand increased. Demand growth continues to be supported by a strong local labor market with Kansas and Kansas City Metro area unemployment rates of 2.7% and 2.9%, respectively, which remained below the national average of 3.6%. I'll conclude my remarks with Slide 14. Our focus remains on continuing to demonstrate a strong track record of execution. As David mentioned earlier, based on solid first-quarter results, combined with our outlook for the remainder of the year, we are reaffirming both our adjusted EPS guidance range for 2023 and our long-term compound annual EPS growth rate target of 6% to 8% from 2021 to 2025 based on the midpoint of our original 2021 EPS guidance of $3.30. We also remain committed to returning capital to our shareholders and target dividend growth in line with earnings growth with a dividend payout ratio of between 60% to 70%. In addition to allowing us to achieve these financial targets, executing on this investment plan advances our key objectives of ensuring affordability, reliability, and sustainability over the long term. And with that, we'll open the call up for questions.

Operator, Operator

First question is coming from Shar Pourreza of Guggenheim. Your line is open.

Shar Pourreza, Analyst

Good morning. Maybe we'll just start with the Persimmon Creek project. Obviously, you pivoted from Missouri to Kansas and included it in the latest cases there. Where is the pathway forward, if you're unable to roll the project into rates there? Does it stay at the parent? And also any color on how to think about the earnings impact if that were the case versus the $0.05 you originally had in plan?

David Campbell, CEO

I’ll begin and ask Kirk to add to this. We believe the Persimmon Creek asset is an excellent investment due to its overall cost for its size. The best value is backed by the integrated resource plan in relation to both capacity and energy requirements. It's strategically located for transmission, aligning well with the needs of our Kansas jurisdiction, which continues to experience growth in demand and new customers like Panasonic. We see this asset fitting nicely with our resource plan and consider it a valuable resource for our customers. As mentioned, it was included in our filing on April 25 and will proceed through the necessary processes, along with our other infrastructure investments. Regarding your question on earnings per share, since it will transition to the Kansas jurisdiction, which has different requirements, we will not see the earnings contribution in 2023 follow the same pattern in subsequent years. Again, we regard it as a significant asset.

Shar Pourreza, Analyst

Got it. Perfect. And then, Dave, I know you and Kirk have been working tirelessly with the KCC. I know obviously, the capital components of the case have been really well vetted through the STP. As we kind of get the process started, I realize it's obviously very early innings, but is the settlement possible here? Or do you expect kind of a fully live case at this point?

David Campbell, CEO

So Shar, that's a question we get from many investors. As you can guess, since we filed it on April 25, probably a little speculative for me to be specific as to what will occur. We do think that we have a pretty straightforward rate case. The complexity only really comes from the fact that it's been five years since our last general rate case. But the elements are straightforward. We have no major generation retirements. We don't have complexities like some of the things that you can see after this longer time period. So we think the framing is there for a constructive set of dialogues and certainly will be our objective to drive towards settlement. Now that will be in the fall. So we're a ways away. But as you noted, what's a real positive in this case is that we've had the opportunity to preview and go through our capital investment plans in a series of workshops over the last three years. Starting with the STP workshops as you noted in 2020 and continuing until the capital workshop that we had in December, and those were multi-hour workshops attended by all three commissioners the whole time. And it included projections on rates. And what we filed is in line with what we laid out in those proceedings. So, we think that sets the groundwork for a constructive set of discussions. And of course, the process will play out as it will. We've got a very capable and knowledgeable staff at the KCC. So, we look forward to interacting with them with Kirk and with other stakeholders through the process, and we certainly hope that we will have a constructive dialogue that enables the settlement as we advance through the year. The eight-month timeline, as I mentioned. So the rates will go into effect in December, and a lot of the crescendo happens in the fall time frame.

Shar Pourreza, Analyst

Got it. Got it. Perfect. And then just real quick lastly for me. It's just the ROE tweak from the TDC bill that passed in Kansas. It seems like it could be a modest drag in '24 and maybe beyond. Is that the case? And how are you, I guess, thinking about potential offsets there? Appreciate it.

David Campbell, CEO

Yes. So, it is a pretty modest impact, Shar, in the range of roughly $0.04 or so. We think we can absolutely manage that in the context of our business, given our size and our overall earnings power. We think the ultimate resolution was reflected in a constructive dialogue. The initial proposal that was issued was to remove the TDC mechanism or concerns by some of why you have a different mechanism in place and a lower level of state oversight. So, we're able to get an accommodation that enhanced data oversight of transmission at an equivalent and the return on equity for different types of infrastructure investments, but keeps the TDC mechanism in place. So, we thought it was a constructive outcome overall, and one that's very manageable and was a sensible approach as we headed into 2023 in a rate case here, and we're glad that we're able to work with parties to get to that outcome.

Michael Sullivan, Analyst

I wanted to just ask on how things are tracking on the year just given the mild weather and then also seeming like the Persimmon Creek nickel that you had in guidance isn't going to be realized potentially until next year now where the offsets are coming from?

David Campbell, CEO

So, I'll actually, Kirk, do you want to take that one? It's been hearing from me for a bit. Do you want to build it?

Kirk Andrews, CFO

Sure, Michael. Look, it's early in the year. We had a strong start to the quarter. We've reevaluated and kind of reset our expectations for the year, including that impact of at least the debt delay, albeit relatively mild delay in terms of the realization of the earnings on percent accrete. We feel confident we've got means at our disposal to offset that through a number of means. Obviously, we're pleased with the performance on O&M. Year-to-date, I mentioned earlier, some of that is relative to timing, but it gives us a lot of flexibility throughout the year to pull levers to offset. So, that's really what underpins our confidence in reaffirming that guidance for the year.

