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AEP AT A GLANCE

P/E ► 11.5 AVG EV/EBITDA ► 5.34 AVG ROA ► 5.4% AVG ROE ► 10.6% AVG Debt to Equity ► 2.61 AVG Current Ratio ► 0.898 AVG Interest Coverage Ratio ► 2.59 AVG

 

 

 

 

 

 

American Electric Power (NYSE: AEP) is one of the largest electric utility companies in the United States, delivering electricity to 5 million customers in 11 states.^[1] About 56% of its revenue comes from three key states: Ohio (32% of revenue), Oklahoma (14%) and Indiana (10%)^[2]. The company can generate over 38,000 megawatts (MW), enough to power nearly 30 million homes, and has an extensive 39,000 mile transmission network.^[3][4] AEP’s transmission system directly or indirectly serves about 10 percent of the electricity demand in the Eastern Interconnection, the interconnected transmission system that covers 38 eastern and central U.S. states and eastern Canada, and approximately 11 percent of the electricity demand in Texas.^[5]

Prices for fossil fuels, the key energy input for AEP’s electrical generation plants, have been volatile over the past couple years. When the demand for coal dropped in the second half of 2008 and caused massive surpluses, the resulting decline in coal prices lowered operating expenses for AEP and increased the company's profit margin. However, the global economic slowdown lowered AEP's industrial electricity usage by an average of 15 percent in the first quarter of 2009, leading to lower revenues than in the previous year.^[5]

Weather can also have a material impact on AEP's business. Generally, extremes of temperature are good for utility companies because they force customers to run either heaters or air conditioners. Unseasonably mild weather on the other hand, results in fewer heating and cooling days, leading to lower electrical demand and lower revenue for AEP.

Electric utilities are heavily regulated by the federal and state governments in the United States. Federal agencies supervise utility companies and ensure that electricity is affordable and that it provides a "fair" return for the utility company without causing them to earn excess profits. As such, AEP must have all electricity rate hikes approved by various government agencies.

AEP generates nearly 66% of its energy using coal power, making it particularly vulnerable to "green" legislation like the Renewable Portfolio Standards being enacted in 26 states and the Advanced Energy Portfolio Standard being enacted in Ohio. The company has faced litigation, such as a suit brought by the U.S. Environmental Protection Agency, eight states, and 14 environmental organizations requiring AEP to limit emissions for its 16 coal power plants and install additional emissions control equipment in two plants. Electric utility companies are under increasing legislative pressure to adopt cleaner electricity generation methods while maintaining competitive prices. AEP produces over two-thirds of its energy from burning coal, but has begun to diversify its electricity generation base by getting into hydroelectric, nuclear, wind and solar power projects. AEP owns over 300+ MW of wind generating capacity within Texas and 800 MW of hydroelectric power from its 17 hydroelectric facilities.

Company Overview

American Electric Power is a utility holding company that generates, transmits, and distributes electric power to retail customers, other electric utility companies, and municipalities. The subsidiaries of AEP include Appalachian Power Company (APCo), Columbus Southern Power Company (CSPCo), Indiana Michigan Power Company (I&M), Ohio Power Company (OPCo), Public Service Company of Oklahoma (PSO), and Southwestern Electric Power Company (SWEPCo).^[6]

Business and Financial Metrics

Q2 2009 Summary
AEP reported net earnings of $316 million for the second quarter of 2009, up 12.5% from earnings of $281 million for second-quarter 2008.^[7] Ongoing earnings from utility operations increased by $63 million in second-quarter 2009 when compared with the same period last year, primarily because of increased rates in AEP’s utilities in Virginia, Indiana and Oklahoma, the implementation of the Electric Security Plan (ESP) approved by regulators in Ohio, and lower operation and maintenance expenses.^[7]These favorable items were somewhat offset by a reduction in both sales to industrial customers and off-system sales, which declined by $155 million.^[7]

2008 earnings totaled $1.3 billion^[8]

Favorable weather, primarily in AEP’s eastern service areas, improved margins in the quarter. Heating degree-days in second-quarter 2009 were 9 percent below normal but 15 percent above the total for the same period in 2008.^[7] Cooling degree-days in second-quarter 2009 were 5 percent above normal and 8 percent above the prior period.^[7] In AEP’s western service areas, cooling-degree days for second-quarter 2009 were 2 percent above normal but 1 percent below the prior period.^[7]

AEP's is highly dependent on coal. With the government pushing for a reduction in greenhouse gas emissions, AEP will have to retrofit existing coal-fired power plants to reduce emissions while shifting towards cleaner, more sustainable generation solutions.

