American Electric Power's (AEP) CEO Nick Akins on Q4 2015 Results - Earnings Call Transcript

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American Electric Power Company Inc (NYSE:AEP)

Q4 2015 Earnings Conference Call

January 28, 2016 09:00 ET

Executives

Bette Jo Rozsa - Investor Relations

Nick Akins - Chairman, President and Chief Executive Officer

Brian Tierney - Chief Financial Officer

Analysts

Greg Gordon - Evercore ISI

Michael Weinstein - UBS

Praful Mehta - Citigroup

Christopher Turnure - JPMorgan

Anthony Crowdell - Jefferies

Gregg Orrill - Barclays

Paul Ridzon - KeyBanc

Paul Patterson - Glenrock Associates

Ali Agha - SunTrust

Shahriar Pourreza - Guggenheim Partners

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the American Electric Power Fourth Quarter 2015 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Ms. Bette Jo Rozsa. Please go ahead.

Bette Jo Rozsa

Thank you, Tom. Good morning, everyone and welcome to the fourth quarter 2015 earnings call for American Electric Power. We are glad that you are able to join us today.

Our earnings release, presentation slides and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors.

Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks.

I will now turn the call over to Nick.

Nick Akins

Okay. Thanks, Bette Jo. Good morning, everyone and thank you for joining AEP’s fourth quarter 2015 earnings call. 2015 will be remembered as a year of significant transition that culminated a 4-year process of focusing on the fundamentals of our business to drive consistency, execution and discipline while driving toward a strategic vision of what the next premium regulated utility should look like. The balance sheet of AEP is strong and we continue to deliver for our shareholders quarter after quarter from a dividend and earnings growth perspective despite various headwinds that have occurred along the way. This quarter and the year, 2015 are no exceptions.

First, let’s talk about the fourth quarter. Fourth quarter ‘15 GAAP and operating earnings came in at $0.96 per share and $0.48 per share respectively compared with fourth quarter ‘14 GAAP and operating earnings of $0.39 per share and $0.48 per share respectively. The difference in fourth quarter 2015 GAAP and operating earnings being mainly driven by the sale of AEP River Operations. Fourth quarter was unusual in the sense that winter particularly in December never occurred. It was more like an April. Even so, operating earnings were consistent with fourth quarter last year even though we gave back approximately $0.11 per share cold weather related load margins finishing the year solidly within our revised guidance range at $3.69 per share operating. The year finished at $4.17 per share on a GAAP basis as well compared with ‘14 results of $3.34 per share and $3.43 per share GAAP and operating earnings respectively.

As can be seen on the graph on the right of Page 3 of the presentation, AEP has consistently performed better than the utility index for the 1, 3 and 5-year periods and as well outperformed the S&P 500 Index over the last 3-year and 5-year periods and lagged the index over the last year given the interest rate and other sensitivities in the electric utility sector in general. Overall, AEP continues to perform very well as the story of the stock continues to become more clear and resonate in the market.

Operating earnings growth year-on-year was 7.6% and we achieved our expected regulated ROE of 9.6% for the year, which increased from the 9% experienced in 2014. During 2015, we also increased the dividend by 5.7% on an annualized basis consistent with our earnings growth and within our stated dividend payout range of 60% to 70%. I mentioned AEP is in transition earlier. There were a couple of important milestones that we achieved during the year, particularly in fourth quarter. Namely, AEP completed the sale of River Operations that we discussed during the third quarter 2015 earnings call and we reached the settlement with several parties regarding the AEP Ohio PPA case.

AEP sale of River Operations occurred during the fourth quarter and the transaction occurred according to plan. The cash proceeds were redeployed in advance of the sale by raising our capital forecast for transmission and then by raising our overall capital plan to $5 billion for 2016 at the November EEI Financial Conference, focus on additional regulated operating company and transmission activities. So, we have successfully converted that portion of volatile earnings to a more consistent, regulated earnings profile.

Regarding the AEP Ohio PPA case, we made significant progress by completing a settlement among the parties, including the staff of the PUCO, along with the industrials, Sierra Club, retail providers and others that defines the PPA relationship and the unregulated generation to AEP Ohio customers. The agreement answers the question of how long is long-term? 8 years with a cost based agreement with a return and an adjustment mechanism that works much like a fuel cost pass-through provision. AEP does guarantee up to $100 million credit to customers at the end of the agreement if in the unexpected event the anticipated savings do not materialize. This deal is a great deal for AEP, our customers and the state of Ohio to ensure capacity is maintained for the benefit of customers during a transition period, where markets do not have a long-term capacity product and during the movement toward the clean energy future contemplated by the Clean Power Plan.

AEP also expects to re-power, retire or refuel generation as part of this transition and build up the 900 megawatts of renewable solar and wind generation to achieve a balanced generation portfolio for Ohio’s future. This arrangement, when approved by the Ohio Commission, will be a model that can be used nationally to assess the tone for parties with substantially different positions about generation resources and the pace of change to come together focusing on the clean energy future and the mitigation of transition cost increases that our customers and the public expect. AEP and the utilities in the U.S. are the ones that can bring the parties together to work with the states defined as clean energy future and deploy advanced technologies to improve our customer’s experience while ensuring that the benefits are universal to all the customers.

As with any agreement, AEP and the other parties didn’t get everything they wanted, but this overall is a good deal that provides clarity and will ultimately benefit our customers and should be approved by the PUCO as quickly as possible. We expect the record to be concluded by February 8 and an order from the Commission shortly thereafter. Assuming that’s the case, the spotlight will move to the remaining unregulated generation which we expect the ongoing strategic process to rapidly move to completion. This will set the stage for the next phase of AEP development with a firm financial foundation and position the company for the future.

