Julie Sloat - SVP and Treasurer
Jim Davidson - Deputy Managing Partner, Ice Miller
American Electric Power Company Inc. (AEP) INVESTOhio Equity Conference Call September 12, 2013 9:55 AM ET
Jim Davidson - Deputy Managing Partner, Ice Miller
Good morning. I’m Jim Davidson. I’m the Deputy Managing Partner with Ice Miller here in Columbus and on behalf of INVESTOhio and its sponsors, I’m pleased to welcome the first presenting company of the day, which is American Electric Power or as we all know it is AEP.
There are some interesting facts about AEP. AEP is one of the largest electric utilities in the United States, delivering electricity to more than 5 million customers in 11 states. AEP ranks among the nation’s largest generators of electricity, owning nearly 38,000 megawatts of generating capacity in the U.S. AEP also owns the nation’s largest electricity transmission system, a nearly 39,000-mile network that includes more than 765 kilovolt extra high voltage transmission lines, more than all of the other U.S transmission lines combined.
AEP’s transmission system directly or indirectly serves about 10% of the electricity demand in the Eastern Interconnection, a system that covers 38 Eastern and Central U.S States and Eastern Canada as well as approximately 11% of the electricity demand in ERCOT, the transmission system that covers much of Texas. AEP trades on the New York Stock Exchange as AEP.
It’s now my privilege to introduce Julie Sloat, Senior Vice President and Treasurer for AEP, who is responsible for AEP’s treasury activity. Please welcome Julie.
Thank you, Jim. I appreciate that very much. It is a privilege to be here at the conference today, and I’m a proud graduate of the Ohio State University. So I’m always looking for an opportunity to come to campus. So, I did undergrad and graduate degrees here and this building was not here, looked much different. So this is quite nice. So glad to be here. I will make sure I get this right here. Here we go. All right.
Before we get started, I just want to make sure everyone has seen our Safe Harbor statements. In the presentation today, there will be some forward-looking statements I will make associated with earnings projections and growth rates, and there are things that could cause actual results to differ from expectation. So I just need to mention that to you and our legal counsel always appreciates that as well.
But more importantly in my opinion, if you take a look at the bottom of the slide, you can see the list of our Investor Relations professionals, who take care of our investors on a day-to-day basis. So, I want to say thank you to them. Bette Jo and Sara are here with me today, and we wouldn’t be able to put these things together if it weren’t for them, so thank you and feel free to reach out to them with any questions you have after the conference today.
All right. So I know Jim kind of walked through a little bit about AEP and who we’re and where we’re, but I want to touch on a couple of different topics here as well. So today AEP is headquartered in Columbus, Ohio just right down High Street here in the Downtown area, and we serve 5.3 million -- I'm sorry, 5.3 million customers across 11 states, and you can see those states are predominantly located or concentrated in the Midwest and Southwest regions of the United States. Our current market capitalization is about $21 billion. So what you would say is AEP is a large cap investor-owned utility company.
In 2012, we produced $14.9 billion in revenues, that’s translated to $1.3 billion in net income, and we also enjoy a very strong balance sheet and credit profile. As a treasurer, I’d would like to bring those things up. It’s evidenced by the BBB, Baa2 and BBB flat ratings that are assigned to us by S&P, Moody’s, and Fitch respectively.
So bear with me – forgot to put that in the little boxes up there, so that’s what I just mentioned. So what’s our focus and what do we do in here? AEP’s core focus is on the regulated utility business. We take a very disciplined approach to managing our business, and what we’ve done is essentially organized ourselves into several different operating companies that are located throughout that map area -- the red areas on the map I just showed you.
And why we have done that is we had senior management at each one of those operating companies. Those operating companies are generally located -- their headquarters are located where our regulators and our stakeholders are. That's really important to us because we need to first of all have clear execution of strategy, so we have line of sight with that management team out there, but they also have a direct line of communication with all the stakeholders that are involved in our regulatory proceedings.
