Southern Company (SO) Q4 2013 Earnings Conference Call January 29, 2014 1:00 PM ET
Dan Tucker – Vice President-Investor Relations and Financial Planning
Thomas A. Fanning – Chairman, President and Chief Executive Officer
Art P. Beattie – Executive Vice President and Chief Financial Officer
Steve I. Fleishman – Wolfe Research LLC
Greg Gordon – International Strategy & Investment Group LLC
Jim D. von Riesemann – CRT Capital Group LLC
Ali Agha – SunTrust Robinson Humphrey, Inc.
Michael J. Lapides – Goldman Sachs & Co.
Andy S. Levi – Avon Capital Advisors, LLC
Kit Konolige – BGC Partners LP
Dan L. Eggers – Credit Suisse Securities LLC
Jonathan Arnold – Deutsche Bank
Anthony C. Crowdell – Jefferies LLC
Paul T. Ridzon – KeyBanc Capital Markets, Inc.
Michael Weinstein – UBS Securities LLC
Mark Barnett – Morningstar Research
Vedula Murti – CDP US, Inc.
Paul Patterson – Glenrock Associates, LLC
Good afternoon. My name is Kenitha and I will be your conference operator today. At this time, I would like to welcome everyone to the Southern Company Fourth Quarter 2013 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. As a reminder, this conference is being recorded today, Wednesday, January 29, 2014.
I would now like to turn the call over to Mr. Dan Tucker, Vice President of Investor Relations and Financial Planning. Please go ahead, sir.
Thank you, Kenitha. Welcome to Southern Company’s fourth quarter 2013 earnings call. Joining me this afternoon are Tom Fanning, Chairman, President and Chief Executive Officer of Southern Company and Art Beattie, Chief Financial Officer.
Let me remind you that we will make 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 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. To follow along during the call, you can access these slides on our Investor Relations website at www.southerncompany.com.
We have a full agenda for today’s call. We will begin with the brief recap of 2013 operational highlights followed by an update on the Vogtle and Kemper projects. We will then discuss fourth quarter and full year 2013 financial and sales result. Finally, we will update our forecast of sales, capital spending and financing which support our earnings and dividend forecast for the next few years.
At this time, I’ll turn the call over to Tom Fanning.
Thomas A. Fanning
Good afternoon and thank you for joining us. 2013 was a year of operational, regulatory, and financial challenges for Southern Company and apart from our difficulties with Plant Ratcliffe in Kemper County, Mississippi, we achieved tremendous success in meeting these challenges and what was arguably our busiest year ever from a regulatory standpoint.
We’ve done unprecedented level of activity across all four states. The results in each of our jurisdictions demonstrate that our continued focus on the customer helps support constructive regulatory engagements.
In Alabama, minor adjustments were made to the RSE mechanism that will serve customer interest well. In Georgia, the PSC approved another constructive three year agreement for Georgia Power. Georgia Power also completed another successful integrated resource plant and in the third regulatory proceeding in Georgia, the VCM Eighth Report was approved unanimously, bringing the aggregate total of costs approved for plant Vogtle Units 3 and 4 to $2.2 billion with no disallowances.
In Florida, the PSC approved the settlement agreement reached between Gulf Power and all of the interveners in its rate case. And in Mississippi, we reached a settlement in January 2013 that paved the way for Kemper-related rate increases in 2013 and 2014 and a subsequent rate increase in 2015 for the securitization of certain project costs. Combined, these steps are projected to stabilize the impact on customers before it lead seven years.
Even with the backdrop of the regulatory proceedings in all four of our retail jurisdictions, Southern Company and its four traditional operating companies occupy the top five spots in the 2013 Customer Value Benchmark survey, which compares our customer satisfaction ratings with those of peer utilities.
We experienced the best year in our company’s history in terms of transmission and distribution reliability, continuing a trend of improvement over the past decade. And most importantly, we completed our safest year ever.
For the third consecutive year, Southern Company achieved a new all time record low, in recordable incidence rate and also saw reductions in loss work day cases and preventable vehicle accidents. This continuing commitment to protecting the health and safety of our workers is a key component of Southern Company’s workplace culture and I’m extremely proud, of our most recent results in this area.
Let’s now discuss our two large construction projects; progress at the Vogtle 3 and 4 construction site is remarkable. We’ve included photos in our slide deck that indicates how much the site has changed over the course of 2013. Also included is a recent photo of CA20, the auxiliary building modules for the Unit 3 nuclear island; the photo which was taken inside the onsite module assembly building showed all of the structural walls assembled, prep work continues to ready this module for a placement in the nuclear island next month.
