Pinnacle West Capital Corp

NYSE:PNW

Earnings Call Analysis

Firm's 2024 EPS Guidance and Dividend Strategy

The company unveiled an EPS guidance range of $4.60 to $4.80 for 2024, incorporating additional revenues from a recent rate case outcome. A pledge was made to continue providing an appealing dividend yield, with a maintained goal of managing the payout ratio within a 65% to 75% range, reflecting a robust record of annual dividend growth .

Strong Earnings and Customer Growth

The company reported a notable year-over-year increase in earnings per share (EPS) of $0.21 for Q4 and a full-year earnings increase to $4.41 per share, exceeding the guidance range of $4.10 to $4.30. These results were propelled by a heatwave-driven $0.22 weather benefit, enhanced gross margin attributable to expanded sales, improved transmission revenue, and contributions from regulatory decisions. The company witnessed continued customer growth at 2% and expects to maintain a growth rate of 1.5% to 2.5% into 2024, benefiting from the constructive business climate in Metro Phoenix.

Constructive Regulatory Outcomes

Regulatory approvals bolstered the company's financial position, with the commission voting for a rate increase equivalent to a 9.85% return on equity and a system reliability benefit surcharge. This enables more timely cost recovery, investment in cost-effective generation resources, and supports future CapEx growth. The company's dedication to improving customer value was reflected in climbing to the second quartile in J.D. Power survey results for both residential and business customers.

Commitment to Clean Energy and Infrastructure Growth

The strategic shift towards clean energy involves plans to retire its remaining Choa units by next year and exit coal completely by 2031. Nearly 5,000 megawatts of additional clean energy and storage have been procured, with more capacity planned. Investments over $5 billion in the next decade for critical transmission projects will ensure safe and reliable service for the growing needs of customers.

Forward-Looking 2024 Financial and Operational Guidance

The company projects an EPS guidance range of $4.60 to $4.80 for 2024, considering both the benefits from the rate case decision and the impacts of increased expenses from continued regulatory lag. While the company anticipates higher expenses and normal weather conditions, it remains confident about capturing increased revenues from sales growth and addressing regulatory lag issues proactively. The sales growth is forecasted at 2% to 4% for 2024, with particular strength expected from high-load factor commercial and industrial (C&I) customers, projecting a sales growth of 4% to 6% through 2026.

Expanding Investment and Improving Financial Mechanisms

Anticipating robust rate base growth at an annual CAGR of 6% to 8%, the company plans to issue a mix of debt and equity securities from 2024 to 2026 to support its capital structure. The emphasis is on improving the timeliness of cost recovery and reducing future regulatory lag through increased tracked capital with anticipated long-term benefits from the SRB mechanism.

Earnings Call Transcript 2023-Q4

[Operator]

Good day, everyone, and welcome to the Pinnacle West Capital Corporation 2023 Fourth Quarter Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Amanda Ho. Ma'am, the floor is yours.

[Amanda Ho, executive]

Thank you, Matthew. I would like to thank everyone for participating in this conference call and webcast to review our fourth quarter and full year 2023 earnings, recent developments and operating performance. Our speakers today will be our Chairman and CEO, Jeff Guldner; and our CFO, Andrew Cooper. [ Ted Geisler ], APS' President; and [ Jacob Telleo ], Executive Vice President of Operations are also here with us.

First, I need to cover a few details with you. The slides that we will be using are available on our Investor Relations website, along with our earnings release and related information.

Today's comments and our slides contain forward-looking statements based on current expectations, and actual results may differ materially from expectations. Our annual 2023 Form 10-K was filed this morning. Please refer to that document for forward-looking statements, cautionary language as well as the risk factors and MD&A [indiscernible], which identify risks and uncertainties that could cause actual results to differ materially from those contained in our disclosures.

A replay of this call will be available shortly on our website for the next 30 days. It will also be available by telephone through March 5, 2024. I will now turn the call over to Andrew.

[Andrew Cooper, executive]

Thank you, Amanda, and thanks to everyone for joining us today. I will first cover our fourth quarter and full year 2023 results before handing it to Jeff, who will discuss our recent rate case outcome, growth outlook and strategy. Afterwards, I will finish up with our 2024 guidance and long-term financial outlook.

In the fourth quarter of 2023, we achieved a $0.21 increase in earnings per share compared to the same quarter in 2022. This year-over-year improvement was largely driven by a $0.41 uplift in gross margin attributable to increased sales and usage as well as higher transmission revenue and contributions from the LFCR and 2019 rate case appeal.

The lack of certain prior period items from Q4 2022 contributed to a $0.21 benefit to other income and expense on a year-over-year basis. These increases versus the prior year were partially offset by higher O&M expense, depreciation and amortization, interest expense and benefit costs.

For the full year 2023 we earned $4.41 per share, a $0.15 increase over 2022, surpassing our guidance range of $4.10 to $4.30 per share. A significant factor in this result was a $0.22 year-over-year weather benefit driven by an unprecedented summer heat wave during the third quarter. Overall, weather contributed $0.48 in 2023 compared to normal weather.

Revenues from adjustor mechanisms, transmission and increased sales and usage were also positive drivers for the year. In addition, other income and expense was $0.33 higher year-over-year, driven by the lack of certain prior expense items from 2022 and the sale of Frank Canyon assets in the third quarter of 2023. These increases versus 2022 were partially offset by higher O&M expense, depreciation and amortization, interest expense and benefit costs.