So we have boots on the ground and that allows us to make sure that we understand the key ingredients to our rate cases. So, things like understanding exactly what the rules are, understanding exactly what stakeholders want and customers want, understanding what regulators’ opinions are, all that good stuff. And as a result, we have a stable regulatory relationship, I think, throughout the entire footprint and it's all attributable to the structure and hard work that we’ve done.
I want to take a moment since we are in the state of Ohio, to talk about that a little bit, and if you haven't focused on AEP all that much, one of the stories that has been at the forefront for us here recently is this whole notion of the deregulation of the generation component in the State of Ohio, and what we're trying to do with that is simply extract the generation component away from the wires or the transmission and distribution pieces of the business, so that that generation component can be competitively priced. So, it will go to a competitive business model versus a regulated business model.
And the reason I bring this up is because since we didn't have a fair amount of clarity a couple of years ago and how that would ultimately happen, it was huge pressure on our share price. Fixed income investors were worried about it, rating agencies were worried about it, we worried about it, because we wanted to understand better exactly how that was going to happen and to make sure we had a smooth glide path and we could manage our way into that. Well, we have that now. And so, as a result we don't have that pressure sitting on our share price associated with that particular issue anymore. But that's a little bit of a history. So you will hear me talk a lot today about Ohio and the deregulation thing and what we call corporate separation and that's just stripping out the generation piece just to give you a little bit of background and backdrop.
Put another box up here, so we can talk about this for a moment. Because we grow our revenues and our earnings through investing in our utility business, we have been vigilant about focusing and rationalizing our core cost structure, and we are trying to do this so that we can essentially alleviate pressure on customer rates, and this also has some additional benefits for us as we go through this corporate separation process.
So essentially, what we are doing is fine tuning, getting leaner, and more muscular on the Ohio generation side. So, once we get to that competitive position, ultimately to give you some idea of timing, we think corporate separation in the assets will be stripped out hopefully by the beginning of 2014, but they will not be fully competitively priced until mid 2015. But in preparation for that, we are trying to rationalize our cost structure so that we are ready to do battle in new world for us, because we believed in this regulatory envelope, essentially our entire lives.
We also have significant transmission growth opportunities as well to make investments in this particular business. This allows us to earn attractive returns. We have attractive cost recovery mechanisms for this particular type of business. I'll talk about it here in a few moments, but this is really one of the core tenants or drivers for the 4% to 6% growth rate that you will hear me also talk about.
As you'd expect from a large cap utility, regulated utility, AEP offers an attractive dividend. It’s supported by our balance sheet and that strength there. Our payout ratio target is 60% to 70%, but it is again a significant piece of the value proposition if you're considering buying AEP shares.
So as I mentioned, our footprint stands across 11 different states with all of our operating companies, and And that gives us a great deal of diversity. And when I talk about – when I'm talking about diversity, I'm talking about specifically we're not entirely dependent on any one utility to produce all the earnings, we're not in -- depending on any one weather system or one regulatory outcome or any type of circumstantial economic issues that type of things, so the diversity gives us strength and this footprint continues to expand as we invest in our new transmission business, meaning outside of our traditional 11 state footprint. So, for example we began to invest in areas in the State of Kansas, in pursuing investments in the State of Missouri, so this diversification in my opinion will only grow and continue to strengthen the story.
So, let's take a look at little bit of the data on how we are earning and what we are producing here. So, essentially on a system-wide basis, our ROE is about 10.2% across our different operating subsidiaries, and you can see back to this whole notion of diversity, you can see that that varies significantly from operating company to operating company again illustrating that strength and diversity. But the reason you could see some substantial swings from OpCo to OpCo is because all of them are in different circumstances or timing as it relates to investment levels, timing of investments, and where they’re in the regulatory recovery process. So, those are the primary drivers for those differences, but again at the end of the day a very healthy ROE for a utility company of 10.2% that’s as of June 30, 2013, is something that we take great pride in and we believe it’s one of our strengths.
