NorthWestern Energy Group, Inc. Q4 FY2021 Earnings Call

Good afternoon, and thank you for joining NorthWestern Corporation's Financial Results Webcast for the year ending December 31, 2021. My name is Travis Meyer, and I am the Director of Corporate Finance and the Investor Relations Officer for NorthWestern. With me today to discuss the results and provide an overall update are Bob Rowe, Chief Executive Officer; Brian Bird, President and Chief Operating Officer; and Crystal Lail, Vice President and Chief Financial Officer. Other members of the management team are also available to address your questions as necessary. NorthWestern's results have been released, and the details are available on our website at northwesternenergy.com. We have also issued our 10-K premarket last Friday morning. Please be aware that the company's press release, this presentation, comments from presenters, and responses to your questions may include forward-looking statements. I encourage you to review the disclosures in our SEC filings and the safe harbor provisions mentioned in the second slide of this presentation. Additionally, this presentation contains non-GAAP financial measures, so please refer to the non-GAAP disclosures, definitions, and reconciliations provided in today’s presentation. This webcast is being recorded, and the archived replay will be available for one year starting at 6:00 PM Eastern today, located in the financial results section of our website. Now, I will turn the presentation over to NorthWestern CEO, Bob Rowe.

Good afternoon. Thank you all for joining us. Travis, why don't you click back to the cover slide for just a second? Just a bit of history tying into our modern service territory. This is readers' alley in Helena. This was built in the 1870s, originally it was housing for miners for immigrants from as far away as Georgia and from across the Pacific Ocean. Today, they're non-profits located here. There's a great little Vietnamese restaurant, just out of the picture to the left and up the hill and a wonderful little bakery to the right, just out of the picture. Helena doesn’t get quite the attention or focus that the Bozeman big sky area does, but this is also very much a growing and dynamic community in our service territory, right below the continental divide and then on the shores of the Missouri River, two of our dams, Holter and Hauser, which have seen a lot of work and investment over the recent years are just north of here downstream on the Missouri. So, there's a little infomercial on one of the wonderful communities we serve. And going back to what you really want to hear about are the 2021 highlights. Starting with the financial results, net income of $186.8 million, or can I call that $187 million or $3.60 diluted EPS. Non-GAAP EPS to $3.51 is very much within our guidance range and a 4.8% increase over non-GAAP results the previous year. We expect long-term EPS growth rate of between 3% and 6%. 2021 was a record year for our capital investment. This is exciting because it’s us living up to our commitments to our customers and the communities that we serve. We've had a 12% CAGR in capital investment over the last five years from 2017 to 2021. This really is in all aspects of our business. We anticipate making a Montana electric rate filing later this year to recover the significant investment since our last test year of 2017. And we expect long-term rate-based growth between 4% and 5%. In terms of balance sheet, we're committed to maintaining investment grade ratings. As you know, in November of last year, we undertook a forward, which should address our equity needs into 2023. And we've maintained our commitment to a sustainable long-term dividend that the Board has approved a quarterly dividend increase of 1.6% to $0.63 per share. This marks the 17th consecutive year of increases and the CAGR would be 5.6% since 2004. So, moving from the highlights into the details, I'll turn it over to our Chief Financial Officer, Crystal Lail.

Thank you, Bob, and good afternoon, everyone. And for those of you who know Bob, if you need a small bakery reference, pretty much anywhere in the U.S. or outside of it, hit him up; he can help you with that. I'll highlight our strong financial results for 2021 and provide some insights looking ahead. As Bob mentioned, we achieved a net income of $168.8 million in 2021, up from $155.2 million in 2020, marking an improvement of $31.6 million or 20.4%. Our diluted earnings per share rose to $3.60 from $3.06. This increase in performance was primarily driven by improvements in our margins, with growth in both transmission revenues and volumes. We were able to maintain our operating costs at a sustainable level, although they had some impact on our results. Additionally, as Bob pointed out, we successfully executed our financing plan announced in late 2021, which supports our ongoing growth and capital investments, particularly through the equity issuance in the fourth quarter. This forward transaction provides us with flexibility to support our capital expenditures in 2022, allowing for record levels of spending without the need for additional equity until 2023. Now, on slide five, our margin has increased by $54.3 million or 6.1%. Notably, the growth in transmission was driven by higher rates and demand, as well as the recognition of some deferred revenue. Throughout 2021, we experienced increased needs for transportation across our lines, which positively affected our results. We also saw a $17.1 million improvement in electric retail volumes, attributable to customer growth and rebound in usage, particularly in commercial and industrial sectors after the COVID impact in 2020. While weather was generally unfavorable overall, it still exhibited some improvement compared to 2020. Regarding our operating costs, we saw an increase of $14.8 million or 2.3%, with $13.1 million affecting the bottom line. These expenses aligned with our expectations for the year, driven by higher labor and benefit costs due to improved financial performance, along with increased generation maintenance and technology costs. It's important to note that these costs are consistent with our goal of achieving a sustainable operating cost level as we move forward and prepare to file a rate case in Montana based on 2021 results. Slide eight shows that our operating income rose to $275.7 million, up from $236.2 million, reflecting a $39.5 million improvement driven by favorable margin results, despite increased operating costs. Interest expense decreased by $3.1 million compared to last year, and other income improved by $3.4 million, thanks to ongoing construction projects. Our income tax increased due to favorable revenues and operating income. Looking at cash flow from operations on slide nine, we reported $220 million, down from $352.1 million in 2020, mainly due to an under collection of energy supply costs impacted by winter storm Uri and increased natural gas costs. We entered into agreements to recover those natural gas costs through trackers in Nebraska, South Dakota, and Montana, which affected our cash flows for 2021. Backing out working capital impacts, our funds from operations were $340.6 million compared to $304.1 million, reflecting improved net income. On slide ten, GAAP earnings were $3.60, leading to a net income of $182.4 million or $3.51 when accounting for non-GAAP adjustments. This aligns with our earlier guidance for 2021 and shows a 4.8% improvement compared to the previous year. Transitioning to slide eleven, we are guiding down our 2022 earnings to a range of $3.20 to $3.40, reiterating our guidance while acknowledging the dilution from the recent equity transaction, as well as a focus on maintaining a sustainable cost structure. We remain committed to a long-term growth rate of 3% to 6% off a 2020 base and reaffirm our commitment to dividends. Bob, I will hand it back to you.