Overall, we ended 2023 with 2% customer growth maintaining the year's long upward trajectory of consistent growth in our service territory. Weather-normalized sales growth was within the expected guidance range at 1.5% in 2023 and driven by 3.3% growth in our C&I customer segment. I'll now pass the discussion to Jeff to talk about our rate case outcome, growth outlook and strategy before I continue with our 2024 guidance and long-term financial outlook.

[Jeffrey Guldner, executive]

Great. Thank you, Andrew, and thank you all for joining us today. As you all know, just a few days ago, the commission voted to approve our 2022 rate case. I'm pleased to say that this rate case decision was ultimately reasonable and constructive. I'll highlight a few of the main outcomes, including an improved authorized return on equity, the approval of a new generation rider, and a balanced revenue requirement increase among other items. I'll also discuss our growth outlook and future strategy coming out of this case. Lastly, as Andrew mentioned, he'll provide our 2024 guidance and our long-term financial outlook.

After the unconstructive outcome of our 2019 rate case, we designed a comprehensive strategy and plan, and I'm pleased to share that we have accomplished the goals that we set out 2 years ago. We executed on a strategy centered on creating shareholder value by creating customer value, and we've seen significant improvements in our J.D. Power survey results.

Not only have we been successful in moving from fourth quartile in 2021 to second quartile at the end of 2023 for both our residential and our business customers. We finished the year second amongst all large investor-owned utilities in phone customer care and in perfect power. Reliability has continued to be a top priority, and we're once again top quartile meeting this milestone 10 years out of the last 11. This reliability was put on full display during the summer of 2023 when Arizona broke numerous heat records yet our team delivered outstanding performance for our customers.

Another important goal that we set was to build more collaborative relationships with stakeholders in the regulatory process, and we succeeded in adding supportive regulatory decisions, and that includes both the efficient implementation of our successful 2019 rate case appeal as well as the most recent rate case.

And finally, we focused on shareholder value by deferring any equity issuances and continuing to grow our dividend during this challenging period.

Now I'll walk through some of the major highlights of the rate case. The commission adopted a net revenue increase of $253.4 million. From the very beginning, we focused this rate case on improving the authorized ROE to recognize the risk and the investment needed to serve our rapidly growing service territory and the commission did that.

The commission voted to adopt an authorized return on equity of 9.55% with a 0.25% fair value increment and a combination of those two is equivalent to a 9.85% return on equity. With this decision, the commission has adopted an authorized return that's more in line with national averages and it recognizes that we're one of the fastest-growing states in the nation and we need to attract capital in order to fund the investments necessary to reliably serve our customers. In addition, the commission voted to approve our request for a system reliability benefit surcharge. This is an important surcharge that will allow us to invest in much needed generation resources to continue to serve our customers reliably and affordably while reducing regulatory lag.

Importantly, the SRB will allow for the most cost-effective generation resources to be built for the benefit of our customers and to promote a healthier balance of PPAs and utility owned assets. Later on, Andrew will discuss how the SRB provides future opportunities for CapEx growth.

It's also noteworthy that the commissioners made positive amendments to the revised recommended opinion and order at the open meeting that increased the net revenue requirement and addressed some items that would have created additional regulatory lag. This highlights the improved regulatory environment and our ability to achieve constructive outcomes. However, even at the final net revenue requirement, the outcome underscores the continued challenge from lagging historical costs. We look forward to working with the commission on addressing these lagging costs in the near future through both the regulatory lag docket, which will have a workshop on March 19 as well as through future rate case filings.

Now I'll share our next step and strategies as we look to the future. We're focused on solid execution and continue to remain optimistic about our future for many reasons, and I'll discuss each of these reasons in more detail. First, I'm optimistic about our attractive service territory and consistent customer growth. Arizona remains among the fastest-growing states in the nation where other states have been experiencing little or negative customer growth, we've been benefiting from steady and consistent retail customer growth of 2% for the last few years and project that growth to continue in the range of 1.5% to 2.5% in 2024.

We believe that the constructive business environment with ample job growth, a competitive cost of living and the desirable climate will continue to grow the Metro Phoenix market and benefit the local economy.

Focusing on our service territory specifically, we continue to see development from a variety of sectors, which is helping to diversify our local economy more than ever. The availability of a skilled workforce in our state's business-friendly policies and regulations, coupled with our low propensity for natural disasters and our clean energy development potential make us uniquely situated for growth. The tremendous demand that we see from large commercial and industrial customers will help spread fixed costs over increasing sales and has a positive multiplier impact for jobs and surrounding communities.

We'll continue to focus our economic development approach on helping to attract and expand businesses and job creators. As you can see from this graphic from the Arizona Commerce Authority the diversity of the commercial and industrial growth in Arizona presents exciting opportunities. Our state is seeing growth in a wide range of sectors, driven by manufacturing, reshoring, the clean economy and digital infrastructure needs, which will help reduce the risk of any potential downturns in a particular industry to keep our economy and grow stable.

Turning to regulatory environment. We've seen meaningful improvement through the last couple of years. The Arizona Corporation Commission has established a record of balanced and constructive decisions, including our most recent rate case. And importantly, beyond those decisions, the commission has also recognized the need to address regulatory lag in a holistic manner and has opened a docket to review and discuss various solutions going forward. And as I mentioned, will kick off next month. We look forward to working with the commission on addressing this important issue.

In addition, the commission reaffirmed its policy on settlements. Historically, outcomes achieved through settlement have delivered new and innovative customer programs and other results that benefit a broad and diverse range of stakeholder interest in our state energy future. We believe the nature of the settlement process itself yields more informed constructive and mutually beneficial results.

