Earnings Call Transcript - PEG Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. And welcome to PSEG 4Q and Full Year 2020 Earnings Conference Call and Webcast. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Carlotta Chan, VP, Investor Relations. Thank you. Please go ahead, ma'am.

Carlotta Chan, VP, Investor Relations

Good morning and thank you for participating in our earnings call. PSEG's fourth quarter and full year 2020 earnings release, attachments and slides, detailing operating results by company, are posted on our website at investor.pseg.com, and our 10-K will be filed shortly.

Ralph Izzo, CEO

Thank you, Carlotta. Good morning, everyone. And thank you for joining us for our 2020 review and future outlook. PSE&G reported non-GAAP operating earnings for the fourth quarter of $0.65 per share. Non-GAAP operating earnings for the full year rose by 4.6% to $3.43 per share, marking the 16th year in a row that PSE&G delivered results within our original earnings guidance. PSE&G's GAAP results were $0.85 per share for the fourth quarter of 2020 compared with $0.86 per share for the fourth quarter of 2019. For the full year, PSE&G reported 2020 net income of $3.76 per share compared with $3.33 per share in 2019. I am pleased to report that PSE&G's fourth quarter and full year results reflected solid contributions from both PSE&G and PSEG Power. I am particularly proud of our employees' achievements during this past year, which was one of the most challenging in recent memory. Their efforts have kept our customers connected to essential energy services to power their homes, businesses, and important institutions. We've made steady progress in several key business priorities, primarily our transition to becoming mainly a regulated utility with our zero-carbon nuclear fleet and future investments in regional offshore wind. In the past six months, we've announced the exploration of strategic alternatives for PSEG Power's 7,200-plus megawatts of non-nuclear generating assets and received initial indications of interest for both the fossil and solar source assets. PSE&G successfully initiated its landmark clean energy future program, securing approval to spend nearly $2 billion on energy efficiency, smart meter installations, and electric vehicle charging infrastructure, all of which will enhance New Jersey's environmental profile for years to come. The New Jersey Board of Public Utilities, referred to as the BPU, recently concluded public hearings regarding PSE&G's nuclear application to extend the zero-emission certificate, which I'll refer to as ZEC for brevity, through May 2025. Our service area experienced milder than normal weather during the fourth quarter, bookending the heating season of the first quarter in 2020.

Dan Cregg, CFO

Thank you, Ralph. Good morning, everybody. As Ralph said, PSE&G reported non-GAAP operating earnings for the fourth quarter of 2020 of $0.65 per share. We provided you with information on slides 12 and 14 regarding the contribution of non-GAAP operating earnings by business for the fourth quarter and for the full year of 2020. Slide 13 and 15 contained waterfall charts that illustrate net changes quarter-over-quarter and year-over-year in non-GAAP operating earnings by major business. I will now review each company in more detail, starting with PSE&G. PSE&G's net income for the fourth quarter of 2020 increased by $0.04 to $0.58 per share, compared with net income of $0.54 per share for the fourth quarter of 2019 as shown on slide 17. For the full year, PSE&G's net income increased by $0.16 per share, or 6.5%, compared to 2019 results. This improvement reflects an 8% increase in the rate base at the end of 2020 to just over $22 billion, which, as we note on slide 22, does not include approximately $1.8 billion of construction work in progress, primarily related to transmission. Continued growth in utility earnings resulting from investments in transmission added $0.2 per share versus the fourth quarter of 2019. Gas margin was $0.02 favorable, reflecting GS&NT roll in and higher weather-normalized volume. Electric margin was flat compared to the fourth quarter of 2019, as higher weather-normalized volumes were offset by lower demand. Mild temperatures during the quarter had a negative $0.03 per share impact, mostly reflecting recovery limitations under the earnings test of the gas weather normalization clause. O&M expenses were flat versus the fourth quarter of 2019. Higher distribution depreciation expense of $0.01 per share offset lower pension expense of $0.01 per share in the quarter. Taxes and other were $0.03 per share favorable, partly reversing the negative $0.07 per share impact that timing of taxes had on nets in the third quarter of 2020. Early winter weather in the fourth quarter, as measured by heating degree days, was 9% milder than normal and 14% milder than in the fourth quarter of 2019. Full year PSE&G weather-normalized residential electric sales increased by 5.6% due to the COVID-19 work-from-home impact, but a larger decline in commercial sales resulted in total electric sales declining by 2%. Total weather-normalized gas sales were up 1.2% for 2020 due to a 4.9% increase in residential use, partially offset by a smaller decline in the commercial and industrial segment. For both electric and gas sales, higher residential uses largely offset declines in commercial and industrial sales, resulting in stable margins overall. PSE&G invested $700 million in the fourth quarter as part of its 2020 capital investment program of approximately $2.7 billion directed to infrastructure upgrades of transmission and distribution facilities to maintain reliability, increase resiliency, make lifecycle replacements, and clean energy investments. PSE&G's updated five-year capital spending plan includes investing $2.7 billion in 2021. As detailed on slide 21, approximately $960 million is allocated to transmission; $700 million to electric distribution, which includes approximately $200 million for Energy Strong Two; $875 million to gas distribution, which includes over $400 million for GSMP2; and $200 million for new clean energy future EV programs and the beginning of the AMI rollout. The clean energy future EV investment will ramp up to approximately $125 million in 2021 before reaching a full annual run rate of about $350 million in 2023.

