Tag Archives: aep

American Electric Power Raises Dividend 5.7%… What Now?

Summary For a utility, AEP’s record of dividend hikes is impressive. However, I suspect growth will be smaller in coming years as the ‘shale boom’ comes to a screeching end. At this time, I believe it’s best to stay on the sidelines on AEP. As a dividend investor, I tend to like utilities. But ‘climate change legislation’ has kept me away from most utilities. Solar and wind energy are expensive relative to fossil fuels. While utilities may ultimately pass those costs on to consumers, utility companies will have to invest a lot of money into new transmission and generation infrastructure. That means lots of new debt, with no significant demand growth: A very bad combination. When I look for utility companies, I look for ones that operate in states which have minimal or no ‘renewable energy mandates.’ I therefore tend to stick with US-based utilities because the US has some of the most reasonable energy policies of the developed world. I also tend to stick with select states where mandates are the lowest. American Electric Power (NYSE: AEP ) is one of the utilities I like. It operates mostly in Ohio, West Virginia, Texas and Oklahoma. While AEP has been increasing its renewable share of power, the numbers remain quite reasonable. Have a look. (click to enlarge) Courtesy of AEP Investor Relations. Even by 2026, only 15% of AEP’s total generation will be from ‘renewable’ energy sources. That’s pretty good. Of all the country’s utility providers, AEP’s generation is among the most economical. Back on November 6th, AEP paid a dividend of 56 cents, which is 5.7% higher than the previous quarterly dividend. For a utility, that’s quite an impressive growth record. That dividend growth has been mirrored by earnings growth. Between last year, this year and next year, AEP expects 4%-6% earnings growth, and the company is making good on that promise thus far. (click to enlarge) Courtesy of AEP Investor Relations. Where is that growth coming from? Well, it’s coming from capital investment, ‘rate recovery’ from investment in fully-regulated assets, and also cost savings. Each account for a good part of AEP’s earnings growth. Courtesy of AEP Investor Relations. A big advantage that AEP has lies in its location. AEP operates in the Eagle Ford, Permian, Marcellus and Utica shales. These territories have been hot-spots for growth over the last few years. Have a look. Courtesy of AEP investor relations. As you can see, industrial load growth in shale areas has far outpaced the rest of the company’s industrial base (and, indeed, the rest of the country in general), even though crude prices have fallen by 60% and rig counts have dropped by over half. This juxtaposition exists because the number of wells drilled per rig has increased dramatically, and the build out of midstream infrastructure has lagged behind the drop in activity. So, does the ‘shale boom’ live on? I don’t think so. Judging from both the comments and actions of OPEC kingpin Saudi Arabia, it really looks as if crude oil prices are going to stay low. But will production in these regions continue to remain stubbornly high? I really don’t think so. In 2016, the hedges of most shale-based E&Ps will roll off. This will ultimately lead to smaller lines of credit, and much less access to capital for these E&Ps (junk bond yields have risen sharply). With credit markets squeezed, I believe that small-sized and even medium-sized shale drillers will find it difficult to continue drilling at some point next year. Energy activity is lagging behind the oil price, but that drop is already coming. Therefore, I really believe that AEP will find it shale-area industrial growth coming to a halt next year. There’s a good chance it could even go negative. Courtesy of AEP Investor Relations. In fact, we can already see that industrial sales growth in shale regions has already pulled back significantly over the last few quarters. Expect much more of this. All things considered, earnings growth is probably going to slow down as a result of this. By how much is difficult to estimate. However, as the energy crisis deepens and takes a bite out of the economies of Texas, Ohio and Oklahoma, overall employment and GDP numbers in AEP’s service areas will underperform the rest of the country. In fact, that’s already begun to happen. (click to enlarge) Courtesy of AEP Investor Relations. Overall, AEP’s total electricity sales are scheduled to increase 0.6% in 2015, and that should translate to 4%-6% earnings growth. Next year, and indeed the years after, will be more challenging as long as crude oil prices remain low. While low oil prices are good for the country as a whole, they do effect AEP’s service areas. That is apparent when looking at the above right chart, where ‘AEP West’ represents both Texas and Oklahoma. Going forward I expect to see considerably slower EPS growth; perhaps something more like 2% or even less, because AEP’s operating territory is about to be hit hard, especially Texas. Overall, AEP will be fine because it is a diversified, regulated utility, but the company’s engine of growth is going to peter out soon. Therefore, I expect tamer dividend growth going forward. Is AEP a buy? Is AEP worth buying here? I would be cautious on this. According to data from FAST Graphs, AEP’s ten-year average price-to-earnings ratio is 13.7 times, but right now the company trades at 15.8 times. As a utility, AEP is also somewhat exposed to higher interest rates. If bonds trade lower, chances are AEP will follow. Right now, as with many stocks, caution is warranted with AEP. Those wanting to pick up a utility should instead look at Entergy Corp (NYSE: ETR ), which is benefiting from the petchem boom along the Louisiana and Texas coasts. That growth story is still somewhat intact.