The third reason that we're confident is the clear path that we are on in our transition to clean energy. We came out with our clean energy commitment in early 2020, and I'm proud that we've made significant progress. We plan on retiring our remaining [ Choa ] units by next year and to completely exit coal by 2031. Since our clean energy commitment, we've procured nearly 5,000 megawatts of additional clean energy and storage and issued another all-source RFP for an additional 1,000 megawatts of reliable capacity, including at least 700 megawatts of renewable energy. With the approval of the SRB mechanism in this rate case, we're even better positioned to establish ownership in these new clean energy assets for our customers' benefit.

The fourth reason I'm optimistic about the future is because of the tremendous amount of growth and opportunities we have in our FERC jurisdictional transmission business. We've increased our FERC transmission spend for the next 3 years and expect to have a much greater need for transmission capital spend over the next decade. We recently filed our 10-year transmission system plan with the Corporation Commission showing five critical transmission projects that are needed to strengthen resiliency to support the growing energy needs of our customers and allow for greater access to diversity of resources in markets across the region.

The total investment for APS' portion of these projects is estimated to total over $5 billion over the next 10 years. We look forward to developing this critical infrastructure that's necessary to continue to provide safe and reliable service to our customers. And finally, I'm optimistic about the future because my entire management team and I have been committed to executing a customer-centric strategy that will allow us to deliver exceptional customer service.

As I mentioned earlier, we've made significant progress in our J.D. Power survey results and have moved from fourth quartile in 2021 to second quartile at the end of 2023. We Additionally, we're focused on delivering on our goal to provide reliable energy to our customers in the most affordable manner. Increase [indiscernible] rates remain well below the rate of inflation, even with the latest rate case decision. We remain focused on customer affordability and keeping it central to our plans to provide long-term sustainable growth. That focus, coupled with continued cost management creates rate headroom for the future. I'll now turn the call back over to Andrew to provide guidance and share our long-term financial outlook.

[Andrew Cooper, executive]

Thanks, Jeff. I'll now discuss our 2024 guidance and future financial outlook. For our 2024 outlook, we are establishing an EPS guidance range of $4.60 to $4.80 per share, reflecting the additional revenues from our recent rate case outcome, with new rates effective March 8. This revenue is partially offset by continued drag from increased expenses not captured in our historical test year.

As Jeff mentioned, this rate case was balanced and constructive and this decision will create a solid foundation from which we will grow. However, it is important to highlight that we continue to face significant regulatory lag due to the timing of our historical test year, which ended June 30, 2022. This lag is mainly due to higher interest rates on borrowed capital, higher depreciation due to increased rate base growth, lower contribution from pension nonservice credits and increased O&M expense due to planned generation outages.

We are encouraged by the commission's focus on holistically addressing regulatory lag through the newly created regulatory lag docket. We are committed to addressing these current costs in our next rate case and working with the commission to find solutions to reduce these impacts on our current comp stop. Our commitment to mitigating regulatory lag is a priority, aiming to preserve our financial stability and build shareholder value between rate cases.

Diving a bit deeper into 2024. The largest positive driver of our guidance will be new revenues from the implementation of the rate case decision. Other positive drivers are expected to include increased revenues from sales growth, the LFCR and the full year impact of the 2019 rate case appeal outcome. The most significant year-over-year negative driver is expected to be weather due to the record-breaking heat wave we saw in 2023 as we plan for normal weather. Other negative drivers are expected to be higher depreciation and amortization expense, increased financing costs and higher O&M primarily due to planned outages.

Turning to customer growth. As Jeff mentioned, we once again expect our customer growth to be within the range of 1.5% to 2.5%, which continues to highlight the attractiveness of our state and service territory for customer in migration. For 2024 sales growth, we expect 2% to 4% growth, of which 2.5% to 3.5% is driven by extra high load factor, C&I cutters. These sales create operating leverage and ultimately rate headroom for all customers. We have seen a steady ramping of these customers and anticipate it will continue to ramp through 2024. Longer term, we expect our weather-normalized sales growth to be within the range of 4% to 6% through 2026 with 3% to 5% of this growth driven by our large C&I customers.

Turning now to what we strive to provide investors going forward, I will discuss our financial outlook and goals. We are rebasing our long-term EPS growth guidance of 5% to 7% and off the midpoint of our 2024 guidance range of $4.60 to $4.80 per share. While our financial plan supports this growth rate for the long term, our goal is to work towards a more consistent and timely cost recovery profile. We have already made solid progress toward reducing regulatory lag with the commission approving the system reliability benefit surcharge.

While this mechanism will enable more timely cost recovery for utility-owned generation, we must first develop these projects before the mechanism begins recovering costs. Therefore, this mechanism has the potential to create strong value in the future. but we must first work through the natural development cycle and get projects in service. In addition, the commission has reiterated its policy on settlements, which may streamline future rate case filings while creating even more collaboration between parties.

Finally, we will engage with regulators to holistically address regulatory lag through the newly created docket and commit our cadence of future rate cases to ensure we are recovering our material costs. We are allocating $6 billion for investment through 2026, contributing to a 14% increase in our capital investment profile compared to this time last year. This plan incorporates additional capital investment in generation that will qualify for the new SRB mechanism. In addition, an increasing portion of our capital plan is directed towards bolstering our FERC jurisdictional transmission infrastructure. Average annual spend is now more than double what it was as recently as 5 years ago. We have designed a well-balanced capital allocation strategy that optimizes our ability to receive timely recovery for investments while providing reliable service across our rapidly growing service territory.

