Public Service Enterprise Group Inc Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. My name is Phyllis and I am your event operator today. I would like to welcome everyone to today's conference, Public Service Enterprise Group Second Quarter 2020 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session for members of the financial community. As a reminder, this conference is being recorded today, July 31, 2020 and will be available for telephone replay beginning at 1:00 P.M. Eastern Time today until 11:30 P.M. Eastern Time on August 11, 2020. It will also be available as an audio webcast on PSEG's corporate website at www.pseg.com.

Thank you, Phyllis. Good morning and thank you for participating in our earnings call. PSEG's second quarter 2020 earnings release attachments and slides detailing operating results by company are posted on our website at investor.pseg.com and our 10-Q will be filed shortly. The earnings release and other matters discussed during today's call contain forward-looking statements and estimates that are subject to various risks and uncertainties. We will also discuss non-GAAP operating earnings and non-GAAP adjusted EBITDA which differ from net income as reported in accordance with generally accepted accounting principles in the United States. We include reconciliations of our non-GAAP financial measures and a disclaimer regarding forward-looking statements on our IR website and in today's earnings materials. I'll now turn the call over to Ralph Izzo, Chairman, President and Chief Executive Officer of PSEG. Joining Ralph on today's call is Dan Cregg, Executive Vice President and Chief Financial Officer. At the conclusion of their remarks, there will be time for your questions. Ralph?

Thank you, Carlotta and thank you all for joining us. PSEG reported non-GAAP operating earnings for the second quarter of 2020 of $0.79 per share versus $0.58 per share in last year's second quarter. PSEG's GAAP results for the second quarter were $0.89 per share compared with $0.30 per share in last year's second quarter. Our results for the second quarter bring non-GAAP operating earnings for the first half of 2020 to $1.82 per share. This increase over non-GAAP results of $1.66 per share for the first half of 2019 reflects the growing contribution from our regulated operations, effective cost controls at both the utility and PSEG Power. The absence of two extended plant outages that took place in last year's second quarter and the favorable settlement of audits covering the 2011 through 2016 tax years, which in combination mitigated much of the weather-related headwinds experienced in the first quarter of 2020. Slides 11 and 13 summarize the results for the quarter and the first half of the year. We are especially pleased to report solid operating and financial results at both businesses. Our employees continue to effectively respond to the challenges and requirements of providing essential energy services under extraordinary conditions. The statewide mandated closure of most businesses, schools, and government buildings in New Jersey contributes to a decline of approximately 7% in weather normalized electric sales for the second quarter. As the state continues the gradual reopening of businesses and activities, effective containment of COVID-19 should expand commercial activity and energy usage in the months ahead.

Terrific, thank you, Ralph and good morning everyone. Ralph said PSEG reported non-GAAP operating earnings for the second quarter of 2019 of $0.79 per share and that's versus $0.58 per share in last year's second quarter. We have provided you information on Slide 11 regarding the contribution to non-GAAP operating earnings by business for the quarter. And in Slide 12, you will see a waterfall chart that takes you through the net changes, quarter-over-quarter in non-GAAP operating earnings by major business. So now I'll go through each company in more detail starting with PSE&G. PSE&G reported net income of $0.56 per share for the second quarter of 2020 compared with net income of $0.45 per share for the second quarter of 2019 and that's shown on Slide 16. PSE&G's second quarter results were driven by revenue growth from ongoing capital investment programs. Transmission results contributed an incremental $0.05 per share to second quarter net income which included approximately $0.02 per share related to 2019 true ups and lower pension expense. Gas margin was $0.02 per share favorable driven by Gas System Modernization Program investments, and weather normalized volumes. Favorable weather comparisons quarter-over-quarter added a $0.01 per share, and while electric bad debt expense is recovered through our societal benefits charge, gas related bad debt expense in excess of the amount included in rates reduced earnings by $0.01 per share compared to the second quarter of 2019 reflecting higher uncollectibles related to COVID-19. Distribution-related depreciation and interest expense each over net income by $0.01 per share and non-operating pension expense was $0.03 per share favorable compared to the second quarter of 2019. And lastly, flow-through taxes and other items were $0.03 favorable compared to the second quarter of 2019 as driven by the timing of taxes and the settlement of federal tax audits for the 2011 to 2016 years. Weather in the second quarter of 2020 was favorable compared with the second quarter of 2019 but year-to-date weather remained a mild headwind. Early summer weather was below normal but 7% warmer than the second quarter of 2019 and weather normalized electric sales in the second quarter declined by about 7% with residential loads up 8% but more than offset by commercial and industrial sales that were approximately 14% lower in the quarter.