Ralph Izzo, CEO

As I mentioned, the BPU approved two CF settlements in January, totaling approximately $875 million covering energy cloud and electric vehicle investments. The capital and operating costs of these programs will begin to be recovered in PSE&G's next rate proceeding, expected to be filed in the second half of 2023. From the start of these programs until the commencement of new base rates, estimated in late 2024, the return on other non-capital will be included for recovery in these rates, as well as operating costs and stranded costs associated with the retirement of the existing leaders. Of these amounts, the vast majority—about 90%—received contemporaneous or near contemporaneous regulatory treatment either through the first formula rate or clause recovery mechanisms or recovered in rates as replacement spend or new business. As I also mentioned, we continue settlement discussions with BPU staff and re-counsel regarding our FERC transmission return on equity (ROE). Although our forecast for 2021 is close to being resolved, those discussions remain confidential and ongoing. PSE&G's net income for 2021 is forecasted at $1,410 million to $1,470 million, reflecting an assumed reduction of our transmission formula rate, along with incremental investment in EV infrastructure and energy efficiency.

Dan Cregg, CFO

Moving on to PSEG Power, PSEG Power reported non-GAAP operating earnings of $0.10 per share in the fourth quarter unchanged from the non-GAAP results in the fourth quarter of 2019. Results for the quarter brought Power's full year non-GAAP operating earnings to $430 million or $0.84 per share, compared with 2019 non-GAAP results of $409 million or $0.81 per share. Non-GAAP adjusted EBITDA totaled $182 million for the quarter and $990 million for the full year of 2020. This compares to non-GAAP adjusted EBITDA of $198 million and $1,035 million for the fourth quarter and full year 2019, respectively. Non-GAAP adjusted EBITDA excludes the same items as our non-GAAP operating earnings measure, as well as income tax expense, interest expense, depreciation, and amortization expense. The earnings release and the waterfall on slide 13 and 15 provide you with a detailed analysis of the items impacting PSEG Power's non-GAAP operating earnings relative to net income, quarter-over-quarter and year-over-year from changes in revenue and costs. We've also provided you with added detail on generation for the fourth quarter and full year on slide 26. PSEG Power's fourth quarter non-GAAP operating earnings were aided by the scheduled increase in PSEG Power's average capacity prices in PJM covering the second half of 2020 and higher gas operations, which resulted in improved non-GAAP operating earnings comparisons of $0.04 and $0.01 per share, respectively, compared to the fourth quarter of 2019. However, lower generation output and re-contracting at lower market prices reduced non-GAAP operating earnings by a total of $0.08 per share versus the year-ago quarter. The decline in O&M expenses in the quarter improved results by $0.01 per share and reflects the absence of the Hope Creek refueling outage that occurred in the fourth quarter of 2019. The extension of the Peach Bottom Nuclear operating licenses contributed to lower depreciation expense of $0.01 per share, and lower taxes improved non-GAAP operating earnings by $0.01 over the year-ago quarter. Gross margin for the quarter was $32 per megawatt hour, a $1 per megawatt hour improvement over the fourth quarter of 2019, mainly reflecting the scheduled increase in capacity prices that began June 1, 2020 and remain in place through May of 2021. For the full year 2020, gross margin was flat at $32 per megawatt hour compared to the full year 2019. Mild fall temperatures and holiday-related spikes in COVID-19 positivity rates dampened market demand in New Jersey and kept our prices and natural gas prices lower than the quarter and year-ago comparisons. Total output from Power's generating facilities declined 9% in the fourth quarter of 2020 compared to the fourth quarter of 2019. Unplanned outages at fossil and an extended outage at one nuclear unit reduced fourth quarter generation levels compared to the fourth quarter of 2019. However, full year 2020 output of 53 terawatt hours came in above our 50 to 52 terawatt hour forecast. The nuclear fleet operated at an average capacity factor of 78.9% in the quarter and 90.3% for the full year, producing nearly 31 terawatt hours of zero carbon baseload power. The combined cycle