Importantly, the SRB will expand our capacity to self-build generation to meet customer needs while reducing lag. Projects that meet the requirements of the outsource RFP and compete from a cost and reliability perspective would qualify for recovery through the SRB. We expect approved projects to be included in rates with an approximately 180 days of in-service significantly shortening the time between investment and recovery on those assets compared to a traditional rate case. Recovery will be at the prevailing weighted average cost of capital, less 100 basis points until a future rate case. This discount will provide customers an immediate benefit while achieving rate gradualism and reducing lag.

We have highlighted five potential near-term opportunities to secure project cost recovery through the SRB with final outcomes dependent on ongoing procurement processes. Additional opportunities are also expected to arise based on future RFP outcomes and projects aligning with this mechanism.

Expansion of our capital investment plan is poised to drive substantial rate base growth. Consequently, we are revising our rate base growth guidance to an annual CAGR of 6% to 8%. In addition, with the adoption of the SRB, we now expect an increase in tracked capital, which will reduce regulatory lag in the future. By increasing our transmission spend and generation investment that qualifies for the SRB, we expect to double the amount of tracked capital, which will improve our ability to receive timely cost recovery and reduce the amount to be recovered in future rate cases.

To fortify our capital structure and support our robust capital expenditure plan, we are planning to issue a mix of debt and equity securities over the 2024 through 2026 period. Our principal goal is to have a healthy capital structure at the utility with no less than 50% equity. We have noted since 2021, the need for up to $500 million of equity to support a balanced utility capital structure. You'll recall this was deferred over the past 2-plus years as we sought to insulate shareholders as we work to improve the regulatory environment in Arizona. The capital structure need has grown by an additional $100 million to $200 million over that time and will be required to true up our equity ratio.

At the same time, our CapEx profile has grown by almost 15%, nearly $1 billion over a 4-year window. While we will pursue a blend of financing solutions across APS and Pinnacle West to address our investment objectives, sources of incremental capital may include up to $400 million of additional equity or equity-like securities over the period, size to approximately 40% of this incremental CapEx. The financing options for this incremental CapEx may potentially include at-the-market issuances, though we will continue to evaluate alternatives to common equity.

As we advance into 2024, our dedication to cost management continues to guide our operations. Core O&M is declining year-over-year despite continued inflation, which supports our long-term goal of reduced O&M per megawatt hour. Notably, planned major outages are scheduled for Four Corners, Unit 5, Red Hawk and West Phoenix with refueling outages at Palo Verde, marking a critical phase in our maintenance strategy. The Four Corners outage at Unit 5 specifically is the last major planned outage at the unit before its retirement with the last major planned [indiscernible] Unit 4 scheduled for spring of 2025. Despite these necessary planned outages, our commitment to operational efficiency and lean practices remains intact for the long term.

Our goal of declining O&M per megawatt hour is strongly established and underscores our effective cost management with rapid growth in our service territory. The second chart on this slide highlights our success in maintaining O&M cost increases below the rate of inflation since 2017 and outperforming both national CPI trends and more specifically, local inflation rates in Phoenix. This achievement is a testament to our unwavering focus on optimizing operations and fostering a culture of efficiency, across our organization.

We continue to provide an attractive dividend yield as part of our total shareholder return and maintain a goal of managing our payout ratio into a sustained range of 65% to 75% in the future. With a solid track record of annual dividend growth, we understand the importance of returning value to our investors. We are committed to working diligently to ensure our dividend remains competitive.

Turning to our credit ratings. Following our recent rate case resolution and other developments in the Arizona regulatory climate, we are working with the rating agencies as they evaluate our credit. Healthy investment-grade credit ratings are pivotal to our financial profile as they contribute to reducing borrowing costs, thereby directly benefiting our customers through more favorable financial conditions.

We are adjusting our FFO to debt target range to 14% to 16% to properly balance the financing needs of the company and solid credit metrics. Our balance sheet remains strong, reinforcing our financial foundation. This balance sheet strength provides us flexibility to navigate the current interest rate environment and strategically address our near-term maturities and as well as ongoing and future investment needs.

Looking back at the last few years and the strides we've made, we are enthusiastic about our future and the potential of the company. Overcoming the setbacks of the private case, we achieved the goal set forth during the preceding 2 years, and we've aligned closely with the commission and stakeholders to secure a constructive outcome in this rate case. While challenges such as regulatory lag persist, our commitment to seek collaborative solutions with stakeholders, ACC staff and the commission remains firm.

Our dedication to keeping customer costs affordable is evident through our efficient O&M practices, seeking to ensure that rates and costs stay below inflation during this period of unprecedented growth in our service territory. With a more constructive regulatory environment and a continued focus on affordability, we look forward to approaching the future with a clear vision and optimism for our customers and investors. This concludes our prepared remarks. I'll now turn the call back over to the operator for questions.

[Operator]

Certainly. Everyone at this time, we'll be conducting a question-and-answer session. [Operator Instructions] Your first question is coming from Shahr Pourreza from Guggenheim Partners.

[Jamieson Ward, analyst]

It's Jamieson Ward here for Shahr. So just a couple of quick questions here. After your upcoming presumably '24 equity issuance, what would you expect your typical funding cadence to look like? And obviously, over the next couple of years, but kind of going forward beyond that, it's been a special situation waiting for the ROE to come back up in this last rate case. So we just want to get a sense, especially now that you have the SRB and as rate base growth is picking up. You'd mentioned both ATM and hybrids. How would you characterize your preference between implementing a regular ATM, annual ATM and then continuing to space out equity issuances.