Ladies and gentlemen, we will now begin the question-and-answer session. The first question comes from the line of Durgesh Chopra with Evercore ISI. Please proceed with your question.

Hey, good morning team. Thank you for taking my question.

Good morning, Durgesh.

Maybe if you could help us just size the EBITDA for the non-nuclear generation assets you were thinking it's roughly 20% of the total Power EBITDA does that, does that seem reasonable, can you comment on that?

Yes, Durgesh, we have not broken that out in the past and are not going to do that at this juncture. I think as we continue to go through the process, more information will come forward but at this point we're not going to provide that and you can put together your best estimate.

Understood. That's fair. Could you share your thoughts on the current market for merchant generation and how you are evaluating the valuation of these assets as you enter the strategic review?

Yes, I'd say Durgesh our expectations is to conduct an extremely robust process without redetermining or self-limiting it in any way and we'll let the market decide what these assets are worth there, or highly efficient with good heat rates, environmentally compliant and terrific market. So we're pretty optimistic about it.

Okay. Thanks for that, Ralph. And just one really quick one and then I'll jump back in the queue. Is there a regulated to non-regulated business mix, Ralph, that you were targeting from this transaction?

Yes. So what we're trying to do is become as regulated as is possible and whatever remains being as contracted as possible to remove that earnings volatility and to have people explicitly recognize the valuation that PSE&G deserves. So the contracted piece would be things like PSEG Long Island, right, that's a multi-year contract to operate that system out there. And then to the extent that the nuclear plants supported by ZECs, that's not exactly contracted but Plaza, supported by public policy and instrumental in terms of New Jersey's carbon aspirations.

The goal is to reach a mix of regulated and contracted revenue as high as possible.

Exactly right.

Understood. Thanks guys, I appreciate the time.

Your next question comes from the line of Jeremy Tonet with JP Morgan.

Hi, good morning.

Good morning.

Just wanted to follow-up with the strategic process as well. And just wondering if you could give a little bit more flavor as far as why now versus any point in the past and I imagine it sensitive overall the process, but didn't know if you could speak at all to what would be the driver for a single asset versus multi-asset process and the release, you mentioned the release just trying to see what details you can share here?

We've always believed that eventually these businesses will separate, and we've outlined certain conditions that would lead to that. One of these conditions is a sustained discount in valuation, indicating that investors are not satisfied with the integrated model. Currently, we are addressing a couple of issues that suggest the market is awaiting positive news. The utility sector is expected to grow at a 6.5% compound annual growth rate, and the Competitive Energy Fund will contribute to that. However, there are still challenges, particularly related to transmission return on equity, which remains somewhat uncertain but not significantly so. We also anticipate positive developments from the FERC MOPR, allowing our nuclear plants to bid effectively in the market. The current valuation concerns connected to the integrated model cannot solely hinge on transmission return on equity; it would require unrealistic assumptions to justify PSEG valuations based solely on that factor. Importantly, the sustained valuation discount we have monitored appears to be becoming evident, prompting us to take action.

Great, that makes sense. That's helpful.

In the US, also in terms of pieces or the whole thing, I really at the risk of repeating what I said a moment ago, our plan is to make this process as robust as possible to get the cleanest signal from the market about how to optimize the value to our shareholders. And if that means one check for everything or 5,700, 6700 checks for each megawatt, I'm being observed there obviously, we will entertain that whole range.

Thank you for that information. Do you anticipate any significant changes in managing the nuclear portfolio after selling the power assets, and how might this sale affect your financing plans considering the importance of power free cash flow for funding utility growth?