AEP's energy production breakdown by source^[9]

Key Trends/Forces

AEP is expanding its portfolio to include renewable energy

Wind
AEP owns 310.5 megawatts of wind generation capacity in Texas.^[11] AEP also has agreements to purchase 742 megawatts from several wind power facilities in Illinois, Indiana, Oklahoma and Texas.^[11] Additionally, in 2005, Public Service Company of Oklahoma (PSO), a unit of AEP, became the largest purchaser of wind energy in Oklahoma with agreements for nearly 300 megawatts.^[11] In 2006, PSO announced it will purchase an additional 94.5 MW from the Sleeping Bear wind project, also located in Oklahoma.^[11]

AEP led in the development of the e8’s San Cristobal Wind Project in the Galapagos Archipelago, dedicated in March 2008. The 2.4-MW project, completed in collaboration with e8, the United Nations and Ecuador, is the first large-scale wind project in Ecuador and is one of the largest wind-diesel hybrid systems in the world.^[11]

Hydroelectric
AEP’s 17 hydroelectric facilities in Virginia, West Virginia, Ohio, Indiana and Michigan generate more than 800 megawatts of electricity.^[11] Smith Mountain Hydro Project, on the Roanoke River southeast of Roanoke, Virginia, was the nation’s first major development combining run-of-the-river hydro with pumped storage generation.^[11]

Solar
AEP has also expanded its renewable portfolio to include solar energy. On June 15, 2009, AEP's Ohio unit signed a long-term power purchase agreement for a 10 megawatt solar energy plant to be built in Ohio.^[12] The deal is AEP's first commercial solar energy agreement in its renewable portfolio. Under the agreement, AEP Ohio will purchase all of the output and renewable energy credits from a Wyandot Solar plant to be built in Salem Township, Ohio. Construction is expected to begin in November, and commercial operation is expected by mid-summer 2010.

Biomass
Biomass represents a potentially carbon-neutral energy source, in that the carbon released during the conversion of plants and trees into electricity is the same carbon that is taken out of the atmosphere during photosynthesis. AEP has conducted biomass co-firing test at several of its power plants in the U.S.^[11] AEP continues to investigate biomass fuels and views biomass co-firing as an effective means of meeting possible renewable energy requirements in the future.^[11]

Reducing carbon emissions
AEP has launched several initiatives to reduce the carbon emissions from its coal plants. AEP has launched a carbon capture project using Alstom's chilled ammonia process the is scheduled to be operational at its Mountaineer Plan in West Virginia in the fall of 2009.^[13] Carbon capture and storage (CCS) is an approach to mitigating the contribution of fossil fuel emissions to global warming, based on capturing carbon dioxide from fossil fuel power plants. The carbon dioxide is then stored away to prevent it from entering the atmosphere.

AEP has also launched gridSMART, a plan to provide customers with greater control over their energy consumption through the use of a "smart" electricity meter. The program will also deploy advanced technologies to identify potential problems with AEP's electricity delivery system, preventing disruptions and increasing the reliability and efficiency of electricity transmission.

Falling coal prices lower AEP's input costs

Prices for fossil fuels, the key energy input for AEP’s electrical generation plants, have been volatile over the past couple years. Higher coal spot prices lead to increased operating costs for AEP. When the demand for coal dropped in the second half of 2008 due to the global economic slowdown, coal miners had huge surpluses of coal already out of the ground.^[14] While electric utilities and the steel industry bought less and less coal in the second half of 2008, coal miners began to lower the prices of both thermal and coking coal in order to sell their huge surpluses, which were expensive to store.^[15] The decline in coal prices lowered operating expenses for AEP and increased the company's profit margin.

