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American Electric Power (AEP) has posted healthy financial performance in the recent years. The company offers a decent dividend yield of 4.2%, next five years growth rate of 3.6% and has a PEG of 4. Based on these metrics AEP seems to be lagging behind its competitors Duke Energy (DUK) and Southern Company (SO). However, on the basis of its forward P/E of 13.9x, AEP is believed to be fairly valued. Therefore, I recommend a 'hold' rating on the stock.

AEP has delivered satisfactory financial performance in the past. In the last five years, the company has expanded its top line at a rate of 2.20% and boosted dividends by 3.5% on average. The earnings and dividends offered are stable and likely to be maintained, as more than 85% of the company's earnings are generated through regulated operations. Despite the fact that the company's earnings are less volatile (due to significant contribution by regulated earnings), demand growth for electricity has been on the lower end, which has translated into lower capital expenditures (CAPEX) and hence lower earnings growth. Analysts are anticipating a modest growth rate of 3.6% per annum for the next five years. The following chart shows the decreasing trend for CAPEX in the recent past.

Source: Annual Reports and Calculation

For the first quarter of 2013, AEP registered net revenues of $3.82 billion, beating the analysts' consensus of $3.74 billion, up 5.5% year-on-year basis. Operating earnings per share for the first quarter were $0.80, in line with analysts' consensus and prior year earnings figure. The following financial metrics displays return on average assets and equity along with margins for AEP for the recent three years.

Source: Annual Reports and Calculation

AEP offers a decent dividend yield of 4.2%. Quarterly dividend of $0.49 was declared by the company, representing an increase of more than 4% as compared to previous quarterly dividend. AEP management intended to maintain its dividend payout ratio in range of 60% - 70% and grow its dividends in line earnings growth. Following are the recent annualized dividends and payout ratio for AEP.

Source: Annual Reports and Calculation

AEP has been working to strengthen its balance sheet in recent years, which is evident from its decreasing total debt to capitalization and decent interest coverage ratio of 4.6x, which is higher than the company's target of >3.6x. Also, AEP has been increasing its funding for pension liabilities, and reducing its pension liability gap. This has strengthened the balance sheet for the company, as risk of underfunding the pension liability has decreased. According to the most recent quarter, earnings release pension liability funding stands at 94%.
(click to enlarge)
Source: Investors Presentation

S&P and Fitch has assigned ''BBB" credit rating to AEP. The following chart shows the debt maturity profile for the company from 2013 through 2017.

Source: Company Report

Coal to Gas Switch
AEP power generation system has experienced a decline of approximately 30% year-to-date in natural gas fired generation, while on the other hand coal fired generation increased 9% during the same time period. Decrease in natural gas fired generation was mainly due to rising natural gas prices and cost competitiveness fleet of the company. Coal fired power plants for AEP are located near coal mines which also give it a competitive edge for the use of coal instead of natural gas for power generation.

Outlook
AEP has a target to grow its earnings per share in the range of 4% to 6% in the long run. Last week, AEP reaffirmed its operating earnings guidance of $3.05 - $3.25. In contrast, analysts are anticipating EPS of $3.16 for fiscal year 2013.

Conclusion

AEP

Duke Energy

Southern Company

Exelon Corp. (EXC)

Average

Forward P/E

13.9x

14.7x

15.5x

13.4x

14.3x

PEG

4

3.8

3.35

-

3.70

Next 5 years growth rate

3.6%

4%

4.8%

-

4.10%

Debt to Equity

123%

100%

120%

94%

110%

Dividend Yield

4.2%

4.5%

4.6%

4%

4.35%

Source: Yahoo Finance

On the basis on relative valuation, AEP seems to be lagging behind its peers in the industry. AEP has a higher PEG of 4 as compared to its peers' average, indicating the company offers expensive growth. Also, AEP has a lower next five years growth rate of 3.6% as compared to peers' average of 4.10%. Moreover, a dividend yield of 4.2% and a debt-to-equity of 123% for AEP appears unattractive compared to its peers as shown in the table above. However, based on its forward P/E of 13.9x, which is below its peers average, AEP appears to be fairly valued. Therefore, I recommend a 'hold' rating for the stock.

Source: American Electric Power Is Steady