Utility Investors: Embrace Pending Rate Hikes

Utility investors should be more afraid of declining interest rates than rising. History points to rate cycle turns in 2004-2007, 1993-2000, and 1986-1989. Overall annual total return for utility stocks during the previous three rates hike cycles was 7.5%. In July 2014, I penned an article investigating the effect of previous interest rate cycle upswings on share prices of utilities, and with the pending rate hikes anticipated to begin in just a few weeks, it may be time to revisit this topic. The premise of the previous article was to review the performance of some well known utilities stocks after the previous three turns in the rate cycle. History points to rising interest rate cycles of 2004 to 2007, 1993 to 2000, and 1986 to 1989. I will not reiterate all the finer historic points of the previous article, including the graphs of the respective yield curves, but will analyze stock performance over the time frames. As background, I suggest reviewing the previous article. Many investors believe utilities are negatively hurt by rising rates. The most common reasoning is: •Higher rates increase interest costs for utilities and the capital-intensive nature of their business makes profits more sensitive to leverage expense. In addition, weak share prices reduces the effectiveness of equity raises to fund capital expenditures, along with raising the cost of the debt portion of billions in cap ex budgets. •Higher rates cause income-oriented investors to gravitate to bonds where principal risk is perceived to be lower. •If interest rates are increasing to stem the tide of rising inflation, utility operating costs, such as coal fuel costs, will also increase along with labor cost pressures. A traditional cost-push inflation cycle could be distressing to more than just a few utilities. Yes, corporate interest costs go up as new borrowings reflect current yield conditions. However, interest expense is part of operating expenses that are incorporated in most rate decisions. While there is a delay between cash out due to greater interest costs and inclusion in rate decisions, the higher expense is usually passed on to customers. While income investors will gravitate to safer bonds as their yield rises, selectively reviewing top quality utilities with a higher spread to 10-yr Treasuries will mitigate downward pressure in stock prices. Currently, rising rates are not being caused by cost-push pressures but due to stronger economic growth. Stronger growth usually leads to higher energy demands. In addition, a large percentage of infrastructure growth and cap ex is upgrading older assets and accommodating new sources of green energy, which are not as sensitive to underlying population and economic growth. The age of sector ETFs is relatively short and most do not encompass the above listed time frames. For example, S&P Utility ETF (NYSEARCA: XLU ) started trading in Dec 1998. In order to evaluate utility stock performance during these periods, a list of some of more popular stocks was chosen. These include: Duke Energy (NYSE: DUK ), NextEra Energy (NYSE: NEE ), Dominion Resources (NYSE: D ), Southern Co (NYSE: SO ), American Electric Power (NYSE: AEP ), PPL Corp (NYSE: PPL ), and PCG Corp (NYSE: PCG ). Combined, these represent 45% of the current value of XLU. Below are two tables outlining each stock’s performance during the last three up cycles in rates. The first table lists the starting and closing price of each stock, the individual performance of its share price and the value of an equal weight holding for these seven firms. The Fed Fund Rate is listed as well. The second table relies on information from buyupside.com to calculate the overall total return for each stock, the number of days held, and the value of an investment of $10,000 at the start date. As most utility investors realize, returns from utility stock dividends is an important portion of total return, and an overriding reason for buying utility stocks. The table also compares these with the return of S&P 500. These tables support the strategy of buying potential weakness in utilities when investors mistakenly sell at the turn in the rate cycles. Many utility stocks have declined from their 52-week highs, with the most common reason being a fear of rate hikes. For example, Duke Energy is trading -24% below