American Electric Power (AEP) is one of the largest regulated utilities. With a market capitalization of $21 billion, AEP ranks as the eighth-largest utility by market cap. AEP is among the nation's largest generators of electricity with over 40,000MW of capacity. In addition, the firm is the largest owner of electric transmission lines with over 39,000 miles, of which it owns more ultra-high voltage lines than all other transmission companies combined.
AEP serves over 5.3 million customers in 11 states as a regulated electric utility. The states covered are Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia, and West Virginia. Ohio is its largest market and represents about 32% of overall retail electric revenue while Texas is second with 12%. AEP services 41% of all electric customers in Ohio. In addition, AEP operates a fleet of railcars, boats and barges to logistically handle its large coal consumption. 57% of revenue from AEP River Operations was generated from coal with 43% non-coal related.
Even with the closing of some coal-fired plants, coal remains a majority of the fuel sourced for generation. As of the most recent AEP November 2012 Factsheet , coal represented 63% of generating fuel, natural gas 24%, hydro/wind 8%, and nuclear 5%. Management has announced the closing of 5,100MW of generating capacity by 2016, the majority of which is coal-fired.
One of AEP's major strengths is also its current weakness - the large exposure to the Ohio regulated electricity market. There has been a push to deregulate the power markets in Ohio by 2015 and AEP is in the process of transforming its business to comply. This entails transferring generating plants to either their neighboring regulated businesses or to their merchant power operating segment. For example, AEP filed in December to transfer its Mitchell coal plant from Ohio Power to its regulated subsidiaries, Appalachian Power and Kentucky Power, as part of the corporate separation plan. AEP intends to transfer 50% to Appalachian Power and the other 50% of the plant to Kentucky Power. Additionally, AEP made a filing in December to transfer the remaining 2/3rds of unit 3 at the Amos coal plant from Ohio Power to Appalachian Power. To complete the transfer, regulatory approvals are required from the Virginia Commission, the West Virginia Commission, and FERC.
In addition to the restructuring of its Ohio assets, AEP will be subject to customer switching when the deregulation becomes fully effective in 2015. The extent of the switching and the final outcome of the corporate asset separation has created ambiguity in a business where investors value the opposite - certainly of revenue, earnings and return on invested capital. This uncertainty is probably the reason for AEP's relatively underperforming share price.
Looking past the uncertainty, there is a lot to like about American Electric Power. AEP could be considered in the "4+4+4" category that includes some of the best managed firms in the utility sector - 4%+ dividend yield, 4%+ dividend growth, 4%+ earnings growth (the most recent eps growth is negative, but the outlook is for a return to 4%+ in 2013).
Below compares selected estimated operating fundamentals of AEP, D, FE and SO
Gross Margins 2011
Gross Margins 2012 e
Gross Margins 2013 e
Operating Margins 2011
Operating Margins 2012 e
Operating Margins 2013 e
Net Margins 2011
Net Margins 2012 e
Net Margins 2013 e
2012 EPS e
2013 EPS e
2014 EPS e
2015 EPS e
Est EPS Growth 2011-2015
Est EPS Growth 2012-2015
Source: finance.yahoo.com, reuter.com, Morningstar
AEP offers a 4.4% current yield, a five-year dividend growth of 4.28% and a payout ratio of a comfortable 63%. Gross, operating and net margins are comparable with SO, considered one of the best-managed regulated utilities in the sector. SO may get a nod due to historically better regulatory environments in the Southeast versus the Midwest.
The following table compares anticipated 2013 PE, beta, trailing 12 month (TTM) return on invested capital, five-yr average return on invested capital, long-term debt to equity, and current payout ratio:
ROIC 5-yr Avg
Source: finance.yahoo.com, reuters.com
AEP offers a 4.4% current yield, a five-year dividend growth of 4.28% and a payout ratio of a comfortable 63%. The slightly lower five-yr ROIC compared with SO is offset by a 12% reduction in anticipated 2013 PE ratios. AEP management has generated about average for the industry for both TTM and five-year average for ROIC.
In the current low interest rate environment, state regulators have been reducing allowable returns. AEP seems to be in the middle of the industry for allowable returns across its regulated asset base. Below is a list of recent rate cases by operating area:
A major bright spot for AEP is its transmission business. The FERC regulates interstate transmission rates and historically has allowed a higher rate of return than most state regulatory bodies. AEP has approved capital expenditure transmission projects totaling $1.9 billion going out to 2015. Based on a current rate base asset pool of $350 million, this represents a large commitment to expand its transmission footprint. The company has estimated its transmission business generated about $0.08 per share in earnings in 2012. By 2015, transmission earnings could exceed $0.35. Below is a graphic from the Dec 2012 investor presentation outlining this growth.
As indicated above, the FERC has allowed a higher ROE. AEP's Transco operating unit has a current allowed ROE of between 11.20 to 11.49%, ETT of 9.96% and Prairie Wind of 12.8%. The majority of earnings growth between 2012 and 2015 will be generated from AEP's transmission operations. While not a large percentage of overall earnings, it is obvious this higher margin business is, and will continue to be, an important driver of future investor returns.
AEP offers utility investors diversification across both regulated and non-regulated assets. Management has a stated goal of maintaining an 85% ratio of regulated assets, with a growing exposure to higher-margined transmission assets.
Due to the uncertainly as to the outcome of the 2015 deregulation in Ohio, AEP is ranked either Neutral or a "Weak Buy" by many on the Street. Investors seeking a well-managed regulated utility that is out of favor with most analysts should review AEP. Investors should expect 4% to 6% annual growth in share price along with a 4% dividend yield, for a total stock return in the 8% to 10% range. As AEP expands its regulated transmission base past 2015 and as the uncertainty in Ohio dissipates, earnings, dividends and share price will continue to expand.
Author's Note: Please review important disclaimer in author's profile.