[Andrew Cooper, executive]

Thanks for the question. Fundamentally, if you think about the financing plan, you have the equity need that we've identified, which we've talked about for a long time, is up to $500 million. And we have now trued that up to an additional $100 million to $200 million that we need to make sure that the equity ratio at the utility is strong. And that 51.9% equity ratio that was approved in the most recent rate case is a good example of a solid, consistent with the market type equity ratio. And so that's kind of that need. And I think what you're focused on is what is the cadence for some of the -- that up to $400 million that I mentioned earlier to support future CapEx.

And really, the way we think about it is what is the structure or type of issuance that would allow us to meet the needs of that CapEx as it's incurred. And certainly, an ATM program is one option that would allow us to draw equity periodically and have proceeds that match up with our capital. The capital is relatively consistent across the period. And I just want to be clear that up to $400 million, that is future capital spending as you work through the next 3 years of our plan. And so we're very flexible in terms of thinking about what the options available are to us. whether an ATM or some sort of equity like security.

We'll look at all those options. We don't have a strong preference. I think we wanted to make clear that as we think about our capital structure, and we think about our CapEx plan, something that has -- there will be external financing needs for the company to support that CapEx and they could include equity type products. I think we'll continue to evaluate over the next few years. what product matches the best and what market is most available to us. But I do cite ATM as an example because of the way it allows that periodicity to match up against CapEx, which is ultimately what we're solving for over the longer term, both from the increases in transmission spend on the FERC side and then generation spend that we expect would be eligible for SRB.

[Jamieson Ward, analyst]

Got it. That makes a lot of sense. The second question, last one I had is turning to your SRB. How should we think about the 42% figure you call out on Slide 25? This is just a high-level question. Is that just projects which could potentially be eligible for the SRB if you were to win them in an all-source RFP or are you expressing any sort of probability of these projects ending up in plan?

[Andrew Cooper, executive]

Yes. So the projects that we've listed out are examples of the opportunities. When you think about -- we're currently in our 2023 RFP where we ask for outsourced resources. And so the five projects listed there cover that span of time. And we're still negotiating with third-party developers around PPAs. These projects are still in that very early stage of development. they are examples of the potential that we have within the existing window that we're in for the RFP. There will be future RFPs and future time span that match up.

But one of the things we wanted to emphasize here is a long time, we've been talking about feeling hamstrong for bringing competitive projects forward because of capital limitations and uncertainty around recovery. With the SRB you have a list of opportunities that demonstrate that, that 10% to 15% of megawatts that we've been developing historically, has that upside into a range much closer to kind of that 35% to 50% that we thought was potential based on looking at our own pipeline. So within the window of the existing RFP and the time period we're talking about, you take the megawatts that we expect need to be built from a utility scale perspective over that window and what megawatts are available to us as potential opportunities. That's the 42% you see there.

Will all these projects be built, we're still in that development time line. We'll make that termination as we go along. The CapEx in our 3-year plan that we believe is probable includes generation capital related to potential SRB projects, but we're not breaking those -- that capital out granularly. But the 42% is representative of that upside opportunity relative to our prior view of our investment profile on the generation side.

[Jeffrey Guldner, executive]

And James, this is Jeff. As you know, it's still very specific on the negotiations of the individual projects, and there's really two things we'll be trying to capture with these SRB projects. One is the benefit -- long-term benefit to customers that would be better than if you just did a PPA. And then the second, as was mentioned at the hearing, from a reliability standpoint, when we build the projects, they come in on time. So when we have a critical need for a summer and we're developing the project, we've been good at getting those in timely and you have more risk when you have a PPA and somebody can slide the in-service date and sometimes that makes it suboptimal, but it's a pretty project-specific analysis that you'll have to go. So I think just showing representative projects was what we were trying to get across here, but the details will matter, and those will come up in the negotiations with these projects.

[Jamieson Ward, analyst]

Perfect. No, that's exactly what we're looking for in terms of an answer. It looked like an opportunity set to us, but we had a few inbounds and people were asking us to clarify. And so we did. Thank you so much. That's all we have. Appreciate it. .

[Operator]

Your next question is coming from Nick Campanella from Barclays.

[Nicholas Campanella, analyst]

So I guess -- it's good to see that ACC is kind of heading in the right direction here, especially acknowledging the capital investments you're putting in and working on the earned ROE lag. I guess just how would you kind of characterize under-earning this year just as -- on maybe that ACC rate base from a percentage basis? And how much do you think you can kind of get back in the upcoming rate case filing versus what could be addressed in the [indiscernible].

[Jeffrey Guldner, executive]

Let me -- I'll start, Nick and -- the challenge with this case in particular was that we came into it with a very inflationary environment that we haven't seen before. So we had a lot of the kind of lag that flat interest rate environment you don't necessarily see as pronounced. I think probably the biggest one that [indiscernible] [ Coop ] mentioned in the narrative was the interest cost because we're actually lowering the embedded interest cost in this case that just was cited, but our interest costs are significantly higher. And so those are hopefully the things that will get picked up in the regulatory lag docket. And so structurally, I think it's kind of open right now as to seeing what they want to focus on. It's good, again, that they're actually focused on is a real issue, that if you're in a historical test your jurisdiction like Arizona and you don't have trackers or other things to pick up some of that regulatory [indiscernible], particularly when you get into an environment like we're in now with the higher inflationary pressures, you can really come out of a case with some significant [ bake ] [indiscernible] , which then actually then means when you come in for your next case, you've got a higher ask because you're not getting the rate gradualism as you pick it up.