Moving to expectations for 2016, we reaffirm our guidance range of $3.60 to $3.80 per share and we will continue our focus on disciplined capital allocation, emphasizing investments in our regulated companies and transmission with CapEx budget of $5 billion for 2016. AEP continues to project long-term earnings growth of 4% to 6%. Additionally, as a result of the available bonus depreciation, as a result of the 2015 tax bill from Congress, and our ability to invest as a result of the incremental cash, we are raising our capital budgets for the succeeding years to $5 billion in 2017 and $5 billion in 2018. This will enable us to put money to work on behalf of our customers for needed infrastructure, including transmission means basically interest-free while maintaining rate base levels that support earnings growth.

Brian will be covering the subject of customer load in a few minutes. But I would like to say since the economic recovery began post-2008, we have seen quarter after quarter of inconsistent results, indicating the economy, while generally getting better, is still challenged in several sectors. Also, we have moved from one extreme to another from a weather perspective from the polar vortex in 2014 to the warmest fourth quarter in the last 30 years in 2015. So, it’s difficult to evaluate sustaining trends at this point. We continue to believe load will increase overall during 2016 albeit at a slightly slower pace than originally forecasted, but not enough for AEP to adjust guidance.

During 2016, we will focus on obtaining approval for the Ohio PPA settlement, continue our strategic review of competitive generation and continue to work with our states on ways to comply with the Clean Power Plan, all with the continued focus on driving efficiencies through lean initiatives, capital allocation, disciplined operational excellence and continual focus on cultural initiatives that I believe is a prerequisite to remain agile and innovative for the future.

Now, I will move over to the equalizer graph, which we go over every quarter and this sort of rolls out for the year. The 2015 earned regulated ROE on the left side of the page and then what we anticipate for the 2016 pro forma regulated ROE on the right side of the page. So, let’s talk about Ohio Power for the Ohio area. AEP Ohio is in line with expectations and we expect to finish the year in line with the 12% ROE that’s forecasted. As far as APCO is concerned, the West Virginia rate case that we got achieved in 2015 addressed the weak returns in West Virginia. So, it helped the ROEs in APCO as well. Rates were implemented in June of 2015. So, we expect to see that the rate case will also help improve the ROE in 2016 for APCO.

Kentucky, it’s good to see it coming up. We are seeing the expected improvement at year end. The commission authorized the $45 million rate increase in July with 10.25% ROE to be used in weighted average cost of capital for riders and AFUDC. So we continue to see an increase from that perspective, which last quarter as you recall, it was locally short.

I&M achieves an ROE of 10.2%. This was a result of positive regulatory outcomes associated long-term capital investment programs in generation Rockport SCR, solar and nuclear with a critical lifecycle management and transmission projects as well. So I&M is well positioned for another positive year end 2016. PSO’s ROE is generally in line with expectations. The economy in Oklahoma experienced a slowdown due in part to lower oil prices and reduced oil and gas activity in the state in December though the Oklahoma Corporation Commission heard the rate case and PSO implemented interim rates of $75 million at the first of the year. So a final commission order is expected in the second – during the second quarter of this year.

SWEPCO continues to be somewhat of a challenge. The operations are strong, but it’s challenged in the oil and gas area, natural gas price area. And as well the continued issue with Arkansas portion of the Turk plant which we continue to analyze alternatives for that, hopefully a retail rate case in Arkansas at some point would be helpful from that perspective.

AEP Texas, the ongoing distribution capital investment in TCC to serve higher levels of electric load and to maintain the reliability of the grid has gradually lowered the regulated ROE over time. AEP Texas continues to monitor the earnings levels and the jurisdictions. They basically have three avenues available to them. One is the transmission, T calls transmission capital cases that they have been involved with currently, and then also, whether it’s a traditional rate case filing or under the legislated approach of the distribution costs recovery factor, that’s another opportunity for them as well. So they can look at earnings and we will focus on those alternatives.

As far as the AEP Transco – Transmission Holdco, transmission was at 11.1%. It should drop to 10.2% during the year. But obviously, we are spending a huge amount of capital in the transmission area so you do have some lag there. So with that said, overall, the regulated ROEs are moving from 9.6% to an expected 10.1% for the year. So overall, we should have a good year from a regulatory standpoint.

Now that we are in 2016 and before I turn it over to Brian, I will end by saying, I was recently struck by an article I was reading on the 2016 commemoration of 50 years of Star Trek. While it all started with the original series in 1966 with a 5-year mission, it has over the last 50 years, consistently reinvented itself to remain relevant. AEP after 110 years is doing the same thing. This team started out in 2012 after a rough period in Ohio on a 5-year mission of our own that’s set a course toward a firm foundation around execution and discipline to advance operationally, financially and culturally. AEP has performed well since then despite some significant headwinds and as we move into 2016, our focus remains the same to complete our mission to position AEP as the next premium regulated utility. This will provide AEP the firm foundation to reinvent itself by focusing on the customer experience, resources or technologies of the future and disciplined capital allocation to become the model utility of the future. So the next generation is about to begin.

So Brian, make it certainly number one.