We overcame early issues with the sub module fabrication and documentation in Lake Charles Louisiana. Our demonstrated ability to work through challenges is indicative of the strong collaborative relationship we have with Chicago Bridge & Iron and Westinghouse as well as a testament to the rigorous oversight we have in place for this project.
As we look ahead to 2014, the site will continue to change shape in dramatic ways. Product risks on the Turbine Island and Cooling Tower for Unit 3 will continue and the Nuclear Island for Unit 3 will really start to come out of the ground. After the placement of CA20, we are scheduled to see two of the containment vessel rings stacked on the bottom edge, the large CaO-1 module placed inside the containment vessel and the six foot thick walls of the Nuclear Island will come all the way to ground level.
Progress on Unit 4 will also continue and a year from now, we expect that many of the units components to be further along than Unit 3 is today. We are also pleased to announce after an extensive negotiations on loan guarantees, Georgia Power has delivered its documents to DOE. Now there remain a series of steps that must be taken prior to closing and while we can’t disclose final terms, we do believe that our earlier estimate of approximately $200 million of present value benefits is still representative of the loans value to customers.
Combined with other customer benefits including production tax credit, four of which we have qualified after the completion of the concrete basemat pours in the nuclear island, we project approximately $2 billion worth of additional benefits to customers relative to the amount originally certified by the PSC. We will continue to provide more color on these savings and other aspect of the project in the next Vogtle Construction Monitoring report which is scheduled to be filed in late February.
The Kemper IGCC project also continues to make progress and we are still working towards a fourth quarter in service states. During 2013, the transmission infrastructure was completed. The pipelines were all completed and the lignite mine was place into service. At this stage, more than 75% of the piping has been installed and testing of the combined cycle is underway.
In fact, we produced electricity using natural gas throughout most of January, generating approximately $1 million to offset project costs. We will move towards testing of the gasifier in the second quarter, which will mark the first heat up of a gasifier at the facility. The key milestone expected prior to commercial operation is a reliable supply of syngas to the combined cycle.
Recognizing that there are risks associated with start-up activities, we have recorded an additional charge for the project of $40 million pre-tax, $25 million after-tax in the fourth quarter of 2013 to increase the contingency for those risks.
Overall, we continue to anticipate this Vogtle Unit 3 and 4 and Plant Ratcliffe in Kemper County will benefit customers with clean, safe, reliable, and affordable energy for decades to come.
I will now turn the call over to Art for a financial and economic overview.
Art P. Beattie
Thanks, Tom. As you can see from the materials we released this morning, we had strong results for the fourth quarter of 2013, which positively influenced our results for the full year.
For the fourth quarter of 2013, we earned $0.47 per share, compared to $0.44 per share in the fourth quarter of 2012. For the full year of 2013, we earned $1.88 per share, compared with $2.70 per share in 2012.
Our results for the fourth quarter 2013 include after-tax charges of $25 million or $0.03 per share and earnings for the full year 2013 include after-tax charges totaling $729 million or $0.83 per share related to increased cost estimates for construction of the Kemper project.
As a reminder, Mississippi Power will not seek recovery of estimated cost to complete the facility above the $2.88 billion cost cap net of Department Of Energy grants and exceptions to the cost cap. Results for the full year 2013 also include an after-tax charge of $16 million or $0.02 per share for the restructuring of a leveraged lease investment recorded in the first quarter of 2013.
Earnings for the fourth quarter and full year 2013 include $12 million or $0.02 per share and earnings for the full year 2012 include $21 million $0.02 per shares of an insurance recovery related to the March 2009 litigation settlement agreement with MC Asset Recovery, LLC. Excluding these items, earnings for the fourth quarter and full year 2013 were $0.48 and $2.71 per share respectively, compared with $0.44 and $2.68 per share respectively for the same periods in 2012.
Year-over-year results were positively influenced by revenue effects associated with new generating capacity at our traditional operating companies, as well as reductions in interest expense and AFUDC. These positive effects were offset by significantly milder than expected weather. Increased depreciation and amortization and non-fuel O&M expenses. And an increase in the number of shares outstanding.
A full listing of earnings drivers were about the full year and the fourth quarter is included in the slide deck. Our full year 2013 results are perhaps best understood however by examining the response of our traditional operating companies to unexpected headwinds in revenue. Weather in territory was especially unseasonable in 2013 resulting in one of the mildest summers in the past 20 years and rainfall during the third quarter of 2013 was the heaviest in nearly 100 years.