And so [ Coop ], do you want to maybe talk -- we do what we can to mediate it. There's some structural stuff that you just can't do and you have to -- you have to come in with the subsequent case and then hopefully, this regulatory lag docket gives us some visibility on mechanisms or structures that you can use that mitigated.

[Andrew Cooper, executive]

Yes. Nick, we haven't quantified the lag as it varies year-to-year. But the drivers that you should think about, and Jeff mentioned one in the context of interest expense, that's certainly one we have a 3.85% embedded cost of debt in this case. But the two debt issuances we've done since the case are in the mid-5% range to the low 6% range. So substantially above it, we knew going into the case, we really wanted to focus on getting the ROE back up to the right level. We had a good equity capital structure. And so in terms of the elements of WACC, cost of that was one that we deemphasized in this case, it would create a lower revenue environment, but we do need to recoup that to be more representative of forward financing costs. O&M is the other one where if you think about the test here, we were in a period of mid-2021 to mid-2022 as our test year. I'd like to say it's -- it was during the time where the Fed was still talking about inflation as transitory.

But if you look at it ever O&M guidance, you're talking about somewhere in the neighborhood of $100 million of incremental O&M. And that's what really good from our perspective O&M story, where year-over-year we are bringing O&M down despite having a full year of higher wages at some of our business units and on a -- that's on a core basis. And even with the higher amount of plant outages given the Four Corners outage, you're still talking about a less than 2% O&M increase to the midpoint of our guidance range.

So a good store, but a lot of historical O&M to catch up on. Pension, which we've talked about in the past, Fortunately, it's not a story. If you look at the guidance walk to 2024. No further impacts from pension effect, it's a $0.01 positive on the nonservice credit side, but we are carrying with us the 2022 market impact. Impacts to our pension asset as well as the substantial change in discount rates year-over-year, and so we'll need to recoup that as well.

And then the final one, and you'll see that again in our walk this year, increases in depreciation related to plant going to service. a great story from this rate case, that's the one area where we got 12 months of post test year plant, plus one major project that fell outside that 12-month window. But our 2024 projects include some IT investments, which have a shorter depreciation life and will contribute further that lag. So we've -- we're excited to get into the opportunity to have a dialogue with the commission and stakeholders about these issues. And of course, we'll continue to look at the cadence of future rate cases to address them as well.

[Nicholas Campanella, analyst]

Thanks for laying all that out there. Really appreciate it. I guess, Andrew, just on this 5% to 7% growth rate, I think in the past, it's been tough to kind of extrapolate that linearly off of the base year just because of the rate filing cadence. Can you just kind of give us a flavor of how you're thinking about it? I guess you have new rates in mid-25. But then as you get past that, you start to ramp this SRB capital potentially. You have some FERC transmission opportunities you highlighted. So do you kind of start to grow linearly in 2016 and beyond? Or how do you kind of think about that?

[Andrew Cooper, executive]

Yes. It's a really great question, Nick, because we have the investment profile. We have, fortunately, a [indiscernible] headroom. The IRA is a TBD. We'll see where that goes. But we really have the profile to grow that 5% to 7% over the long term. And much of the conversation we've been having here has been about the regulatory lag kind of embedded in a historical test here. And so if we could address that and go into a more stable price environment, we certainly have the opportunity to create more smooth cost recovery.

Over the medium term, the SRB is a significant contributor to that, because you basically double the amount of track capital that you have that are going through some form of adjustor mechanisms. So between the transmission spend and the SRB eligible generation spend, you're having a much smoother pace of recovery where your customer -- your sales growth is supporting any O&M increases and supporting needs of growing distribution system and then your transmission and generation spend is tracked. So we view our ability, once we've caught up on these historical lagging cost to be in a place where that cost recovery profile can smooth. [indiscernible] the past to 5% to 7% either way. but it is really addressing some of these near-term pinch points that come out of the last few years of inflation that we need to address to get to the other side of that. Between the SRB and sales growth because as you look at the long-term sales growth, not only is it providing us some top line, but it's also, as I mentioned earlier, blunting some of the O&M and ensuring that we create operating leverage out of those increased sales.

[Operator]

Your next question is coming from Michael Lonegan from Evercore ISI.

[Michael Lonegan, analyst]

So you've talked about your equity issuance plan, balancing your capital and intended to balance your capital structure to greater than 50% equity at the EPS level. Obviously, you lowered your FFO to debt target of 14% to 16%. Just wondering if, ideally, more specifically, if you're looking to target as high as 52% equity at APS structure to match the rate case outcome. And then where you anticipate landing on FFO to debt metric this year and over your plan?

[Andrew Cooper, executive]

Yes, Michael, I think there's two pieces to the equity capital structure story. One is we never want to fall too far behind. Because the equity ratio has been an issue that through the last two rate case cycles, for example, with nearly 55% in 2019 and then nearly 52% in this most recent rate case. It's been an issue that's largely not been one that has been subject to a lot of debate is the actual capital structure at the end of the historical past year. And we think that a balanced capital structure of a little bit more than 50% equity at the utility is an appropriate one. It's consistent with national averages.

As I mentioned earlier in my remarks, the 51.9% that we got in the last rate case is a solid capital structure. It is consistent with where averages are around the country. And while in any given year, we want to make sure that we're trying to stay above 50%, so we're not in a catch-up situation. we are going to look at any time period, what does the overall WACC look like, what's the right rate question from going into a rate case and want to make that the WACC overall is one that's affordable to customers. So it's really a balance. That equity that we talked about earlier, the up to 500, which now needs to be trued up a little bit higher.