Brian Tierney

Thank you, Nick and good morning everyone. I will be taking us through the financial results for both the quarter and the year with most of the focus on the annual results. Let’s begin on Slide 6 with the fourth quarter comparison where operating earnings for both years were $0.48 per share despite extremely mild temperatures which adversely affected the quarter by $0.11 per share as well as lower earnings from our competitive businesses. Total company earnings were unchanged from last year. These unfavorable drivers were effectively offset by favorable rate proceedings, the absence of unfavorable regulatory provisions from 2014 and the decline in the effective tax rate, each of which added $0.09 to the fourth quarter of 2015.

Turning to Slide 7, you will see that the fourth quarter’s earnings when added to the results through September pushed our annual operating earnings to $3.69 per share compared to $3.43 per share in 2014, an increase of 7.6%. The increase in earnings for our largest segment, Vertically Integrated Utilities, was the primary factor contributing to the overall increase in earnings. The major drivers for this segment include the favorable effects of rate changes, regulatory provisions and lower O&M and income tax expenses, partially offset by reduced margins from retail and wholesale energy sales.

Rate changes were recognized across many of our jurisdictions, adding $0.31 per share to the year. This favorable effect on earnings is related to incremental investment to serve our customers as well as the successful transfer of the Mitchell plant to Wheeling Power. The effective regulatory provisions bolstered boosted earnings by $0.12 per share due to the Virginia legislative change and the unfavorable Kentucky fuel order in 2014. Lower O&M expense for this segment favorably affected comparison by $0.06 per share, primarily driven by lower employee-related costs. Similar to the quarterly comparison, the annual effective tax rate for this segment was lower in 2015 due to the impact of annual tax rate adjustments and the effect of accounting for tax items on the flow-through basis. Partially offsetting these favorable items were declines in normalized margins in our system sales, net of PJM charges. The lower normalized margins which reduced earnings by $0.09 per share were driven by lower usage across most of our operating regions. I will talk more about load in the economy in a few minutes.

The $0.17 per share decline in off-system sales reflects the significant margins realized during the polar vortex events in early 2014 and the soft power prices in 2015. The transmission and distribution utility segment earned $0.72 per share for the year, matching the results for 2014. The major drivers for this segment include the favorable effective rate changes and regulatory provisions, offset by lower off-system sales margins and higher O&M expenses. Rate changes added $0.04 per share to earnings, primarily related to the recovery of distribution investment in Ohio.

Unfavorable Ohio regulatory provisions in 2014 that did not repeat created a favorable variance, adding $0.04 per share. The decline of $0.04 per share in earnings related to off-system sales margins was related to the Ohio Commission’s order on OBEC. O&M expense was higher than last year, which lowered the results for this segment by $0.05 per share. This was due in part to intentional incremental spending with the remaining change related to regulatory commitments in Ohio.

The Transmission Holdco segment continues to grow, contributing $0.39 per share for the year, an improvement of $0.08 or 26%, reflecting our continued significant investment in this area. In the past 12 months, this segment’s net plant less deferred taxes grew by approximately $1 billion, an increase of 49%. The Generation and Marketing segment produced earnings of $0.75 per share, down $0.09. However, this segment exceeded expectations in several areas. The lower capacity revenues in Ohio, beginning in June, contributed to Generation Resource’s decline in earnings of $0.11 per share. This was partially offset by the favorable effect of lower fuel costs and favorable hedging activity, helping to add energy margins in the period of soft power prices. In addition, expenses were lower due to unit retirements and the sale of properties which allowed for the reversal of certain ARO liabilities.

Our trading and marketing organization also performed well, exceeding last year’s results by $0.03. Our retail business exceeded 2014 results by $0.04. AEP River Operations, which was sold in mid-November, contributed $0.06 per share to this year’s results, $0.04 lower than 2014. We have been deploying the proceeds from this transaction into our regulated businesses. Corporate and Other produced a loss of $0.06 per share, down $0.07 for the year. The decline was driven by higher O&M expenses, franchise taxes and other costs. Our performance throughout the year resulted in our raising guidance twice with the final results solidly in the latest range. Despite the headwinds associated with lower capacity revenue in Ohio, 2015 was a successful year for AEP, both financially and operationally.

Now let’s take a look at Slide 8 to review normalized load performance for the quarter. Before we go into particulars by class, I would like to provide some context around the load as depicted on this slide. If just look at the bars, you will notice that they are volatile from one quarter to the next. It’s important to remember that these comparisons are not to the prior quarter but to the prior year. So this year’s fourth quarter is being compared to the fourth quarter of 2014 which as you can see was particularly strong across all classes.

With that context, let’s now plow into the detail for the fourth quarter of 2015. Starting in the lower right, you see there a load decrease by 3.7% compared to the strong fourth quarter results in 2014. This brings the annual normalized load contraction to eight tens of a percent. The upper left quadrant shows that our residential sales were down 4% for the quarter and 1.8% for the year. While we are starting to see the impact of lower energy prices on a regional economy, most of the decrease is a result of the unusually strong 2014. If you compare our normalized residential sales in 2015 to 2013, volumes were down only by an average of 0.4% per year. In the upper right corner, commercial sales were down 3.9% for the quarter compared to 2014. Both commercial and residential sales were stronger in our Eastern and Western territories, which is consistent with the economic indicators I will share with you on the next slide.

For the year, commercial sales were down 0.2%. The strongest growth in commercial sales happened in Ohio Power and in I&M, where majority of our auto-related jobs are located. As you know, 2015 was a banner year for domestic auto sales. This was certainly one of the bright spots in our regional economy.