David Campbell, CEO

Yes, Michael, I want to point out that we experienced a very mild winter, especially in the Midwest, and we were fortunate to be able to offset that impact. We're happy with our solid quarterly performance. While all companies have to deal with weather challenges, we managed to offset it and are satisfied with our results this quarter instead of simply reacting to it as a yearly management issue. The team did an excellent job navigating the situation during the quarter. Therefore, we feel positive about the year and are reaffirming our guidance range.

Michael Sullivan, Analyst

Okay. Great. And on the IRP, I know that's coming in a couple of weeks. Can we just get sort of a high-level preview there of maybe just how material changes we should be expecting in terms of new capacity need and some of the moving pieces on cost of renewables post-IRA and inflation and all that?

David Campbell, CEO

So, Michael, I won’t jump ahead of the results regarding our total renewables build-out plans. What I can say is that under the surface, there’s been a lot of activity. We did not include the renewables incentives from the IRA in our last RFP update since that law was recently enacted. That’s a significant change. Additionally, we have bids from our all-source request for proposals that we can incorporate with capital costs from that real-time market information in the Integrated Resource Plan. Most of those costs have risen. Hence, there are some offsets. Underneath it all, there are notable changes in our assumptions regarding commodity costs. We experienced considerable fluctuations in natural gas prices in the latter half of the year. While we might hope for consistently low natural gas prices, what we are likely seeing is potential for ongoing volatility. Many factors are at play, but as we process these through our ongoing modeling, it reinforces the long-term value of renewables, which largely hinges on availability, especially given supply chain challenges. I believe there is strong support for renewables as a cost-effective option for customers in a long-term planning context. In the near term, however, we must contend with supply chain issues that affect resource availability. Some elements will change going forward, particularly regarding different EPA rules currently being introduced; while some have been issued, others are being reported on. I do not anticipate this IRP will reflect the new greenhouse gas post rule since it hasn’t been formally released yet, but the discussions surrounding it further emphasize the value of integrating lower-cost resources into the system and highlight the importance of capacity. One notable change since last year is the increasing benefits associated with having greater capacity, alongside rising demand. To summarize, while I am not providing new figures, the factors supporting the benefits to customers of integrating renewables into the system are present, alongside some additional motivation regarding capacity resources, and we need to navigate some near-term supply chain challenges. We are optimistic about the future, and we will provide a comprehensive update when we release the Integrated Resource Plans.

Michael Sullivan, Analyst

Okay. That's very helpful. Yes, the end of your response there was kind of where I wanted to follow up. I mean at the end of the day, in terms of where to expect pushback? Is this really just approving lowest cost type thing as long as you can get the reliability where it needs to be? Is that kind of what stakeholders are going to be looking for most?

David Campbell, CEO

We consider the overall lowest cost based on the net present value of the revenue requirement. Our focus is on identifying what will provide the greatest value for customers while taking into account various incentives. This is a 20- to 30-year model, which makes it complex. Our 15- to 20-year model involves a lot of inputs, but ultimately, it boils down to what will deliver the best value to our customers while maintaining reliability.

Durgesh Chopra, Analyst

Straightforward and my questions have been answered. Maybe I was just curious and I can follow up with Pete if you don't have the answer. David, in your prepared remarks, you mentioned that the cost savings exceeded the original kind of targets you had when the merger happened? Can you quantify what that looks like? If not, I'll just follow up with Pete.

David Campbell, CEO

Durgesh, it was a few hundred million dollars, but which we exceeded, several hundred million overall. Now that's across the corporate enterprise. And it's a tremendous result that was achieved by our employees. So, we can get you the exact number of several hundred million dollars in excess of what was initially predicted if you look at the cumulative savings over the five years.

Paul Patterson, Analyst

I noticed that there seemed to be a labor capitalization benefit. Could you explain that further and what the impact might be on its trajectory? Specifically, do you anticipate there will be more benefits in the near term? Additionally, is there a possibility of a reversal? Please provide more details on this.

David Campbell, CEO

Certainly, Paul. I appreciate your thorough review of the materials. Like all utilities, we have a strict process for evaluating our capitalization rates to ensure we accurately reflect the necessary amounts in our activities. We’ve invested significantly in capital, and there is a proper proportion of labor that should be capitalized, backed by a solid methodology that utilities utilize. We are applying that rigorously. For instance, in our Wolf Creek plant, the capitalization rate was slightly higher due to ongoing activities. Overall, our trajectory regarding operational and maintenance expenses and capital is integrated into our planning process. Therefore, I wouldn’t expect a major change. Instead, you will notice continuous implementation of adherence to established rules in this area. This is reflected in our plans and supported by diligent accounting practices. The observations you've made were primarily influenced by specific projects at our nuclear plant and Wolf Creek.

Paul Patterson, Analyst

I'm wondering if this is linked to those projects. Going forward, it seems this isn't a permanent change but rather tied to specific project activities.

David Campbell, CEO

That's right, Paul. It reflects the activities that are underway and the application of the relevant rules that are in place. We're looking at and making sure we're following the right approach, if you think about being in an industry like ours sorry, that we're well benchmarked. We got great support from our accounting team and our external auditors, so well-established approaches to take in that regard and best practices.

Operator, Operator

Thank you, that concludes the Q&A session. I will turn the call over to David Campbell for closing remarks.

David Campbell, CEO

Lisa, it was efficient. It's like the first round of the NFL Draft, which I hope everyone enjoys in the great city of Kansas City. We appreciate all of you joining us this morning. Thank you for your interest in Evergy, and have a great day. That concludes the call.

Operator, Operator

Thank you, everyone, for joining you. Enjoy the rest of your day. The conference call has been concluded.