Continued prudent investment in our utility infrastructure ensures that our customer receives safe, reliable, affordable electricity, and it also provides us with earnings growth opportunities for our investors. And the way we view capital at American Electric Power is very, very precious resource to us. It's the lifeblood of our growth, and we spent an incredible amount of time trying to determine exactly where we should place that capital. And so what we want to make sure that we're doing is finding areas and opportunities to place the capital where regulators, other stakeholders can support it, where we have attractive returns for our investors and where we can actually get reasonable returns like I just showed you and get very timely cost recovery there, because that's a win, win, win for all of us then. That's how we approach this.
So,let me give you an order of magnitude. At the end of 2012, our net regulated property, plant, and equipment totaled $33.8 billion. We expect that to grow by $7.5 billion by 2015. That is a 6.9% compound annual growth rate, so you can see where we're putting the dollars to work.
So let's look a little bit more granularly. So, as we move forward, I mentioned transmission as an opportunity for us. You're going to continue to see that grow as a larger piece of our business. We like it again because there is a need for it. There is a need for transmission across our country, and quite frankly AEP is one of the very best in the business. It's not the best in the business, so it totally makes sense for us to do this. And again, we have nice cost recovery mechanisms in this particular business. So, let's just focus on that for a minute.
I mentioned there is a huge amount of need for transmission across the country. And what's nice about that actually is that once we are looking at different projects, they go through a pre-rigorous scrutiny as it relates to regulatory look, when we’re looking at various projects that we put dollars to work at, so regulatory bodies like Regulatory Transmission Organizations, you name it. So, once we know that we have a project that's viable, it's pretty well assured, so a lot of that uncertainty that we typically have with an investment kind of goes by the wayside, so then we can actually just focus on the actual business and in putting the dollars to work.
Transmission investments are -- that we’re talking about here are done in our Transco operations, and what we call a Transource operations or organizations. And the reason I bring this up is because they’re truly pure play transmission companies or operations for us. And the reason that’s important is because essentially they are regulated by the Federal Energy Regulatory Commission or FERC, so you got one regulator that you’re dealing with and the cost recovery mechanisms are very transparent, so that process is something that investors can understand and the company can understand and all other stakeholders can understand.
So we also know what our returns are, because they are essentially pre-established. So returns can range from 11.1% in our footprint for this particular piece of the business up to 11.49%. And what we refer to these mechanisms as formula rates, so you may hear our company talk about formula rates, and that's what we’re talking about. And effectively what they’re is rates that are set annually, so you essentially have to just look at the math and see where you are in terms of how much plant you’ve put into place and what this does is it reduces lag, you know what the returns are and it keeps the cash flows coming in, keeps the revenues coming in, and it's a very smooth process for us. What it also does, it allow us to put additional investment capital to work. So, opportunities for the customer to continue to receive low-cost energy or electricity, but then also investment returns for our shareholders.
So I want to kind of show you a little bit how we’re going to grow here. Effectively, we expect that our -- I think I actually -- let me go back a minute here. I went too fast, bear with me here. We expect that our net property, plant, and equipment will grow from 2010 level of $50 million, up to $2.8 billion in 2015. That is a growth rate of 124%. So, it’s huge, and you would expect earnings to kind of track with that and they do. So effectively we would expect that earnings per share from this particular piece of the business to be a contributor of $0.36 in 2015. You could see that came from $0.06 contribution in 2011.
I'm not going to spend the whole heck of a lot of time on this slide right here, but I do think it’s worth a note or drive by, because this is a growing piece of the business. I touched on a lot of these things that are already listed up here on the slide, but it is a low-risk business for us with loud returns and transparent cost recovery mechanisms and that's what utilities like and that's what our investors generally like. So that's why it works for us.
So I mentioned at the beginning of my presentation here on my comments that management of our expense is critical to our success in realizing earnings in a traditional sense, but also by helping us through the regulatory process because it reduces pressure on customer rates. And so we have enjoyed a fair amount of success in this regard at this point.