Finally, the lower left quadrant shows that our industrial sales were down 3.3% for the quarter and 0.2% for the year. We saw the biggest decline in our largest sector, primary metals, which was down 21% this quarter. The weak global demand, strong dollar and oversupply of Chinese steel, has created a challenging market for our metals customers and export manufacturers. Fortunately, we continue to see robust growth from our customers in oil and gas related sectors to help offset the decline in manufacturing load. I will provide more detail on this later in the presentation.

Now, let’s review the most recent economic data for AEP service territory on Slide 9. Let’s start on the left hand side of the page, where we compare the economy of the U.S. to that of AEP service territory. For both GDP growth and employment growth, AEP service territory trails the U.S., but both indicators for AEP have been relatively stable for the last several quarters. The interesting detail is on the right side of the slide, where we compare the U.S. indicators to AEP East and AEP West separately. What this shows is U.S. and AEP West GDP and employment growth are slowing, while rates are improving for AEP East. The deceleration in AEP’s western service area is associated with energy sector job losses. The acceleration in AEP’s eastern territory is associated with auto, healthcare and professional service sectors.

U.S. auto sales in 2015 were at their highest level since 2000. We are also seeing exceptional growth in recreational vehicle shipments, which have tripled over the last 5 years. This has been an important boost for places like Elkhart, Indiana, whose economy is largely independent on transportation manufacturing. And finally, the relatively low business costs, along with higher educated workforce in places like Columbus, Ohio, have created an attractive business environment resulting in over 11,000 new healthcare and professional service jobs in 2015.

Turning to Slide 10, I will provide an update on the domestic shale gas activity within AEP’s footprint. Given the impact of low energy prices we are having on our regional economy, one might expect our electricity sales to the oil and gas related sectors to be down. However, as you can see in the upper left chart, we are still seeing over 10% growth in our sales to oil and gas sectors this quarter despite oil prices being down 40% from last year, rig counts being down by nearly two-thirds and the fact that there are significantly fewer oil and gas workers today than we had at the end of 2014.

In fact, the bottom left chart shows that our sales to oil and gas sectors are at all-time highs. The upper right chart shows that growth in oil and gas loads was spread across all major shale plays within AEP service territory with the strongest growth coming from the Permian, Woodford and Eagle Ford shales. If we dissect the oil and gas growth into its components as shown in the bottom left chart, we continue to see the strongest growth from the pipeline transportation sector, which grew by over 33% in 2015. This was mostly due to the expanding infrastructure in West Virginia, Ohio and Texas to support the Marcellus, Utica and Texas shales.

Our oil and gas extraction volumes were up nearly 7%, while petroleum and coal product sales grew by approximately 1% in 2015. We still have a number of oil and gas related expansions expected to come online over the next 18 months that should drive our industrial sales growth through 2016. Obviously, we are monitoring the situation closely, given current oil prices and we will update you on these segments throughout the year. In contrast to the oil and gas sectors, the red bars in the upper left chart show that sales to the remaining industrial sectors are not growing as they were last year at this point, down 5.3% for the quarter.

Now, let’s turn to Slide 11 and review the company’s capitalization and liquidity. Our debt to total capital improved by 0.2% this quarter and is now in a healthy 53.2%. Our credit metrics, FFO interest coverage and FFO to debt are solidly in the BBB and Baa1 range at 5.5x and 20.8% respectively. Our qualified pension funding held firm this quarter at 97%. During the quarter, a slight decrease in the asset returns was offset by a slight increase in the discount rate. Our pension assets are now weighted at 60% and duration matching fixed income securities with the balance being held in global equity and alternative investments. We adopted this more conservative investment stance in 2014 to better align the investment portfolio with the pension obligation.

Our OPEB obligations remain fully funded, but decreased from 112% to 109% during the quarter. Although plain investment returns were positive, they were more than offset by an increase in higher healthcare costs. Finally, our net liquidity stands at $3.5 billion and is supported by our two revolving credit facilities that extend over for the summers of 2017 and 2018.

Let’s see if we can wrap this up on Slide 12 and then quickly get to your questions. The employees of American Electric Power have a proven track record. Over the last several years, they have delivered operating earnings growth within our targeted 4% to 6% range and we have grown the dividend in line with earnings. With the current dividend at the midpoint of annual operating earnings guidance, we anticipate paying out 61% of total earnings and 68% of regulated earnings in 2016. Our employees have executed continuous improvement initiatives, lean activities and have begun the cultural transformation that has allowed us to keep expenses in a very tight range of $2.8 million to $3.1 billion net of earnings offsets since 2011. We forecast expenses net of offsets this year to be in the $2.8 billion range. In addition, our employees have been thoughtful about every $1 of investment in our system. We have allocated more dollars to the wire side of our business and designed our Transco business to allow for the efficient deployment of low cost capital for the benefit of our customers.

At this point, let me say a word about bonus depreciation. This cash saving vehicle is not new to us. For several years now, AEP has elected bonus depreciation. During this time, the company has consistently grown rate base and earnings. Earlier, you heard Nick announce that we will increase our capital spending by $1 billion in both 2017 and 2018. Our customers will realize improved service at a savings due to the rate reducing impacts of the regulatory flow back of accumulated deferred income taxes and AEP will be able to grow earnings. In this way, our community’s benefit through increased economic activity, our customers benefit through rate savings and our debt and equity holders benefit through the maintenance of our cash flow metrics as we grow our net plant and service. The ability to make incremental investment in our own system for the benefit of our customers differentiates AEP.