If you look at our 10-K and you calculate the APS equity ratio it's below 50%. And so this is the company that we believe we need to get to the right spot going forward. This is all balanced with credit metrics. The 14% to 16% you mentioned is an opportunity for us to balance the needs of our capital investment plan and having solid investment-grade credit ratings. We're still in conversations with the rating agencies as they've been watching the regulatory environment over the last 2 years and expect to continue to work with them to clarify where they're coming out now in the rate case is complete.

[Michael Lonegan, analyst]

Great. And then secondly for me, regarding your sales growth forecast through 2026 guiding to 4% to 6% through that '26 period versus 2% to 4% this year. Obviously, you're expecting large C&I customers to come online. Just wondering how we should think about sales growth in '25 and specifically and also in when we see the spike or is it consistent in those 2 years?

[Andrew Cooper, executive]

Yes. And we haven't been granular between the two. Because as we've seen over the last few years, and we conservatively forecast our sales growth. And I think we learned a lot last year in terms of the ramp rate of some of these larger high load factor customers, both on the advanced manufacturing side and the data centers. And so we forecast conservatively and there can be some variability intra-year as far as you've got a data center box and you've got an anchor in there and you can keep building it out. That happens over time.

And so for these large customers, we're not sharing a granular view between '25 and '26. I would say that Taiwan Semiconductor, which is one of the larger new customers that we have coming in. They're committed to full ramp-up of their first fab in the first half of 2025. And the ecosystem of other companies that surrounds them is part of that sales growth rate. And so their timing, reaching that full production and then having a full year impact to that in 2026 kind of gets you to the terminal year there of the growth rate range. It doesn't give you an answer to your question on '25 versus '26 exactly. But the trends that we watch are fundamentally the ramp rates of each of these customers and our team is having regular conversations with each of them and has a pretty close pulse on what the ramp looks like.

[Operator]

Your next question is coming from Paul Patterson from Glenrock.

[Paul Patterson, analyst]

Good morning. Just really quick sort of bookkeeping questions. When -- I apologize if I missed this. What is the timing of your next rate case do you guys expect to file?

[Jeffrey Guldner, executive]

Yes, Paul, we haven't -- have not picked the timing for that. The regulatory lag docket is starting on March 19. And so that's going to be the first workshop. I expect they're going to -- I expect the commission is going to engage probably most of this year in conversations around that docket. And I think consistent with what we had kind of shared at EEI, we want to see how that dock is evolving. And make sure that if there's opportunities to have a better structure in terms of a different process that picks up regulatory lag, you would want to wait until you see how that docket plays out. So we have to balance that continuing to watch with the progress on that with than just the regulatory lag that Andrew has talked about earlier.

[Paul Patterson, analyst]

Okay. You anticipated my next question, which to follow up on that, when do you think -- you said you expect them to be engaged with it this year. Always hard to sort of predict when a docket like that would be resolved. But do you have any sense? I know it's really early, but I'm just curious, do you have any idea when you think that might be -- they might -- we might get a conclusion or at least a better idea about where they're headed on that?

[Jeffrey Guldner, executive]

Yes. I think if you watch probably the initial dockets, I'm guessing they're probably going to have some conversation around the timing that they look for that. I would not be surprised particularly because I think the start of the dock waited until all the utilities were through their rate cases. So we had a [ tep ] case, UNS case and so I think they're just waiting for our case to get cleared before opening this generic docket up and looking at the utilities. And given the focus that I think the commission has indicated around dealing with regulatory lag. I would not be surprised if you've got a pretty good progress throughout this year. And that the idea would be then in 2025 and beyond, if there's a clarity in terms of a process or an approach to take that. That's when you start seeing utilities begin to adapt the recommendations or whatever comes out of the docket. But you got to watch early on and just see how it begins to develop.

[Paul Patterson, analyst]

Okay. And then I guess so the answer to the first question sort of is probably not until 2025, would we see an actual filing for a new rate case. Does that make sense when I think about it correctly?

[Jeffrey Guldner, executive]

Yes. I think -- I mean, a, you've got -- you want to put rates in effect. If we put rates in effect in March, you typically want to have at least half year rates in effect. That's been the process that has been used in Arizona. And then if you start lining up calendar versus split years. But obviously, like you said, we want to watch how the docket evolves and decide how we move forward. The other thing, just to -- we've got flagged that, I think, an important driver, and you saw it with the complexity of this case is that continuing to work with stakeholders on the value of settlements. We had a long history prior to the last couple of cases where we were able to reach pretty constructive settlements that had benefits and the real benefit of moving into a settlement is you don't see -- typically, you don't see binary outcomes. There's things where there's benefits to both sides. And so some of the customer-related programs, in particular, you can actually get pretty good results in a settlement when you're crafting things like that.

And so I would hope that at the same time as the commission is working through the regulatory lag docket that we continue to work with stakeholders to set up an environment where we could see the next case moving in, and again, maybe taking advantage of whatever comes out of that docket, but moving into more of a settlement structure than a fully litigated case. So still too early to tell on both counts, but those are two areas we'd be focused on.

[Operator]

Your next question is coming from Bill [ Upcheli ] from UBS.

[Unknown Analyst]

Just a question. So on the practically speaking, would that be deployed in 2026 when some of these assets are coming into service? Or when will we first see that deployed?

[Andrew Cooper, executive]

Short answer, yes. If you think about the RFP, assuming that our projects clear through the RFP, the earliest in services you have are in advance of summer 2026. There is a filing process around the time the assets going into service, which I mentioned earlier in the remarks, could be in the 6-month range, but that's something that we'll work through at the time. The first kind of slug of projects is ensuring that we have reliability over summer '26.