So in terms of the nuclear, I'll let Dan speak to the financing, but in terms of nuclear operations, they have largely been separate for their entire existence, nuclear engineering group, it's on maintenance group, it's on operations group, it's on supply chain, it's on HR support. So that should be a non-event from an operations point of view.

Yes, I think from a financing perspective, one of the key uses of proceeds I think would be to pay down debt at Power, obviously, if you think about the indenture and the structure of that you've got the assets sitting underneath Power and to the extent that we see some separation there to sell the cash that would come in would be used to pay down that debt. So, you would also have less interest expense on a go-forward basis to the extent that would end up happening. And also a better business mix and a better credit profile. So the ability to draw some debt capacity from that as well. So that's how we would think about it.

Overall, there is currently no significant impact on our future equity needs.

That's correct.

That's correct.

Great, thank you so much for taking my question.

Thanks, Jeremy.

Thank you. Your next question comes from the line of Julien Dumoulin-Smith with Bank of America.

Hey, good morning. Thanks for the time.

Good morning, Julien.

Pleasure. Hey, so following up on Jeremy's question there. Can we talk about how you think of the financing on a go-forward basis. I don't want to get into the proceeds expectation, but again, given the backdrop of the Dominion transaction recently and the repositioning, can you just give us a little bit of a sense on how you think about financing the business prospectively, and specifically, how you think about equity needs relative to dividend and specifically emphasis on dividend if you can?

I'll begin, and then Dan will provide more details. The utility earnings are significantly exceeding the dividend, and the utility rate base growth has outpaced our dividend growth over the last 5 to 10 years. Regarding the dividend policy, we trust the Board to make decisions each quarter. We are very confident about the situation. With the change in business mix, the parent company will have different borrowing potential, and the deleveraging from the proceeds will create some investment capacity, particularly from the nuclear plant. Additionally, it's important to note that the utility has been our biggest cash generator for the past few years. We have conducted extensive analysis and will monitor how the situation develops, but we are optimistic about our financing sources and our ability to support robust utility growth, which remains our primary objective.

Right. But let's move forward.

No. Go Julien.

I'm sorry, I was going to say to that point, how do you think about your balance sheet at a consolidated level, you talked about paying down if I heard you right, that basically the entirety of proceeds would be used to pay down power debt, but from a consolidated basis, how do you think about pro forma metrics from FFO to debt perspective right given a different risk profile, et cetera. I think that's probably another angle here right?

Yes, whether it's the entirety of proceeds is to be determined, right. I think that it's more likely the entirety of the debt and then we'll see what ultimate aggregate proceeds are coming in. I think that where you land from the standpoint of overall debt capacity is going to be a function of that business mix and it's going to be a function of working with the rating agencies to make that determination. And but undoubtedly that is going to be an improvement and undoubtedly that's going to be some debt capacity that's going to open up from that perspective. So, that's how we're thinking about it, the fine points on that are ahead of us yet, but I think that's how you think about it, and frankly Julien, we tend to think about our overall financing as coming from the utility, a very strong cash from operations in its own right. And then, ultimately on the other side, there is a Money Pool where you'd have access to the power and parent as funding vehicles. And I think it's just more of a shift in potential to the parent, although the remaining operations that would sit at power certainly would have a stream of cash flow and would have the ability to have some finanical.

Just quick question or clarification on the release, timing, key issues get resolved before actually completing?

I'll take that. Those are totally dependent processes.

Excellent, thanks for clarifying that especially the dividend.

Thanks.

Your next question comes from the line of David Akira with Morgan Stanley.

Hi, good morning. Thanks for taking my questions. Could you give your latest thoughts on the transmission ROE and negotiations in terms of what timing, you might be aiming for. And then, one other ways that you have in mind that could potentially mitigate some of the EPS impacts from that, whether it be on the equity ratio or cost allocation side of things?

