Executive Summary / Key Takeaways

• Pinnacle West (PNW), through its primary subsidiary APS, is strategically positioned to capitalize on unprecedented economic and population growth in Arizona, particularly driven by the booming semiconductor, advanced manufacturing, and data center sectors.
• The company's significant capital plan ($9.65 billion through 2027) aims to expand and modernize the grid, enhance reliability, and integrate clean energy resources, targeting 6-8% rate base growth.
• PNW is actively pursuing regulatory reform, including proposing a formula rate plan in its upcoming mid-2025 rate case, to address persistent regulatory lag and improve the timeliness and predictability of cost recovery.
• While strong sales growth and strategic investments provide tailwinds, near-term earnings are pressured by regulatory lag on rising costs (O&M, D&A, interest) and the absence of prior-year one-time benefits, reflected in the 2025 EPS guidance range of $4.40 to $4.60.
• The long-term investment thesis hinges on successful execution of the capital plan, favorable regulatory outcomes to mitigate lag, and continued strong economic development in Arizona, supporting the reaffirmed 5-7% long-term EPS growth target.

Powering the Desert Bloom: Pinnacle West's Strategic Response to Arizona's Growth

Pinnacle West Capital Corporation, rooted in Arizona since 1886 through its principal subsidiary Arizona Public Service Company (APS), operates as a regulated electric utility holding company. APS serves approximately 1.4 million retail customers across 11 counties, forming the backbone of Pinnacle West's business and contributing essentially all of its revenue and earnings. The company's historical journey reflects the evolution of Arizona's economy, transitioning from a predominantly residential customer base to a more diverse mix that now includes significant commercial and industrial load, mirroring the state's emergence as a hub for advanced manufacturing and technology. This shift necessitates a fundamental transformation in how APS plans, builds, and operates its system.

Arizona is currently experiencing unprecedented economic and population growth. The state has become a national leader in the semiconductor and advanced manufacturing sectors, attracting massive investments like Taiwan Semiconductor Manufacturing Company (TSM)'s planned $165 billion total investment for six fabrication centers and related facilities, and Amcor Technology (AMCR)'s $2 billion investment. This influx is stimulating growth across the supply chain and other sectors like healthcare, driving robust demand for electricity. Retail customer growth reached 2.3% for the period ended March 31, 2025, with over 32,000 new residential meters installed in 2024 alone, the highest number since before the Great Recession. Weather-normalized retail electricity sales increased 2.1% in Q1 2025, propelled by strong commercial and industrial (C&I) growth of 5.3%, fueled by the ramp-up of manufacturing and data center customers. The company projects annual customer growth of 1.5% to 2.5% and weather-normalized sales growth of 4% to 6% through 2027, with 3% to 5% of sales growth attributed to extra high load factor C&I customers. This rapid expansion presents both a significant opportunity and a challenge, requiring substantial investment in infrastructure to maintain reliability.

In response to this surging demand, APS has embarked on the largest transmission and generation expansion in its history. The strategic Ten-Year Transmission Plan includes critical high-voltage lines and substations necessary to support growing energy needs and integrate new resources. The capital plan through 2027 totals $9.65 billion, a 24% increase from earlier projections, targeting 6-8% rate base growth. This plan includes investments in new generation, such as contracted simple cycle combustion turbines at Sundance (90 MW by 2026) and Redhawk (397 MW by 2028), and resources procured through competitive All-Source RFPs, including nearly 7,300 MW expected online between 2026 and 2028. Over 40% of these future capital investments are expected to qualify for more timely cost recovery through mechanisms like the System Reliability Benefit (SRB) surcharge or FERC formula rates, a strategic move to mitigate regulatory lag.

Navigating the Regulatory Landscape and Financial Performance

Despite the strong underlying growth drivers, Pinnacle West's financial performance in the near term is significantly influenced by the regulatory environment and the challenge of timely cost recovery. The company reported a consolidated net loss attributable to common shareholders of $5 million for the three months ended March 31, 2025, a decrease from net income of $17 million in the prior-year period. This decline was primarily driven by a $42 million increase in operations and maintenance (O&M) expenses (including higher planned generation outages and IT costs), a $25 million increase in depreciation and amortization (D&A) from increased plant and intangible assets, $9 million lower net pension and other postretirement non-service credits (due to amortization roll-off), and $5 million higher net interest charges. Additionally, other income was $9 million lower, primarily due to the absence of a gain on the sale of Bright Canyon Energy recognized in Q1 2024.

