PPL Corp

NYSE:PPL

Earnings Call Transcript 2020-Q3

[Operator]

Good day, and welcome to the PPL Corporation Third Quarter Earnings Conference Call. [Operator instructions] Please note, today's event is being recorded.

I would now like to turn the conference over to Andy Ludwig, vice president, investor relations. Please go ahead.

[Andy Ludwig, Vice President, Investor Relations]

Good morning, everyone, and thank you for joining the PPL conference call on third quarter 2020 financial results.

We have provided slides for this presentation and our earnings release issued this morning on the investors section of our website. Our presentation and earnings release, which we will discuss during today's call, contain forward-looking statements about future operating results or other future events. Actual results may differ materially from these forward-looking statements.

Please refer to the appendix of this presentation and PPL's SEC filings for a discussion of factors that could cause actual results to differ from the forward-looking statements. We will also refer to non-GAAP measures including earnings from ongoing operations and adjusted gross margins on this call. For reconciliation to the comparable GAAP measures, you should refer to the appendix of this presentation.

I'll now turn the call over to Vince Sorgi, PPL's President and CEO.

[Vince Sorgi, President and Chief Executive Officer]

Thank you, Andy, and good morning, everyone. We appreciate you joining us for our third quarter earnings call.

With me today are Joe Bergstein, our Chief Financial Officer; Greg Dudkin, the Head of our Pennsylvania Utility Business; Paul Thompson, the Head of our Kentucky Utility Business; and Phil Swift, the Head of our U.K. Electric Distribution Business.

Moving to Slide 3. I'll begin this morning with brief highlights on third quarter earnings results and our continued strong performance during the COVID-19 pandemic. I'll share a few updates on regulatory and ESG related matters. And Joe will then provide a more detailed overview of the third-quarter financial results. And as always, we'll leave ample time for your questions.

Turning to Slide 4. Today, we announced third quarter reported earnings of $0.37 per share. Adjusting for special items, primarily a deferred tax adjustment in the U.K. based on the 2020 Finance Act and unrealized losses on foreign currency economic hedges. Third quarter earnings from ongoing operations were $0.58 per share compared with $0.61 per share a year ago. At a high level, results for the quarter were in line with our expectations. I'll note that the lower earnings compared to last year include $0.02 of lower volumes in the U.K., which will recover in future periods, and $0.01 due to the timing of our estimated federal income tax computation, which will reverse in Q4. Joe will cover the financial results in more detail in his section.

Regarding a COVID update, throughout the quarter we continued to deliver strong operational performance, providing outstanding customer service and reliability. At the same time, we've remained focused on innovation and building for the future. In September, we launched the new digitalization strategy in the U.K. The strategy focuses on transforming the way we develop and operate the network, to empower customers, drive greater efficiency and deliver faster decarbonization. And in Pennsylvania, during Q3, we reached the $1 million mark for customer outages avoided as a result of our investments in automated power restoration technology.

Regarding customer sales during the quarter, residential load continued to be strong than our weather-normalized forecast, driven by sustained work-from-home measures in all of our service territories. Conversely, C&I demand remained lower in all three business units, albeit less pronounced in Q3 than it had been earlier in the pandemic. From a financial perspective, we are well-positioned to weather the continued economic downturn. We've maintained a strong liquidity position of over $4 billion. Our cash receipts remain steady and our capital plans remain largely intact.

And as the moratoria are starting to lift across our U.S. service territories, we will comply with all state utility commission requirements and continue to work with our customers to maintain uninterrupted electricity and gas service. This means offering flexible payment plans, connecting our customers with agencies and programs that can provide assistance and working with them to address overdue balances before they become unmanageable. Service terminations are always a last resort.

Overall, we continue to believe the full-year impact of COVID-19 will be manageable as we close out the year. As a result, we've narrowed our forecast range to $2.40 to $2.50 per share from the prior range of $2.40 to $2.60 per share. We continue to expect to track toward the lower end of this guidance range due to the impacts of COVID-19 and warmer than normal weather during the first quarter. Lastly, on the slide, I would note that the U.K. sale process remains on track, and we continue to expect to announce a transaction in the first half of 2021.

