Hawaiian Electric Industries, Inc. (HE) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2013 Hawaiian Electric Industries Inc. Earnings Conference Call. My name is Taheesha, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Shelee Kimura, Manager of Investor Relations and Strategic Planning. Please proceed.

Thank you, Taheesha, and welcome, everyone, to Hawaiian Electric Industries First Quarter 2013 Earnings Conference Call. Joining me this morning are Connie Lau, HEI President and Chief Executive Officer; Jim Ajello, HEI Executive Vice President, Chief Financial Officer and Treasurer; Dick Rosenblum, Hawaiian Electric Company President and Chief Executive Officer; and Rich Wacker, American Savings Bank President and Chief Executive Officer; as well as other members of senior management. Connie will provide an overview of the quarter and an update on our strategies, Jim will then update you on Hawaii's economy, our results for the quarter and outlook for the remainder of the year. Then we will conclude with questions and answers. In today's presentation, management will be using non-GAAP financial measures to describe the company's operating performance. Our webcast presentation materials, which are posted on our Investor Relations website, contain additional disclosures regarding these non-GAAP measures, including reconciliations of these measures to the equivalent GAAP measures. Forward-looking statements will also be made on today's call. Actual results could differ materially from what is described in those statements. Please reference the forward-looking statements disclosure accompanying the webcast slides, which provides additional information on important factors that could cause results to differ. The company undertakes no obligation to publicly update or revise any forward-looking statements, including EPS guidance, whether as a result of new information, future events or otherwise. I'll now turn the call over to our CEO, Connie Lau.

Thanks, Shelee, and aloha to everyone. We are pleased with the solid start to our year with financial results consistent with our expectation and significant progress on our strategies, which are designed for long-term value across our companies. We successfully completed our common equity offering in March, which we expect will satisfy all of our equity needs through 2014. Under the equity forward structure, we have the flexibility now to take down equity as needed over the next 2 years. This will enable us to fund the largest capital plan in our utility's history as they modernize the electric grid for more lower-cost renewable energy. Significant regulatory issues have been resolved at the utility with the PUC's March approval of the previously disclosed settlement agreement. And our bank continued to deliver solid results, profitability metrics remained strong and we generated strong loan growth to help offset the impact of the low interest rate environment. Based upon our progress to date and our outlook for the remainder of the year, we are reaffirming our 2013 EPS guidance. We believe we are well positioned to continue to deliver attractive risk-adjusted returns and earnings growth to our investors. As shown on Slide 3, first quarter earnings were $0.34 per share in 2013 compared to $0.40 per share in the prior-year quarter. This is consistent with our expectations and 2013 EPS guidance as we expect improvement at the utility in the second half of the year. As shown on Slide 4, HEI's core ROE for the last 12 months was 10%. The equivalent ROE contributions from our operating companies were 8.4% at the utility and 11.4% at the bank. Now focusing on the utility's strategic progress. As we reported last quarter, we recorded a $40 million write-off in 2012 as a result of the January settlement agreement. With the PUC's subsequent approval of the agreement, $50 million of costs related to CT1 and CIS were included in the 2013 RAM filing. The Hawaii Island utility withdrew its 2013 rate case. HECO Oahu pushed back its rate case to file its 2014 test-year rate case at the start of 2014 and starting in 2014, the timing of the HECO Oahu RAM revenues will move up to the start of each year through 2016. This will eliminate the 5-month lag currently in place at HECO Oahu. All 3 utilities filed for the 2013 revenue adjustment mechanisms in March. The filings represent approximately $38 million in consolidated annual revenues over current level, of which $32 million relates to increases in invested capital. Based on the mechanism, the RAM revenues are expected to be effective starting June 1. On the clean energy front, the utility's 2012 final RPS was 13.9%, which is well on its way to passing the next clean energy goal of 15% in 2015. Our utilities are constantly seeking ways to add more lower-cost renewable energy. As a result of their efforts, they are currently evaluating a number of viable renewable energy proposals that are priced lower than the existing cost of our oil fire generation. These proposals could have a meaningful impact on renewable megawatt additions. In order to ensure that we can integrate more renewables, our utilities are executing on their capital plan. Year-to-date, the utilities executed projects totaling over $60 million of capital expenditures. And in addition to the equity financing I discussed earlier, the utility also has plans underway to refinance existing debt at lower rates and issue additional debt to cost effectively fund its regulated indebtedness. Turning to American Savings Bank on Slide 6, we continue to execute on our strategy to grow the bank in a controlled and prudent manner and deliver solid profitability metrics relative to our publicly traded peers. The bank's year-to-date annualized return on assets was 112 basis points, in line with our annual target of approximately 110 basis points and attractive compared to our peers. We are also on track to achieve our financial performance target for net interest margin, loan growth and net charge-offs. Overall, the bank continues to maintain its low-risk profile, strong balance sheet, terrific funding base and straightforward business model. I'll now ask Jim to provide additional detail and insight to our results and outlook for 2013.