The impact on our base revenues equated to negative $0.14. At the same time retail sales growth in 2013 was slightly less than anticipated. 2013 therefore marks yet another year in which our flexible spending plans have proved an effective in offsetting unforeseen shortfalls in revenue. Each year as part of the development of our financial plan we build flexibility into our operations and cost to serve as a mitigation for revenue variances.
Since 2010 with the economy struggling to recover and with two very mild weather years back to back our O&M spending has been down $500 million compared against our plan helping us to deliver on our short-term financial commitments while adding more than $7 billion in capital assets. All the while, our operating companies have been keenly focused on safety, reliability and customer satisfaction with a view towards maintaining the long-term sustainability of our business model.
Moving now to an economic and sales review of 2013. As expected economic growth in 2013 was slow during the first half of the year, but picked up considerably during the second half of the year. This trend is reflected in our retail sales results which showed improved growth in the second half of the year in all customer classes. For example, industrial sales which decreased 0.7% in the first six months, increased 3.6% during the second six months and 4.8% during the fourth quarter. Bring it as to 7 consecutive month’s year-over-year of industrial sales growth.
So strongest segments included paper up a 11%, primary metals up a 11% and pipelines up 6%, housing-related industries improved as well was with stone, clay, and glass up 9% and lumber up 5%. Commercial and residential sales were essentially flat for the year although we did see a noticeable increase for residential in the fourth quarter. Meanwhile, our economic development pipeline remains robust growing nearly 20% in 2013 compared with 2012. Our traditional operating companies are currently supporting some 350 potential projects representing 35,000 jobs and $15 billion in capital investments.
Earlier this month we reengaged our economic roundtable participants. As a reminder, this group consists of several regional economists and executives from a handful of our largest customers. The viewpoints of our roundtable participants are well aligned with Southern Company’s economic forecasts. The momentum experienced during the second half of 2013 is expected to carry over into 2014 with anticipated GDP growth of between 2.5% and 3%.
Industrial activity and exports are expected to be the key drivers with growth expected in chemicals, steel, auto manufacturing and transportation. The housing market is improving but likely has a long way to go before returning to free 2007 levels. Multi-family customer growth is 10% higher is a 10% higher share of our growth than during the pre-recession period, consistent with many antidotes about robust growth in multi-family housing. Building permits were up more than 25% over 2012, but are about 50% below normal levels.
The dynamics of supply and demand in this sector are returning to historical levels which should translate into an increase in single family home starts. This continued recovery of the housing sector will support stronger residential customer growth and further support a rise in activity we saw at housing-related sectors in 2013 with expectations of continued growth in 2014. Much of the feedback we have heard from our economic roundtable participants is consistent with the factors that drive our electric sales outlook for 2014.
Overall, our forecasts reflects 0.7% growth from our 2013 weather-normalized results. As one looks at how the forecast breaks down by our customer class, the expected trend is similar to that of the past several years and that industrial growth leads the way. Specifically, our forecast of 0.7% overall growth assumes a 1.1% growth for industrial sales and about half of that rate for both residential and commercial.
Now let’s focus on the other elements of our new forecast including our three-year projection of capital expenditures and the associated financing plan. Based on our CapEx forecasts for 2014 to 2016, it totals $14.5 billion more notably the forecast reflects a slowing trend in the rate of capital investments by a regulated subsidiary. The main drivers of this trend are expected completion of Plant Ratcliffe in Kemper County, Mississippi, the transition to startup activities for Vogtle units 3 and 4 and the expected completion of compliance investments for EPA's MATS rule.
In addition, we have outlined potential Southern Power investments for the three-year period which totaled $1.4 billion. These placeholders represent potential acquisitions or new build capacity projects consistent with Southern Power’s longstanding capacity contract-oriented business model as well as potential opportunities to invest in additional PV solar projects over this timeframe. As always, we will provide the details of any specific opportunities as they arise to an appropriate level of certainty.
Overall, our three-year CapEx total is expected to be $15.9 billion. As we turn to the financing plans for the next three years, there are several things to note. First, the only equity issuances we are forecasting over the three-year periods are the same $600 million in 2014 that we highlighted late last year. This was primarily driven by our desire to preserve our target equity ratios in light of the estimated Kemper loses recorded in 2013. Our current forecast anticipates that all this equity will be issued through our various internal plans. We currently project zero equity needs in 2015 and 2016.
