Earnings Call Transcript - SO Q1 2023

Operator, Operator

Good afternoon. My name is Kathy, and I will be your conference operator today. At this time, I would like to welcome everyone to The Southern Company First Quarter 2023 Earnings Call. As a reminder, this conference is being recorded on Thursday, April 27, 2023. I would now like to turn the conference over to Mr. Scott Gammill, Vice President, Investor Relations and Treasurer. Please go ahead, sir.

Scott Gammill, Vice President, Investor Relations and Treasurer

Thank you, Kathy. Good afternoon, and welcome to Southern Company's First Quarter 2023 Earnings Call. Joining me today are Chris Womack, President of Southern Company; and Dan Tucker, Chief Financial Officer. Let me remind you, we'll be making forward-looking statements today in addition to providing historical information. Various important factors could cause actual results to differ materially from those indicated in the forward-looking statements, including those discussed in our Form 10-K, Form 10-Q and subsequent filings. In addition, we will present non-GAAP financial information on this call. Reconciliations to the applicable GAAP measure are included in the financial information we released this morning, as well as the slides for this conference call, which are both available on our Investor Relations website at investor.southerncompany.com. At this time, I'll turn the call over to Chris Womack.

Christopher Womack, President

Thank you, Scott, and good afternoon, and thank you for joining us. I am delighted to be joining you today on my first earnings call as President of Southern Company. I've enjoyed the opportunity to interact with many of you over the last couple of months and look forward to meeting with many more of you in the months ahead. I am incredibly excited about the future of Southern Company, the energy industry, and the valuable work that we're doing to serve our customers and communities. I am excited about the opportunities ahead of us and proud to be a part of a team that is making such a significant impact in building the future of energy. Our mission remains unchanged: provide our customers and communities with clean, safe, reliable, and affordable energy, while continuing to keep our customers at the center of everything we do. Unchanged is our goal to deliver superior risk-adjusted total shareholder return. And I believe our financial plan supports that objective. The strength of our value proposition is a function of our customer and community-focused business model, the robust economic growth in our service territories, and the constructive regulatory frameworks in our states. It is also a function of our discipline as we remain committed to our objectives of strong investment-grade credit ratings with a regular, predictable, and sustainable dividend policy. Along with our focus on long-term execution and value accretion, we are executing on our plans and believe we're well positioned to achieve our financial objectives for 2023. Dan, I'll now turn the call over to you for our financial update.

Daniel Tucker, Chief Financial Officer

Thanks, Chris, and good afternoon, everyone. For the first quarter of 2023, our adjusted EPS was $0.79 per share, $0.18 lower than the first quarter of 2022 and $0.09 above our estimate. The major driver for the variance to last year was milder-than-normal weather, as the first quarter of 2023 was the warmest on record in the Southeast. Higher depreciation and amortization and interest expense also impacted earnings for the first quarter compared to last year and were somewhat offset by constructive state regulatory actions. A complete reconciliation of our year-over-year earnings is included in the materials we released this morning. When looking at adjusted EPS impact compared to our estimate for the quarter, the main drivers were a strong start for our state-regulated natural gas utilities and continued strong electric and gas customer growth. Given the mid-February timing of our last earnings call, we were able to factor milder than normal January and February weather into our estimate for the quarter, so weather was not a major driver of our performance versus our estimate. You may recall that our adjusted earnings in the first half of 2022 were significantly better than projected due to weather and other market-driven factors. Our early 2022 outperformance supported our full-year adjusted EPS performance and enabled us to accelerate maintenance activities in several areas of the business. Those initiatives positioned us with additional spending flexibility entering 2023, such that we expect the significant weather impact we experienced in January and February to be manageable over the remainder of the year, assuming a return to more normal weather throughout the balance of the year. Turning now to retail sales in the economy. In the first quarter, weather-normal electric retail sales were 0.4% higher than the first quarter of 2022. This increase reflects stronger residential and commercial sales from continued robust net migration to our service territories, a strong labor market, and a return to more normal business trends. Industrial sales for the quarter were down 1.6% as we are beginning to see weakness in housing-related sectors, such as stone, clay, and glass, lumber, and textiles due to inflationary pressures and higher interest rates. Half of the industrial variance for the quarter compared to last year can be attributed to the closure of a caustic soda manufacturing facility in Alabama. Excluding the impact of this single customer, industrial sales were down approximately 0.8%. In a trend that continues to differentiate our Southeast service territories from many other areas of the country, we once again saw record levels of economic development activity with job creation and capital investment announcements at all-time highs in the first quarter. We are beginning to see supplier announcements related to the Rivian and Hyundai electric vehicle manufacturing facilities in Georgia, with six supplier announcements made during the quarter, totaling over 4,200 jobs and nearly $2 billion in capital investment. We expect additional automotive supplier announcements in the coming months. Beyond the automotive industry, QCells recently announced a new $2 billion solar panel and component manufacturing facility in Georgia, which is expected to create 2,000 jobs. Additionally, the Port of Savannah continues to set records, posting its highest national market share ever and second busiest February on record. The port continues to expand capacity, including the recent announcement of the addition of 55 electric cranes, which are expected to eliminate 500,000 gallons of diesel consumption and related emissions per year. Before I turn the call back over to Chris, I'd like to call your attention to our recent dividend increase. At its last meeting, Southern Company's Board of Directors approved an $0.08 per share increase in our common dividend, raising our annualized rate to $2.80 per share. This action marks our 22nd consecutive annual increase, and for 76 consecutive years, dating all the way back to 1948, Southern Company has paid a dividend that was equal to or greater than the previous year. This remarkable track record supports Southern Company's value proposition. Lastly for me, our adjusted EPS estimate for the second quarter is $0.75 per share. Chris, I'll turn it back over to you.