Thank you, Connie. As a backdrop to our results and outlook, I'll briefly comment on Hawaii's economy, which continues to improve. Tourism industry surpassed last year's record-breaking numbers in the first quarter of 2013, continuing the positive growth trend from 2012. Year-to-date, visitor arrivals were up 7.1% and expenditures were up 7.6% compared to 2012. The 2013 outlook for the visitor industry remains positive. Statewide unemployment was at 5.1%, city and county of Honolulu at 4.6% in March, continuing its declining trend and remains low compared to the national average of 7.6% in March. Oahu single-family home sales and prices were up 4.1% and 2.4%, respectively, for the month of March 2013. And now construction activity has begun to add to the economic rebound. Private building permits increased over 40% in 2012 and total commitments to build are expected to increase over 20% in 2013. Overall, we expect to see strengthening growth in Hawaii economy, with expectations of recovery in the construction industry and continued expansion of the visitor industry. On Slide 8, utility net income for the first quarter of 2013 was $24.4 million compared to $27.3 million in the first quarter of 2012. The detailed variances are shown in the slide, and I'll just highlight a few. Utility net revenues after tax were $3 million higher than the prior year, largely driven by the recovery of costs related to the Oahu 2011 and Maui County 2012 rate cases. HELCO's negative earnings impact from decoupling is primarily driven by the implementation of the heat rate deadband in the second quarter of 2012. Operations and maintenance expense after tax was $5 million higher compared to the first quarter last year largely due to timing. The rate of O&M expense in the first quarter of 2012 was lower than the rest of the year, whereas 2013 O&M expense is expected to be more evenly distributed throughout the year. In the quarter, O&M reflects higher customer service expenses, as such costs received deferral treatment in most of the first half of 2012. In addition, higher employee benefits expense was driven by higher pension costs. We expect full year O&M expense to be flat to up 1% with 2012. At the bank, net income for the first quarter of 2013 was $14.2 million in line with the linked quarter. Net interest income was flat as loan growth helped offset lower financing margins. Noninterest income was lower largely due to lower gains on sales of residential loans but was offset by lower provision for loan losses and lower noninterest expense. Compared to the first quarter of 2012, excluding the effect of the $1 million release of tax reserves, bank net income was down less than $1 million and consistent with the trends we saw in 2012. Now we'll look more closely at the utility. Slide 10 shows our actual ROEs for the last 12 months. The March 2013 consolidated core ROE of 8.4% improved slightly from 8.3% in March of 2012. Our largest utility on Oahu achieved a core ROE of 8.9% over the last 12 months compared to 8.4% over the prior-year period. This improvement reflects cost recovery associated with the settlement of the East Oahu Transmission Project in March 2012 and the 2012 RAMs. The ROE for our Maui County utility reflects improvement due to its 2012 rate case that became effective in the second quarter of 2012. In the first half of 2012, it had been spending in advance of cost recovery. Our Hawaii Island utility had lower returns from the prior year due to the 2012 implementation of the heat rate deadband and the O&M spending in advance of recovery. Since the settlement agreement resulted in the withdrawal of the Hawaii Island utility's 2013 rate case, HELCO's ROE will underperform in 2013. While the RAMs will provide some recovery, O&M reductions at the other 2 utilities are expected to provide some offset. Looking forward to 2014 to 2016, we expect the structural gap between our earned and allowed ROE to be 80 to 110 basis points for the consolidated utilities, an improvement of 40 basis points from our original expectations. Between rate cases, items not covered by the annual RAMs could continue to add to the gap. The