As you can see in focusing on our base utility operation and maintenance expense or otherwise known as O&M, you could see that’s come down over the last few years at 2.9%. The figures in the blue bars of the graph here represent O&M dollars that we spent, but they have revenues that offset them that are predetermined through regulatory proceedings and essentially what we’re talking about here you will hear us say is trackers and riders. We like those two because it's very fluid in terms of cost recovery. But what tends to happen is because there is this contemporaneous thing where it increases in expenses occur, revenues go up and if reduction expenses come down, revenues come down, we don’t have a lot of opportunity to influence the bottom line if we just focus on those pieces. So we’ve got those largely in-step and locked with the regulatory proceedings or process. So what we try to focus on is this base utility O&M and you can see that we've been quite successful here because this actually impacts the bottom line and you see it coming off at almost 3%.
So this whole expense savings or continuous improvement on this front didn't happen by accident, it's been a very conservative effort at the company and particularly so as we reposition the Ohio generation to get ready for competition and we also have other opportunities that continue to come around and we’re exploring those.
If you look at the box on the right, the 2014 box those different types of initiatives was essentially they look like and what you’ll hear us say is that we have lean activities underway at our generation plants. And so that’s just getting smarter by how we’re operating our plants and trying to squeeze out every last penny in terms of getting cost down. Same thing on the information technology side trying to leverage that infrastructure that we already had in place to make sure we’re getting the most bang for our buck and keeping those costs low.
On the procurement and supply chain side, as you can imagine we’re in 11 States. We’re a very large utility company. You can only imagine how many supplies, materials, equipment we buy on any given year or any given day. And as a matter of our size you can expect also that there should be some economies of scale or cost efficiencies we should receive across breaks that we should receive. So what we’re trying to do is make sure that we’re exploiting or taking advantage of all those that are available to us and working with our vendors to make sure that we’re getting the best deal. So that continues to be underway at our company.
We also have on the distribution side of the business real initiatives there. I guess the point I’m trying to make is, I don’t think there’s any space in AEP Company or throughout the entire organization that hasn’t been touched by this continuous cost improvement effort. I can tell you sitting in finance; we absolutely have it under way. I can guarantee if you talk to the guy climbing the pole outside to make sure your electricity is on, he can tell you about it. But it’s really is completely embraced by the entire organization to the point where people are bringing ideas around. And since they’re out in the field they probably have better ideas than anybody sitting in the office because they actually know how the job is done. So, anyway I just bring that up because it's a continuous opportunity here at the company and it's really important to us.
So I mentioned a lot about regulatory stuff at the beginning of my presentation. And as I am sure you can imagine, being successful in our regulatory cases is a fundamental to our ability to deliver the earnings and growth that our investors have come to expect from us. On that note we have several applications that are pending at the Federal Energy Regulatory Commission. Actually we had six that we had made specifically in conjunction with separating the Ohio generation assets away from the Wires assets. And I’ll be just going through a little bit of background there I guess.
First of all those proceedings are going well. You can see we already got several of them approved. The other are still, we’re still working those angles. But at this point, we don’t see any issues. It just takes a little while to get through all these. People have a lot on their plate, and a lot of parties to talk to. But effectively AEP had and has been operating its system on a, kind of a pooled basis, so we share assets. For example, in the mid west or the east part of our jurisdictions all those operating companies that I talked about or you saw on that bar chart, they would share assets and resources. And so what we had to do is make these applications, so we can modify those agreements that we had, so we can extract the Ohio generation assets.
And that’s all working, however what's that precipitated is a couple of other filings at the State level particularly for our Kentucky Power and Appalachian Power companies are located in Kentucky obviously and then West Virginia and Virginia. So we’ve had to make applications there to essentially request that we’re able to maybe transfer some plants, the Mitchell plant and Amos plant in particular to those companies. And the reason they bring that up is because those plants are currently owned by Ohio Power, and these companies have been dependant on Ohio Power’s long position of generation to serve their customers needs. So if all of those plants at Ohio Power go to the unregulated generation piece of the business, these companies will be left short. So we have applications pending and activities underway in those various jurisdictions to try to get a workable solution so that we can make sure that these companies are able to serve their customers with low rates and with those utility assets that they had been paying for. So those are underway.