fleet operated at an average capacity factor of 46.2% in the quarter and 48.3% for the full year, generating approximately 22 terawatt hours in 2020. This coming June, PSEG Power will complete the planned early retirement of the 383-megawatt coal-fired Bridgeport Harbor 3 generating station, eliminating the last coal unit in Power's fleet. For 2021, Power has hedged approximately 90% to 95% of its expected output of 48 to 50 terawatt hours at an average price of $32 per megawatt hour, which represents an approximately $2 per megawatt hour decline from 2012. Additionally, 2021 average hedge prices no longer include cost-based transmission charges for New Jersey's basic generation service contracts due to a change in how they are billed and collected. This change further reduces revenues by approximately $3 per megawatt hour starting on February 1, 2021. However, there is no P&L impact due to this change.

Ralph Izzo, CEO

We are forecasting 2021 non-GAAP operating earnings and non-GAAP adjusted EBITDA for PSEG Power to be $280 million to $370 million and $850 million to $950 million, respectively. Power segment guidance reflects a full year of fossil and solar operations, lower expected generation volume, and lower market prices, along with the absence of a one-time tax benefit realized in 2020. Now, let me briefly address operating results from enterprise and other, which reported a net loss that increased by $0.03 per share compared to the fourth quarter of 2019. This reflects lower tax benefits compared with the fourth quarter of 2019 and lower results from KCG Long Island. Regarding PSEG Long Island, following several challenges related to our response to tropical storm Isaias, we've made significant improvements in our outage management to lessen business continuity and other systems and processes. The Long Island Power Authority filed a complaint against PSEG Long Island in New York State court last December, alleging multiple breaches of the operating services agreement in connection with PSEG Long Island's preparation and response to tropical storm Isaias. We are in discussions with LIPA to address their concerns, which could include potential amendments to our operating services agreement with LIPA to resolve all claims. As a reminder, our 12-year contract is scheduled to run through 2025. We are committed to addressing the identified performance issues and to continue our strong track record of performance for Long Island customers since taking over operations. For 2021, PSEG Enterprise and other are forecasted to have a net loss of $15 million as parent financing and other costs exceed earnings from PSEG volume. PSEG ended 2020 with approximately $3.8 billion of available liquidity, including cash on hand of $543 million, and debt representing 52% of our consolidated capital. In December, PSEG issued $96 million of 8.63% senior notes due April 2031, in exchange for a like amount of 8.63% senior notes due April 2031, originally issued at Power, which were canceled following the completion of the exchange. PSEG also retired a $700 million term loan at maturity. Power's debt as a percentage of capital declined to 27% on December 31 from 28% at September 30. To summarize, non-GAAP results for the quarter were $0.65 per share; full year non-GAAP operating earnings were $3.43 per share. As we move into 2021, our guidance for the year is $3.35 to $3.55 per share, with regulated operations expected to contribute over 80% of consolidated results. The range for 2021 reflects incremental investment in our transmission and distribution infrastructure and a ramp-up of new clean energy future programs, as well as an assumed reduction in return on equity of our transmission formula rate during the year at PSE&G. Additionally, a full year of fossil and solar operations at PSEG Power is expected. PSE&G has also raised its common dividend by $0.08 per share for an indicative annual level of $2.04, representing a 4% increase over 2020. The 2021 indicative rate continues to represent a conservative 59% payout of consolidated earnings at the midpoint of the 2021 guidance, and utility earnings alone are expected to cover 140% of the dividend at the midpoint of the 2021 guidance. We expect our strong cash flow will enable us to fully fund PSEG's five-year $14 billion to $16 billion capital investment program, as well as our planned investments during the 2021 to 2025 period without the need to issue new equity. That concludes my comments. Shelby, we're now ready to take questions.

