Constellation Energy Corporation

Good day, ladies and gentlemen, and welcome to the Constellation Energy Corporation's second quarter 2023 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to introduce your host for today's call, Emily Duncan, Senior Vice President, Investor Relations. You may begin.

Good morning, everyone, and thank you for joining Constellation Energy Corporation's second quarter earnings conference call. Leading the call today are Joe Dominguez, Constellation's president and chief executive officer, and Dan Eggers, Constellation's chief financial officer. They are joined by other members of Constellation's senior management team who will be available to answer your questions following our prepared remarks. We issued our earnings release this morning along with the presentation, all of which can be found in the investor relations section of Constellation's website. The earnings release and other matters which we discussed during today's call contain forward-looking statements and estimates regarding Constellation and its subsidiaries that are subject to various risks and uncertainties. Actual results could differ from our forward-looking statements based on factors and assumptions discussed in today's material and comments made during this call. Please refer to today's 8K and Constellation's other SEC Today's presentation also includes references to adjusted EBITDA and other non-GAAP measures. Please refer to the information contained in the appendix of our presentation and our earnings release for reconciliations between the non-GAAP measures and the nearest equivalent GAAP measures. I'll now turn it over to Joe Dominguez, the CEO of Constellation.

Thanks, Emily. Good morning, everyone. Thanks for joining our call. I'm sorry about the delayed start here. I know it's a busy day for many of you, but it's a reminder of the old adage that all very good things are worth waiting for. I want to begin by thanking the women and men of Constellation for delivering a fantastic second quarter. It builds on the great work they did in the first quarter. For the second quarter, we earned $1 billion and $31 billion in adjusted EBITDA. As a result of the strong year-to-date results and our expectations for the performance to continue, We are raising our 2023 adjusted EBITDA guidance range by $400 million to $3.3 to $3.7 billion. And we remain, despite this update, bullish for the balance of the year. What's more, the strong performance of the team is now limited to 2023. As you can see in the disclosures, it also reflects an increase in our 2024 gross margin updates. which is increased by another $150 million on top of the $100 million increase you saw just a quarter ago. And we continue to find opportunity for further improvement. Our O&M remains on plan with the only material variance being the expected increase in employee compensation and profit sharing that comes with such an extraordinary year. Of course, Dan will discuss all of the drivers in more detail in his remarks, but the short story here is this. In Constellation, you own the largest and most reliable clean energy fleet in America, as well as the best CNI and commercial platform in the business. We strategically couple these businesses with a strong balance sheet that, in turn, gives us a powerful competitive advantage across all retail and load channels. It all translates into a unique ability to give our customers the certainty and visibility they want on energy costs and sustainability solutions, and ultimately leads to margin expansion and better value for you. In addition to the strong financial results I just touched upon, we had a great operational quarter, which I'll go through. And we also had some exciting developments since our last earnings call. That should give you great confidence in the long run strength of our company. First, we announced the acquisition of 44% of the dual unit South Texas Project nuclear station from NRG last month. This is an excellent asset. It's one of the youngest and largest in the country. And like our fleet, it has been well maintained. Regulatory approval has been filed with the NRC, and we expect to be able to close by the end of the year. Second, we announced a deal with Microsoft to provide them with an hourly time-matched clean energy product. It's the first agreement of its kind, and we think it will lead to many more. I'll cover the importance of that deal in a moment. Third, we reached an agreement with NYSERDA to share the value of the PTC with New York customers. New York was the first state to adopt a program that recognizes the unique value of clean carbon-free nuclear energy, and so it makes sense that they are first in receiving the benefits of the IRA. The resolution of this issue is exactly what we planned for. Fourth, at Constellation, you know that our mission is to accelerate the transition to a clean, carbon-free future, but we think that natural gas is an important bridge fuel, and we have invested in technologies to make natural gas generation cleaner. In May, we set an industry record for blending hydrogen with natural gas at our Hillaby