This is a spelling question: When you're reporting on a speech in
which the speaker stretches out the word "pretty" in the phrase
"pretty good," what is the convention for spelling the stretched-out
word? Would it be "p-r-e-t-t-y good"? Or would that suggest that the
speaker actually spelled out (pee are ee tee tee wye), which isn't the
case here?

I do not believe there is a universal convention except the convention
of actually reporting the words used by the speaker. So simply use
"pretty".

Court reporters, Congress reporters, Parliament reporters, Hansard
Reporters, Secretaries, Minute takers, etc. the world over do not try
to record the inflections of voice, or pronunciation, or lisp or
drawal, etc. of the speaker.

If your desire is to record so as to produce or reproduce accurately
the original pronunciation of the speaker there are recognised systems
for recording in writing the pronunciation, phonetic alphabet symbols,
etc. most commonly found used in dictionaries for recording
pronunciation of words. If accuracy is important you could employ one
of those systems to record the manner in which the word was actually
spoken.

The manner in which you propose then would more commonly be attempted
by writers of the type attempting to put character or meaning into the
writing typical of essays, short stories, plays, novels, poems, etc. I
suggest then that the use of "p-r-e-t-t-y" will have a meaning
depending on the context you have set up in that particular writing.
So if early in the story you write:
"S-e-x tonight dear?" he spelled to his wife as they sat at the dinner
table surrounded by their brood of 4 pre-school children."
Then later in the story I will assume "p-r-e-t-t-y good" means the
speaker spelled the word unless you change the intention by saying
something like " "P-r-e-t-t-y good" he lazily drawled."

Very good comment.  
I agree, in a narrative, I would include a description of how the
person spoke, maybe:  "p-r-e-t-t-y good," he replied hesitantly  -
or however you mean it.

Just my .02

I would take p-r-e-t-t-y as meaning that it was spelled out.

If the fact that the speaker drew out the word is important, say so.

CH

I would simply write 

   Mr. Smith said that the meal was pretty good, slowly drawing out
the word "pretty" for emphasis.

I agree that there isn't a standard convention.  A more common one is
repeating the letters that correspond to the drawn-out sounds, e.g.
"prreeeetty," but of course, this can give a distorted idea of the
vowel sound (the "e" in this case) and make it harder to recognize the
word.  As a test, I searched Google for some examples of such
spellings.  "Weeell" got 44,000 hits and "hellllo" got 64,600.  Even
"prreeeetty" got 95, to my surprise, and it looked like some of them
might even have been expressing elongation rather than bad spelling.

Thank you, these are very helpful comments.