Operator, Operator

Your first question is from Jeremy Tonet of JPMorgan.

Jeremy Tonet, Analyst

Hi, good morning. I wanted to start off with the Power by sales if I could, if there's any additional color that might be possible, including the relative progress of solar versus the wind assets there, and if the events in Texas last week have any impacts on the process overall.

Ralph Izzo, CEO

I'll handle it, because Dan will be too modest. When Dan laid out for the board in July what the process would look like in terms of participants, timing, and expected outcomes, he nailed every element of it. The process is going exactly as planned. Our near-death experience in January 2014 during our own polar vortex has winterized these assets, and I am sure Texas will now follow suit as a result. So no, Texas has not had any impact on us. I don't apologize for not being able to give more information; we will give greater clarity sometime in the summer, I'm sure as we get past the round two bids. But so far, no surprises, the process is going well. Our assets are fully winterized as a result of the 2014 polar vortex we experienced.

Jeremy Tonet, Analyst

Got it, that makes sense. Maybe just flipping over to the transmission ROE and any expectations for transmission ROE reductions that are incorporated into your 2021 guidance here? Should we assume any changes on a prospective basis versus having a retroactive impact as well?

Ralph Izzo, CEO

Yes. The second question, when I can give greater specificity, yes, it would only be prospective. Typically, when something is filed with FERC, notwithstanding the time lapse to the actual decision, the tariff adjustments go to the filing date and not sooner. We can't disclose what we've assumed in terms of guidance, but that shouldn't be a big surprise. I mean, we don't break out the guidance in terms of individual components. So we are where we were for a while now—close—and both sides are eager to resolve this. However, in deference to the BPU, they've had an incredibly active agenda for the better part of two years, dealing with the same challenges everyone else is in terms of working from home. They've successfully facilitated one offshore wind solicitation and are in the middle of the second one. They've done stakeholder processes for energy efficiency and gotten a lot done, and this ROE discussion is part of the portfolio activities, but not resolved yet.

Jeremy Tonet, Analyst

Got it, fair enough. Figured I’d give it a try. Thank you.

Operator, Operator

Your next question is from Julien Smith of Bank of America.

Julien Smith, Analyst

Hey, good morning, team. Thanks for the time and the opportunity. What intrigued me in your slides is the potential investments in offshore wind. Can you talk about; obviously, this is dynamic and evolving quarter-over-quarter? Could you share your latest expectations on offshore wind and how they could fit into your capital budgeting process and earnings overall, as best you see to date between expanding ownerships and potential new leases, et cetera?

Ralph Izzo, CEO

Just at a high level, Julien, I'm sure you're aware that there's an ongoing solicitation in Maryland. There's a second round in New Jersey, and we have not fully developed our jointly owned Garden State Offshore Energy site, jointly owned with Ørsted off the coast of Cape May. There have been 29,000 megawatts of hopes and dreams announced by states up and down the East Coast and 9,000 megawatts of awards granted. Even if we just focus on the Mid-Atlantic region, going from Maryland to Delaware to New Jersey offers ample opportunities, and we still have leasehold that is not fully developed. I don't think we've set any more specifics than that, right, Dan? So we'll probably leave it there.

Julien Smith, Analyst

If I can ask you to put parameters on how you think about this business, is it more palatable? For instance, how do you think about return metrics and how you might balance these opportunities with your established operations? For example, what percent ownership in a given project do you think is ideal, and what size should it be relative to your business?