Moving to Slide 5, and starting with key regulatory developments. On October 1st, WPD responded to Ofgem's RIIO-ED2 sector-specific methodology consultation, advocating for the continuation of a strong incentive-based regulatory regime that supports the best outcomes for our customers in terms of low prices and high-quality service. We believe RIIO-ED1 largely achieved this balance and that the basic structure of the RIIO-ED1 regime should broadly remain intact under ED2.

WPD's response to the consultation focused on several areas, where we believe Ofgem should reconsider its position and the robustness of its supporting evidence before making its methodology decision. In the end, we continue to believe that Ofgem has made it clear that DNOs will be critical to supporting decarbonization efforts in the U.K. to deliver a net-zero economy. Based on our discussions with Ofgem, we expect the incentive scheme for ED2 to continue to play a significant role in the overall returns for electric distribution companies. And we expect that WPD will have the opportunity to earn reasonable returns and invest significant amounts of capital during RIIO-ED2 and beyond.

Moving forward, WPD will remain very focused and engaged with its stakeholders and Ofgem to ensure it delivers a plan that will achieve the U.K.'s ambitious carbon reduction goals. Ofgem is expected to issue its RIIO-ED2 sector-specific methodology decision in December. In other U.K. developments, the Competition and Markets Authority or CMA issued a recent provisional ruling that supports more stable returns for regulated utilities in the U.K. to incentivize appropriate levels of investment. The CMA ruling concluded that the water sector regulator, Ofwat, went too far in its efforts to sharply reduce returns for water utilities. We expect the provisional ruling will be one that Ofgem studies closely as it nears its decision on the RIIO-2 final determinations for the gas and electric transmission sectors and ultimately for the electric distribution sector.

Turning to the U.S., the FERC on October 15 issued an order in a complaint filed by a third-party challenging PPL Electric Utilities based return on equity for transmission. The FERC order sent the complaint to settlement procedures. If no settlement can be reached, the case will go to public hearing. We continue to believe that PPL Electric Utilities current transmission return on equity is just and reasonable, and that complaint is without merit and based on flawed assumptions and calculations. Also in the U.S. on October 23rd, LG&E and KU notified the KPSC of the company's intent to file a rate request later this month. As part of the rate case, we will be applying for approval to deploy advanced metering to further enhance grid automation and reliability in the state.

Assuming the maximum suspension period for such a proceeding, the resulting base rate changes would be effective July 1, 2021. Shifting gears to a few notable highlights related to our sustainability efforts and governance updates. In August, we announced that we joined an exciting new initiative to accelerate the development of low-carbon technology. The low carbon resources initiative led by the Electric Power Research Institute and the Gas Technology Institute focuses on identifying, developing and demonstrating affordable pathways to economy-wide de-carbonization.

PPL is an anchor sponsor for the five-year program, which supports our clean energy strategy. At a high level, that strategy is focused on de-carbonizing PPL's own generation, de-carbonizing our non-generation operations, enabling third-party de-carbonization and advancing research and development into clean energy technologies. As we've shared previously, PPL has set a goal to reduce its carbon emissions by at least 80% by 2050. We're confident this goal is achievable with today's technology. At the same time, we recognize that going further and faster, we'll require new ideas, new technology and new systems that can be delivered at scale safely, reliably and affordably for those we serve.

We also remain squarely focused on diversity, equity and inclusion as part of our long-term corporate strategy. I'm pleased to share that PPL has been named a best place to work for people with disabilities. In July, the company earned a top score of 100% on the 2020 Disability Equality Index, the nation's most comprehensive annual benchmarking tool for disability inclusion. PPL's top score is the result of policies and practices that we've put in place to promote the success of those with disability. And it's just the latest recognition of PPL policies focused on ensuring all employees have the opportunity to succeed. Earlier this year, for example, PPL was named the best place to work for LGBTQ equality by The Human Rights Campaign after achieving a perfect score on their corporate equality index.