Christopher Womack, President

Thank you, Dan. Before taking your questions, I'd like to first provide an update on recent progress on Plant Vogtle Units 3 and 4. Importantly, the projected completion timeline and capital cost forecast for both units are unchanged from the updates that we provided last quarter. Since that time, we've seen sustained progress consistent with our expectations for each unit. At Unit 3, we've achieved initial criticality in March and successfully synced to the grid earlier this month. We continue to work through final startup testing and commissioning and are currently performing testing at the 50% thermal power plateau. This testing is expected to continue in the coming weeks with extensions to higher power plateaus and force trips to test the unit's safety systems. Following completion of this final testing sequencing and consistent with our long-term plans, we expect Unit 3 to enter into a brief maintenance outage window before returning to full power. After the successful completion of all appropriate preoperational and power extension testing, as well as any necessary fine-tuning, Unit 3 will be ready for commercial operations. We continue to project placing Unit 3 in service in May or June of 2023. Turning now to Unit 4. Substantial progress continued throughout the last quarter, with hot functional testing commencing in March, with lessons learned from Unit 3 continuing to benefit our execution on Unit 4. Hot functional testing is approximately 80% complete. We have already achieved peak planned output of the test and are currently in the process of cooling the unit back down. Progress throughout the test has been consistent with our plan. We project to complete hot functional testing in the coming weeks to be followed by planned inspections and surveillance, along with the middle of our final ITAAC's receipt of the 103(g) finding from the NRC and fuel load later this year. Only six systems remain for turnover to testing for Unit 4, and we continue to project an in-service date between late fourth quarter of 2023 and the end of the first quarter of 2024. We look forward to sharing our exciting progress in the weeks and months ahead as we bring these units online to provide reliable, carbon-free energy to the benefit of our customers in the State of Georgia for decades to come. In closing, I'd like to highlight that Southern Company was named the top utility on Forbes Magazine's Best Large Employers in America 2023 rankings. We ranked nearly 100 places higher than the next industry peer and in the top 15 of the 500 large employers ranked for the second consecutive year. Being recognized amongst the best in the nation once again is an honor. This accolade is particularly gratifying because it is directly based on employee feedback. We are committed to creating a workplace where all groups are well represented, included, and fairly treated within all levels of the organization and that everyone feels welcome, valued, and respected. At Southern Company, we aspire to be a leader in our industry. As such, we will continue to strive to create the best workplace possible for our thousands of team members who work tirelessly each and every day to provide world-class service to the customers that we have the privilege to serve. Thank you for joining us this afternoon. Operator, we are now ready to take questions.

Operator, Operator

Operator Instructions. And our first question comes from the line of Steve Fleishman with Wolf Research.

Steve Fleishman, Analyst

Hey, good afternoon, Chris. Congrats on your first call in a new role. And hi to Tom out there, I'm sure he's listening. Just on the prudency filing in Georgia, when would that come and roughly when that's going to be scheduled this year?

Christopher Womack, President

It is scheduled to come as we enter fuel load on Unit 4. Right now, we're looking for fuel load to occur in the July timeframe. So we'll work with the commission and the staff on moving through that process. But it will get started as we enter fuel load on Unit 4.

Steve Fleishman, Analyst

Okay. I think most things take about six months in Georgia.

Christopher Womack, President

Yes, we expect a six-month time frame based on what we expect today.