Generating Station to reduce emissions. The test showed that with only minor modifications, an existing natural gas plant, I think this plant is a little bit over 15 years old, that kind of technology can safely operate on a blend of nearly 40% clean hydrogen and 60% natural gas, nearly doubling the previous blending record for similar generation stations. As many of you know, EPA's proposed regulations for reducing carbon emissions from gas-powered plants depends upon clean hydrogen blending, and we just showed that it works. In addition, we have worked on gas generation with carbon capture technologies that have the potential of making natural gas generation truly carbon-free. We have been investors and collaborators in NetPower and its CCUS technology for many years. We were pleased to see the successful launch of this publicly traded company with our stake presently valued at over $450 million. These accomplishments and many more are laid out in our second sustainability report that we published last month. It details how Constellation and its customers are leading the fight against the climate crisis. your reading. Now before I turn to the quarterly operational updates, let me remind you that we just launched this company. August 2nd marked the first 18 months of our business and I think folks would be hard pressed to find a better launch and we appreciate you being on that journey with you. Let me turn to slide 6. We saw strong performance across our generation fleet during the quarter and meeting or exceeding our operational targets, and we have continued to see good performance in July. That's one of the reasons we have such confidence in the updates we're providing you today. Our nuclear plants had a second quarter capacity factor of 92.4%. Folks, that's even with five refueling outages during the quarter. And these outages were completed in less than 24 days on average. By the way, just for context, that's two weeks less time than the industry average for refuels. Scale matters. Our power assets have exceeded their plan, delivering a dispatch match of 99.1%, meaning they were available just about every time they were called. Our Texas fleet continues to meet the challenge of extreme heat this summer, putting needed power on the grid, and allowing us to capture additional value from the higher prices that we are seeing. And lastly, our renewables fleet performed near plan, despite the lower wind speed that it seems just about everyone is talking about. Turning to slide seven, as I mentioned, our commercial business is driving the outperformance this year because of the way that we optimize our positions across both the generation and load portfolios to create additional gross margin. We saw just that during the quarter. The team also continues to have success in helping our customers meet their sustainability needs. But this quarter, our team made history setting a new bar for corporate procurements. As I touched upon previously, in June, we reached a landmark agreement with Microsoft that combines the environmental attributes of nuclear power with renewable energy to produce a time-matched clean energy solution for Microsoft. This agreement enables one of Microsoft's facilities to time match clean energy production and energy use in order to operate on nearly 100% clean power every single hour of the day. Matching clean energy production to the exact moment when a customer uses energy is essential to reaching carbon reduction goals while maintaining electric reliability. You'll recall that the first generation of clean energy accounting rules, as well as state clean energy programs, allowed customers to claim that they are reducing emissions even when the credits they're buying are from electricity produced in faraway regions or at a completely different day, time, or even year. In effect, we were allowing people to take RECs from April and pretend that it was offsetting energy consumption in July or August. People were buying RECs from Texas and pretending it was deliverable in New England or the Mid-Atlantic to meet sustainability goals. Now, to be fair, this approach was a good starting point, but leaves a large gap between stated emissions and reduction goals and actual emissions reductions. Unfortunately, it also sent the wrong message. It told developers to build generation in places where customers are not located and encouraged them to produce energy at times customers don't need it. Among other things, that mismatch in time and location has led to the enormous interconnection problems that we're really seeing across the nation and which, in our opinion, will only get worse. It is a tough problem, but the answer is simple. In order to meet the climate crisis head-on and preserve electric reliability, we need clean energy that predictably operates so that output is time-matched to customer demand. As we see in Europe and elsewhere, clean energy, time, and geographic matching is where energy policy and corporate sustainability must go. The leading sustainability companies in the nation and the world's governments and NGOs get that. Constellation and Microsoft are