American Electric Power Company, Inc. — Q2 2016 Form 10-Q
Business context and reporting period
AEP is an electric utility holding company whose businesses include regulated generation, transmission and distribution, transmission development, and competitive generation and marketing. This combined unaudited filing covers the quarter and six months ended June 30, 2016, and also includes separate reports for five utility subsidiaries.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $3,892.9 million | $3,826.7 million | $7,937.8 million | $8,407.1 million |
| Operating income | $866.2 million | $804.1 million | $1,759.1 million | $1,906.9 million |
| Income from continuing operations | $506.4 million | $431.4 million | $1,009.5 million | $1,051.6 million |
| Earnings attributable to AEP common shareholders | $502.1 million | $430.0 million | $1,003.3 million | $1,059.2 million |
| Diluted EPS | $1.02 | $0.88 | $2.04 | $2.16 |
For the six months, operating cash flow was $1.726 billion, versus $2.199 billion in 2015. Capital construction expenditures were $2.286 billion, and investing cash outflow was $2.300 billion. Cash and cash equivalents were $246.8 million at June 30.
At June 30, total debt was $21.604 billion, including $19.544 billion of long-term debt and $2.060 billion of short-term debt. Debt was 54.0% of total capitalization, up from 53.2% at year-end 2015. AEP reported $2.338 billion in net available liquidity, supported by $3.5 billion in credit facilities; management said liquidity was adequate. The credit agreement debt-to-capitalization measure was 51.5%, below its 67.5% covenant limit.
Material changes versus the prior comparable periods
- Q2 common earnings increased to $502.1 million from $430.0 million. Key contributors included higher transmission earnings, increased Ohio transmission and distribution rider revenues, and lower income tax expense. A $56 million reversal of an unrealized capital-loss valuation allowance followed the effective settlement of an IRS audit issue.
- Six-month common earnings declined to $1.003 billion from $1.059 billion, principally reflecting lower competitive generation revenues and weather-related usage. Consolidated revenue and operating income also declined for the six-month period.
- Transmission and Distribution Utilities earnings rose to $232.6 million for the first half from $174.8 million, while AEP Transmission Holdco earnings increased to $138.5 million from $101.0 million, reflecting rider revenues and transmission investment. Generation & Marketing earnings fell to $120.4 million from $268.7 million, mainly due to lower capacity revenues and wholesale energy prices.
- Weather-normalized retail sales volumes decreased 0.4% in Q2 and 0.3% in the first half year over year. Industrial sales were weak, particularly in manufacturing. Short-term debt increased substantially from year-end, primarily due to short-term borrowing.
Outlook, management commentary, risks and unusual items
- No specific full-year earnings or revenue guidance is provided in the filing text.
- AEP is exploring a sale of four merchant plants totaling 5,326 MW; binding bids were anticipated in Q3 2016. Their net book value, including related inventory and construction work, was $1.7 billion. Management had not decided on alternatives for the remaining 2,732 MW of merchant generation, with a $2.0 billion net book value. A sale or other strategic alternative could result in a loss.
- Ohio’s approved power purchase agreement rider was affected by a FERC order rescinding waivers for the proposed affiliate power agreement; management stated it did not intend to pursue that affiliate agreement. OPCo sought rehearing and proposed an OVEC-only rider, and filed an amended electric security plan seeking an extension through May 2024. Rate recovery, capacity deferrals, potential refunds, and fuel-cost audit proceedings remain material uncertainties.
- Environmental compliance is a significant capital and recovery exposure. AEP estimated $3.2–$3.8 billion of investment through 2025 to meet proposed requirements. Management intends to seek recovery through regulated rates; disallowances, accelerated depreciation, or impairments could affect future earnings and cash flow.
- Recent unit retirements created regulatory assets whose recovery remains subject to approval, including $87 million related to PSO’s Northeastern Unit 4 and $76 million related to SWEPCo’s Welsh Unit 2. PSO’s base-rate case and the prudence review of SWEPCo’s Turk Plant investment also remain unresolved.
- AEP retired its commercial barge subsidiary in November 2015; it recorded a $3 million loss in Q2 2016 for final sale accounting. AEP also disclosed litigation and other contingencies, including an appeal in the Rockport Unit 2 matter and potential regulatory refunds. Management could not estimate a reasonably possible loss range for certain proceedings.
- The Board declared a quarterly dividend of $0.56 per share in July 2016. Management cautioned that future dividends may vary with earnings, operating cash flow, capital needs, and other conditions.
Important facts for investors to verify
- Whether reported Q2 earnings benefited materially from the tax valuation-allowance reversal and other tax adjustments, and how much of the earnings improvement is recurring.
- Final outcomes and customer-rate implications of OPCo’s ESP/PPA rider, capacity-cost and fuel-recovery proceedings, including potential refunds or disallowances.
- Progress and pricing in the merchant plant sale process, and any impairment or loss associated with the remaining competitive-generation assets.
- Regulatory recovery of retired-plant balances and environmental investments, including the PSO base-rate case, Turk Plant prudence review, and Welsh Plant costs.
- Whether operating cash flow, capital spending, short-term borrowing, and liquidity remain consistent with management’s financing and investment plans.