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 almost 38,000MW of capacity. In addition, the firm is the largest owner of electric transmission lines with almost 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 revenues 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 revenues from AEP River Operations were generated from transporting coal with 43% non-coal related.
Below is a map of the AEP service area:
Revenues in 2012 were $14.9 billion with operating earnings of $1.5 billion. Earnings per share were $2.60 in 2012, down from $3.25 in 2011. EPS are expected to be between $3.10 to $3.20 in 2013 and $3.25 to $3.40 in 2014. While the diversified assets of AEP assist in maintaining a 4% to 6% earnings growth, the current share price is unexciting. With an slightly above average current yield, AEP offers stability but mediocre potential dividend growth.
Like many utilities, capital expenditure spending in regulated businesses will be the growth driver. Currently about 95% of AEP revenues are derived from either FERC or state PUC businesses. Below is a breakdown of 2012 and 2013 capital expenditure budgets along with a chart of future cap ex budgets. Source is the latest AEP Investor's Presentation (pdf) dated Sept. 18:
Cap Ex Allocation
Base Fossil/Hydro Generation
River Operation, Other
Total Cap Ex
Source: AEP Investor's Presentation
Looking out to 2015, investments in regulated businesses will continue to expand at a robust pace. Below is a slide from AEP's latest Investor Presentation outlining the three major segments for increasing capital spending.
Source: Investor Presentation
These planned capital expenditures will generate steady allowable returns on investments as outlined below:
Source: Investor Presentation
The two biggest areas of investment growth are in Environmental Upgrades to meet new EPA regulations and Transmission Upgrades. What becomes interesting is one is a platform for ongoing continued growth while the other is not. Investments in transmission assets improve the performance of the grid and reduce power congestion.
Increasing capital investments in AEP regulated operations will drive both earnings and dividend growth. Management expects earnings growth of between 4% and 6% going out to 2015. Since 2004, AEP has raised its dividend an average of 3.7% and has paid a dividend for the past 103 years. Management is targeting a comfortable payout ratio in the 60% to 70% range. With the reduction in earnings in 2012 vs 2011, the payout ratio moved from 57% to 72%. If AEP earns $3.15 this year and pays out $1.94 in dividends, the payout ratio would fall back to a comfortable 61%.
The chart below outlines AEP's dividend payment history since 2004:
Source: Investor's Presentation
AEP is moving away from its coal-fueled generating footprint to a more balanced fuel approach. Below are three graphics from its Sustainability Report:
Currently, 60% of generating capacity is fueled from coal. By 2015, this percentage is expected to drop to 47% and by 2020 to 46%. In order to achieve this new mix of lower reliance on coal, management expects to shutter a bit more than 6,000MW of generating capacity, or about 16% of total current capacity. AEP is moving more to natural gas as a fuel source and expects to convert about 11,000MW from coal to natural gas. Additional alternative fuels, such as wind and solar, play a minor role in current capital investment plans.
Below is a table of peer regulated electric utilities and their trailing and forward PE ratios, along with trailing 12 month net margins. While a few company valuations are lower than AEP, for the most part AEP trades within a few points of major high quality peers.
Trailing PE Ratio
Forward PE Ratio
Net Margin %
American Electric Power
Over the past five years, AEP has marginally outperformed the S&P Electric Utility Index on a total return basis. Below is a chart from AEP 2012 Proxy Appendix outlining the comparisons of AEP, S&P 500 and the Utility Index.
Source: 2012 Proxy Appendix
AEP has generated an average 5-year return on invested capital ROIC of 5.2% and a trailing twelve month ROIC of 3.9%. AEP 10-year average ROIC is 4.5% and is about the industry average. Following is a graph courtesy of fastgraph.com outlining AEP ROIC over the past 15 years:
Recently, AEP share prices have fallen from $50 to $44. This reflects investor worries of rising interest rates. While the stock and the S&P Utilities ETF (XLU) received a small boost with the recent Federal Reserve comments concerning its taper program, over the medium term, these same concerns will appear again. The slide in share prices moved the current yield from 4.1% to 4.4%. The consensus share price target for AEP is $50, or about 11% above its current level.
There are other regulated electric utilities that offer a bit better growth potential, including Southern Company (SO). For those willing to take on a bit more risk, ITC Holdings (ITC) or Exelon (EXC) should be considered. While there is nothing fundamentally wrong with AEP, its prospects are a bit wanting compared to some of its peers.
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