leading by example with this landmark agreement. It shows that time matching works, and it shows that nuclear energy in combination with renewable energy can make it all happen. Basically, nuclear fills the gap when the wind isn't blowing and when the sun doesn't shine, and that produces a solution that cannot be matched by renewables alone. Having Microsoft, one of the world's sustainability leaders, recognizing the value of nuclear as a sustainability solution that will lead to even better environmental outcomes is a very big deal. It paves the way for others to follow. And this is the way I think about it. 2022 will always be remembered as the year in which the federal government finally began to put nuclear energy in the high echelon of premium, clean energy products that must be supported by policy as a national priority. I believe that 2023 will go down as the year in which large customers begin to think the same way and recognize the reality that including nuclear energy and sustainability solutions leads to even better outcomes. My compliments to the Microsoft team and their vision. We're glad to have them both as a partner and as a customer. I'll now turn it over to Dan for a more detailed update on the financial outlook. Dan? Thank you, Joe, and good morning, everyone. Beginning on slide eight, as Joe mentioned, we continue to see strong performance from the business that is driving our earnings results and expectations for the year. We earned $1.031 billion in adjusted EBITDA in the second quarter, which compares to $603 million last year. We realized higher prices on our generation output compared to 2022, and the commercial team had another exceptional quarter. They captured significant value from higher margins, successful load auction wins, and through optimization of the portfolio as volatility in the market persisted through the second quarter. The volatility creates opportunities to help our customers who are looking for certainty in their costs, and we can provide it where others cannot, in part due to our strong investment-grade balance sheet. Volatility also leads to higher unit margins as risk is more appropriately priced in, and we can optimize our positions across our load serving and generation businesses, which creates additional value. This performance flowed through our quarterly results and also improved our expectations for the remainder of the year, which I will discuss in a few minutes. In addition to the strong performance of our team this quarter, we recognized $218 million of EBITDA from the Illinois ZEC program for the full 2023-2024 planning year covering June of this year through May of next year. As some of you may recall from when the legislation was passed, the Illinois ZEC program is subject to an overall cost cap as one of its consumer protection features. Over the course of the program to date, that cost cap has been reached in each planning year and thus, we had ZECs that were produced, but we are not compensated for. The law allows for this revenue to be banked and compensated in a subsequent planning year when the cost cap is not reached. For the 2023-2024 planning year, the ZEC price is 30 cents per megawatt hour, and so for the first time, the cost cap will not be reached. Therefore, some of those uncompensated ZECs from prior years will be recovered in this cycle up to the level of the overall cost cap. Our gross margin tables for 2023 and 2024 have already included the use of Bank's X on a ratable basis over the planning year. However, accounting rules require us to instead recognize the full planning year's banked revenues at the beginning of the planning year, which caused us to recognize the $218 million in June, and therefore pulling forward some revenues in the full year 2023 from 2024. The change in timing is now reflected in our updated gross margin tables for both 2023 and 2024. To put all this in context, Clinton and Quad Cities have received an average realized price for energy, capacity, and ZECs of $40 to $45 per megawatt hour during the first six years of the program. Looking forward, we forecast energy capacity in ZECs to be at least at PTC levels over the remaining life of the ZEC program. As a refresher, slide 19 in the appendix provides more details on the mechanics of the Illinois ZEC program. Turning to slide 9 in our gross margin outlook, we've increased our gross margin forecast for 2023 and 2024, incorporating the strong execution and performance Joe and I have discussed. For 2023, total gross margin increased by $350 million. The increase primarily reflects our performance in our commercial business, strong margins, higher customer win rates, and opportunities created by the sustained volatility in commodity markets. As a result, we executed $400 million of our Power New Business target. This benefit is seen on the table in the marked market of hedges lines. as executed business moves out of the power to go line. In addition, we raised our new business target by $300 million based on our expectations to continue to create value during the remainder of the year. Our contracted revenue line also increased