According to a report by UBS analysts, 2009 coking coal prices will drop to $85 per metric tonne and thermal coal will sell on average for $55 per short ton (0.91 metric ton).^[16] UBS argued that slowing capital investment, idle high-cost mines, and over supply are the primary forces that will drive 2009 U.S. coal consumption down a predicted 8.2% for coking and 0.7% for thermal.^[17] Altogether, coal production is expected to fall 4% in 2009. ^[18]

Internationally, coal consumption will depend primarily on the economic conditions in China, India, and Europe. Led by strong economic growth and rising need for cheap energy in China and India, coal consumption is projected to double 2005 consumption levels by 2030.^[19] However, the largest increases in consumption are from coal produced and consumed in China, meaning that exports to China have declined dramatically.^[20] However, growth in Asia and production problems in China, South Africa, and Australia were the primary reasons U.S. coal exports increased 40% in 2008.^[21] Although economic growth in China is expected to slow, its infrastructure-focused $586 billion stimulus package should increase the need for coal as a cheap power source.^[22] Economic growth abroad is important not only because coal exports accounted for 5.2% of total U.S. production in 2007 but also because they import steel, which requires coking coal to produce.^[23]

Regulations to disproportionately affect coal dependent power generators

Utilities face growing pressure from government regulatory bodies to curb their emissions of greenhouse gases. In 2008 three major investment banks, predicted that the U.S. government would cap CO2 emissions in the next three years. AEP generates nearly 66% of its energy using coal power, making it particularly vulnerable to "green" legislation like the Renewable Portfolio Standards being enacted in 26 states and the Advanced Energy Portfolio Standard being enacted in Ohio. The company has already experienced troubles related to its emissions. In October of 2007, AEP reached a settlement agreement with the U.S. Environmental Protection Agency, eight states and 14 environmental organizations requiring AEP to limit emissions for its 16 coal power plants and install additional emissions control equipment in two plants. AEP will also pay a civil penalty of $15 million. ^[24] The company's CEO believes that fossil fuels will remain the dominant form of energy production in the 21st century, and emissions will be mitigated through the implementation of new technologies^[25], and as a result has taken few steps to increase the company's nuclear portfolio. It has, however, started to increase its investment in renewable energy sources. In 2007, the company announced a voluntary plan to increase its renewable generating capacity by 1000 MW by 2011, and on April first its subsidiary, Appalachian Power, issued a request for electric utilities to propose long-term purchases of up to 100 MW of electricity coming from proven renewable sources.

Mild weather dampens AEP's revenue

Weather can have a material impact on AEP's business. Generally, extremes of temperature are good for utility companies because they force customers to run either heaters or air conditioners. Unseasonably mild weather on the other hand, can lead to fewer heating and cooling days, in the winter and spring respectively.

Over 14% of the electricity used by household powered central air-conditioning systems and refrigerators in United States.^[26] With close to 60% of U.S. households equipped with central air conditioning systems, the number of hot days and cold days impacts the amount of electricity used in homes and the amount of coal needed to supply that electricity.^[27] In order to account for weather-related electricity usage, the National Oceanic and Atmospheric Administration (NOAA) records the number of heating degree days and cooling degree days, which reflect the need for air conditioning during cooler days and warmer days.^[28] Although the data collected by the NOAA can help explain past and current electricity consumption and, therefore, coal consumption, future weather patterns are hard to predict. Additionally, during drought seasons, the amount of hydroelectric electricity generated drops, and coal power electricity is used as an alternative. In 2007, hydroelectric energy accounted for 6% of electrical power generated in the United States.^[29] That same year, hydroelectric power dropped 14.6% due to drought. On the other hand, coal consumption grew 1.9% partly because of the fall in electricity produced by hydroelectric plants.^[30] In general, AEP benefits when the demand for electricity rises and the load on its electrical grid increases, whether caused by drought, unseasonably warm or cold weather, or other factors.

Governments must approve AEP rate hikes

The U.S. and state governments play critical roles in the financial performance of the highly regulated energy sector since the government sets the price of electricity. Electricity is considered as a necessary service, and with regulation in place, the government can guarantee that adequate service at an affordable price will be rendered to all who apply for it. Federal agencies that supervise the utilities ensure that it is affordable and that it provides utilities a "fair" return on their investment without earning excessive profits. How "fair" returns on investment and excessive profits are determined has been subject of much controversy. Each of AEP's utility businesses face a variety of challenges and potential benefits that may arise from changes in legislation and regulatory schemes. In recent years, the company has had relatively successful attempts at lobbying for rate hikes; $481 million of the $518 million in rate increases that the company applied for in the first quarter of 2008 were approved.^[31] In Ohio, however, new utilities legislation that is being debated could have an "excessive earnings" clause that would compare the returns of utilities to private-sector companies with similar risk, in order to determine if the utilities are abusing their monopoly powers. If the bill passes, AEP will find it more difficult to obtain rate hikes.