Looking ahead to 2016, we are reaffirming our operating earnings guidance of between $3.60 to $3.80 per share. We are keeping our CapEx plans for 2016 at $5 billion while increasing our CapEx forecast in 2017 and 2018 to $5 billion per year. And finally, as Nick said, we anticipate getting clarity on the Ohio PPA and the strategic review of our competitive businesses. We experienced the successful 2015 and are poised for success in 2016 and beyond.

With that, I will turn the call over to the operator for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Greg Gordon with Evercore ISI. Please go ahead.

Greg Gordon

Thanks. Good morning, guys.

Nick Akins

Good morning, Greg. How are you?

Greg Gordon

I am well. My first question goes to your last point, when I look at Slide 31 of the handout, certainly one of the hallmarks of the company under your management has been a very, very focused on balance sheet integrity. And what I see here is that from ‘16 to ‘18, you are – even with the increase in capital spending, because there is such a significant increase in cash from operations, your ‘16 to ‘18 excess capital required is down by $1.1 billion, plus your debt capital market needs are also down by $1.1 billion, doesn’t that basically flow to retained earnings and further potentially strengthen the balance sheet from here?

Nick Akins

It does, Greg. And so the issue is, part of what we talk about here is increasing the CapEx sum. But as we get the increase in retained earnings that also increases our ability to access debt capital markets and we will be reviewing that as we evaluate our plans as we enter a period where we will be spending in order to get ready for the Clean Power Plan and other opportunities like that later this decade.

Greg Gordon

But it’s fair just eyeballing this to say that exiting ‘18, the balance sheet should be in an even stronger position than it is today, unless you decide to spend further capital over the period?

Brian Tierney

Yes. We have not consumed all of the excess cash that bonus depreciation extension has created for us.

Greg Gordon

Great, that was my key question. Thanks. I will let somebody else ask and go the back if I have more.

Nick Akins

Yes. It is interesting Greg, that this time around, Congress instead of waiting until the end of the year to give the existing year, they did the 5 years. So it really helped in terms of the cash and capital planning. And you are right we didn’t have it utilized all of the capital available to us. But nevertheless, we will continue to focus on additional opportunities for us, particularly as it relates to infrastructure spending.

Operator

Our next question is from the line of Michael Weinstein with UBS. Please go ahead.

Michael Weinstein

Hello, just a follow-up on Greg’s question. Does that mean that you could in theory lever up more on certain subsidiaries as for just transmission going forward, is that one of the possibilities?

Brian Tierney

Yes. So debt avoidance is one of the possibilities that we are looking at. Obviously, the closest thing that we have done is spending incremental CapEx. But debt avoidance and/or levering up our opportunities that the incremental cash makes available to us.

Michael Weinstein

I am just thinking of the stronger balance sheet you could also lever – increase the leverage on that subsidiary?

Brian Tierney

We could, Michael.

Michael Weinstein

Okay. And then also I was wondering if you can go into a little bit more detail as to why you think sales forecast for the shale plays will continue to be in 0.9% or continue to grow going forward that you don’t see any potential problems, I guess in the next 2 years or considering the low prices?

Nick Akins

It is interesting because we continue to see more and more opportunities for the electric load to continue to pick up in addition to compressor loads, optimization within the fields of sales, improved production of the existing wells, that continues. And of course, we are also looking very closely at new opportunities that are coming online that have been identified, engaging the progress of them coming in 2016 as well. So we continue to – and we are in very close touch with our customers out there, particularly ones who have discussed expansion or addition of new facilities and keeping in touch with them about timing of projects and the additional load associated with that. So we are keeping our ear close to the ground on all of that activity.

Operator

Next question is from the line of Praful Mehta with Citigroup. Please go ahead.

Praful Mehta

Hi guys.

Nick Akins

Hello.

Praful Mehta

Hi, my question was firstly on the EPS and cash flow guidance that you have for ‘16 and obviously the cash flow guidance going out as well, what is embedded in that in terms of both the PPA and also the outcome of the strategic review?

Nick Akins

Yes. We don’t have anything in there for that forecast at this point. And what we will do, obviously we want to get the PPA done and evaluate fully where we are at in terms of not only the incremental, any incremental earnings associated with the PPA. But obviously, we have other factors we are looking at in terms of load and other issues to look at. So we will deal with that one when that time comes.

Praful Mehta

Got it. Just to be clear, if there is a PPA, outcome is positive, then that obviously is an incremental upside to the guidance you have right now, is that fair?

Nick Akins

So we have to work through that process and fully understand it first. So I don’t want to get out on a limb and tell you that that would be the case. But obviously, getting the PPA in place will be very good for the company. But we are also looking at, like I said other things that may – because I think at the first quarter, we will probably have a better handle on what load looks like and then see that the relative degree of consistency to make it good, really a good forecast in terms of guidance and that kind of thing.

Brian Tierney

Praful, I think if we were to get new data sets around a PPA and/or disposition of a business, I think it would be incumbent on us to provide and update the guidance and we would do that.

Praful Mehta

Thanks. That’s very helpful. And then secondly, I heard there is rumblings around a legal challenge associated with the PPA, who knows where that goes, but just trying to understand, if that legal challenge comes up, how does that impact strategic review of the non-PPA assets, because I am assuming the outcome of that legal challenge would have an impact on the buyers view about the value of the assets?

