Going forward, American Electric Power (AEP) offers investors stable underlying core utility earnings, although with only modest growth potential. Consistent performance in the residential segment, new 765-kV transmission lines at PJM — its joint venture with Duke Energy (DUK) — and favorable approval of rate changes from the PUCO and PUCT, represent a mildly bullish outlook for the stock.
However, pruned expansion plans on account of tightening credit markets, high debt level, escalating coal costs, lower off-system and industrial sales, and uncertainty surrounding pending regulatory cases collectively continue to weigh on the stock.
Q1’09 Results:
American Electric Power reported disappointing 1st quarter 2009 GAAP earnings of $360 million, or $0.89 per share, down over 37% from $573 million, or $1.43 per share, for the year-ago quarter.
Likewise, disappointing operating earnings for the reported quarter were also $360 million, or $0.89 per share, down over 12% from $410 million, or $1.02 per share, for the year-ago quarter.
Ongoing earnings from Utility Operations decreased by $67 million during the 1st quarter of 2009 compared with the same period in 2008 as the result of lower sales to industrial customers, lower off-system sales and higher operating expenses. These unfavorable items were somewhat offset by increased rates, primarily in AEP’s utilities in Virginia, Indiana and Oklahoma, the activation of a fuel clause in Ohio, and by insurance payments related to the September 2008 fire and resulting outage at the Cook Nuclear Plant in Michigan.
The company also reiterated its fiscal 2009 outlook and expects earnings of $2.75 to $3.05 per share.
Return-on-Equity (ROE) DuPont Decomposition Analysis:
From 2004 through 2008, AEP’s ROE fluctuated significantly within a high single-digit to low double-digit range. Over this five-year historical period, the overall uptrend in ROE was driven by regular improvements in operating profit margins, and volatile yet favorable trends exhibited by increasing tax retention rates and lower leverage — albeit at a higher cost of debt.
Looking ahead through 2009, we expect ROE to remain in the low double-digit range, driven by improving leverage; partially offset by slight declines in operating profit margins, cost of debt and tax retention.
AEP common stock trades at 9.3x our current-year 2009 operating earnings per share estimate and 9.0x our forward 2010 EPS estimate, or at the lower-end of the P/E range of comparable diversified energy utilities and the broader electric power utility industry. Likewise, relative price multiples of cash flow indicate a discount valuation for AEP. Meanwhile, relative price multiples of sales and book value are in-line with the electric utility industry median values.
The stock’s $1.64 per share annual cash dividend will appeal to conservative income-seeking investors as it currently yields significantly above the utility industry average at 6.0%.
Accordingly, with a mildly bullish outlook, modest earnings growth expectations and an attractive dividend yield — yet slightly mixed valuation metrics — we maintain our market-neutral Hold recommendation on AEP common stock with a six-month target price of $28.25, or 9.6x and 9.3x, respectively, of our 2009 and 2010 EPS estimates. Price appreciation to our near-term valuation target, coupled with the stock’s $0.41 per share quarterly cash dividend — which we deem sustainable and secure given reasonable projected earnings payouts of 55.6% and 53.8%, respectively, of our 2009 and 2010 EPS estimates — represents annualized total return potential of 12.2%.
Columbus, Ohio-based American Electric Power Company, Inc. is a public utility holding company which, through directly and indirectly-owned subsidiaries, generates, transmits and distributes electricity, natural gas and other commodities in North America and Europe. The company is one of the largest integrated utilities in the U.S., serving more than five million customers in 11 states with more than 38,000 MW of primarily coal-fired generating capacity and nearly 39,000-mile electricity transmission system network.
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