specific magnitude of the impact will primarily depend on the size and timing of software projects, changes in fuel prices related to fuel inventory and management's ability to manage costs within current mechanisms. Now we'll look more closely at the bank. Slide 12, our net interest margin was 3.78% in the first quarter of 2013. The 3-basis-point decline from the linked quarter was primarily attributed to the ongoing trend of lower yields on interest-earning assets as loans continue to reprice down due to the low interest rate environment. First quarter 2013 NIM benefited by 3 basis points due to the prepayments of commercial loans. Excluding the impact, NIM continues to track our annual expectations of 3.6% to 3.7% for 2013. Our liability cost of 23 basis points in the first quarter of 2013 remains extremely low by industry comparisons, reflecting the value of our stable low-cost core deposit base. Turning to credit quality, the bank recorded $1.9 million in provision for loan losses in the first quarter of 2013. This is a $1.5 million and $1.7 million improvement from the linked and prior-year quarters, respectively, consistent with the ongoing improvement in the credit quality of the bank's loan portfolio and the Hawaii economy. We're off to a good start relative to our expectation of $10 million to $12 million provision expense for the year. Net charge-offs were $1.1 million in the first quarter of 2013, which is a slight decline from the fourth quarter of 2012 and a 57% decline from the prior-year quarter. The net loan charge-off ratio remained low at 12 basis points compared to 13 basis points in the linked quarter and 28 basis points in the prior-year quarter. The allowance for loan losses was 1.11% of outstanding loans at quarter end, unchanged from the linked quarter. On Slide 14, American's nonperforming assets ratio of 1.89% was essentially flat to the end of the fourth quarter, lower than the 2.02% at the end of the first quarter last year and remains better than its high-performing peers. Slide 15 is our balance sheet, which shows you the attractive asset and funding mix of American relative to its peer banks. We compared American's March 31, 2013 balance sheet with the last complete available data set for our peers, which is as of December 31, 2012. 100% of our loan portfolio was funded with low-cost core deposits versus our peers' at 92%. In the first quarter, core deposits increased by $87 million to $3.8 billion, which helped fund our loan growth, while maintaining an average cost of fund that is approximately 31 basis points lower than median of our peers. American remains well capitalized, with a leverage ratio of 9.1%, tangible common equity to total assets of 8.4% and total risk-based capital of 12.8%, all at March 31, 2013. In the first quarter, American paid $10 million of dividends to HEI while maintaining solid capital levels. Now I'll turn to HEI's outlook for 2013. HEI continues to maintain a strong capital structure, with 51% consolidated equity to total capitalization at March 31, 2013. In March, HEI issued $50 million of 3.99% unsecured senior notes through a private placement which refinanced $50 million of unsecured 5.25% medium term notes that matured on March 7, 2013. We also entered into an equity forward transaction in connection with the public offering of 7 million shares of HEI common stock, which included an overallotment option of 900,000 shares that was exercised by the underwriters. Net proceeds from the offering were $180 million. To date, we have not drawn on any of the proceeds from the equity forward. We expect to settle a portion of the equity forward agreement in the fourth quarter of 2013 by delivering roughly 3 million shares or 40% of the 7 million shares while receiving net proceeds of roughly $75 million to invest in our utility. The company has until March 25, 2015 to settle the remainder of the equity forward agreement. We are reconfirming HEI's earnings guidance range of $1.58 to $1.68 per share, including the impact of the partial settlement of the equity forward. There is no change to the EPI guidance range at our utility or our bank.