by about $100 million due to the Illinois ZEC timing I just covered. In 2024, our total gross margin, including PTCs, is $9.2 billion. of $150 million from our last update. Lower prices were offset by an increase in expected nuclear PTCs from plants without existing ZEC programs, reinforcing the downside protection the PTC provides against declining power prices. Consistent with what we are seeing in 2023, the favorable margin trends with our CNI customers and load auctions are showing up in business being contracted into 2024. This favorability is supporting the $150 million increase in our overall 2024 gross margin outlook. Our disclosures currently do not reflect the SDP acquisition. Following our typical practice, we will include them once we have closed the transaction and expect SDP will be included in our fourth quarter disclosures. Moving to slide 10, we are raising our full year EBITDA guidance outlook by $400 million to a $3.5 billion bit point, the new range of $3.3 to $3.7 billion. This upward revision reflects the significant increase to our gross margin forecast since the beginning of the year, which is slightly offset by an increase to our O&M, driven by increased compensation for our employees due to the strong financial performance of the company this year. Turning to financing and liquidity update on slide 11, Our strong balance sheet is critical to our business model, allowing us to participate in volatile markets in ways that many others cannot. It also supports our capital allocation strategy, providing us with options from organic and inorganic growth to capital return. Keeping in step with this advantage, Moody's upgraded its outlook from stable to positive during the quarter, referencing our balance sheet strength and recognition of the commodity provided by the PPC. We want to thank our colleagues at Moody's for their thoughtfulness, and we look forward to continued productive conversations. Our credit metrics remain on target and well above our downgrade thresholds. As we discussed during the SDP announcement call, we plan to issue debt later this year to fund the transaction We have now completed half of the $1 billion buyback program authorized by our board in February. We purchased an additional 3 million shares through the end of the second quarter, including through June. We continue to see our stock as attractive at these levels and will be opportunistic for the remainder of the authorized program. We still have an additional $1.2 billion of unallocated capital in 2023 and 2024 to create additional shareholder value growth investments, M&A, or additional return of capital to our owners. I'll now turn the call back to Joe for his closing remarks. Thanks, Dan. That's a good summary. Folks, this management team remains focused on creating value for our shareholders. Our business is unique, and we continue to have many opportunities in front of us to create incremental value for our investors. As you know, we're the best operator of nuclear plants and the largest producer of carbon-free electricity in the United States. Our commercial business serves nearly 25% of the competitive CNI market in the United States and is helping our customers, like Microsoft, meet their sustainability goals through products like our hourly matching product. Our businesses are essential to addressing the climate crisis, and our assets are durable. The Inflation Reduction Act provides unique opportunities for Constellation and its investors. We believe we will be able to use nuclear energy to produce hydrogen. We will be able to relicense our nuclear fleet to run at least 80 years without needing to replace it. And the IRA provides, at long last, the long-term commitment that nuclear energy is part of the national security of this great nation. And we have many ways to grow and bring more value to our shareholders. Against a baseline earnings level supported by the PTC floor over the length of the PTC, we will benefit from floor price inflation. If you're a believer that 2% inflation for the US is going to be hard to reach, then you should like this company a great deal. We generate strong free cash flow that can be used to fund robust organic growth at double-digit unlevered returns, discipline the M&A like the SDP deal, fund a growing dividend, and buy back stock. We're doing all of those things already. We've announced a $1.5 billion growth in upgrades, hydrogen, and wind repowering, double the first-year dividend, and have bought back. approximately $500 million of our own stock as part of the authorized $1 billion buyback. And as Dan mentioned, there's more we can do. We have $1.2 billion of unallocated capital in 23 and 24 that can be used to further enhance our earnings growth in the ways that I've outlined. Constellation is a uniform that cannot be matched anywhere in the marketplace. Our large, clean, carbon-free nuclear fleet, paired with our customer-facing business, provides us with opportunities to grow and create value for our shareholders. And that's what we're focused on. Now, Dan and I and the rest of the management team look forward to your questions.