Moving forward, we will continue to work with employee-led affinity groups to better enable all employees to reach their full potential. In other updates, PPL recently earned a trend-setter ranking by the CPA-Zicklin Index, which benchmarks political disclosure and accountability policies and practices of leading U.S. public companies. We believe it's important to be transparent on these matters, highlighting one of our core values of integrity and openness and our overall compliance and ethics commitment that is supported by robust internal controls.

Lastly, PPL's Board of Directors appointed Ar Beattie as a new Director effective October 1st. Ar brings to the Board a wealth of knowledge and experience with regulated utilities and the energy industry and we're certainly glad to have him onboard as we strategically reposition PPL for the future.

With that, I'll now turn it over to Joe for a more detailed financial update. Joe?

[Joe Bergstein]

Thank you, Vince, and good morning, everyone.

I'll cover our third quarter segment results on Slide 6. First, I would like to highlight that the estimated impact of COVID on our third quarter results was about $0.04 per share, which was primarily due to lower sales volumes in the U.K. and lower demand revenue in Kentucky. This is less than the $0.06 impact we experienced during the second quarter, primarily due to the improving electricity demand that Vince mentioned earlier in his remarks. As a reminder, the majority of this impact is recoverable via the U.K. decoupling mechanism, which adjusts revenues on a two-year lag.

Turning to the quarterly walk, starting with the Q3 2019 ongoing results on the left, we first separate the impact of weather and dilution for comparability purposes of the underlying businesses. During the third quarter, we experienced a $0.02 unfavorable variance due to weather compared to the third quarter of 2019, primarily in Kentucky. We experienced substantially higher degree days in Kentucky during the third quarter of 2019 that led to a favorable variance last year. Weather in the third quarter of 2020 was about $0.01 favorable overall compared to plan, primarily due to stronger load in Pennsylvania versus normal due to the warmer conditions in July. In terms of dilution, during the third quarter, we continued to recognize the impact of the November 2019 draw on our equity forward contracts, which resulted in dilution of about $0.03 per share for the quarter.

Moving to the segment drivers. Excluding these items, our U.K.-regulated segment earnings increased by $0.01 per share compared to a year ago. Factors driving the U.K. earnings results include higher foreign currency exchange rates, compared to the prior period, with Q3 2020 average rates of $1.54 per pound, compared to $1.26 per pound in Q3 2019, and lower interest expense, primarily due to lower interest on index-linked debt. These increases were partially offset by lower sales volumes, primarily due to the impact of COVID-19; lower other income due to lower pension income and higher income taxes.

Moving to Pennsylvania. Segment earnings were $0.02 per share higher than our comparable results in Q3 2019. The increase was primarily driven by higher adjusted gross margins, primarily resulting from returns on additional capital investments in transmission. And as we saw in Q2, our customer mix mitigated the impact on sales from COVID-19 as our positive impact from our significant residential base in Pennsylvania and fixed charges more than offset lower demand in the C&I sectors.

Turning to our Kentucky-regulated segment. Results were flat to the comparable results one-year ago. Factors impacting the results include lower commercial and industrial demand due to the impact of COVID-19 offset by factors that were individually not significant. Results at corporate and other were $0.01 per share lower compared to a year ago, driven primarily by higher income taxes due to timing, which is expected to reverse in the fourth quarter.

Turning to Slide 7. We again outlined the changes in weather-normalized sales for each segment by customer class as we did last quarter. And like Q2, we saw lower demand in the C&I sectors, partially offset by higher residential load in each of our service territories. Demand in the C&I sector was still lower than last year has been steadily recovering as certain COVID restrictions have been lifted. In Pennsylvania, demand improved from about an 11% decline in C&I load in the second quarter to a 4% decline during Q3 compared to a year ago. C&I declines in Pennsylvania continue to be primarily in retail trade and services industry and manufacturing, respectively. Our large industrial customers have generally returned to pre-COVID operations and are not expecting future reductions at this time.

Moving to Kentucky. Our Kentucky segment reported about a 7% C&I load decline during Q3, compared to the greater than 14% decline we saw last quarter versus the prior year. And like Pennsylvania, the services industry such as restaurants, retail and hotels continue to be negatively impacted in our commercial sector in Kentucky. Much of the improvement we experienced during Q3 was on the industrial side as many manufacturing companies were able to reopen after temporarily being forced to shut down in Q2. Specifically, industrial volumes were driven in part by auto manufacturing volumes returning to pre-COVID levels. Coal mining and non-auto manufacturing continue to be more negatively affected.