Thanks, Jim. In summary, we are successfully executing on our strategies. Our utility continues to focus on fulfilling its clean energy mandate for Hawaii, and our bank is focused on growing in a controlled and prudent manner in this ongoing low interest rate environment while continuing to deliver solid results. Turning to our quarterly dividend, yesterday the board maintained the dividend of $0.31 per share payable on June 12 to shareholders of record on May 22. Our dividend yield remains attractive and as of yesterday's close, our dividend yield was 4.4%. We believe we are well positioned to continue to deliver a unique investment combination of attractive and stable earnings growth, with reduced risk and volatility and an above-average dividend yield. And with that, we look forward to hearing your questions.

[Operator Instructions] You have a question from the line of Charles Fishman from Morningstar.

On the RAMs, at this point going forward then, they'll always be filed in March and effective in June as part of that settlement? Is that all 3?

For Oahu, the RAMs are always filed in March and effective in June 1.

Okay, so nothing -- okay, I thought something had changed with the settlement but appears not. And then on HELCO -- I'm sorry, go ahead.

Could you hold on just one sec? Charles, I'm sorry, we were debating what question you had actually asked. And let me just state what it is. So the filings are always done March 1, effective June 1 -- I'm sorry, March 31. Going forward in 2014 through 2016 for the Oahu utility, for that particular cycle, it will be effective January 1.

Okay, and that was the one that changed with the settlement, correct?

Yes, that's correct. So that is now effective January 1, although still the cash collection begins on June 1.

Okay. And then on the statement that HELCO will -- ROE will likely underperform the rest of this year and next year, but do you see improvement over the 6.3% just because of the reduction in O&M, et cetera?

I'll let Dick answer that.

Let me explain what's going on. Because we canceled the HELCO rate case, there are some expenses at HELCO which we need to fund and an example, for instance, is tree trimming. So what we're doing is we're managing our O&M on a consolidated basis, which means we shift some from the other utilities to HELCO to fund the tree trimming. That will result in the isolated results for HELCO looking worse, but the integrated results being as we predict. That make sense?

Well, okay. So but -- and it will be less than the 9.6% that you realized last year in the core ROE then, is what you're saying?

Yes. Correct.

Okay. Now the island interconnect. If that was to go forward, that would be the kind of event that would trigger more -- an additional need for equity in 2015. Am I thinking about that correctly?

It's unlikely if it did go forward that it would go forward that quickly.

Okay, so that's out there and something we don't have to think about with this equity -- recent equity, okay.

Absolutely, that's correct.

[Operator Instructions] Your next question comes from the line of David Paz from Wolfe Research.

Regarding the structural lag, can you just -- what makes up the 80 to 110 basis points that you expect in 2014 through '16?

David, this is Tayne Sekimura. The structural lag consists of mainly 4 items. One relates to the general rate case lag. The second would be the RAM 5-month delay. This is for HELCO and MECO where the RAM accelerations were not part of the settlement agreement. The third item would be the RAM baseline additions because it's based on a 5-year historical average to the extent that actual baseline additions are higher than that lag. And then the fourth item relates to nonrecoverable expenses and these include things like incentive compensation and advertising. Our guidance is between 80 and 110 basis points, and that can vary depending on the size of our rate cases, as well as how big these baseline plant additions are. That's an improvement over our previous guidance we said about 120 to 150 basis points and that's because of the RAM acceleration on Oahu improved consolidated ROE by 40 basis points. Does that help?

Yes, just a follow-up though on the nonrecoverable items. How much of that lag -- how much is that percentage basis were -- are on a per basis point?

It's roughly 50 basis points, David.

Okay, is that current 50 basis points or is that even by '16 you'd still expect about 50 basis points? Because I would think like advertising would be fixed costs and therefore, declining -- well, anyway, I mean, is that 50 basis points through '16?

Yes.

Okay, great. And then just your rate base growth roughly is 7% through '17. Is that correct?

Rate base growth for the 3-year period?

No, I'm sorry, just what do you have for rate base growth currently?

5% in 2013 and over the next 3 years it's roughly 5% to 10%.

5% to 10%? Okay, and that's based off of 2012 rate base?

That's correct.

Okay. And how much equity do you expect to carry there for -- through 2016?

David, this is Jim. We've prefunded the equity requirements in the next couple of years. And we would tell you also that you should assume that the dividend reinvestment plan will stay on. And so we'll basically say that we've covered the next couple of years and assumed the DRIP will continue, open. And we'll probably not provide any more guidance at this point in time relative to the years '15 and forward. The equity forward transaction actually can be settled as late as the end of March in 2015.

So David, we didn't talk specifically about CapEx this time, but the discussion and the slides that we provided earlier on CapEx at year end have not changed at all. So all that CapEx forecast is still the same and the way in which we target the ratios at the utility company and then funded that through common stock offerings at the holding company all are still the same.

Okay, so if I'm hearing you right, the 56% or so you target out the equity -- the utility, you will still try to maintain that through at least '15?

Yes. Right, correct, and if you recall, we normally do that at year end, close to year end, to prepare the balance sheet for the year end numbers. So that's why Jim was talking about funding for December 2013 and December 2014 or thereabout since the forward actually goes until the end of March 2015.

We have no more questions in the queue. I'd like to turn the call back over to Ms. Shelee Kimura for any closing remarks.

Thanks, everyone, for joining us today. We will be going into our annual shareholders meeting in about 1.5 hours. So I'll be available to take any calls you have until then and otherwise, I'll return your calls as soon as we're done with that meeting. Thanks so much. Bye.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.