Steve Fleishman, Analyst

Okay. You mentioned the remaining steps for the start-up of Unit 3, but regarding the testing so far, you've maintained the timeline. Can we say that everything is proceeding as expected? Are there any issues that have arisen? Any additional details would be appreciated.

Christopher Womack, President

Steve, as you've noticed, unforeseen issues can arise. I can say that testing has gone quite well. We have encountered some challenges, but the systems performed as expected, and we have addressed those issues. We are making progress and advancing as planned. Overall, things are looking positive, but we understand that challenges can occur during a first-time startup. That's why we conduct tests, and our focus remains on the secondary side. Thus far, everything has been going well, and testing is an ongoing process to ensure we are prepared for commercial operation.

Operator, Operator

And our next question comes from the line of Shar Pourreza with Guggenheim Partners.

Shar Pourreza, Analyst

Chris, you guys recently just lowered the '24 guidance on the back of ongoing inflation and interest rates. How are you seeing things develop now? And do you see opportunities to manage your exposure like we saw with the prior convertible note you issued in February, which had a bit of a better sales outlook today? What are some of the pushes and takes since you revised that '23 guide? It seems like there are some incremental tailwinds here.

Christopher Womack, President

Shar, you asked about '23 or '24.

Shar Pourreza, Analyst

'24.

Christopher Womack, President

Okay. So let me start, and then I'll kick it to Dan. We moved the lower end of our band down because we pushed out the expected start-up of commercial on Unit 4. We lowered the range down to around 3.95. So that was based on the push on the schedule for Unit 4. Dan, do you want to comment on any other aspects of guidance?

Daniel Tucker, Chief Financial Officer

Yes. And just following on to what Chris said, once we have clarity, which again will be the end of this year or early next year on Unit 4, we'll narrow that 2024 guidance down to something that's more akin to what we typically do, around a $0.10 range or so based on the actual in-service date. As for the other moving parts, we’re executing in a way to ensure that we're managing where we need to. We'll continue to be creative and thoughtful around how we're financing, particularly at the parent company. I think the convertible deal was a tremendous success. We'll see what other opportunities we have, not necessarily that specific instrument, but just to be opportunistic in how we do that. From a cost perspective, everyone is seeing pressures, and we are no different. But we've got a lot of efforts underway to ensure that we're running the business as efficiently as we can while supporting that guidance range.

Shar Pourreza, Analyst

Got it. And then just, Chris, I'm kind of curious about your overall thoughts on the cost side because Southern doesn't really have a stated cost-cutting target like some of your peers despite managing O&M fairly well. Looking at things from a fresh lens, are you seeing opportunities to cut costs incremental to your current plan, maybe at the holdco level, like shared services or even at the opcos? I mean, are there any opportunities you see as a new CEO that could be additive to the plan as we're considering further streamlining the business?

Christopher Womack, President

Yes. And Shar, I would say that's a wonderful question. I'd build on what Dan has said. We will continue to look at how we can run this business more efficiently. There are opportunities to create shared service opportunities and find efficiencies in places; we will do that. As you know, there's a lot of conversation around affordability, and we take it very seriously. We continue to find ways to put downward pressure on our pricing and find ways to account for the interest rate and inflation implications. From an O&M perspective, we aim for it to either be flat or declining over our forecast period. We will continue to pursue those opportunities. We've successfully done this in the past, and we'll continue to do so.

Daniel Tucker, Chief Financial Officer

Additionally, particularly the shared service opportunities, as Chris mentioned, one of the significant opportunities we have is to optimize how our internal resources are deployed between operating expenses and capital investments. We're certainly doing everything we can to optimize the deployment to focus on our capital spend while simultaneously reducing costs.

Operator, Operator

And our next question comes from the line of Ross Fowler with UBS.

Ross Fowler, Analyst

So Dan, I just want to go through the seasonality again. You mentioned it in your prepared remarks, but I want to make sure I fully understand your drivers. You had a little over $2 in the first half of '22, and you've got a little over $1.50 in the first half of '23. So if I heard you correctly, you said that outperformance in '22 allowed you to pull a lot of O&M forward into the year, so that's part of it. But there are other pieces I think like a reduction in part of the Vogtle penalty once Unit 3 goes in. And then I think there was some sharing outside the band in Q4 of last year. Other than those three pieces, is there anything I'm missing around sort of getting back into the guidance range with a better second half number this year versus last?

Daniel Tucker, Chief Financial Officer

In terms of making those comparisons year-over-year, Ross, I think another important element that helped us reach that strong start last year was earnings driven by where energy prices were. Not only on our regulated side, we saw some commercial and industrial pricing benefit from that, but also on the Southern Power side got off to a great start because of market energy prices. In a year-over-year comparison, that will be a difference. Another key point to note is the refunds to customers, which was significant in the second half of last year if you combine all our jurisdictions in terms of what was accrued to refund back to customers or what was held in regulatory reserves. That accounted for $0.33 just in the fourth quarter. This was a significant year-over-year reconciling item, which will not be present this year, but we will still be able to support that $3.60 as a midpoint.