Finally, in the U.K., C&I load improved to about a 14% decline in the third quarter, compared to a 20% decline that we experienced last quarter versus a year ago as government restrictions put in place in late March were further eased throughout the month of July. The primary driver of the increase was seen in the large industrial and manufacturing sectors that have largely closed during the full lockdown phase and have since opened, albeit not quite the pre-COVID levels. It's clear on this slide that the U.K. demand has not recovered as sharply as our U.S. service territories, which underscores the value of the effective decoupling mechanism there.

We remain encouraged by the recovery we've observed in each of our service territories during the third quarter, but we'll continue to monitor load impacts as we move into the winter months, including the impact of additional temporary lockdowns should they arise, such as the lockdowns we are currently experiencing in England and Wales. At this time, the current lockdown is not as stringent as what we experienced early in the year as workers that are not able to work from home can still go to work and many retail establishments can still provide takeout options. In addition, strong residential demand is expected to continue to act as a hedge to lower C&I demand.

Now I know I just stated a lot of percentages. So let me take a moment to summarize the impact of COVID-19 on our ongoing results in 2020. We experienced a $0.10 per share impact to the end of the third quarter. 70% of that relates to lower U.K. sales volumes that will be recovered through the U.K. decoupling mechanism. The remaining $0.03 is primarily from lower demand in Kentucky, and we have been able to offset the majority of that through effective cost management. Overall, we believe our strong regulatory constructs, balanced rate structures and customer mix, positions PPL well to continue to operate at a high level in this challenging environment.

That concludes my prepared remarks, and I'll turn the call back over to Vince.

[Vince Sorgi, President and Chief Executive Officer]

Thanks, Joe.

In closing, I remain very proud of how our teams across PPL have risen to the challenge of COVID-19. We continue to deliver electricity and gas safely and reliably to our customers. At the same time, we remain as focused as ever on innovation and continuous improvement as we position the company for future success.

With that, operator, let's open the call for Q&A.

[Operator]

Thank you. [Operator instructions] Today's first question comes from Ryan Greenwald at BofA. Please go ahead.

[Ryan Greenwald, BofA]

Good morning. I appreciate the time.

[Vince Sorgi, President and Chief Executive Officer]

Good morning.

[Ryan Greenwald, BofA]

Can you guys just talk about your confidence and conviction levels and how that kind of evolved over the last few months around being able to reach constructive deal terms between the CMA findings and what you're seeing internally? And how are you thinking about additional upcoming Ofgem data points in terms of ability to really further improve sentiment and drive renewed interest?

[Vince Sorgi, President and Chief Executive Officer]

Sure. So as you can appreciate, we are in the middle of a competitive process. So I don't think it's appropriate to get into too much detail in terms of the process that we are currently – is currently under way. But to your point, I think the CMA decision for the water company, that provisional decision was certainly positive as we think about overall returns in the U.K.-regulated utility sector. I think it should play well into what we would expect for gas and transmission coming here in about a month or so, that should be coming out early December.

We also have the government's white paper on decarbonization. That should be coming out. They said autumn, so that could be this month or early December as well. And then, the CMA final decision. So I think to your point, things seem to be progressing in a positive light in the U.K. regulatory construct. And I would expect that to translate positively in our process, but I don't want to get into a lot of detail in terms of where we are with potential bidders.

[Ryan Greenwald, BofA]

Got it. Fair enough. And how are you guys thinking about your hedging strategy ahead of any transaction, corresponding cash proceeds, just given the latest backdrop? I'm curious if you can kind of frame your thoughts around any internal forecast you guys have on the currency over the next several months?

[Vince Sorgi, President and Chief Executive Officer]

Sure. Joe, you want to talk about that a little bit?

[Joe Bergstein]

Yeah. Well, as far as hedging the proceeds of the transaction that is something that we're considering at this time. Nothing really to update at this point, but if and when appropriate, we'll provide an update then. I think how the pound moves here could depend on – would depend, we think, on our U.S. collection results and which way that goes. So certainly watching the pound closely and giving consideration to hedging.

[Ryan Greenwald, BofA]

Got it. Appreciate the time.

[Vince Sorgi, President and Chief Executive Officer]

Thanks, Ryan.

[Operator]

And our next question today comes from Durgesh Chopra with Evercore ISI. Please go ahead.

[Durgesh Chopra, Evercore ISI]

Hi, team. Good morning. Who do you think is going to win the election? I'm just kidding. Maybe just can you talk about – you mentioned asset swaps or asset exchange events in the past and Joe – so maybe just talk about where that stands? And then, in light of that, I do have a follow-up question, but maybe just address that and then I have a follow-up as it relates to sort of possible future M&A.

[Vince Sorgi, President and Chief Executive Officer]

Yes, Durgesh, I don't think it's appropriate to get into. We're kind of getting into the process now with potential buyers. So just not appropriate to get into any kind of detail around the process.

[Durgesh Chopra, Evercore ISI]

Okay. That's fair, Vince. Totally understandable. And then, maybe can you talk about just maybe there's – the reason why I ask is there's, obviously, Center Point earlier today talked about putting one to two gas LDCs in their infrastructure – in their asset base on market next year. NiSource is another – one of your peers, has made that commentary. Maybe can you talk about the M&A growth opportunities in the U.S. outside of this whole deal with the U.K.? Just how do you think about potential consolidation opportunities, your views on electric versus gas and geographies that you might be interested in, anything that you can sort of speak to that?

[Vince Sorgi, President and Chief Executive Officer]

Sure. So overall, I would say we are interested in acquiring regulated utilities. We do have a preference toward electric, but electric and gas utilities are also attractive to us. In terms of geography, I'm not sure that that contiguous service territories or anything like that is necessarily something that we put a high emphasis on. So at this point, I would say, we are pretty open to opportunities that may come-up in the market.

Again, where – our base case is fix the balance sheet, not really fix the balance sheet, but improve the balance sheet from where we are to kind of the mid-teens and then share buybacks, right? It would be the kind of the base case as that we would look at M&A as potential to improving value above that. Renewables is also another area that I think we're seriously considering. We did acquire Safari Energy back in 2018, hasn't been a significant component of the PPL earnings profile to date.

However, when we come out of the WPD sale we could possibly be a cash taxpayer at that time, which, obviously, would put us in a good position around the renewables business. So I think we have opportunity to organically grow that business given kind of how we've positioned the DER business that we acquired a couple of years ago, but also there could be possibility or potential to do some M&A there as well.

[Durgesh Chopra, Evercore ISI]

Great. Super helpful, Vince. So I'll let others to ask. Thank you.

[Vince Sorgi, President and Chief Executive Officer]

Thanks, Durgesh.

[Operator]

[Operator instructions] Today's next question comes from Paul Patterson of Glenrock Associates. Please go ahead.

[Paul Patterson, Glenrock Associates]

Hi, good morning.

[Vince Sorgi, President and Chief Executive Officer]

Good morning, Paul.

[Joe Bergstein]

Good morning.

[Paul Patterson, Glenrock Associates]

I appreciate you guys are in the middle of the process. And obviously, if – you can share only what you can share. But can you give us any flavor, I mean, as to sort of the level of interest? I mean, in other words, have there been a lot of people who have been showing interest in the property? And are you – I mean, you mentioned these regulatory events in the U.K. Are these things that people are looking to see, I guess, before they do – before they show interest? Or can you give us any flavor as to – or at least how optimistic you feel about what you've encountered so far?

[Vince Sorgi, President and Chief Executive Officer]

Yes. I would – so Paul, I would say that the process and the level of interest is progressing as we would have expected. I did talk about in August when we made the announcement that I did expect there to be quite a bit of interest in WPD, given the quality of the assets, the quality of the management team. And again, we think electric distribution is the premier sector in the utility industry in the U.K. given its role in where it's going to play in the decarbonization efforts to get to net zero in the U.K. So at this point, I would say, nothing that I'm seeing would kind of alter that view. And things are progressing as we had expected.

