Business context and reporting period
American Electric Power Company, Inc. (AEP) filed this unaudited Form 10-Q for the quarter ended September 30, 2015. AEP is an electric utility holding company with regulated generation, transmission and distribution operations, alongside competitive generation and marketing and river transportation businesses. The combined filing also includes five registered utility subsidiaries.
Weather-normalized retail sales volumes rose 0.9% in the quarter and 0.1% in the first nine months versus 2014. Management attributed quarterly growth mainly to commercial and residential sales and increased industrial sales, including from oil and gas customers.
Key financial metrics
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $4.432 billion | $4.161 billion | $12.839 billion | $12.559 billion |
| Operating income | $960 million | $905 million | $2.868 billion | $2.697 billion |
| Net income | $520 million | $494 million | $1.582 billion | $1.446 billion |
| Earnings attributable to AEP common shareholders | $519 million | $493 million | $1.578 billion | $1.443 billion |
| Diluted EPS | $1.06 | $1.01 | $3.22 | $2.95 |
Margins: Operating margin was approximately 21.7% for Q3 2015 and 22.3% for the first nine months, compared with approximately 21.8% and 21.5%, respectively, in the comparable 2014 periods. These are calculated as operating income divided by total revenue.
Cash flow and investment: For the first nine months, operating cash flow was $3.910 billion, investing cash flow was negative $3.248 billion, and financing cash flow was negative $647 million. Construction expenditures were $3.283 billion, up from $2.897 billion. Cash and cash equivalents were $178 million at September 30, 2015, versus $163 million at year-end 2014.
Debt and liquidity: Total debt was $20.289 billion at September 30, including $19.507 billion of long-term debt and $782 million of short-term debt. Debt-to-total capitalization improved to 53.4% from 54.3% at December 31, 2014. Net available liquidity was $3.613 billion, including $3.5 billion in revolving credit commitments; AEP reported compliance with its credit covenants.
Dividends: AEP declared $0.53 per share for Q3 and $1.59 per share for the first nine months. In October, the board declared a quarterly dividend of $0.56 per share.
Material changes versus prior comparable periods
- Quarterly earnings attributable to AEP shareholders increased $26 million; nine-month earnings increased $135 million. Management cited rate proceedings, formula-rate adjustments, weather-related usage and transmission investment as principal contributors.
- Lower wholesale market prices and sales volumes reduced off-system sales margins. Generation & Marketing earnings fell to $91 million from $117 million for the quarter and to $360 million from $378 million for the nine-month period, with lower capacity revenue following the May 2015 end of the AGR-OPCo power supply agreement.
- Transmission investment increased: AEP Transmission Holdco’s nine-month transmission revenue rose to $245 million from $140 million, primarily as projects entered service.
- Generation retirements and changes in plant classifications were significant. AEP reported 5,535 MW of plant and unit retirements in May 2015; certain remaining plant balances depend on regulatory recovery.
Outlook, commentary, risks and unusual items
- Capital plan: AEP raised its 2015 construction expenditure forecast by $200 million to approximately $4.6 billion, primarily for transmission investment.
- River Operations sale: In October 2015, AEP agreed to sell AEP River Operations, subject to regulatory approvals, with closing expected in Q4 2015. Management expected approximately $400 million of net cash proceeds and an after-tax gain of approximately $100 million to $150 million, subject to adjustments. The business was classified as held for sale and discontinued operations; its Q3 earnings were $8 million after tax.
- Merchant generation: AEP was evaluating continued ownership, a sale, a spin-off, or a power agreement with a regulated affiliate for its merchant fleet. No decision or timetable had been set; some alternatives could produce a loss.
- Regulatory recovery: OPCo reported $392 million of net deferred capacity costs at September 30. Recovery and potential refunds remain subject to proceedings, including audits and appeals. Management disputed an auditor’s recommendation concerning possible fixed-fuel-cost over-recovery. PSO’s pending Oklahoma rate case sought $137 million in annual revenue increases; staff and intervenor recommendations were materially lower and included proposed disallowances.
- Environmental exposure: AEP estimated $2.8 billion to $3.3 billion of system environmental investment through 2020. New coal-ash requirements contributed to a $95 million increase in consolidated asset retirement obligations in Q2. Environmental rules, litigation, permitting and the ability to recover compliance costs could affect earnings, cash flow and asset values.
- Other unusual items: AEP recognized a $32 million gain on the August sale of the retired Muskingum River Plant site. Management also cited a settlement and revision of certain asset retirement obligations as reducing Generation & Marketing operating costs.
- Contingencies: The filing describes regulatory and environmental proceedings, Rockport Plant litigation with no reasonably estimable loss range, and a PSO wage-and-hour case for which management said loss was not probable but possible losses could reach $30 million. AEP stated that no material changes had occurred in previously disclosed risk factors.
- Forward-looking caveat: Results remain sensitive to weather, load, fuel and power prices, interest rates, capital-market access, plant performance, regulatory decisions, environmental requirements and cost recovery.
Important facts for investors to verify
- Progress, final terms, approvals, proceeds and realized gain from the AEP River Operations sale.
- Outcomes of OPCo’s capacity-cost recovery and fuel-cost proceedings, including the $392 million deferred balance and potential refunds.
- PSO’s final approved rate relief and recovery of environmental investments, retired-plant balances and replacement power costs.
- Actual environmental compliance spending, asset retirement obligations, and recovery of costs through regulated rates.
- Capital spending, funding needs, debt levels and liquidity as the transmission and environmental investment programs continue.
- Any decision on the merchant generation fleet and its effects on earnings and cash flow.