Ross Fowler, Analyst

And then on the industrial sales decline, you mentioned about half of that was sort of a one-off item due to the caustic soda facility. The rest was kind of seen in lateral housing-related sectors. Maybe excluding housing, what are you seeing for the economic backdrop currently in that context?

Daniel Tucker, Chief Financial Officer

Still, and I want Chris to add on to this, from an overall sales perspective, we're still seeing year-over-year growth in a lot of sectors. There is a bit of slowing, but the overall strength here in the Southeast continues to show itself. Chris, do you want to add anything there?

Christopher Womack, President

Yes. We look at the economic development pipeline here in the Southeast, which remains robust. In the first quarter of '23 versus the first quarter of '22, we announced projects expected to create over 10,000 jobs and around $4 billion of investment here in Georgia. Alabama is also seeing increases around EV and battery supply chain. The pipeline continues to be very full. We continue to be excited about the economic activity and the economic development pipeline from population growth and migration. Customer growth was around 11,000 on the electric side and around 6,000 on the gas side. We see very positive indicators; while some may claim there might be a recession, we believe that in our territory, it may lessen due to this ongoing economic strength and activity.

Ross Fowler, Analyst

That's great, Chris. And maybe this is an unfair question, but how do you think about the EPA power plant rule potentially coming around natural gas and emissions reductions? How do you perceive that regarding sustainability achievements versus affordability and reliability, given that natural gas is needed for both sustainability and affordability as we walk through the energy transition? What are the risks and opportunities around that type of regulation?

Christopher Womack, President

Let me break that up into two parts. In terms of the proposal using the process before, it will undergo different iterations. When there is a final rule, we'll assess it and determine what it means for us. We have been pursuing our fleet transition, maintaining our focus on sustainability along with a commitment to balancing affordability as we strive for net zero. We'll continue down this path. Whenever a new rule emerges, we'll evaluate it. I would add that I believe natural gas is very important for the economy. It's crucial for this country and its economy, particularly in regions that cannot transition entirely to all-electric sources from an affordability standpoint. It's essential to recognize the importance of natural gas moving forward.

Operator, Operator

And our next question comes from the line of Julien Dumoulin-Smith with Bank of America.

Julien Dumoulin-Smith, Analyst

Congrats, again. So with that in mind, I want to pivot back to the credit conversation. As we pivot out of U3, U4, and the timelines get narrower, what are you thinking today about prospects of credit improvement? What metrics do you target? You've seen some fluctuations during the construction phase. How far do you intend to go with that improvement, and what does it mean for your targeted broad metrics? I understand the rating agencies have different standards, and what does that translate to regarding target FFO for you?

Daniel Tucker, Chief Financial Officer

With both Unit 3 and 4 in service, reflected in rates from a cash flow perspective, it represents about a $700 million improvement in our operating cash flow, thus improving FFO from an FFO to debt ratio. Given the rest of our business, combined with that improvement, we should comfortably have an FFO to debt ratio around the 7-ish zone. It could push as high as the 18 in later years or in the high 16s. But we should remain comfortably above existing rating thresholds. I've stated our objective is to have all our regulated utilities in the A category and our parent company at BBB+. I believe we can achieve that merely through execution.

Julien Dumoulin-Smith, Analyst

Right. But that means a further improvement in the underlying metrics per se?

Daniel Tucker, Chief Financial Officer

Absolutely.

Julien Dumoulin-Smith, Analyst

Okay. And then, if I could pivot to Georgia Power specifically around solar opportunities. I know the IRA has unlocked certain opportunities. I know that this isn’t in flight in the process of maybe not necessarily, right? But can you share your prospects for investing in that realm, particularly around solar at Georgia Power and/or any of the other opcos today post-IRA, given the RFP?

Christopher Womack, President

Yes. We have opportunities due to the 2022 integrated resource plan as well as the Inflation Reduction Act, which levels the playing field from tax policy. It provides us the opportunity to own renewables ourselves. Our teams are investigating opportunities, and we'll be working with the commissions to pursue options for building and owning more renewables as we progress, capitalizing on the opportunities the IRA affords us. Furthermore, we'll explore options for Southern Power as we advance. We are enthusiastic about these opportunities and look forward to investigating and executing around them.