its 52-wk high and 1% over its low, NextEra Energy -12% and 8%, Dominion Resources -16% and 3%, Southern Co -15% and 10%, American Electric Power -15% and 6%, PPL Corp -11% and 17%, and PCG Corp -12% and 13%, respectively. If an investor were to buy as the total return table outlines, their investment would have been a total of $210,000 combined, $70,000 each cycle. The value of these investments at the end of the respective rate hike cycle would be $350,000, or a total annual return of 7.5% over the 8.5 year covered. Utility investors should embrace the beginning of the rate up cycle by not dumping their stock holdings. If anything, investors should be looking for bargains as others are fearfully selling. Author’s Note: Please review disclosure in Author’s profile.

Comparing Consolidated Edison And American Electric Power

In a previous article I detailed the past history of Consolidated Edison. In detailing this observation, it can be helpful to compare that security to others. This article compares the results of Consolidated Edison and American Electric Power, along with how you might think about the securities moving forward. In a previous article I looked at the past business and investment growth of Consolidated Edison (NYSE: ED ). This is useful for two reasons: it gives you a historical view of the company and it allows you to better think about potential repeatability moving forward. The historical look gives you much more insight than a simple stock price. Instead of seeing a line squiggle about, you can observe how revenues translate to earnings, earnings to earnings-per-share, EPS to share price growth and ultimately to your total return. There are a lot of factors at play that are not adequately captured in a stock chart. Moving forward, this type of information allows you think about the business in the future, with a solid understanding of how it previously got to where it was. If past investment growth was driven by an uptick in the earnings multiple or reduction in the share count, for example, these would be areas that you might want to explore on a forward-looking basis as well. Of course looking at a single security, even through the lens of various return drivers, does have its limitations. Its hard to tell whether revenue growth or investment growth is reasonable or not without also comparing this to other similar firms. As an illustration, let’s compare Consolidated Edison to American Electric Power (NYSE: AEP ), a similar-sized utility, to get a better feel for the company. Here’s a look at both companies historical business and investment growth during the 2005 through 2014 period: ED AEP Revenue Growth 1.1% 3.9% Start Profit Margin 6.2% 8.6% End Profit Margin 8.3% 9.6% Earnings Growth 4.5% 5.2% Yearly Share Count 2.0% 2.4% EPS Growth 2.1% 2.6% Start P/E 15 14 End P/E 18 18 Share Price Growth 4.0% 5.6% % Of Divs Collected 46% 43% Start Payout % 76% 54% End Payout % 70% 61% Dividend Growth 1.1% 4.1% Total Return 7.3% 8.4% From this table we can learn a variety of things. First, note that AEP was able to grow its revenues at a faster rate than Consolidated Edison. AEP also began with a higher net profit margin, and grew this over the period. Interestingly, due to the lower starting base, Consolidated Edison actually made up some growth ground in this area. Total earnings growth for Consolidated Edison came in at 4.5% per year against 5.2% for AEP. Part of the higher growth for AEP was offset on the shareholder level due to having to issue more shares. Once you get to earnings-per-share Consolidated Edison was growing at 2.1% per year against American Electric’s 2.6% annual growth. Allow the companies got there a bit differently, shareholders saw markedly similar growth during the time. Shares of both companies began the period trading around 14 or 15 times earnings and moved up closer to 18 times earnings by the end of the period. The P/E expansion was slightly higher for AEP, resulting in 5.6% annual share price growth versus Consolidated Edison’s 4% annual growth. This is an important point. It’s not just the ending valuation that matters, but also the expectations that lead up to that value. Consolidated Edison started with a higher dividend yield, but grew its payout at a slower rate. Still, an investment in the New York utility would have provided more aggregate income, resulting in