The negotiations are confidential, so I apologize for not being able to provide specific details. However, your question touches on a key point. This situation involves more than just one number, such as the return on equity; it encompasses various issues, including the depreciation rate of assets, the equity layer associated with the business, and acceptable components of the FERC formula rate filing in terms of costs, some of which may not have been considered previously but could be now. Both sides are eager to provide relief to customers and reduce uncertainties about the outcome. Our main focus is on the overall economics, while regulators are concerned about the cash impact on customers. We are attempting to balance these factors to reach our objectives. I am hopeful we can accomplish this, but I cannot guarantee it at this time. The BPU staff and consumer advocates are working diligently, but they also have other responsibilities. It is an overall economic assessment that we need to approach voluntarily, which we believe is becoming more challenging. More developments will follow.

Excellent. And I guess would there be any change in the timing of the rough time frame that you've communicated in the past for that?

No, I don't think so. I mean yes, it's a question of the patience that BPU staff and the consumer advocate have, I mean they could file a complaint tomorrow and we certainly are not encouraging that, but we're not going to let the potential of filing a complaint make us deviate from what we know is an economically reasonable outcome and it would be a shame if we couldn't reach that outcome because the fact of the matter as the complaint was filed, it wouldn't be resolved that FERC for years to come and New Jersey is struggling with 16% unemployment and all manner of economic challenges that it would be in everybody's interest to try to return some rate relief to customers today. But no, I mean they could file tomorrow. I can't constrain that. But we're still trying.

Okay, great. Thank you very much.

Your next question comes from the line of Michael Lapides with Goldman Sachs.

Thank you for taking my question. Two questions, one on power and why sell down given the Clean attributes associated with it, I know it's small, but why sell down was solar assets, or why sell off the solar assets, why not keep those embedded and do you see utility scale solar or not see it as that in attractive business longer term?

Yes. So Michael, it's 479 megawatts, I think the biggest project is like 40 or 50 megawatts and most of them are 5 and 6. They spread around 17 states. So the scale is what we'd like it to be and candidly, we'd like to focus more of our green and carbon-free attributes in the Mid-Atlantic region and as it relates to particularly nuclear and potentially offshore wind plus, it's really because of its size, what I'm about to say, it's hard to prove it. We don't think we were getting proper credit for it in our own valuation, it's almost never picked up, you put an EBITDA multiple on something that's largely benefiting from investment tax credits and that doesn't get reflected in the stock price in a way that it might provide greater value to somebody who has a different calculus around, and know how to measure economic value. Yes, you said you had a second question, Michael.

Yes, I had a second question. When I go back and look at your investor slide decks and I'm looking at the capital spending charts and slide decks from the last few months or so, in the CapEx by year, for PSE&G. And this has happened for years with your company, is that your forecast transmission CapEx to just fall off a cliff, kind of gradually every year, year two is lower than year one, year three is lower than year two, year four is lower than year three. It actually never happens. Do you have any incremental color about what could make 2021 or 2022 Transmission CapEx, materially different or significantly different than kind of what you've shown on your latest slide decks for those years?

Yes. Your observation about transmission applies to the overall capital program. We used to emphasize this during in-person investor conferences. The uncertainty increases in the later years compared to the initial ones. Regarding transmission specifically, most major projects from the PJM RTEP are either completed or nearing completion. Currently, we are focusing on upgrading our 26 KV and 69 systems, which will lead to an overall decrease in transmission expenditures, and this has already been factored into our 6.5% CAGR projection. There is a chance that transmission investment could rise as New Jersey advances its offshore wind initiatives, expanding from a 1 gigawatt capacity to potentially 7.5 gigawatts. The current project has had minimal impact on the onshore transmission system, but increasing to 7.5 gigawatts could change that. Additionally, the BPU is discussing with all utilities, including us, the potential for speeding up infrastructure programs that could stimulate the economy. Given the age of our transmission and gas infrastructure, this could present additional opportunities for us as well.

Are there any public filings or any dockets or proceedings open whether at PJM or whether at the BPU regarding incremental transmission spend over the next couple of years?

I’m not sure, but there could be a BPU docket about how to bid on future offshore wind projects, particularly regarding whether there will be separate transmission from the wind farm itself. As you may know, the first solicit was combined, and I thought the BPU was considering that, but that might have changed. We can look into it and get back to you.