Ralph Izzo, CEO

First of all, we don't view ourselves as the lead developer; we partner with others. We have an option for 25% on Ocean Wind and previously entertained going as high as 60% on this project. There is likely to be a transmission solicitation managed by PJM on behalf of New Jersey, and we feel very confident that we could pursue that without necessarily needing partners. Our number one growth engine remains rate base growth with PSE&G. However, there's a significant opportunity here as states aggressively pursue offshore wind, and we do not exclude ourselves from that market. The commercial risk is mitigated by the PPA or orders, and operational risk is minimized by partnering with a world-class partner. We believe we have that in Ørsted. We have never disclosed what our hurdle rates are, but suffice it to say we can manage both commercial and operational risks and that we would only engage in these projects for utility returns.

Dan Cregg, CFO

It’s important to note that the developments come about solicitation by solicitation. The ultimate outcome will be determined through those bite-sized chunks as we address the opportunities in both New Jersey, Maryland, and the transmission opportunity that Ralph mentioned.

Operator, Operator

Your next question is from Michael Lapides of Goldman Sachs.

Michael Lapides, Analyst

Hey, Ralph, thank you for taking my question. One on the utility—just looking at the CapEx guidance. I want to ensure I understand something, as it appears that transmission spending levels are falling significantly year by year. What types of things might backfill this to prevent that decline in years three to five? What opportunities are your engineering teams exploring?

Ralph Izzo, CEO

A couple of things, Michael; even though the numbers appear to be coming down in years four and five, as we get closer to that time, we learn more, and that very spend comes back up. So you might see more of the same—not a mega project that's readily predictable—but you could see more 69 kV upgrades and an increasing transmission budget as we learn about what we need to do. We are also increasingly aware that as a result of the pandemic, I believe long-term patterns and lifestyle changes will occur. At PSEG, we're informing our employees that many will be able to work from home. The combination of homes becoming centers of business and the growth of electric vehicles, coupled with an increase in electric devices in homes, is changing the calculus behind the importance of reliability as the home transitions into a commercial center. This public policy discussion has just begun and hasn't been reflected in our numbers yet. You'll see those numbers rise in the future, as we’ll either get smarter about traditional investments or need to address this last mile question.

Michael Lapides, Analyst

Got it. And then my question is this: One for Dan, regarding rate base—one of the footnotes talks about the billion a day and your $1.8 billion of transmission in construction work in progress. Can you remind me, do you earn on that, or do you not necessarily earn a cash return on that?

Dan Cregg, CFO

Yes, we earn on equipment. The reason it's included is that in the past, people calculating whether or not there was over-earning would sometimes overlook the equipment component. We're trying to clarify that.

Operator, Operator

Your next question is from Steve Fleishman with Wolfe Research.

Steve Fleishman, Analyst

Hey, good morning. So regarding the 80 to 90% from PSE&G that you highlighted, Ralph, that's a bit less than I would have anticipated after selling these fossil assets. Is it more around 90% once the sale is completed and before the offshore wind? And does it come down again some? How should I think about that range?

Ralph Izzo, CEO

So, Steve, as you know, building blocks are important. The foundation, the house, the roof, all lead to the utility. It has a rate base CAGR of 6.5% to 8%. We may perform slightly worse or better than expectations depending on O&M and load growth, but those numbers have hovered around zero. Regulatory lag may impact the final years as clause mechanisms recover non-clause-related costs. The utility is approximately 80% this year and is growing. Once we sell the fossil units, those will go away. But we're hopeful New Jersey will adhere to its energy master plan, allowing nuclear to remain. The BGSS will also persist. That’s why I’m being vague about narrowing projections; we are eager to revisit multiple year earnings guidance and recalibrate everyone's expectations post-sale of fossil assets.

Steve Fleishman, Analyst

Okay. One other question on nuclear. If I heard right, I think you reiterated that you would shut down the nuclear plants. But if the ZEC is anything but the $10 it currently is, given that market prices are even lower, is that correct?