Julien Dumoulin-Smith, Analyst

Got it. But perhaps in the next quarter or so, we’ll receive more detail there?

Christopher Womack, President

We'll keep you posted.

Operator, Operator

And our next question comes from the line of David Arcaro with Morgan Stanley.

David Arcaro, Analyst

A couple of quick questions on the Vogtle units. I was wondering when we would expect Unit 3 to be running at full capacity. We've seen it ramping up and down, getting to 50% power. When might we see it at full capacity? And then just on Unit 2, have the testing and running so far been going smoothly enough to not push out any incremental delays within the May to June time frame?

Christopher Womack, President

No. We're not announcing any schedule or cost estimate increases. We expect 100% power sometime in May. We're working through the process, completing testing, and ramping up. Just look for sometime in May to achieve that milestone.

David Arcaro, Analyst

Okay. Got you. And then on Unit 4, during hot functional, I guess, similar question: have you seen any issues pop up in that testing phase that would add incremental time even within the 4Q to 1Q 2024 window?

Christopher Womack, President

We're about 80% complete on hot functional on Unit 4. There are no issues to note, and I think it’s evident that we have taken lessons learned from our Unit 3 experience. If we maintain our schedule, we will complete hot functional testing sometime in early May, then focus on critical path items of ITAAC's and testing, leading towards fuel load in July. So, so far, so good.

Operator, Operator

Our next question comes from the line of Durgesh Chopra with Evercore ISI.

Durgesh Chopra, Analyst

First, Chris, you talked about the maintenance outage at Unit 3. I want to confirm that's just standard process, right? That's not an added step based on...

Christopher Womack, President

Yes, it's a standard outage. There are some testing equipment that has to be removed, and we have learned various things. We will fine-tune and perform some remediation during what will probably be about a 10-day maintenance outage. But yes, it’s standard and what's expected.

Durgesh Chopra, Analyst

Perfect. Thank you for clarifying that. And then maybe I can pivot to the Georgia Power under-recovered fuel filing. I believe you made that in February. Any initial stakeholder feedback? I know in the last call, we discussed offsetting some of that balance with lower gas prices going forward. Just any insights on that front would be great.

Christopher Womack, President

As you may know, we reached a stipulation with the staff, and we're looking at a 12% price increase on retail rates over a three-year period to recover that under-recovered fuel balance, which will take effect in June. This is lower than our initial request and 30% less than what we expected. This outcome reflects our sensitivity toward affordability, and we recognize the necessity to recover this under-recovered fuel balance. Our approach minimizes the impact on customers, and that's where we currently stand. More hearings and considerations will take place, but the rates will take effect starting in June.

Operator, Operator

And our next question comes from the line of Sophie Karp with KeyBanc.

Sophie Karp, Analyst

Most of my questions have been answered. Let me just throw this one at you. With Vogtle moving towards the completion of Units 3 and 4, would you take some time in the medium term to reassess the businesses you own and determine which ones could be recycled capital-wise to optimize the business mix? Or are you satisfied with your current position?

Christopher Womack, President

As we have success with Vogtle 3 and 4, it gives us the opportunity to unlock the full value of this company and recover our premium valuation. We will evaluate our business and all parts of it from a buyer and seller perspective. We feel confident about our existing positions. We will always remain vigilant and study marketplace opportunities. However, we believe our current strategy will allow us to unlock our full potential as we move forward.

Operator, Operator

Our next question comes from the line of Angie Storozynski with Seaport.

Angie Storozynski, Analyst

So I’ll just ask a bit for clarification. Would you be willing to acquire some assets now that you have seemingly a clean slate? You've mentioned having no equity needs. You have a strongly improving cash flow, and there are assets available for sale. From our perspective, you seem to have sold for roughly the sector average earnings growth, which is surprising.

Christopher Womack, President

As I mentioned, we are enthusiastic about the progress we're making with the Vogtle units. We're looking forward to bringing both units online and completing them. Once that is achieved, we intend to focus on unlocking the company's complete value and all available opportunities. We possess adequate capacity for this as a stand-alone, and we continue to investigate all market options available. We are satisfied with our current position and strive for a 5-7% return in the industry to ensure the best risk-adjusted return.

Operator, Operator

Our next question comes from the line of Ashar Khan with Verition.

Ashar Khan, Analyst

Congratulations. My questions have been answered. Thank you.

Operator, Operator

That will conclude today's question-and-answer session. Sir, are there any closing remarks?

Christopher Womack, President

Thank you for being with us today. We look forward to speaking with you in the future. But otherwise, operator, thank you very much for the call.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this concludes the Southern Company First Quarter 2023 Earnings Call. You may now disconnect. Have a great day.