These negative impacts were partially offset by favorable factors, including a $46 million benefit from new rates implemented in March 2024, higher retail revenues from customer growth, increased transmission and LFCR revenue, and a gain from a non-utility equity investment by El Dorado. Operating revenues less fuel and purchased power expenses increased by $58 million, demonstrating the positive impact of new rates and growth on the top line before accounting for rising costs.

A key challenge highlighted by management is regulatory lag, particularly on income statement costs like O&M, interest expense, and pension expense, which have increased since the test year of the last rate case (dating back to July 2021). To address this, APS plans to file its next general rate case application with the Arizona Corporation Commission (ACC) mid-year 2025. This filing will seek recovery of necessary costs and investments and propose a modernized rate structure for high load factor customers. Crucially, it will include a formula rate proposal, consistent with the ACC's recently approved policy statement, aimed at reducing regulatory lag and enabling more timely, potentially annual, adjustments to keep rates aligned with costs and allow the company to earn closer to its authorized return on equity (9.55% in the last rate case). The outcome and implementation of this formula rate mechanism are critical for achieving a smoother, more predictable earnings profile going forward.

The company's liquidity position remains sound, supported by committed revolving credit facilities ($200 million for PNW, $1.25 billion for APS, both maturing in 2029). As of March 31, 2025, PNW had $44 million in commercial paper outstanding, while APS had $627 million. Both entities also have term loan facilities. Pinnacle West is utilizing equity forward sale agreements under its ATM program (approximately $800 million available) and non-ATM forwards to support its financing needs, with expected annual equity requirements in the range of $250 million to $300 million through 2027. The company maintains debt-to-capitalization ratios within covenant limits (59% for PNW, 50% for APS as of March 31, 2025) and holds stable credit ratings.

Strategic Initiatives, Technological Edge, and Competitive Positioning

Pinnacle West's strategy extends beyond infrastructure investment and regulatory efforts, encompassing a strong focus on operational reliability, customer experience, clean energy transition, and leveraging technology. The company aims for top-tier reliability, particularly crucial during Arizona's increasingly extreme summer heat. This involves robust planning, generation maintenance (including major outages at Four Corners and Palo Verde refueling), and investments in grid resilience, such as wildfire mitigation efforts using AI-based fire sensing cameras and implementing a Public Safety Power Shutoff (PSPS) program.

A foundational element of APS's resource portfolio is the Palo Verde Generating Station, one of the nation's largest carbon-free energy resources, providing reliable, around-the-clock power. The company is committed to a clean energy future with goals of 65% clean energy by 2030 (45% renewable) and 100% clean, carbon-free electricity by 2050, alongside a plan to exit coal-fired generation by 2031 (Cholla units retired in March 2025). This transition involves significant investment in solar, wind, and energy storage. APS is also exploring new nuclear generation technologies, like small modular reactors (SMRs), applying for a DOE grant for site exploration, recognizing the potential for reliable, carbon-free baseload power.

Technological advancements are integral to APS's operations. The new Energy Management System (EMS), live since April 2024, is expected to improve the integration of renewable and storage assets, maximize resource flexibility, and enhance participation in western energy markets like WEIM and the upcoming SPP Markets (APS expects to go live in 2027). This market participation aims to lower fuel and purchased power costs and improve grid situational awareness. In the demand-side management space, APS is implementing programs like the Bring-Your-Own-Device (BYOD) Battery Pilot Plan, approved in March 2025, which allows dispatching residential batteries for grid support, demonstrating an innovative approach to managing peak demand and integrating distributed resources. While specific, quantifiable technological advantages over competitors in terms of efficiency metrics or cost reduction are not detailed, the strategic intent is clear: leverage technology to enhance reliability, integrate clean energy, optimize grid operations, and manage costs, thereby strengthening the company's competitive position.