And you'll see the types of projects that are in that list of potential opportunities. a pretty diverse group of [indiscernible] types. And so that was really the other thing, I think, that I would highlight from that opportunity set as it addresses reliability needs for the summer peak as well as some of the shifts that we're making in our clean energy commitment.

So 2026 is the period -- and I talked about earlier, this is a medium-term part of the solution around regulatory lag is increasing the share of track capital, and that will pair nicely with the work that we're doing right now on some of those income statement costs that we want to make sure that we're recovering in a timely way.

[Unknown Analyst]

Okay. And then I guess around that on the cost side, did you guys take advantage of some of the weather and pull forward some of the O&M from '24 into '23? Or I guess, maybe how are you combating some of these inflationary pressures to keep the core O&M declining year-over-year?

[Andrew Cooper, executive]

Yes. So as the weather continued to be a positive benefit through the year, we did look at opportunities to take some of the O&M out of 2024. As we were triaging during the summer, we were really just making sure that we are allocating O&M to the right spots within '23 to make sure that we're meeting the needs of our generation fleet and keeping reliability through that summer. So there was some modest pull forward. And that's something that we look at every year and look at the opportunity to take costs out.

What's really driving the long-term trend is our overall focus on customer affordability and on that lean culture that we've ingrained in the organization. That's a fundamental driver. You also have [ Choya ]. This is the last year of operations. And so some of the O&M from [ Choya ] rolls off. as we move away from some of the heavier fuel, heavier O&M assets into some of the lighter O&M assets. So it's really a combination. All of that is offset by a full year impact of our contracted IBW and some of the other wage pressure that we've seen. But we're -- there's a lot of pride internally on the ability to manage O&M and operator reliable system with a lean mentality underlying it.

[Unknown Analyst]

Okay. All right. And then lastly, just two quick ones on the '24. There's $0.10 in the guidance for the BCE sale, but I just want to clarify that you're still good growing off of the midpoint, right, even though that obviously is a sale, that's not going to repeat. And then secondly, just on the equity, the $600 million to $700 million, that should be sort of block equity that we should expect upfront this year, right? And then the $400 million is more ratable through all the options that you discussed earlier. Is that the way to think about it?

[Andrew Cooper, executive]

Yes. Just going back to your first question, yes, the -- our guidance range includes the expected gain on the sale of Bright Canyon this year. And we're very confident that, that 5% to 7% earnings growth is available to us on that rebased level, including that year-over-year $0.10.

Going to the equity I wouldn't want to comment on the timing specifically of that $600 million to $700 million. But fundamentally, you're thinking about it the right way, which is that we have a need to true up our capital structure. And that capital structure need goes with the question that was asked earlier around the timing of our rate case, which we're also going to continue to monitor. So we're fortunate our flexibility from the perspective of our capital plan and our financing plan as to when we do that larger equity ratio true-up need common equity is the default kind of base case option for that need. We are flexible in terms of the timing. We'll continue to monitor the market and execute the optimal time for us. The $400 million that comes later is really a longer-term periodic need over the period to make sure that we're supporting our CapEx from right mix of external financing sources.

[Unknown Analyst]

Right. Great. And congrats on getting through a successful rate case.

[Operator]

Your next question is coming from Anthony Crowdell from Mizuho. .

[Anthony Crowdell, analyst]

Just two quick ones. Where did you end 2023 on an FFO to debt basis at Pinnacle West? And second, to Mike's question earlier on the balance sheet, you talked about a lot of discussions with the rating agencies. I'm just curious if you think the recent balanced outcome in the APS case is enough to remove the negative outlook at the agencies?

[Andrew Cooper, executive]

Yes. Thanks, Anthony. The agencies haven't provided their kind of official calculations on FFO to debt at year-end yet. We had -- if you think about the old range that we had said 16% to 18%, if you look at any of the kind of trailing periods before that, we had fallen below that. We were in the 15s -- so I don't have a Q4 number, but from the agencies, it's in the 15s on a trailing basis before that. And so one of the things we wanted to do is be realistic about setting a range that made sense to meet our capital needs that we believe allows us to preserve solid investment-grade credit ratings, and that's why we reset that target of 14% to 16%. And S&P was pretty clear in the middle of the year that their downgrade threshold with a constructive rate case outcome is in the 13% range and they're, of course, the one that's one notch lower. And so we feel confident that our ranch allows us to continue to manage around that.

The other agencies, which have a one notch higher rating, we're still at a point to your second question, where we're waiting to see how they evaluate the credit. But we felt comfortable moving to this 14% to 16% target range over the longer term to match up our capital needs and where we thought we'd be okay from a ratings perspective.

So to your second question, we've had quite a bit of conversation with the agencies over the last couple of years. They have -- we've spent a lot of time highlighting with them, and they're certainly mindful of the constructive regulatory outcomes that we've seen. And so we can't really predict when they're going to act, but we are actively going to engage with them now that the rate case is complete, to continue to highlight these factors. As we said all along, the agencies are focused as much qualitatively here on the improvements and derisking of the regulatory construct, which we believe we've seen over the course of the proceedings over the last 2 years. But certainly, we'll be sharing with them numbers and forecasts and that dialogue so that they can -- they don't typically have outlooks not resolved for this period of time. They were clearly waiting for this rate case outcome to complete in order to resolve their outlook.

And so again, while I can't anticipate how and when they'll act. Our expectation would be that now that they have all the information in front of them, they can make an evaluation of the ratings.

[Operator]

Thank you. That concludes our Q&A session. Ladies and gentlemen, this completes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.