Now all those cases that I just mentioned are in addition to our traditional base cases that we file and effectively when we invest a dollar we build our net property plant and equipment and then we also have some other costs associated with that what we call cost to service, and so we need to be able to recover the capital in terms of recovery on and off that capital and recover our expense as well. So we make what we call base case applications to our different jurisdictions. So we have two of those underway; one in the State of Kentucky, one in the State of Texas for our South Western Electric Power Company.
We also expect that we’ll be making future applications here in the not too distant future in Virginia, West Virginia, in Oklahoma. So, going back to that point I made I mean in terms of the importance of having success in the regulatory arena and having decent relationships there that are functional and workable, just absolutely critical. And it looks like I’m loosing some battery power here. I’m just going to try to go real fast. How about that?
All right. So back to the notion of importance on regulatory cases and successes, that’s why we’re organized the way we are, and we’ll continue to move down that path and make sure that all of our parties are taken care of. So AEP stated earnings growth rate, I think I mentioned this at the beginning of my presentation is 4% to 6%, that’s nothing knew. How do we get there? Well we invest capital. And so in 2013 we would expect our capital investment level to be $3.6 billion in 2014 -- we’re looking in 2015 we’re looking at a level of $3.8 billion in each of those years. And as a result we would hope to be able to earn the returns that are listed here in terms of being authorized, it would range anywhere from 9.96% to at highest 12.8%.
Our stated guidance range for 2013 is $3.05 to $3.25 and that grows to a range of $3.15 to $3.45 for 2014. Strong and stable dividends, you bet I think that’s anonymous when talking about any healthy regulated utility investment and AEP has exactly that. If you take a look at our dividend history we got a long history and this is just a very small window of that. Our dividend has grown at a clip of about 3.69% on a compound annual growth rate basis. You can see that here on the slide. And let’s just take a look at a couple of the statistics around that. I’m going to put these boxes up here so I don’t forget to do it.
Our current dividend is $0.49 per share on the quarter, and that translates into a current yield of 4.6%. Our current payout ratio is 62%. Remember I mentioned that our target is 60% to 70% so we’re at the lower end. And the way I calculated that is just assume the $0.49 persists on the quarterly payment and I just took the midpoint of my 2013 guidance range because we had to assume something to come up with that payout ratio. And I mentioned we have a long, rich history. We sure do.
We have paid 413 consecutive quarters of dividends, that’s over a 100 years. I think you would probably be hard pressed to find any other company that can state that claim and I also think if that passes any indication of the future I think our divided is solidly in place and I’m sure that the IR team would agree with me because they sure as heck wouldn’t want to be on the phones that day if we changed that policy. As far as the dividend policy, I mentioned 60% to 70% is our payout ratio. Our dividend is supported by earnings from our regulated operations and you can largely expect the dividend to grow in line with earnings from our regulated operations.
Again I’ll go back and throw my treasury head on focusing on financial health has to do it. I think that every investment we make at AEP starts with understanding what our financial position is and that is the cornerstone for every larger or small investment decision we make, any strategic decision we make. So we work diligently to get to the credit profile we have today. There were times in last several years where it wasn’t nearly as strong and we’ll go back and we’ll take a look at a couple of other statistics here and you’ll see what I’m talking about. But once you get there and you work so hard to get there, there’s really no way you want to give that up and that’s exactly where our mindset is.
So a couple of the statistics that we look at or metrics we look at on a regular basis. To make sure that we’re tracking along and our financial health is in check because we look at the debt to total cap, so it should be no surprise to anybody. You can see that our debt to total cap at the end of the second quarter was 55.2%, that’s at the lower end of this entire range here and you can see back in 2009 it was a touch higher and actually if you go back a little touch higher than that in previous years. So when I talk about working hard to get to where we are, we sure did.
