Summary Company has encouraging fundamental outlook due to increased efforts on getting a broader regulated asset base. Continuous investments in regulated operations such as transmission business give it huge opportunity for future rate base growth. AEP’s on-track cost containment plan will better its future earnings growth prospects. I have a bullish stance on American Electric Power (NYSE: AEP ); the company’s focus on getting a broader, regulated asset base and its escalated growth investments in the transmission business will better its long-term growth trajectory. In addition, the resolution of the company’s previously filled rate cases with West Virginia and Kentucky by the end of this month will strengthen its future top-line and cash flows. Owing to the attractive outlook of AEP’s future cash flows, I believe its dividend payment will remain attractive for investors. Moreover, the company’s on-track cost savings plan, “Lean deployment”, will continue improving its bottom-line. Furthermore, my price target calculation suggests a potential upside of approximately 25% for AEP. AEP’s Strategic Growth Drivers Remain Intact In the recent past, increased focus on infrastructure development investment by utilities has been positively affecting the industry fundamentals and performance. For 1Q’15, the earnings growth of the U.S. Utility Industry was 8.4% , well above the S&P-500’s growth of only 2.4% year-on-year. As far as AEP is concerned, the company has made great strides in becoming a high-quality regulated utility, with improved execution and better management of its intelligent strategic growth efforts. One of the most important strategic growth drivers, increased focus on regulated asset base, has been helping its financials grow at a decent pace. In fact, AEP’s management has reiterated their intentions to sell the company’s unregulated business under its plan of growing its regulated utility business; the decision is on hold until state regulators make a final decision about the company’s proposal regarding state subsidized purchase power agreement that will help it maintain 3,100MW of coal-fired capacity. AEP has requested regulators make the final decision regarding this matter, at least by October ’15. The prevailing uncertainty around the acceptance of the PPA agreement and the recent industry merchant divestitures make me believe that the company will either sell or spinoff its Ohio-based power generating subsidiary and the proceeds from the sale would be reinvested to support its growth-generating regulated transmission business. In fact, one of its former competitors, Dynegy, is interested in buying AEP’s unregulated assets. Since the transmission business is one of the most promising businesses of AEP, I believe reinvesting cash proceeds from the unregulated business sale in the transmission business will strengthen its long-term growth potentials. Moreover, the sale of Ohio plants (unregulated assets) will support its strategic move, which is away from de-regulated operations to regulated ones. In fact, the company has several multibillion-dollar projects in place for the next five-to-ten years, in order to grow its regulated asset base by improving the operational performance of its transmission business. Currently, AEP stands tall in the U.S. utility business with its major stake in several advanced transmission projects, and moving ahead, further increases in transmission project-related investments will improve its fundamentals. As part of its long-term growth plan, AEP has announced hefty investment of almost $4.8 billion in transmission projects from 2015 to 2017; I believe that these up-scaled investments in the transmission business will help the company’s rate base expand, which will increase its future cash flows and ROE. Moreover, increase in its earned returns will better AEP’s EPS growth. Furthermore, the company’s previously filed rate cases in West Virginia and Kentucky are expected to gain approval at the end of this month. AEP has requested a $227 million rate increase in West Virginia and a $70 million rate increase in Kentucky, which will allegedly go into effect on 1st July 2015. I believe that these recent rate hikes will portend well for raising the level of earned returns for the company and will add towards the certainty of its cash flow base success in the years ahead. On the bottom-line, AEP’s multi-year cost saving plan “Lean deployment” is working really well to get it a leaner cost base. Thus far, the company has completed the implementation of lean deployment at 13 distribution districts, whereas work at almost 19 more is still in process. Moreover, on the transmission business side, AEP has completed work on just one area and four more are scheduled for completion, this year. Given the fact that the implementation of lean deployment is keeping the company’s operational and management (O&M) expense down, I believe with the ongoing execution, cost efficiency gains from the lean deployment plan will keep on improving AEP’s earnings growth level. Safe & Sustainable Returns AEP’s strong growth prospects have been helping its cash flows grow and support its management’s dividend policy. With the increasingly healthy cash payments under its attractive dividend payment policy, the company has earned a strong five-year dividend growth rate of around 4.87%. Keeping track of its attractive dividend payment plan, AEP had recently announced another quarterly dividend payment of $0.53 , which translates into a dividend yield of 3.95% . Given the company’s strong strategic growth prospects and due to its management’s strong commitment towards paying healthy dividend payments, I believe AEP will have cash flows available to make and increase dividends in the years ahead. Guidance The company’s management has reaffirmed its guidance for 2015. AEP expects full year 2015 EPS to be in a range of $3.40-to-$3.60 . Also, it has maintained its stance about achieving long-term earnings growth in a range of 4%-to-6%. Thus far, the company has done pretty well in achieving allowed ROEs at its regulated subsidiaries; I believe its correct growth efforts and cost controls will help AEP achieve its anticipated 4%-to-6% growth rate in the years ahead. Risks The company’s future growth prospects will continue to face the risk of potential negative regulatory restrictions in its service territory. In addition, AEP’s inability to pull off well-timed, constructive regulatory rate base approvals by negotiating with FERC might pressurize its future growth prospects. Moreover, the company’s ongoing and planned development plans, if not properly executed, might burden its bottom-line with cost overruns. Furthermore, unfavorable temperature trends, environmental regulations and unforeseen negative economic changes are key risks hovering over its stock price performance. Price Target I reiterate my previously calculated price target of $69 for AEP, which was calculated using a dividend discounting method. In my price target calculations, I used cost of equity of 6% and nominal growth rate of 3%. Based on my price target, the stock offers potential price appreciation of 25%. Conclusion The company has an encouraging fundamental outlook due to its increased efforts on getting a broader regulated asset base. In fact, continuous investments in regulated operations such as the transmission business give it a huge opportunity for future rate base growth, which increases certainty about its future cash flows and earnings base. Moreover, the company’s on-track cost containment plan will better its future earnings growth prospects. As a matter of fact, the healthy future earnings growth will strengthen its cash flows, which will support its dividends. Furthermore, my price target calculations suggest a potential upside of approximately 25% for the stock. Analysts have also anticipated a healthy next five-years growth rate of 4.92% for AEP. Due to the aforementioned factors, I am bullish on AEP. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
