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Pinnacle West: Nearing a Strong Entry Point with Regulatory Problems in the Past

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Pinnacle West Capital Corporation (NYSE:PNW) is the holding company for APS, or Arizona Public Service, the largest electric utility in Arizona. With a market cap of $8.05 billion, it is the 26th largest electric utility in the country and had the fifth highest utility shareholder return for 2022 at 12.9%, per the Edison Electric Institute. The company serves 1.3 million customers and currently has the largest nuclear plant in the US as part of its generating capacity. Standard & Poorโ€™s rates the company as BBB+, or lower investment grade, and it is a component of the S&P 500.

PNW shares are currently trading at $70.50, down 31.9% from their February 2020 peak of $103.50. At that time, the dividend yield was 3.0%, the Federal Funds Rate was 1.5%, and the 30-year treasury yield was 2.25%. Utility dividends seemed like a potent alternative to most other yields available in the market three years ago. Today, however, the 30-year yield is 4.74% and utility dividends have some competition, so share prices are down. Pinnacle Westโ€™s current dividend is 5.0%, slightly higher than 30-year treasuries, but below the current 3-month interest rate of 5.24%. While utilities have been marked down by 15.0% by the market this year according to Morningstar, most yields are still slightly lower than treasuries, so if you are purchasing shares they need to have the possibility of appreciation upside.

Pinnacle West Capital โ€“ Overall Performance and Future Projections

The latest earnings per share guidance for 2023 is $4.10-$4.30 on a GAAP basis. Pinnacle has projected long-term growth of 5.0-7.0% for earnings per share, with retail customer growth of 1.5% to 2.5% per year. The preliminary consensus for 2024 is now $4.50 per share. In order to value PNW shares, P/E ratios and a discounted cash flow model are used.

Predicting PNWโ€™s Share Valuation and Analysis

Using the projected EPS and P/E ratio, the fair value of the company is estimated to be in the range of $66.83-$72.00. Additionally, a discounted cash flow method suggests a fair value of around $67.00 per share, making anything below $70.00 a strong entry point for Pinnacle.

Pinnacleโ€™s Service Area and Regulatory Environment

APS, PNWโ€™s electric subsidiary, operates in 11 of Arizonaโ€™s 15 counties and the company has a generating capacity of 6,300 megawatts. About 51.0% of this is โ€œcleanโ€ energy generation today. Its territory includes the major Arizona cities of Phoenix, Tucson, Flagstaff, Yuma, and Prescott. APSโ€™ retail customer base has traditionally grown at 1.5-2.5% per year, and given the population statistics, this growth trend is projected to continue.

Current Regulatory Environment and Impact on PNW

APS currently has one of the more moderate consumer electric rates in the country. Regulatory decisions have led to fluctuations in the companyโ€™s allowable return on equity and rate structure, impacting its earnings and growth trajectory. Moreover, there is a $378.0 million rate increase currently pending, which is expected to enhance electric residential rates by 11.2% when approved in early 2024.

Pinnacleโ€™s Capital Expenditures and Renewable Targets

Pinnacle has set ambitious goals for rebalancing its current generation portfolio by 2030, with targets of a power generation mix of 65.0% clean energy and 45.0% renewable energy, while also aiming to end the use of coal generation by 2031. This shift necessitates a $5.45 billion capital expenditure plan to transition into renewable sectors over the next three years.

Pinnacleโ€™s Sustainable Dividend and Debt Management

Pinnacle West has a history of steadily increasing dividends, and despite recent muted growth, the 5.0% dividend yield remains sustainable with strong cash flow support. The companyโ€™s long-term debt and equity ratios remain within reasonable and manageable levels, further supporting its financial stability.

Risks and Conclusion

The company faces potential risks associated with customer shift to residential solar installations and the regulatory dynamics in the state. However, with its strong service area and growth potential, Pinnacle West presents an attractive investment opportunity. Shares have been discounted to a compelling entry point, backed by a sustainable dividend, making it a promising prospect for discerning investors.

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