Nick Akins

Well, okay, so let’s keep in mind there is really two sets of assets here. One is the ones that are covered under the PPA. And the other are probably rumblings and probably more than rumblings. At this point there is filings have been made apparently. And if you have the PPA piece of it, that’s really about 3,000 megawatts of generation nominally. Then you have the other 6,000 megawatts out there normally that would be associated with the remaining unregulated. So if there is a case out there, I think anyone that would look at it, if it’s only unregulated part of the generation, they – there will be people who are buying unregulated assets and fully understand the risk associated with that. As far as the PPA is concerned, we will continue to progress associated with the PPA. Those cases will work themselves through. We feel like we are in very good shape from a legal perspective. There is a lot of dust being kicked up. But that’s what happens when you try to do progressive things, particularly things that have the state supported self as opposed to waiting on a Federal outcome for a long-term capacity market for example. So I think any perspective buyer in a transaction on unregulated generation, they would fully understand what the issues are and the risk involved.

Operator

Our next question is from the line of Christopher Turnure with JPMorgan. Please go ahead.

Christopher Turnure

Good morning guys.

Nick Akins

Good morning.

Christopher Turnure

I have more kind of CapEx and balance sheet questions here to kind of follow on some of the previous questions as well. First, on the incremental CapEx of $2 billion over 2 years, kind of what’s embedded in that, it looks like it’s mostly transmission related, but is there any incremental renewables in there that stem from the PPA settlement. And then also on your ability to finance that capital kind of how do you think about the moving parts there, especially in ‘17 and ‘18 given the fact that you are not assuming any kind of asset sale proceeds, any PPA incremental cash. And I think my understanding of your tax situation was that even though bonus depreciation is certainly adding to your potential in outer years, you probably wouldn’t have been a cash tax payer in ‘17 and ‘18 anyway. So how does the bonus depreciation going to help your cash in those years to finance some of this incremental capital?

Nick Akins

So let me touch the point on what’s covered under the $2 billion that’s included. Yes, you are right, a majority of it is transmission. And then there is some on the rest of the regulated activity. But there is also a piece in there associated with as you mentioned renewable projects. But it’s not related to the PPA. It’s really not to the Ohio PPA. It’s related to other arrangements, there are other PPA arrangements that we have for long-term PPAs with solar projects, universities and that kind of thing. So it very much supports what we are trying to achieve from a customer side of things. We go out and we participate in arrangements that with long-term PPAs with creditworthy counterparties to ensure that we can put those kinds of facilities in place. And you see a category there. I think that’s competitive parts, where that competitive part is really around our onsite partners’ opportunities associated with projects that they are doing with that are supported by long-term PPAs.

Brian Tierney

So – and let me address Chris for the last part of your question. Without the extension of bonus depreciation, we were going to be significant taxpayers beginning in 2016 and in 2017 and going forward. So, this does significantly change our cash position. And as Nick just said in his response, we have not committed dollars yet for the renewables associated with the PPA. If that’s gets passed, that will be an opportunity for incremental investment that’s currently not in our CapEx plans. And if there were any proceeds from sale of any assets or businesses that we have that would be incremental to our balance sheet and cash flow position as well.

Christopher Turnure

Okay, great. That’s very clear. And then just another kind of follow-up on the load side here. You mentioned that you do kind of expect somewhat of a continuance in the E&P and energy-related sectors there in growth or at least stability there. Kind of what else are you thinking in terms of growth by customer class that underlies your 80 basis points of growth overall for next year?

Nick Akins

Well, certainly, all our manufacturing, travel and leisure, those categories continue to grow. Brian, you may have others?

Brian Tierney

Healthcare and business services are other areas that we are seeing growth, particularly in places like Ohio and I&M.

Nick Akins

We mentioned RV sales and I remember when President Obama was running for office in 2008, one of the places that he was going is the sign of a downturn economy was Elkhart, Indiana. And if you look at Elkhart, Indiana now, it’s just absolutely booming with RV sales being up as much as they are. So, that’s another sector where we are seeing significant improvement.

Operator

Our next question is from the line of Anthony Crowdell with Jefferies. Please go ahead.

Anthony Crowdell

Hey, good morning. I appreciate the Star Trek reference in last quarter, but back to the future. Just a couple of questions. First, easy one on your favorite equalizer slide, transmission ROE is coming down in ‘16. You said there is some lag there. Do you think that returns back in ‘17?

Nick Akins

I don’t have those numbers, but I would expect as we continue to accelerate transmission, I think it will probably stay pretty steady be my guess, but we obviously have to look at the investment cycle there, but obviously transmission continues to be a near-term investment recovery perspective and as long as we can accelerate it and bring those earnings in, which we started to do obviously last year, then we can mitigate the impact of the ROE drop. And then you also have couple of other things that are occurring in there as well. ETT, ROE is also forecasted to decrease from 11.7 down to 10.4. So, that’s sort of embedded in there as well. And obviously, you will have interim T calls, filings need to be made. And so I fully expect it to stay relatively consistent with that.

Anthony Crowdell

Also staying with the equalizer slide if I look at Kentucky Power, I mean, that’s the smallest ball here. I guess, it’s the smallest contributor for earnings. With the market and people paying exorbitant premiums for at least some of these smaller utilities, any thought of monetizing that? It doesn’t really seem instrumental into the AEP story and it’s also lagging your ROEs there.

Brian Tierney

I get that question quite often. And Kentucky, on the one hand, it certainly is a regulated jurisdiction. So, we are still in the process of becoming more fully regulated and I sort of measure it up from that approach. Number one, it’s a regulated entity. Number two, it’s been one that it was one of the first to do a rider for cyber. It was one of the first to allow the transfer of Mitchell. So, while it maybe small, there are some positive things about that jurisdiction that we obviously have to take a look at. But what you are saying obviously is we see that going on in the market as well. But at this point, we are focused on being a premium regulated utility and that means we need to deal with the issues that everyone is asking us about and that is our strategic discussion around the unregulated generation. So, that’s really where our primary focus, if we did something with a regulated entity at this point, we would become more unregulated and that’s not the direction that we are going.