Ralph Izzo, CEO

That’s correct, Steve. We value our corporate citizenship in the state, and we've shown how important it is to follow the BPU's leadership on clean energy goals and projects. However, nuclear plants need more than $10, and we'll explore longer-term solutions if necessary. We hope that pricing on carbon will emerge from the federal government or progress through the FRR process. If we're only offered $10 now, that’s a reflection of what the state can currently do. So yes, we need more than that. If there's a requirement for larger compensation, we could be forced to shut the units down.

Operator, Operator

Your next question is from David Akira of Morgan Stanley.

David Akira, Analyst

Hi, good morning. Thanks so much for taking the question. I wanted to follow up on your previous comments regarding the new FERC in place. Do you think there's a chance that New Jersey doesn't pursue the FRR, seeing a new path ahead for morpher, and how do you think about your strategy with your nuclear plant if that were to happen?

Ralph Izzo, CEO

The short answer is anything is possible. New Jersey's goal should be to avoid paying twice for capacity. Under the current construct, without question, offshore wind will not clear the market, and at some point, neither will nuclear under the capacity market. As New Jersey increases its carbon-free footprint, customers will face double payments for capacity, costing about $25 million to $30 million per gigawatt. If we transitioned to a unit-specific FRR, which we support, it might prevent some of these double payments. However, there are a lot of uncertainties surrounding this, and it's challenging to pinpoint how things will progress.

Dan Cregg, CFO

It largely comes down to timing, David. While things stand as they are today, the double payment issue Ralph mentioned exists and remains a consideration. If something changes with the FERC and how New Jersey pursues it, timing becomes crucial. Double payments will be significant come 2025. So, it’s two timelines converging as we assess how the parties approach these changes to address this concern.

David Akira, Analyst

That’s helpful context. Just to clarify, if you receive a $10 ZEC, do you still anticipate needing further assurances for the nuclear plants for long-term stability?

Ralph Izzo, CEO

Yes, it has become increasingly obvious that the market continues to decline more than we expected. This trend is not reversing as we see more zero marginal cost renewables being integrated into the market, which impacts how nuclear plants operate economically. Given the state’s ambitious carbon-free goals, these exceed the current licensed life of our nuclear plants, and we cannot go into re-licensing based solely on the three-year ZEC process unless compensating adequately, which is currently insufficient. It’s a complex situation as the nuclear sector confronts challenges similar to fossil fuels, which operate at 70+% capacity and currently enjoy healthy margins.

Operator, Operator

Your next question is from Paul Fremont of Mizuho.

Paul Fremont, Analyst

Hey, how are you? Just a quick question on the hedging. There were, I think, some adjustments previously incorporated into your hedge calculations—like some renewable programs and maybe ancillary charges. Are those eliminated as well for now? Should we expect no adjustments whatsoever to the $32 number you're providing?

Dan Cregg, CFO

Think of it the opposite way, Paul; the only relevant change is the difference concerning transmission charges.

Paul Fremont, Analyst

So you would continue to include the other charges in your number?

Dan Cregg, CFO

Yes, or stated another way, not to back out those revenue-oriented numbers. We have stripped out capacity as a separate item. Since transmission is no longer part of the revenue, it won't be incorporated there.

Paul Fremont, Analyst

Okay, and finally, you have a 25% option on Ocean Wind. If you were to acquire a higher stake, would that require a separate negotiation with Ørsted, or do you have existing rights to go higher?

Ralph Izzo, CEO

Yes, we would need to negotiate, Paul. As we wrap up, I want to thank everyone for joining us. Just to recap: rate base growth with the utility, which has driven EPS growth at PSE&G, continues to trend upward. We project a 6.5% to 8% CAGR in that rate base over the next five years due to initiatives that are important to customers and driven by state policy. The positive outcomes we've achieved through our work with the BPU have created additional stability within our utility revenues. We have challenges ahead with ROE negotiations and a ZEC application pending before the BPU, but resolution will allow us to embark on a period of regulatory communication and execution as we move forward with our projects. We look forward to providing clarity on strategic alternatives in the coming months, and I wish to express our appreciation to all frontline workers supporting families through this difficult situation amid COVID-19. Thank you, and have a great day.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.