Michael, the initial solicitation included both offshore wind and the transmission line coming onshore. This has been the only solicitation in New Jersey so far. If there are more solicitations in the future and a chance to connect additional projects from offshore, different approaches could be considered as part of the policy discussion. However, regarding your inquiry about the immediate capital deployment, I wouldn't anticipate anything occurring in 2021 or 2022, as that seems too early for these developments. If that's your timeframe, it's less likely. Looking further ahead, as we try to determine how to effectively meet the state's offshore wind goals, we may see more opportunities emerge.

Got it. Thank you, Ralph. Thank you, Dan.

Yes.

Your next question comes from the line of Paul Patterson with Glenrock Associates.

Hey, how are you guys doing?

Great, Paul.

How are you?

I just wanted to clarify something here. The divestiture or the strategic review is essentially driven by stock valuation. There hasn't been a significant change in market outlook or regulatory aspects. It's mainly about determining if the valuation suggests it's a good time to consider this, is that correct?

That's exactly right.

And then with respect to the FRR, and I guess Ralph touched on this. There is no change in that process that you see taking place as a result of this and do we still, do you think I think you guys were basically under the impression that it was a very good chance, you don't need legislation, is that sort of still the case?

So, while we're not in charge of the FRR process, which is being managed by the BPU's, it's completely independent. The state is still determining if they want an FRR that only secures carbon-free energy or one that secures all their energy. I don't believe our decision to divest from fossil assets will influence that. When it comes to legislation, it depends on the kind of FRR they design. There is a possibility that no legislation will be necessary, but for instance, legislation was required for the creation of an old REC. If similar considerations arise for other technologies, legislation may be needed. It's still too early in the FRR discussions to make any definitive statements. Historically, we thought our nuclear plants would only require BGS support without the need for legislation. However, the PJM compliance filing indicating that our nuclear plants can participate in capacity markets has reduced the necessity for specific legislation concerning them at this moment.

Okay, great. The rest of my questions have been asked and answered. And thanks so much, have a great one.

Your next question comes from the line of Paul Fremont with Mizuho.

Thanks. Hi, I think I just wanted to follow-up a little bit on Julien's line of questions. It looks like your downgrade threshold, according to the Moody's report put out earlier this year was 17% and you ended the year 1% below that. If you were to essentially lose some additional cash flows on the merchant side and use back leverage to fund the utility investment going forward that could put further pressure on your FFO to debt ratio. So I guess my question is, would you be willing to accept ultimately a downgrade in the credit rating or what would you see as potentially happening on the FFO to debt side?

There is obviously a whole lot of moving parts with respect to what we're talking about and a lot of discussions yet to be had and an ability to work through those things I think what I would say is, if you think about the overall business mix of enterprise and you think about that business mix without the non-nuclear generation, I think you have a more stable set of cash flows coming off the business and I think at the end of the day, you would have a lower threshold from the standpoint of what that newly designed entity look like. So I think that's a part of the calculus that becomes important in all this as we work forward and come to some determinations.

Great, thank you.

Paul, sorry, I was hoping, you'd ask us the question about CEF. By the way, our annual run rate right now at CEF is $200 million a year, it's not $40 million a year, because we got a $110 million extension for six months. And also as far as we can tell, negotiations are pretty active. We expect either a settlement or decision about the BPU in September. So we're…

Yes, no, I think we were definitely anticipating a settlement, I think is what we wrote in the last report that we put out. So we don't know the timing but we are very optimistic that there will be a settlement in that proceeding.

Okay. Well, my timing is September, just so the world knows that.

Your next question comes from the line of Steve Fleishman with Wolfe Research.

Good morning. Thought I was going to . Hey, Ralph.

How are you?

I'm doing great, thanks. So just couple of questions, first of all, you have kind of talked for a little while about kind of willingness to sell the fossil assets, so maybe could you just give a little more color like what is different now versus what you've already been saying for kind of 6 to 12 months. I think you were worried about getting a fair price to some degree. So, are you more confident on that or some color there?

Yes, I would like to highlight two points, Steve. First, securing a fair price considering the uncertainty in the capacity market in PJM is important. We haven't conducted an auction yet, but the rules are quite clear about what will occur. However, I would say the valuation discount has widened to a level that seems unreasonable; it doesn't make sense for PSEG to be valued where it currently is.