Operator

Our next question is from the line of Gregg Orrill with Barclays. Please go ahead.

Nick Akins

Good morning.

Gregg Orrill

Yes, thank you. Good morning. Two quick questions. First, if you have any update around timing of merchant sale how you are thinking about that? I know you said you expect Ohio PPA order soon after the briefs are done. And then second on the O&M slide, the $2.8 billion for ‘16, ex-riders and trackers, maybe is that a fair assumption to kind of back into what that is from ‘15 and assume that continues or maybe provide some guidance around what that is for riders and trackers? Thank you.

Nick Akins

Yes. I will let Brian cover the second one. On the first one, on the merchant sale piece as you talked about, I think the timing is still, as I said earlier, we need – it’s sequential in terms of outcomes, but not sequential in terms of the activity that’s going on. We are already in a strategic process around the unregulated generation. The question is what’s in and what’s out? So, we will get through the PPA approach with Ohio. Hopefully, they will make a decision here and it should be after over 2 years, be in a decent decision to make a decision quickly. And then we know and understand what we are dealing with, with the rest of the fleet. And so that process we would expect would move very quickly and I would expect us to be in a good position to get that done as quickly as possible as well and that is a focus to make sure that we complete that activity in 2016.

Brian Tierney

Gregg, this is Brian. A little bit over $1 billion in offsets that we are talking about in terms of trackers. And in terms of how we get there from ‘15 to ‘16 in O&M it’s employee-related expense. It’s one-time reductions that we will be doing and we have been planning for the reduction in capacity revenues in Ohio now for the last 3 years. So we have had as a management team, our focus on the fact that they go away fully in 2016 so whether it’s lean initiatives, procurement initiatives, one-timers that we are doing, some of the benefit that we got in 2015, we are able to move expenses out of ‘16 into ‘15. We have really been very, very focused on maintaining that O&M discipline for the first full year of no capacity revenues in Ohio and it’s all those initiatives together that are allowing us to get to that $2.8 billion level.

Gregg Orrill

Thank you.

Operator

Next question is from the line of Paul Ridzon with KeyBanc. Please go ahead.

Nick Akins

Good morning, Paul.

Paul Ridzon

Good morning. Just wondering what you are seeing as far as buyer interest out there? Are you still talking to private equity? This would be for the non-PPA assets?

Brian Tierney

Well, we have had to be really careful with that obviously. We do have an ongoing process and I would not be surprised if private equity involved with that, because they are interested in that kind of business. But I probably should stop there, because obviously, that’s an ongoing process.

Operator

Our next question is from the line of Paul Patterson with Glenrock Associates. Please go ahead.

Nick Akins

Good morning.

Paul Patterson

Can you hear me?

Nick Akins

Yes, yes.

Paul Patterson

I am sorry, okay. I wanted to touch base to you on two things. Just first on the non-PPA merchant plants, just I apologize if I am a little slow on this. What is exactly the decision process on them?

Nick Akins

So, once we get past the PPA part of the approach, then on the rest of those assets, it really is centered around number one valuation, because these, we feel, like are really competitive units and ones that positioned well in the marketplace. So if there is an opportunity to understand what the valuation of that is. And obviously, there is ensuring that there are parties involved that are interested in those assets. And so we will go through that process very quickly. And there is – certainly, there is an opportunity there. But we obviously want to understand what the economics look like for that kind of transaction and what it means to our business going forward. And this is not a share of sale. So we are going to be very mindful about what it means to our shareholders in terms of not only in terms of any potential dilution if that exists or what we do with the proceeds. It’s just as important as the question of what you do with the assets in sales. There is a multitude of different things that we have to think about in that process. As you know, we are in a pretty good cash position, capital position right now. And to go through that process or it could be more cash associated with that. So we have to really think about just as much on the use of proceeds and obviously what it does to shareholders as well. So we will go through that process and really that’s the nature of it. And it’s a relatively simple process for the set of units.

Paul Patterson

Okay. And then with the [indiscernible] energy what have you challenge that was made at FERC regarding the waiver, they want the waiver rescinded regarding the affiliate PPA, what – do you guys have any comments on that?

Nick Akins

Yes. We feel pretty strongly about our position. And obviously, they perceive that maybe they didn’t think we would even get this close to getting the PPA done. And we have PPAs now. We have got PPAs for solar in Ohio. We have OBEC generation that’s under a PPA. We have got in other regulated jurisdictions and there is no difference between those activities and what we are doing here. And really, it centers on the notion of whether there is customer choice or not. And in fact, FERC has said before the customer choice does exist in Ohio. Leads us up to Ohio determines the mechanism under which that proceeds and there is precedence for that. So we feel pretty strongly about our position. I think as far as FERC is concerned, it’s asked and answered. And I think when you look at the case that’s been filed, I would presume they proceed of trying to address it there when they may be have difficulty addressing Ohio and we have had a case for 2 years where they could have been involved with that and our settlement is, keep in mind, we have a settlement with a lot of significant parties in this case. So yes, there are some on the outside looking in and they are going to do what they need to do. But the settlement of the parties exists. It’s a good settlement. And certainly, it’s one that addresses the Ohio issues and that’s what we are about. I don’t know, they have their own motivations about what they want to achieve. But we are wanting to achieve consistency from a pricing perspective for consumers protection, for consumers for a sliver of their energy needs. But customers still have the ability to choose in Ohio. They can choose any supplier. So – and that has not changed. So I think we feel good about it.