Secondly, we have highlighted the appropriate size and timing for Georgia Powers draws under the DOE loan guarantee program and an estimated total for securitized bonds to be issued by Mississippi Power to fund a portion of the Kemper project. As our cash profile continues to improve over the next several years, our three-year financing plan reflects very little new capital market issuances which may increase with potential new investments by Southern Power.
However, it is important to note that our forecast would still reflect zero equity needs for 2015 and 2016 even if we spend the entire amount reflected in our CapEx forecast for potential Southern Power growth projects. We have provided a more detailed financing schedule in the appendix of our slide deck which breaks these out by subsidiary. All of the forecast elements we discussed sales, CapEx, equity and cash flow factor into our earnings guidance which I would like to share with you now.
First, let’s focus on 2014. As noted earlier, our 2013 earnings per share results of $2.71 excluding charges came in a year of extremely mild weather, heavy rainfall and a still sluggish economy. However, we largely overcame the financial impact of those external factors by demonstrating an ability to mitigate revenue shortfalls with lower spending.
As a result, it’s fair to consider $2.71 a normalized earnings per share result. Using $2.71 as the starting point, we then adjust for the additional share dilution resulting from the estimated Kemper losses, which totaled $0.07. As we have shared previously, this step change is simply a function of the new shares we’re issuing to preserve our target equity ratios at both Mississippi Power and Southern company.
Growing 4% to 5% from this adjusted starting point establishes a midpoint for our new 2014 guidance range. To establish a reasonable range for the year, we then add plus or minus $0.04 a very modest 1.5% to this midpoint to set a range at $2.72 to $2.80 per share.
Now let’s transition to expectations for 2015 and 2016. In our last earnings call, we shared a very distinctive trend where we are beginning to see which we are beginning to see in our long-term forecast. More specifically, we highlighted a slowing of EPS growth in the middle of the decade. This slowing is largely a function of a slowing level of capital spending especially relative to a capital base that has grown significantly in the recent years with new generation and environmental investments.
Combined with the increased operating cash flow associated with these same projects, the rate of growth and total invested capital slows over the next several years. Consistent with these trends, our estimates for earnings per share growth for 2015 is 3% to 4% from our 2014 guidance range and our estimate for 2016 is another 3% to 4% above our estimate for 2015.
As we look beyond 2016, we continue to see potential for the growth rates we accelerate. For instance, we are likely to see new generation investment opportunities later this decade for both Southern Power and our traditional operating companies as well as new environmental spending.
Additionally, beginning several years ago, we raised our equity ratio by several hundred basis points to preserve our financial integrity during a period of increased construction risk. As our major projects are completed, there maybe an opportunity to unwind some of that equity ratio cushion and maintain our credit quality at the same time; this would also have a positive impact on earnings per share growth.
In accessing our earnings estimates for 2014 through 2016, we have also reconfirmed our ability that continuing with dividend increases of $0.07 per year is sustainable. While dividend increases are subject to Board approval, the implied payout ratios associated with a $0.07 per year increase are reasonable within the context of our strong cash flow, business model and constructive regulatory jurisdictions.
So to summarize, we estimate EPS growth of approximately 4% to 5% in 2014, off of an adjusted 2013 base. Our growth estimates for 2015 and 2016 is 3% to 4%. Beyond 2016, we see potential to reaccelerate that growth. Based on our level of confidence, we expect to continue our current dividend growth strategy. As a side note, our earnings estimates for the first quarter of 2014 is $0.56 per share.
I will now turn the call back over to Tom for his closing remarks.
Thomas A. Fanning
Thanks Art. Earlier, I highlighted something that I want to take a minute to reinforce namely our track record of delivering regular, predictable and sustainable earnings along with that, a consistent dividend growth trajectory.
We are extremely disciplined in how we approach earnings guidance and dividend in Southern Company. We provide guidance once a year during our fourth quarter conference call in January like this one and we have never changed our guidance range during the remainder of the year.
Additionally, our range is tentatively small relative to those of other utilities. On the average, over the past decade, our guidance range has been the smallest relative to the other 19 companies in the Philadelphia Utility Index and as an affirmation of Art’s earlier point on the effectiveness of our spending flexibility, we have been inside or slightly above these narrow EPS ranges every single year over the past decade as we were inside those ranges other than excluding items.
Combined with the fact that we have had sustainable dividend growth every year for more than a decade, even through the toughest of economic times, we believe the risk return profile of Southern Company remain an unmatched value.
We are now ready to take your questions. Operator, we will now take the first question.
Earnings Call Part 2: