Duke Energy Corporation (DUK) Q3 2011 Earnings Report, Transcript and Summary

Good day, everyone and welcome to the Duke Energy Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks, I would now like to turn the call over to Mr. Bill Currens, Managing Director of Investor Relations. Please go ahead, sir.

Thank you, Lisa. Good morning, everyone and welcome to Duke Energy's third quarter 2011 earnings review and business update. Leading our discussion today are Jim Rogers, Chairman, President and Chief Executive Officer; and Lynn Good, group Executive and Chief Financial Officer. Jim and Lynn will review our quarterly results and provide an update on our key priorities. After these prepared remarks, we will take your questions. Today's discussion will include forward-looking information and the use of non-GAAP financial measures. You should refer to the information in our 2010 10-K and other SEC filings concerning factors that could cause future results to differ from this forward-looking information. A reconciliation of non-GAAP financial measures can be found on our website and in today's materials. Note that the appendix to the presentation materials includes additional disclosures to help you analyze the company's performance. Now I'll turn the call over to Jim Rogers.

Thank you, Bill. Good morning, everyone, and thank you all for joining us today. We appreciate your interest and investment in Duke Energy. This morning, we released strong third quarter results and are very pleased with the exceptional performance of our fleet. As a result of our year-to-date earnings, we are increasing our 2011 adjusted diluted per-share earnings guidance range from between $1.35 and $1.40 to $1.40 and $1.45. We committed to you after announcing our proposed merger with Progress Energy that we would continue to stay focused on running the business, delivering results and executing on our long-term strategic initiatives. The ability to increase our earnings outlook in a year that includes a pending merger transaction, a busy docket of regulatory proceedings, continuing economic uncertainty and significant storm damage to our system is due primarily to our employees who are single-mindedly focused on safety, and excellence and execution. I thank them for their efforts. Today, after Lynn reports on our quarterly earnings, I will provide updates on the key initiatives that are positioning the company for the long-term. These initiatives include; one, the status of our fleet modernization program. two, our Ohio ESP stipulated settlement; three, the latest developments in our pending merger with Progress Energy; and finally, our rate cases in the Carolinas. But first, let me give a brief overview of our earnings and performance for the quarter. Turning to Slide 5. Today, we reported third quarter adjusted diluted earnings per share of $0.50. This compared to $0.51 in the prior year. Our year-to-date results due to third quarter were flat to the prior year. However, when we take into account the significant weather that favorably impacted our results last year, this performance is outstanding. That U.S. Franchised Electric and Gas, our largest business segment, this strong operational performance in our generation investments helped offset less favorable weather and higher planned O&M cost. At international, we saw strong results from our Latin American operations, as well as increased earnings from our stake in National Methanol Company. For the quarter, our nuclear fleet had a capacity factor of 99.27%. The fleet dispatched more than 15 million-megawatt hours, setting an all-time company record for best quarterly nuclear generation performance. Additionally, our nonregulated Midwest gas fleet continues to generate at record levels. Results at both commercial power and Duke Energy International, based upon their performance to date, are on track to exceed the earnings contributions we originally projected for the year. Now I'll turn the call over to Lynn who will provide more details on our quarterly results.

Thank you, Jim. Turning to Slide 6, let me begin with a review of the adjusted earnings drivers for each of our business segments for the quarter. For the U.S. Franchised Electric and Gas, quarterly adjusted segment EBIT was relatively flat to the prior year. Weather, while favorable to normal, was not as favorable as the prior year. To put this in context, last year, the Carolinas recorded the hottest third quarter since the company began keeping records in 1961. Additionally, our operation and maintenance expense is higher than the prior year, reflecting our planned increase in outage and maintenance spending. For 2011, we were targeting an O&M cost increase of 3% to 4%, net of deferrals and cost recovery writers. This target has been pressured by year-to-date storm restoration costs of approximately $75 million, most of which was incurred in the first half of the year. Excluding these significant storm costs, we are within our expected O&M increase range for the year. We will continue to aggressively manage our costs. Quarterly results were favorably impacted by the continued earnings contributions from our new generation investments, as well as the lack of the prior-year $44 million impairment charge related to Edwardsport which was included in adjusted earnings. In commercial power, the quarter's adjusted segment EBIT was lower than the prior year, primarily due to the expected financial impact from customer switching in Ohio. This is partially offset by increased pull and emission allowance sales, higher base generation rates charged to existing ESP customers and favorable O&Ms. Through the third quarter, growth customer switching is at approximately 68%, consistent with the first half of 2011. Switching for the year is forecasted to negatively impact 2011 earnings by approximately $0.07 per share. It is important to remember that under the terms of…

Thank you, Lynn. We often discuss the challenges our industry is facing and how we are positioning our company for the long-term. Cost to replace and modernize our aging infrastructure and to comply with more stringent environmental regulations mean our customers will face increasingly higher energy prices now and in the future. In response to these industry-wide challenges, we are focused on several strategic initiatives, our fleet modernization program, our Ohio ESP, rate cases in the Carolinas and our pending merger with Progress Energy. Taken together, these initiatives will help us continue to deliver affordable, reliable and cleaner energy to our customers while helping us earn reasonable and fair financial returns. We'll begin with a discussion of our fleet modernization program. Slide 9 outlines the status of our major construction projects. When completed, they will introduce approximately 2,700 megawatts of new generation into our system at a total investment of roughly $7 billion. These new modern facilities will allow us to retire older, less efficient coal plants which cannot be cost effectively retrofitted with emissions controls. First of all, let me bring you up-to-date on the Edwardsport IGCC project which is nearly complete, at about 96%. Extensive start-up testing is underway. All of the mechanical and electrical systems will be turned over to the start-up crews later this year. We continue to remain on track for an in-service date in the fall of next year. The plant which will use Indiana coal will provide cleaner, more efficient energy to our customers in the state. Due to its efficiency and low cost of energy, Edwardsport will be the first plant to be dispatched on our Indiana system and remains the best solution for our customers' needs, helping to ensure the energy future of this region. As a reminder, the Indiana commission…

[Operator Instructions] And then we'll take our first question from Dan Eggers with Credit Suisse. Dan Eggers - Crédit Suisse AG, Research Division: Jim, the demand recovery situation is kind of been disappointing across the country, but you guys have been struggling maybe a little more than others, it seems on a weather-adjusted basis. As you look out on the next year, 2 years, 3 years, are you guys seeing signs that this could start to come back and when you look at the regions between the Carolinas and the Midwest, are you seeing different trends that might give you more confidence or pessimism from here?

I think our current view is that the recovery is very anemic and that with unemployment 9.2%, the rebound in the demand for electricity is going to be slow. Historically, the rebound in electricity from a deep recession like we have is an early indicator that the economy is recovering. And in my judgment, we don't see the rebound yet and that is not good news, with respect to the economy at least through this year and through 2012. Dan Eggers - Crédit Suisse AG, Research Division: And Jim when I -- you take that to the next step, you think about trying to earn your allowed returns and obviously got a lot of rate cases going on. But what kind of cost management do you guys see forward that can help offset and the lack of top line growth to kind of support your long-term EPS growth strategy?

Dan, that's really a good point. And obviously, we went through a number of years where we were able to keep our O&M flat, in the early days, the early years of the recession. But as we move forward and we closed the deal with Duke. That's really going to allow us to really reduce further our cost and allow us to maintain our strong ROEs on our business. Dan Eggers - Crédit Suisse AG, Research Division: And Jim, when you think about the rate base growth you guys have and the rate increases you're asking for, will we have the volume growth that the customer impact is, appears to be more significant, are there mitigation opportunities you guys see out there and what sort of conversations you had with the Commission during these rate cases, kind of talking about the net bill impact to customers?

Sure. That also is an important point. As you know, over the last several years, we worked hard in every state that we operate in to put in place the right incentives for us to invest in energy efficiency and to put control of the use of electricity in the hands of our customers. We have foreseen for some time, as we modernize our fleet and our grid, that the price of our product is going to go up. And that's why we acted early to be able to help consumers control the bill. And as our price goes up, if they can control the volume, that will help mitigate these increased prices. And clearly, everyone today understands, probably more than they did when we first introduced our energy efficiency measures, the importance of having those in place, in giving control to our consumers, during this rising price environment. Dan Eggers - Crédit Suisse AG, Research Division: Turning to Carolinas just real quick, with the last 2 plans kind of coming into service next year, how much more of a rate increase do you guys anticipate requesting after this rate case gets done?

You know, Dan, we do need an additional case to pick up in-service of these plants. We have not estimated an increase at this point. I think it will be dependent upon the success of this case, as well as what we see in terms of our cost structure for next year. So more to come on that.

[Operator Instructions] We'll now take our next question from Jim von Riesemann with UBS.

A question for you, just following-up on Dan's. Would you -- you mentioned on your prepared remarks, Jim, that you saw 4% to 6% earnings growth and that now seems to add an upper end to that range. Would you mind taking a moment to bucket the major categories of that growth? So saying that differently, how much is from merger savings? How much of it is from new plant reducing regulatory lag? And the follow-up to that is, can you refresh my memory as to how much of your O&M is clause versus discretionary?

Sure. That's a great set of questions and let me with that turn it over to Lynn.

You know, Jim, I think those are good questions and we'll of course give you a better feel for what '12 looks like, if we come to the street after the merger closes with expectations for '12. But I would think about, in terms of the 4% to 6% is, as you think about the new company being a largely regulated company, it's going to be dependent on rate-based growth, it's going to be dependent on outcomes, regulatory outcomes, the ones that we are in the process of, as well as the ones in the future, merger benefits, ongoing cost control. We do expect that we will have some load growth, although as we've been talking about, perhaps not as strong as we might have thought, even a year ago. So I think it's going to be a collection of all of those things and we can talk further about that, as we give more specific guidance for 2012.

Super. Just on a separate question on the merger, what do you think the FERC took a different tack this time, in terms of the market power issues?

It's my understanding that the FERC has been in the process of reviewing its whole criteria for approving mergers. And it appears to me that in this case, because you're combining and creating the largest company in the industry, that they made a decision to go on and apply some of their new criteria to this case. So I think that's what it is. I think it's part of a -- we're in the middle of the period where they're reviewing their historic criteria. And I don't think it's any more than that.

Okay and that the final question is on the dividend. The dividend policy with this seemingly higher EPS outlook, how are you thinking about the dividend going forward?

Jim, that's something that we continue to evaluate and will do so. We're committed to the dividend, committed to growing the dividend. We're going to move the growth rate to roughly 2% at the time we saw a sluggish economy. I think that's a good planning assumption, but we will continue to evaluate growth as we move into the new company.

And we'll now go to Greg Gordon with ISI Group.

So when looking at your generation assets in Ohio, is it fair to say that based on the current level of revenues they're generating, that they basically make no money?

Greg, that's a good question. I think the coal assets are challenged in this environment with low power prices. I think our team in Ohio has done an extraordinary job of optimizing around those assets and delivering returns that are consistent with what you would expect elsewhere. They've also been very aggressive on O&M and will continue to be. One of the things we like about the settlement agreement is, with the stability charge, it does provide a bit of strength to the earnings over the next 3 years.

Okay, would you characterize the capacity or would you characterize the revenue stream that you're asking for being at a level that would allow you to return sort of commensurate with what you would expect from a regulated asset, or is the math different?

Jim, do you want to take that?

Yes, I think the math's different. I think the actual ROE is lower than what you'd expect from a regulated business. I mean, that's the reality of the settlement. But the good news is the settlement is that we have all the key parties on board and that is -- increases the probability that it will be approved by the commission.

Okay, and then in '15 obviously we transition to a fully deregulated model where your revenue streams will be driven by capacity and power market pricing?

That's right and I think that's a good thing. Because if you look at the forward curve, you start to see the prices rises more in the '16, '17 timeframe. But as you can imagine in PJM, and I'm sure you've heard from others who have a much larger position in PJM, with the retirement of a lot of the old coal plants that will happen by 2015, and with the new regulations on emissions, I believe the prices -- will be upward pressure on the prices and the forward curve will, in all likelihood move up even more.

Okay, so I would summarize in non-financial terms, assuming this settlement's approved, it makes the assets financially viable in the transition?

I think that's true.

Now the returns are unsustainably low, right?

Absolutely. And here is the most important point about the settlement. It gives us flexibility with what we want to do with these assets. And remember, after the close of the merger that they represent less than 5% of our total earnings. And so that kind of puts it in perspective.

And we'll now take the next question from Jonathan Arnold with Deutsche Bank.

Not to belabor that topic, but Jim, I think in your prepared remarks, you said that though the earnings implications of the ESP settlement has filed, coupled with everything else, including the merger benefits, et cetera, will be consistent with your growth rate forecast. But within, should we think of the net of all of that within the Commercial Power segment as a up EBIT year in '12 or a down EBIT year in '12? Can you at least give us some directional view on how this it all translates into top line numbers?

You know, Jonathan, we're not going to give specific guidance today on Commercial Power as a segment. I think we have some elements to it that you can consider, new generation margins, the stability charge, O&M, depreciation, the results in the Midwest gas assets, all of those drivers for Commercial Power. We'll give you some more specifics on that, as we come to the street in '12. But we thought it would be helpful that within the context of those results, as well as the other things that we see, we still believe we are positioned within our growth rate.

Okay. And then on a separate topic that -- the benefit at National Methanol surprised us. It seems to kind of come in higher than your sensitivities to WTI would suggest just in the quarter. Is that -- is there a sort of brand spread factor there that's more the relevant oil price?

It is at this point, Jonathan. We're seeing a bit more correlation to that. We also saw higher methanol prices, so a couple of sensitivities there.

And we'll now take our next question from Steve Fleishman with Bank of America Merrill Lynch.

Just to clarify some of the questions previously. The 4% to 6% growth rate, if I recall, that was not off of 2011, was it off of 2010? When you kind of based that growth rate?

Steve, we set it off of 2011 to be the basis for the post-merger, you know, the combined new company. So you can think about 2011, and I would think about it in a weather-adjusted way, as we typically do to start the foundation for driving earnings growth.

Okay, in that context, what is the weather benefit this year, so far? Versus normal?

It's on Slide 18, See, if you can see weather normal, so we've had $0.06 to $0.07 in 2011.

Okay, so you're still kind of on the same base roughly that you were. In my recollection when you talked about the 4% to 6%, I think you typically mentioned the -- there's some lumpiness to that, the 4% to 6% growth by year. Is that -- I remember, if you go back to your S-4 documents, things like that, on the merger, there's certainly was some lumpiness.

I think there will always be lumpiness on a long-term basis because of regulatory outcomes, et cetera. And so I think we'll be able to give you a better sense of how it will look when we give guidance on '12. But I think some lumpiness is just consistent with the nature of this industry.

On a historic basis, our 4% to 6%, on a stand-alone basis, is really off of '09, just to level...

Right, okay, and then just a last question again on international. All the drivers of upside this year versus your expectation, how many of those are things like weather, things that might be temporary versus ongoing benefits that are exceeding plan? Can you give us some sense of that?

Sure. Steve, I think the International business has a nice diverse mix of geographies. We have seen some benefit of hydrology in Central America, but you can expect hydrology to benefit some region almost every year. We have core fundamental improvement in Brazil with prices rising. We'll also see a modest amount in new resources coming in, in future years as we're building a small hydro in Brazil and other assets. And then of course you can expect to see some volatility around oil and FX which should be somewhat visible to you based on what you see in the market.

And our next question will go to Michael Lapides with Goldman Sachs.

Guys, real quick question on the Indiana. Looking at it I think of Slide 15. The dockets for, not necessarily for IGCC 4, but for the other 3 ones, 5, 6 and 7. They all imply that this all gets wound down and you get all of your rate increases for multiple IGCC Edwardsport dockets early next year. Just curious what's the -- what are your level of concern of that being pushed out somewhat into later in 2012? And then, can you walk us through when you would kind of go in for follow-on increases, you know, IGCC 8 and beyond?

Michael, I'll take the cost riders. We have been filing those biannually from the beginning of project and we'll continue to do that, for they get filed every 6 months. What you see on Slide 15 is the schedule for hearing. So we have an opportunity to present those hearings, or those cases, and the commission will rule, in accordance with their own timeframe. I think our expectation would be 2012. But I think we'll await the actual timing as we see how this progresses. And I think IGCC 8, for example, will be filed in November or December of this year.

When would you go in for your final rate increase related to Edwardsport?

We would typically go through a conversion of this plant at in-service in Indiana through a rider mechanism. The mechanism we have in place would have an ability to convert at that time. and then we would evaluate the need for a general rate increase based upon other costs in the business, other maintenance and spending, et cetera. So that's something that's still under evaluation.

Okay, and how should we think about the math -- I'm just kind of thinking about the math in Ohio as part of the settlement. I think your current rate, residential rate was around $90 or so a megawatt hour, kind of directional. If I just look at forward power prices for 2012 and known capacity prices, plus the $5 or so stability charge. That's a pretty decent drop-off in Ohio. How do you make up for that?

Michael, I think you've got some of the pieces, margin stability, you need to consider O&M, how we're managing the plants, you need to consider any optimization activity we may have around whole emission allowances, you also need to evaluate the Midwest gas assets which has been a strong contributor. So I think it's all of those pieces together.

And we'll now take our last question from Paul Patterson with Glenrock Associates.

With respect to the FERC filing, I know that lawyers often gets protective and gets somewhat defensive, but I'm just wondering, since this new market power criteria conditions were put on the merger, do you guys feel -- how do you feel about the outlook for the merger being completed I guess? I mean, do you feel like any less confident about it or how would you describe -- how would you characterize it?

Paul, I still am highly confident that we will successfully complete this merger. The commission gave us 3 alternatives when they conditioned the approval and we picked the virtual divestiture, and we've submitted it to them and we think, in all likelihood, they will approve that. Now, we filed, because I want to clear up what has been a misunderstanding with a number of people, we filed on October 31, a request for a rehearing of the conditional merger order. And that was a very aggressive filing. But it was something that we had to do because to preserve our rights, under the 30-day rule, that required filing prior to it at that time. So I think the important point is think about that filing as protecting our rights, but the outcome of this case is really going to be driven by our proposed mitigation of proposal. And I believe that the commission will review it and we've asked them to rule on this by December 15. And that's important because both North Carolina and South Carolina commissions will only give us final approval once they've got a final order from the FERC. And that's with respect to the merger, as well as the joint dispatch agreement.

Okay, great. And then just finally on Edwardsport. you're not expecting to see I mean, this latest revisions is probably the last revision we're going to see. Is that a good way to think about it? In terms of cost?

Yes, that's a very good way to think about it.

And that concludes our question-and-answer session for today. Mr. Currens, at this time, I'll turn the conference back to you for any additional or closing remarks.

Great. Thank you. Thanks, everyone for joining us today for the third quarter earnings review and business update. We look forward to seeing many of you at the EEI Financial Conference next week. As always, the Investor Relations team is available for any follow-up questions. Have a great day.

And ladies and gentlemen, this does conclude today's conference call. Thank you for your participation.