[Paul Patterson, Glenrock Associates]

Awesome. Thanks so much.

[Operator]

And our next question today comes from Ryan Levine of Citi. Please go ahead.

[Ryan Levine, Citi]

Hi, good morning. So as the sale process continues to move forward, is there any more color you're able to share around the tax attributes of the portfolio for sale?

[Vince Sorgi, President and Chief Executive Officer]

Yes. No update at this point. But Joe, I don't know if you want to mention anything on – thoughts on tax strategy.

[Joe Bergstein]

No. Nothing. Nothing to update at this time or any additional details at this time, Ryan. We'll give an update on that when appropriate, but I don't think it's appropriate to do so now given where we are in the process.

[Ryan Levine, Citi]

Okay. And then, to follow-up on the comments about being open to gas utility deals, curious about your long-term ESG strategy and your views on decarbonization?

[Vince Sorgi, President and Chief Executive Officer]

Sure. So our stated goals are try to reduce our carbon emissions by 80% by 2050, 70% – at least 70% by 2040. As of 12/31/2019, so as of the end of last year, we've already delivered about a 56% reduction, compared to 2010, and that compares to about a 45% reduction for the sector. So we're feeling very, very good about our transition strategy and the glide path that we're on to achieve that at least 70% by 2040 and at least 80% by 2050.

Our reduction targets are, we think they're comparable to our industry peers, even some of those peers that have indicated a net-zero target by 2050, they've indicated that they see a pretty clear path to 80% reduction, but would require incremental technological improvements to get the remaining 20%. And that's very consistent with how we are seeing things as well. It's one of the reasons why we joined the EPRI, GTI, LCRI R&D project over the next five years to really try to identify that technology to actually get to net zero by 2050.

Again, as we're thinking about the declining costs of renewable energy, we think there'll be continued opportunity to accelerate decarbonization, even in Kentucky, even without retiring coal plants to the extent that the LCOE of solar continues to come down, it could end up being cheaper than the variable cost of generating in Kentucky.

But again, a long-term carbon reduction goals for us is around the retirement of the coal fleet. But we will continue to do that in a very balanced way. We're focused on working with the commission making sure that the power that we continue to generate in the state is affordable and reliable for our customers that is critical. Relatively cheap electric in the State of Kentucky is an important component of their economic development strategy.

So again, as we think about our carbon reduction strategy, it's in a very balanced way to make sure that we're keeping our customers and our regulators in mind. And again, we think we are in a good position to balance all of those things. If technology were to improve or the cost curves continue to come down significantly, what we've noticed and experienced in Kentucky is that the commission has been very supportive of coal retirements when it makes economic sense to do so. They are not supportive when it does not make economic sense.

Just to remind everybody, we've retired over 1,200 megawatts of coal fire generation since 2010, and that was all based on economics. So we think again, the regulatory construct is supportive down there, but it's all based on economics and as – right now, the economics are not quite there to accelerate the retirement. But as that continues to progress, certainly, our team in Kentucky is looking at that. We think the commission will continue to be supportive of things like that as well. I think just the key there is to ensure that the generation is reliable and affordable. And again, I think we're in a good position to balance all of those factors.

[Ryan Levine, Citi]

But just a follow-up, I mean, how does adding or potentially adding a gas utility to your portfolio fit within that framework?

[VinceSorgi]

Well, I don't want to specifically indicate whether or not we would be interested in just a gas LDC on its own. My preference would be in electric and gas utility. Again, I think over time, gas will be deemphasized as we think about a longer-term carbon transition strategy for the U.S. And so that's why I like electric and gas a little better because you can build in that direct edge for electrification there. But I wouldn't say today that we wouldn't take a look at that.

[Ryan Levine, Citi]

Appreciate it. Thank you.

[Operator]

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for the final remarks.

[Vince Sorgi, President and Chief Executive Officer]

Great. I just want to thank everybody for joining us on the call today, and we'll see you all at EEI virtually next week. Thanks, everyone.

[Operator]

And thank you. This concludes today's conference call. Well, thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.