So, on a cash flow basis, very strong cash flow coverage statistics. Our funds from operations to interest coverage ratio stands at 4.5 times it's well in excess of our target. And then our funds from operation to total debt I think I just lost my presentation. So we’re just going to go real time here, I guess unplugged and our FFO to total debt stands at 19.1%. Our range is – comfort range is 15% to 20%, so we’re on the high end of that, doing real well. We also have a qualified pension we need to fund, and we’re doing real well on that as well. We're approaching 100% in terms of that funding. As a matter of fact at the end of the second quarter we were at 97%.
In terms of liquidity we have access to about $3.5 billion of uncapped or unused capacity right now. Again as the treasurer I’m just concerned about these metrics and I’m constantly throwing them up there when I’m presented with ideas or things that we’re considering. So it's unfortunate because we have some pretty pictures here in the presentation right now that you’re not going to see.
But AEP’s investment opportunity, Mark said it earlier, it's a fantastic company and I think everyone should own the stock, but I’m just maybe a touch biased. But we do have a clear regulated business model which defines us. We have stable income and cash flow’s, you saw that on many of the slides I just showed you. Huge amount or significant investment opportunities across our general infrastructure as well as in our transmission business and we’re diversified across our 11 States.
We also are continually focused on our cost profile and that gives us a nice path for success in terms of going to the deregulated market in the State of Ohio and we have a very stable dividend with an attractive yield that’s supported by our balance sheet. I don’t anticipate that we’ll have any equity needs beyond our traditional dividend reinvestment plans, so we don’t have any plans to go out. And then we also have some other tools in our tool bag to boost our cash flows, things like securitization or bonus depreciation, those are nice little kickers to have. And then, as I mentioned our estimated growth rate is 4% to 6% off 2013 based. So you add that to our 4.6% yield and it's a nice return opportunity, so please do consider AEP if you are looking to buy a large cap utility stock. It's a great company and it is just a privilege to be a part of it.
So, with that I’d be glad to try to take any questions. Yes sir.
Yes. Well, AEP has been very, I guess, we have a lot of history in dealing with different type of environmental issues as I’m sure you can imagine being a coal centric utility company. We expect to spend something like I think its $4 billion to $6 billion or $45 billion between 2012 and 2020 to make sure that the coal generating assets that we have in our portfolio are compliant. So keep those in the mix. Right now I think Mark mentioned our percentage of coal generating assets as a part of the total fleet is like 60%, 65%.
I think by 2020 our projection is if that goes down to about 46% so I think that because we’ve had plant retirements the coal pieces has declined. And I think we have had a decent more diversity thrown into the mix in terms of beefing up the other side of the house that’s not coal driven. But I think diversity is the name of the game, balanced name of the game and so that’s something we pay very, very close attention to. We have experts on staff that look at nothing and that so you raised a very good point.
I think the natural inclination is to lean toward natural gas. That’s where we’ve gone. Yes sir.
Yes, yes. We have energy efficiency and demand management details that are embedded in our load projections. So when we provide earnings guidance and we show focus what we think the load will be from a different customer or classification basis so residential, commercial and industrial, that is absolutely embedded. I don’t recall off the top of my head exactly what the erosion is associated with that, but it is not insignificant. And so that’s already embedded in our guidance. We pay very close attention to that.
No, actually it's not a spin off. But what we’re going to do is take the generation assets and move them to another AEP subsidiary that will house the generation assets, so it will still be in the AEP family. It does in the sense that the composition of our earnings mix changes, so we’ll know what stream is exactly coming from that generation piece and then investors can assess the volatility associated with that. So, does that affect them? I think it affects our valuation because it changes the business mix and the risk complexion. Thanks.
Yeah. Thanks very much and good luck.
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