closer overall returns. An investment in AEP would have generated 8.4% annual gains, while an investment in Consolidated Edison would have provided 7.3% yearly gains. As a point of reference, based on a $10,000 starting position, that’s the difference between accumulating $18,900 and $20,600. American Electric Power was able to outperform Consolidated Edison in the past due to its slightly faster earnings growth rate and higher valuation uptick. Consolidated Edison provided more dividends per dollar invested, but still trailed slightly. This type of view can illuminate a few things. First, even though the growth rates weren’t spectacular the returns were reasonable. A high starting yield and an uptick in valuation for both companies drove this result. Perhaps just as important, it shows you why one company might have turned in better performance and not just that it happened. Moving forward you could think about an investment in either security in a similar light. Here’s where things get less compelling, in my view. Below I have presented the same table substituting what actually occurred in the past with a hypothetical example for the next decade: ED Forecast AEP Forecast Revenue Growth 1.1% 3.9% Start Profit Margin 8.3% 9.6% End Profit Margin 9.3% 10.6% Earnings Growth 2.3% 4.9% Yearly Share Count 2% 2.4% EPS Growth 0.4% 2.4% Start P/E 18 17 End P/E 15 15 Share Price Growth -1.6% 1.1% % Of Divs Collected 40% 46% Start Payout % 72% 63% End Payout % 72% 63% Dividend Growth 0.4% 2.4% Total Return 2.3% 4.7% On the top line I used the exact same revenue growth, 1.1% per year for Consolidated Edison and 3.9% for AEP. Naturally these could be switched around or any number of different iterations, but the above is used specifically for a demonstration. The next two rows show improvement in the net margin of each company. So you have two companies growing revenue at the same rate as before, and actually keeping more of those profits. Yet the overall growth rate for both companies would still be lower. As a result of coming off a higher base, formulating growth becomes more difficult – it’s not enough to improve, you would need to improve by a greater and greater margin. If the number of shares outstanding also increased at past rates, you would be looking at rather slow earnings-per-share growth rates. Not that the past growth rates weren’t spectacular, but these would be noticeably lower still. With the same business performance, the growth rate is lower off a now higher base. It becomes more and more difficult to offer continued growth. The big difference between 2005 and 2015 is that today you’d likely want to be more cautious in your future multiple anticipation. Its certainly possible that these two companies could trade with P/E ratios of say 20 in the future, but I would contend that this might not be altogether prudent to expect. As such, share price growth could trail the already quite slow earnings growth. In turn, your main total return reliance would rest with dividends. Although the dividend yields are above average – sitting around 4% – they wouldn’t be expected to grow very fast. As such, you might anticipate collecting the dividend yield, seeing it keep pace with or even trail long-term inflation and not much more. A lack of strong growth, coupled with average to above average expectations, makes for a less compelling value proposition. Of course the above assumptions could be too pessimistic. Analysts are presently expecting 3% intermediate-term earnings growth for Consolidated Edison and 5% growth for AEP. Still, these assumptions would only bump the return anticipations up to the mid-single-digits. And to be complete, these higher assumptions can miss share count dilution and the possibility of a lower valuation in the future. In short, both Consolidated Edison and AEP as businesses didn’t grow very fast over the past decade. In spite of this, investors saw reasonable returns due to an uptick in what investors were willing to pay to go along with a solid ongoing dividend. In the future, you likely still wouldn’t expect these companies to grow very fast. However, this time the returns might not be as reasonable. The valuations are higher and consequently dividend benefits a bit lower. As the growth rate of a security slows, the relative expectations and valuation paid become more and more important.