Thank you, Crystal. I'll say just a little bit about the capital budget at a high level, and then turn it over to Brian. First of all, we're coming off of our largest base capital budget ever, and Brian in his role as COO working with the operational vice president successfully managed that despite all the challenges of supply chain and everything else, so we feel very good about where we are. What you see here is a five-year look ahead that contemplates $2.4 billion of low-risk capital investment. As we tell you virtually every quarter, those stair steps down do fill in with important investment projects. And we certainly expect that to continue. But nonetheless here, what we have is base investment across transmission, distribution, generation, gas, and electric. We expect to finance this with a combination of cash from operations, first mortgage bonds and the equity issuances under existing forward contracts; of course, financing plans are subject to change. So this is an important commitment to invest in our service territory. Brian, could you provide some more detail and then also provide us an update on progress in taking some of the risk out of the Montana capacity deficit?

Thank you, Bob. I want to touch on a few points. The $2.4 billion we are planning to invest over the next five years is significant. As Bob mentioned, last year was our busiest capital year, and we are continuing that trend. In the breakdown of the $2.4 billion, almost 75% is allocated to transmission and distribution, which is generally not a contentious area. A considerable part of that investment in generation will focus on maintaining our current facilities, along with some spending on BGS this year and upgrades to our hydro facilities to boost their capacity. The only new development in this plan is the 175-megawatt gas plant in Montana, which Bob highlighted as having low risk. He also noted the trend of declining spending over this five-year period, which is consistent with our historical projections. However, as we advance our understanding and engineering of the projects, we may see later years of the plan filled in more as we learn more about our system. Currently, there are no additional generation projects included, but there is potential for this to change for South Dakota around 2026 or possibly sooner. As Bob mentioned regarding risk mitigation in our Montana operations, we have been facing a capacity deficit of 725 megawatts for a long time. This poses a notable risk for the company. Our previous RFP allowed us to reduce our capacity needs by 300 megawatts. We still need to finalize plant constructions and contracts, including battery agreements, to address this deficit. Moreover, we are seeing potential qualifying facilities coming online and discussions in the Pacific Northwest about increasing accredited capacity for current resources, which should help alleviate some of our constraints. We estimate that combining these efforts could resolve about 200 megawatts of that deficit. Additionally, with the upcoming heating season and the challenges observed last year in Texas, we wanted to address our capacity limitations promptly. Therefore, we pursued a mix of short- and medium-term capacity contracts to ensure reliability for this heating season and beyond. We also plan to incorporate these contracts into the upcoming rate case to reflect their value in our regulatory planning. This strategy buys us some time while we sort through issues related to Colstrip, which we will further discuss regarding its potential impact. Keeping all this in mind, we aim to submit an updated Integrated Resource Plan by the end of 2022 or early 2023, hoping for more clarity regarding Colstrip during that time. We will consider any outcomes related to Colstrip in our planning, including the 100-megawatt contract with Powerex, which is set to expire in the next five years, and other short- and medium-term contracts that will also conclude around that time. Now, Bob, I’ll hand it back to you.

Thank you, Brian. And with that, we are eager for your questions and discussion.

Thank you, Bob. Thank you, Brian, and Crystal. It appears we have our first question from Ryan Greenwald at Bank of America. Ryan, your line is now open.

Good afternoon. Can you hear me?

Hey, Ryan. Yeah, we can.

We can.