Right.

It's not reasonable to rely solely on transmission return on equity without making extreme assumptions. Therefore, we reached a point where enough is enough. Unlike the BEC process, where we conducted a limited test program and identified a few potential interested parties, we will approach this differently by implementing a comprehensive process. I believe there is a stabilization in the power markets, along with a growing valuation discount, that has prompted us to conclude that enough is enough.

Okay, couple of just technical questions on it. Do you have the tax basis of the assets that you could provide us? And also just how should we think about dealing with like dis synergies. Is that something you can manage?

Yes, Steven, we do have a tax basis number to share. It will be lower on the federal side, considering some of the expensing that has occurred. I suggest thinking about this in relation to some of the bonuses. While there isn't a specific dis-synergy number, there are costs that will be distributed across the different businesses. Consequently, there will be a smaller entity to spread those costs over. We will also be focusing on efficiencies across the entire business to compensate for some of these factors.

Great. For my last question on offshore wind, I might be reading into it too much, but I sense a growing interest in advancing offshore wind growth. Could you provide more details about that, particularly regarding the upcoming auctions?

Yes, we are still focused on maximizing the opportunity to learn. We have gained more experience and confidence in our ability to construct, own, and operate projects, although we still face challenges with the regulatory process, especially at the national level. As you might know, New Jersey has started discussions about the second round of solicitations, which is expected in a couple of months. The state is progressing, and I believe that within Governor Murphy's first term, we will see solicitations that will secure 3,500 megawatts of offshore wind. This is increasingly becoming a reality, and I have every reason to believe that the state's goals of 7,500 megawatts, along with New York's 9,000 megawatts, will be achieved. You can hear in my voice that this is happening at a scale I wouldn't have anticipated three or four years ago, but it's unfolding right now.

Great, thank you.

We have time for one final question. Your next question comes from the line of with KeyBanc.

Thanks. Can you hear me?

Hi.

Hi, thanks for taking my question. I have a couple of related questions about the Power side. You're keeping the nuclear power plants, and we understand they have been significantly derisked through ZECs. Is there a scenario where you see them finding a different home? Additionally, are there any implications for how much headroom you have on your customer bill in New Jersey after this divestiture? Thank you.

Sophie, I wouldn't want to say never, but we are not marketing those nuclear plants. We fully intend to keep them and focus on marketing the non-nuclear assets related to sourcing and fossil fleets. Moreover, I believe there is a significantly larger pool of potential buyers for the fossil assets. So while I hesitate to rule anything out, I think that's mostly speculative and not a good use of our time. Now, what’s your second question?

Is there, are there any implications on the bill headroom in New Jersey?

No. I think power prices in the forward market are down from where they were two years ago, continuing to put pressure on forward power prices due to an abundance of natural gas, reduced demand, and the availability of highly efficient generation. We aim to align our utility proposed programs with a bill impact of roughly equal to the Consumer Price Index and we do this by integrating updates every 6 to 12 months. This approach helps prevent any sudden price increases to the customer. We believe energy efficiency can be particularly targeted at those customers who are either the most vulnerable or are significant service providers to the community, as this ultimately benefits everyone by lowering energy consumption. I want to take a moment to express my hope that you and your loved ones are in good health and not affected by the ongoing challenges of COVID-19. I also extend our gratitude to any friends or family members working on the front lines. Our employees have done an incredible job during this time. Although we have faced some impact from COVID-19, our infection rates are about half of the general population, and our employees have managed to work safely while achieving significant cost savings, resulting in a strong quarter. Even when accounting for one-time expenses, I believe we had an impressive quarter. We are genuinely excited about pursuing strategic alternatives and what that means for the focused growth of the utility, especially with the Clean Energy Framework that we anticipate will be resolved by September. We look forward to seeing everyone in person soon and until then, we hope to see you at some upcoming virtual conferences over the next few weeks. Thank you, everyone.

Ladies and gentlemen, that does conclude your conference call for today. You may disconnect. And thank you for participating.