Grid Modernization And Arizona Expansion Will Create Future Value

Key Takeaways

• Strong customer growth and large-scale infrastructure investments are driving significant revenue and earnings expansion potential, especially from commercial and industrial demand.
  
• Regulatory modernization and grid upgrades are improving cost recovery, operational efficiency, and positioning the company for long-term stability and growth.
  
• Ongoing reliance on fossil fuels, regulatory lag, potential overbuilding, extreme weather costs, and slow renewable adoption all threaten competitiveness and future earnings stability.

Catalysts

Through its subsidiary, provides retail and wholesale electric services primarily in the state of Arizona.

• Sustained population and economic growth in Arizona, supported by record new jobs and major investments, is driving robust customer and volumetric demand, which underpins long-term revenue and earnings growth expectations.
  
• Pinnacle West's accelerated infrastructure investments in transmission, distribution, and generation (including the new regional natural gas pipeline and major grid projects) are expected to significantly expand the regulated rate base, supporting higher allowed returns and future revenue growth.
  
• The ongoing influx of large commercial and industrial customers (notably data centers and manufacturers), along with a backlog of nearly 20 GW in uncommitted customer interconnection requests, signals substantial upside potential for volumetric sales and rate base expansion, positively impacting revenue and long-term earnings.
  
• The company's progress on regulatory modernization, including proposals for formula rate mechanisms and rate design adjustments to ensure large customers pay their full share, should improve cost recovery, reduce regulatory lag, and stabilize net margins as future capital investments come online.
  
• Investments in grid modernization and resiliency (such as advanced infrastructure for wildfire mitigation, automation, and predictive maintenance) position Pinnacle West to capitalize on increasing electrification and decarbonization efforts, supporting both operational efficiency and margin stability.

Pinnacle West Capital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Pinnacle West Capital's revenue will grow by 5.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 11.0% today to 13.0% in 3 years time.
• Analysts expect earnings to reach $794.2 million (and earnings per share of $5.97) by about August 2028, up from $576.1 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $685 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.4x on those 2028 earnings, up from 18.7x today. This future PE is about the same as the current PE for the US Electric Utilities industry at 20.4x.
• Analysts expect the number of shares outstanding to grow by 5.04% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.78%, as per the Simply Wall St company report.

Pinnacle West Capital Future Earnings Per Share Growth

Risks

• Continued reliance on natural gas and coal generation, along with significant future investments in new gas infrastructure, exposes Pinnacle West to long-term stranded asset risks and higher operating expenses as decarbonization policies and renewable competitiveness accelerate, potentially impacting earnings and asset values.
  
• Regulatory lag remains a significant concern, as the next major rate relief will not be implemented until late 2026, and cost recovery will be initially based on 2024 test year data, potentially constraining net margins and earnings growth during a period of elevated capital spending.
  
• Substantial "uncommitted queue" of load requests and high capital investment plans in generation and transmission infrastructure could lead to overbuilding if expected customer and demand growth fails to materialize, causing underutilized assets and impairing future revenue.
  
• Extreme weather events, such as frequent and severe heat waves and wildfires, are resulting in unprecedented peak demands and reliability challenges that drive up operations & maintenance (O&M) expenses and necessitate significant resiliency investments, threatening stable earnings.
  
• Delays in accelerating renewables adoption (as indicated by the shift from explicit interim clean energy targets to long-term carbon neutrality) could leave the company increasingly uncompetitive, require higher near-term capital expenditures, and put pressure on long-term revenue and profit growth versus faster-moving peers.

Valuation

• The analysts have a consensus price target of $96.538 for Pinnacle West Capital based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $110.0, and the most bearish reporting a price target of just $80.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $6.1 billion, earnings will come to $794.2 million, and it would be trading on a PE ratio of 20.4x, assuming you use a discount rate of 6.8%.
• Given the current share price of $89.96, the analyst price target of $96.54 is 6.8% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.