Awesome. Appreciate the time. Maybe starting with the investment plan. So, you guys firmed it up adding $300 million late last year, a lot of moving pieces, obviously with the discontinuation of Aberdeen, some additional spend elsewhere. Looks like you guys came in a little light on 2021. Can you just talk a bit about overall confidence in executing on the five-year plan, which spend might be most at risk and ability to backfill projects and maintain cost discipline, given the inflationary impacts?

I will address that, and I believe Brian and possibly Crystal will add to it as well. Considering the size of the budget and the numerous factors involved, I think 2021 was a significant success. I'm very pleased with the progress that Brian and the operations team have made in establishing strong discipline and productive processes around our operational capital investments. Looking ahead, I anticipate we'll provide more detailed information on capital initiatives as they become clearer. There is much work that any electric or gas company serving a growing area must undertake to meet capacity demands, update aging infrastructure, and adapt to the evolving needs of customers and public policy. I am optimistic about our direction moving forward. Additionally, I believe our operations team has effectively managed the supply chain, especially in light of inflation. Brian?

Thanks, Bob. I have a couple of things to add. First, you might be considering cash. So, we anticipate around $430 million in capital expenditures, and on an accrual basis, our budget was approximately $450 million, which is very close to what we planned. Additionally, regarding the Montana gas plant, we were slightly delayed in reaching full notice to proceed and executing the related capital spending in 2021. Those are the main differences from our viewpoint. We have mostly completed everything within our budget, aside from that.

Great. Appreciate that. And maybe just hitting on Laurel specifically. Obviously, a number of obstacles came up that you guys kind of alluded to. But just in terms of the process and milestones to watch from here and overall confidence in keeping that project on time and on budget.

Brian, do you want to take that?

Sure. We are currently working on a gas line and facing some challenges related to permitting, but we anticipate resolving those issues. We plan to start site work in the spring, specifically in April, and the gas line installation does not need to be completed immediately. We will keep progressing on this, and we hope to start site preparation as early as April.

Awesome. I'll leave it there. Thank you, guys.

Thank you.

Thanks Ryan.

We'll take our next question from the line ending in 5990.

A mystery caller.

If you can please identify yourself once you unmute your line. We have you unmuted here.

Hi. Good afternoon. This is Sophie Karp with KeyBanc. How are you guys?

Good, Sophie.

Doing great.

Great. Thank you for taking my question. Just a quick one, if I may, on Colstrip. Is there any update you can share on how those conversations are progressing?

I can begin, and Brian will likely want to add his thoughts as well. It's interesting to note that throughout 2021, nearly every party involved requested arbitration at some point. We made an arbitration request as per the agreement, while the other utility owners submitted a separate arbitration request in State Court in Washington, and Talen also sought arbitration in Montana. Ultimately, all related litigation was consolidated in Federal Court in Montana. Recently, we renewed our arbitration request with the court and asked for an oral argument. It appears there is strong consensus that arbitration is appropriate, which will enable us to establish the rules moving forward. We will understand our obligations and can proceed accordingly. In the meantime, the asset remains crucial for us to fulfill our responsibilities to our customers as other technologies continue to develop. Brian?

Bob, I wish I could weigh in some more, but I think you covered it.

One footnote, and this is highlighted later in the deck. But in terms of our actual estimated rate base, Colstrip overall has declined to about 10% in terms of the last authorized rate base about 14%. So it's a small, but in terms of serving our customers, continues to be a very important set of assets.

Got it. Understood. Thank you for this comment. And if I may, another question, when you think about the derisk in the Montana capacity deficit, are there transmission solutions to that? Or are we looking strictly at procuring more generation potentially or capacity on that front? Or is there a potential for a solution that involves just supply in the region?

We are very interested in the efficient operation of the overall western transmission system. We participate in western initiatives, including the imbalance market and, more importantly, the resource adequacy work of the power pool. Transmission in the west consists of long lines and is not as dense as the eastern interconnect, which is becoming increasingly congested. Therefore, while we seek transmission solutions, they are limited and constrained. Additionally, a transmission solution relies on generation being available somewhere. What we've observed is that meeting peak generation is problematic across the region. Brian?

From an IRA perspective on resource adequacy, I don't think people will be overly enthusiastic about us relying on their capacity. There is an expectation that we will provide our own capacity to take part. We believe that the group will certainly assist us from a transmission standpoint, but we also need to keep adding to our capacity on the generation side.

All right. Understood. Thank you so much.

Thank you, Sophie. With that, we do not have more queue or questions in the queue. Apparently, everybody's making Valentine's Day reservations for dinner tonight. So, with that, I'll hand it back to Bob.

I cannot recall a quarterly call so short. As always, we appreciate the discussion. We appreciate the support for the company and we'll be seeing a number of you in-person over the coming months. So, Travis, I guess the only thing left to say is happy Valentine's Day.

Great. Thank you very much for joining. That concludes the call.