In the broader U.S. electric utility landscape, Pinnacle West competes with larger, geographically diversified players like Public Service Enterprise Group (PEG), Ameren (AEE), Duke Energy (DUK), and Southern Company (SO). While precise, directly comparable market share figures for all niche competitors are not publicly detailed, PNW holds a significant regional position in Arizona. Compared to these peers, PNW's operational efficiency in transmission and distribution, potentially benefiting from Arizona's geography and targeted investments, may offer an advantage. However, recent financial performance metrics, such as operating margins (PNW's TTM Operating Margin ~19.31% vs. PEG's ~23%, AEE's ~20%, DUK's ~26%, SO's ~26%) and profitability (PNW's TTM Net Margin ~11.28% vs. PEG's ~17%, AEE's ~16%, DUK's ~15%, SO's ~16%), suggest that PNW currently trails some peers in overall profitability and cost management efficiency, potentially due to the impact of regulatory lag on rising costs. PNW's debt-to-equity ratio (TTM ~1.80%) is also higher than some competitors (e.g., PEG ~1.42%, AEE ~1.55%, DUK ~1.70%, SO ~2.00%), indicating a more leveraged balance sheet. PNW's strategic focus on Arizona's high-growth market and clean energy transition differentiates it, but its financial metrics highlight the need for successful regulatory outcomes to close the gap with more financially robust peers. Indirect competition from decentralized renewable providers and energy storage solutions also poses a challenge, potentially offering cheaper alternatives that could impact demand for traditional grid services.

Risks and Outlook

The investment thesis for Pinnacle West is subject to several key risks. Regulatory and judicial decisions, particularly regarding rate cases, cost recovery mechanisms (like formula rates and SRB), and environmental compliance, could significantly impact financial results. The ongoing judicial review of the ACC's decisions on the Grid Access Charge (GAC) and the lawsuit challenging the formula rate policy statement introduce uncertainty. Environmental regulations, including those related to Coal Combustion Residuals (CCR), EPA's power plant carbon and effluent limitation guidelines, and the Good Neighbor Plan, could impose material compliance costs that APS intends to recover through rates, but the outcome of such recovery efforts is not guaranteed. Wildfire risk, including management expenses and potential liabilities, remains a concern, although the company is implementing mitigation strategies and seeking regulatory deferral for associated costs. The successful development and integration of new technologies, including energy storage and potential new nuclear, face technical and cost uncertainties. The ability to access capital markets at favorable rates to fund the substantial capital plan is also crucial, particularly in a volatile interest rate environment.

Despite these risks, management remains confident in the long-term outlook, reaffirming the 5% to 7% EPS growth guidance based on the midpoint of the original 2024 guidance range. This confidence is rooted in the robust economic growth and customer influx in Arizona, the strategic capital plan designed to meet this demand and enhance reliability, and the ongoing efforts to improve regulatory cost recovery. The 2025 EPS guidance range of $4.40 to $4.60 reflects the near-term pressures from regulatory lag and the absence of prior-year benefits, but the underlying business fundamentals, driven by growth and strategic investments, are expected to support the long-term trajectory.

Conclusion

Pinnacle West operates at the nexus of significant opportunity and challenge. The booming Arizona economy provides a powerful tailwind of customer and sales growth, necessitating substantial investment in grid infrastructure and clean energy resources. The company's strategic capital plan and focus on integrating advanced technologies like energy storage and AI-driven grid management are designed to meet this demand and enhance reliability. However, the persistent challenge of regulatory lag, particularly on rising operating and financing costs, currently pressures financial performance and differentiates PNW from peers with more favorable cost recovery mechanisms.

The upcoming rate case and the proposed formula rate plan represent a critical inflection point for addressing this lag and establishing a more stable financial foundation for future growth. While near-term earnings reflect the impact of unrecovered costs and the absence of one-time gains, the long-term investment thesis remains compelling, underpinned by Arizona's favorable growth dynamics and PNW's strategic investments. Investors should closely monitor the outcome of the regulatory proceedings, the company's execution of its expanded capital plan, and its ability to effectively manage costs and integrate new technologies to fully capitalize on the opportunities presented by the growing desert economy.