Competition

Utility companies, historically speaking, have faced little competition due to the regulated nature of the industry. Since utility companies are massive operations requiring immense amounts of capital to build power plants, transmission services, and connections into homes, their services only become economical as they add users as they realize economies of scale and diffuse costs over a larger customer base. In this industry, a monopolistic utility guarantees it can provide vital electricity service at an affordable cost, especially to lower socio-economic classes. The government acts as a watch-guard, ensuring that consumers are not overcharged for electricity while granting these utility immunity from anti-trust/monopoly laws.

As a result, AEP faces mild competition from other electric utilities, even in areas that are moving towards de-regulation and an open/free market.

Electrical Generation Fleet Mix

The above table encapsulates the utilities' current electrical generation fleet broken down by power source (e.g. coal, natural gas, oil etc.). It is worth noting that these percentages do not necessarily reflect the actual source percentages for electricity generated as power-plants are used at various capacities depending on the market demand and price of electricity.

References

1. ↑ AEP's Investor Page
2. ↑ AEP's 2006 Annual Report (Utility Operations)
3. ↑ AEP's Investor Page)
4. ↑ Power of Electricity
5. ↑ ^{5.0 5.1} AEP Q1 2009 Earnings Release
6. ↑ Reuters: American Electric Power Company, Inc.
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5} AEP Reports 2009 Second-Quarter Earnings
8. ↑ AEP Presentation to INVESTOhio, Columbus, OH
9. ↑ AEP 2008 Summary Annual Report
10. ↑ AEP 10-K 2009 "Fuel Supply"
11. ↑ ^{11.0 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8} American Electric Power: Renewables
12. ↑ MSN Money: "AEP signs first solar energy agreement"
13. ↑ AEP 2008 Summary Annual Report
14. ↑ Seeking Alpha: Could Coal Recover, December 2008
15. ↑ Seeking Alpha: Could Coal Recover, December 2008
16. ↑ Reuters.com:UBS slashes coal price forecasts for 2009, 2010
17. ↑ EIA: Short Term Energy Outlook, Coal
18. ↑ EIA: Short Term Energy Outlook, Coal
19. ↑ International Energy Outlook, 2008
20. ↑ EIA: International Energy Outlook 2008
21. ↑ International Energy Outlook, 2008
22. ↑ MSN.com: The Case for Coal 2009
23. ↑ EIA: U.S. Coal Supply and Demand, 2007
24. ↑ AEP reaches settlement agreement in NSR case
25. ↑ Future power: American electric power's Mike Morris
26. ↑ EIA: Household Electricity Uses
27. ↑ EIA: Appliance Report
28. ↑ U.S. Coal Supply and Demand, 2007
29. ↑ U.S. Coal Supply and Demand, 2007
30. ↑ U.S. Coal Supply and Demand, 2007
31. ↑ AEP 1Q08 Earnings Call, Page 1
32. ↑ AYE's 2006 10-k (Pg 52)
33. ↑ AEP's 2006 10-k (Pg A-45)
34. ↑ DUK's 2006 10-k (Pg 40)
35. ↑ AYE - About Us
36. ↑ AEP's Investor Page)
37. ↑ DUK's Energy Business Segments
38. ↑ AYE's About Us
39. ↑ AEP's Investor Page)
40. ↑ DUK's Energy Business Segments
41. ↑ AEP's 2006 Annual Report (Item 2)
42. ↑ DUK's 2006 10-k (Pg 11)
43. ↑ AYE's 2006 10-k (Pg 52)
44. ↑ AEP's 2006 10-k (Pg A-45)
45. ↑ DUK's 2006 10-k (Pg 40)
46. ↑ AYE's Generation Facilities
47. ↑ EIX's 2006 Annual Report (Pg 19)
48. ↑ AEP's Power Plants and other assets
49. ↑ DUK's 2006 10-k (Pg 34)
50. ↑ Entergy's 2006 10-k (Pg 173)
51. ↑ Exelon's 2006 10-k - Properties
52. ↑ PSEG's 2006 10-k (Pg 41)