Operator

Our next question is from the line of Ali Agha with SunTrust. Please go ahead.

Ali Agha

Thank you.

Nick Akins

Good morning Ali.

Ali Agha

Good morning Nick. Nick, I wanted to clarify points you have made earlier. So as you are looking at these sales of the non-PPA merchant assets, we are looking at a market where commodity prices are down, the valuation on public equity merchant power stocks down significantly. So how big of a concern is that and I mean is that a scenario where if the price is not right you stay back and you keep this or strategically as you have emphasized to us many times, you want this to be 100% regulated business, just wanted to understand your thought process in terms of how this plays out?

Nick Akins

Yes. As we look at this, yes, you could look at the present energy market, present natural gas prices. And a lot of people get hung up on, if prices are high, then the world has changed and there is assumptions about what valuations are to be and when the world is low, there is again 180 degrees different assumptions about how the world ought to be. These decisions are made on long-term decisions and mainly driven by capacity markets. And for buyers of these assets, they are looking at long-term capacity markets and long-term energy prices. And they are making bets based upon where they think those energy prices are going to go. So it’s the same discussion that we would have before. But again, these are a great set of assets. And for anyone, even on a low energy market, you have got to look at margins and margins are what’s driving the valuation. So and then from a capacity market, the same thing. So I think there are so many – if you look out in the long-term, there are so many issues involved here. There is going to come down to any valuation would be around what someone else perceives the forward curve to be for capacity and for energy and then our version of it and we will see where it goes. But if somebody comes in and tries to lowball us, then we feel pretty good about these assets. They sit really good in the market and – but our presumption going in is that we will determine the outcome of what we do with these assets.

Ali Agha

So just to clarify, Nick, I mean on the one hand, is that a strategic decision made at AEP, look these assets are going in one way or another, we are 100% regulated over the division be more sensitive to valuation as you are suggesting?

Nick Akins

There is going in, we plan on being the next premium regulated utility. And that is the strategic driver. Now valuation, obviously we have to look at and make determination, well is the valuation consideration enough for us to move ahead from that perspective. Because keep in mind, I mean you are looking at things like currency value improvement, PE multiple improvement, multiple expansion, what you do with the proceeds, all those types of things that are also part of the evaluation. Because with River Ops, we changed from a volatile earnings stream to one that by reinvesting that cash we were able to focus on a continual, consistent earnings growth stream. And that’s what – how we are looking at this as well. I mean it’s a volatile. It may be great, it may be positive, but it’s still volatile. And so we have to look at that and determine the balance of that kind of determination versus what we can do with the proceeds and ensure shareholder value on a consistent basis going forward. That’s the way we look at it. So unless somebody – I mean I don’t think we are going to get any low balls in this thing. I really don’t believe that because it’s a great set of assets.

Ali Agha

Understood. Last question, unrelated, just to be clear on the bonus depreciation, so the CapEx goes up in ‘17, ‘18, obviously has positive earnings implications, but more near-term in ‘16, any earnings headwinds from bonus depreciation we should be factoring to our thinking for this year?

Brian Tierney

No.

Nick Akins

No, we are one of the utilities that has a ready willing and able, remember the transmission graph we always have, the green and the blue on top that we were looking for capital. We found capital.

Bette Jo Rozsa

Operator, we have time for one more question.

Operator

Your last question is from word from the line of Shahriar Pourreza with Guggenheim Partners. Please go ahead.

Shahriar Pourreza

Good morning everyone.

Nick Akins

Good morning.

Shahriar Pourreza

Sorry if this question was asked. I had to hop on late. But just on the higher CapEx call that you released this morning, just want to confirm, is there still levers to increase that budget under the assumption the you sell the 5 gigawatts, so can you redeploy it, avoid some sort of dilution or are we thinking a little bit more buybacks now that you have already raised you CapEx?

Brian Tierney

Sure. So the plan that we have laid out does not assume anything around proceeds of sale from non-PPA assets. So the plan that you have is a business as usual CapEx plan and the things were to change, I anticipate that Nick and I will come out with revised guidance and use of proceeds.

Shahriar Pourreza

Okay, good. So, you could reaccelerate further CapEx additions about what we have done today?

Nick Akins

All the things that are available for people to do with proceeds or things that would be available to us, we obviously look first to reinvest in our organic businesses and with the incremental cash that we got associated with bonus depreciation that was our first and best use of those dollars. So, they are obviously a spade of other things that are available to us. But you would anticipate Nick and I would come out and tell you what those things would be at that time.

Shahriar Pourreza

Got it. Excellent, okay. And then just one last question on the strategic review of the 5 gigawatts, obviously, there is obviously potential buyers here. Is there some optionality in this transaction where you can layer in the other 3 gigawatts if you don’t get the PPA approved? Is that – is there – is there sort of that optionality?

Nick Akins

Yes, if the PPA is not approved, then all of the assets will be in that strategic evaluation.

Bette Jo Rozsa

Okay. Well, thank you for joining us on today’s call. As always, the IR team will be available to answer any additional questions you may have. And Tom, that concludes the call.

Operator

Ladies and gentlemen, that does conclude your conference for today. I want to thank you all for your participation and for using AT&T teleconference services. You may now disconnect.

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