Avista (AVA) Q2 2023: IRM Swings $0.11, Hydro Volatility Drives Guidance to Low End

August 2, 2023 | By EarningsIQ Research

Hydroelectric volatility and IRM cost swings defined Avista’s Q2, driving guidance to the lower end of the range. Management’s regulatory settlements and capital discipline are offset by weather-driven hydro generation shortfalls, exposing the utility’s earnings to environmental unpredictability. Investors should watch for IRM mechanism reforms and the impact of upcoming rate relief as Avista navigates a challenging operating environment.

Summary

• Hydro Volatility Exposed Earnings: Rapid spring snowmelt led to unusable water, swinging IRM from a benefit to a drag.
• Regulatory Progress Buoys Visibility: Multi-party settlements and rate relief agreements advance cost recovery efforts.
• IRM Mechanism Under Review: Management signals potential changes to cost-sharing structure in Washington.

Business Overview

Avista Corporation is a regulated utility providing electric and natural gas service across Washington, Idaho, and Oregon. The company’s core revenue streams are derived from regulated rates tied to its electric and gas operations, with Avista Utilities as the primary segment and Alaska Electric Light & Power (AEL&P) as a smaller contributor. Avista also maintains a portfolio of non-regulated investments, though these represent a minor portion of total earnings.

Performance Analysis

Q2 performance was shaped by a sharp reversal in hydro conditions, which directly impacted Avista’s earnings through the Energy Recovery Mechanism (ERM, a Washington-specific cost-sharing tool for hydro-related power cost volatility). Early-year optimism, driven by strong snowpack and a cold spring, gave way to rapid May warming, causing most snow to melt in a single month. This resulted in excess water that could not be converted to hydroelectric generation, reducing expected power output at the worst possible time and triggering higher power purchase costs.

While rate case wins and customer growth supported margin improvements, the IRM swung from a $0.03 benefit in Q1 to an $0.08 drag—an $0.11 swing that pushed full-year guidance to the low end of the range. Capital expenditures remained on track, with $220 million deployed in the first half against a $475 million full-year plan. Non-regulated investments continued to introduce minor earnings volatility, though management expects these to normalize within the $0.04 to $0.06 range for the year.

• Hydro Shortfall Impact: Fast snowmelt created excess, unusable water, reducing hydro output and increasing reliance on costlier purchased power.
• IRM Cost Share Shift: The ERM flipped from a benefit to an $0.08 per share drag, underscoring Avista’s exposure to hydro variability.
• Regulatory Settlements: Idaho and Oregon multi-party agreements secured, providing some rate relief and earnings visibility for H2.

Liquidity remains healthy after a $100 million credit facility termination and a $500 million line of credit expansion, supporting ongoing infrastructure investment. Management’s reaffirmed guidance signals confidence in the underlying business, but underscores the need for IRM reform and continued regulatory engagement.

Executive Commentary

Strategic Positioning

1. Hydro Exposure and ERM Volatility

Avista’s earnings remain highly sensitive to hydroelectric conditions, with the ERM acting as both a buffer and a risk amplifier. The Q2 swing from benefit to cost highlights the need for a more resilient cost-sharing mechanism, especially as climate volatility increases.

2. Regulatory Advances and Rate Relief

Multi-party settlements in Idaho and Oregon have provided rate certainty and will offset some inflationary and cost pressures in H2. These regulatory wins are critical for margin stability and for supporting ongoing infrastructure investment.

3. Capital Deployment and Grid Modernization

Ongoing capital investment—$475 million planned for Avista Utilities in 2023—focuses on grid hardening, reliability, and modernization. This supports long-term rate base growth but requires consistent regulatory support to avoid earnings dilution from lagging cost recovery.

4. Balance Sheet and Liquidity Management

Avista expanded its credit facility and maintains $292 million in available liquidity, providing flexibility for both planned capex and unforeseen volatility. The planned $120 million equity issuance for 2023 (with $60 million already completed) also supports capital structure discipline.

5. IRM Mechanism Under Scrutiny

Management is actively reviewing the ERM cost-sharing structure, signaling a willingness to propose reforms that could reduce future earnings swings tied to hydro conditions in Washington.

Key Considerations

This quarter underscores Avista’s dual reliance on regulatory execution and environmental conditions. Management’s focus is on balancing infrastructure investment, cost discipline, and regulatory advocacy to navigate a volatile operating environment.

Key Considerations:

• Hydro-Driven Earnings Swings: Avista’s results can shift rapidly with weather patterns, exposing the business to unpredictable margin pressure.
• IRM Reform Potential: A new cost-sharing structure could stabilize future earnings, but regulatory negotiations will be complex.
• Rate Relief Execution: Timely implementation of Idaho and Oregon settlements is essential to maintain earnings trajectory in H2.
• Capital Discipline: Infrastructure investment is on track, but continued access to capital and regulatory support are required to avoid dilution.

Risks

Environmental unpredictability remains the dominant risk, as hydro generation volatility can materially impact margins and guidance. Regulatory lag, especially if rate relief is delayed or diluted, could pressure returns on capital investment. The IRM’s current structure exposes Avista to outsized earnings swings, and any delay in reform increases future volatility. Non-regulated investment mark-to-market adjustments also add minor but persistent unpredictability.

Forward Outlook

For Q3 2023, Avista expects:

• Only 5% of annual utility earnings to be recognized, with the bulk (50%) in Q4, excluding IRM impacts.
• Continued headwinds from higher IRM costs, with full-year drag expected at $0.08 per share.

For full-year 2023, management reaffirmed consolidated earnings guidance of $2.27 to $2.47 per diluted share, but expects results at the lower end due to hydro-driven IRM costs. Management highlighted:

• Timely regulatory relief as a key assumption for guidance.
• Potential IRM mechanism reforms under active review.

Takeaways

• Hydro Volatility Drives Guidance: Rapid May snowmelt and unusable water drove a sharp IRM swing, pushing guidance to the low end despite operational discipline.
• Regulatory Progress Offsets Some Risk: Multi-party rate settlements in Idaho and Oregon provide earnings visibility, but environmental unpredictability remains a persistent headwind.
• IRM Reform and Rate Relief Critical for Stability: Investors should watch for updates on cost-sharing mechanism changes and the pace of regulatory approvals to gauge future earnings stability.

Conclusion

Avista’s Q2 demonstrated the company’s operational resilience and regulatory progress, but also revealed the ongoing earnings sensitivity to hydro conditions and IRM cost swings. The company’s forward trajectory will depend on its ability to secure timely rate relief, reform the IRM, and maintain disciplined capital allocation in a volatile environment.

Industry Read-Through

Avista’s quarter offers a cautionary signal for regulated utilities with significant hydro exposure. As climate patterns become more erratic, weather-driven volatility can overwhelm traditional cost recovery mechanisms, necessitating regulatory reform. Utilities across the Pacific Northwest and other hydro-dependent regions should anticipate similar challenges, with cost-sharing mechanisms and rate case agility becoming critical tools. For investors, the call highlights the need to scrutinize environmental risk management and regulatory relationships in utility portfolios.

AVA Utilities Electric Hydroelectric Regulation IRM Rate Cases Capital Expenditure