American Electric Power Company, Inc. — Q1 2015 Form 10-Q
Business context and reporting period. AEP is an electric utility holding company whose businesses include regulated generation, transmission and distribution, competitive generation and marketing, and river operations. This combined, unaudited filing covers the three months ended March 31, 2015, and includes AEP and five registrant utility subsidiaries. Comparisons are with Q1 2014 unless stated otherwise.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Consolidated revenue | $4.708 billion | $4.648 billion | Up 1.3% |
| Operating income | $1.124 billion | $1.041 billion | Up 8.0% |
| Net income | $631 million | $561 million | Up 12.5% |
| Earnings attributable to AEP common shareholders | $629 million | $560 million | Up 12.3% |
| Diluted EPS | $1.29 | $1.15 | Up 12.2% |
| Cash from operating activities | $1.257 billion | $1.133 billion | Up $124 million |
| Cash used for investing activities | $1.017 billion | $981 million | Higher use of $36 million |
| Cash from (used for) financing activities | $(213) million | $22 million | Down $235 million |
| Cash and cash equivalents, at quarter-end | $190 million | $163 million at year-end 2014 | Up $27 million |
| Total debt | $20.084 billion | $20.030 billion at year-end 2014 | Up $54 million |
| Debt to total capitalization | 53.8% | 54.3% at year-end 2014 | Improved 0.5 percentage points |
| Net available liquidity | $3.5 billion | Not stated for comparable period | — |
Calculated from reported figures, operating margin was approximately 23.9% versus 22.4%, and net margin approximately 13.4% versus 12.1%. AEP reported $17.241 billion of common equity at March 31, 2015. Cash flow figures are quarterly; construction expenditures were $1.077 billion, compared with $907 million a year earlier.
Material changes and management commentary
- AEP attributed higher earnings principally to successful rate proceedings, lower employee-related expenses, increased transmission investment and favorable trading and marketing. These gains were partly offset by lower off-system sales margins and reduced weather-normalized retail sales.
- Weather-normalized retail sales fell 1.3%. Industrial sales rose 1.2%, primarily reflecting oil- and gas-related customers; residential sales declined 4% and commercial sales declined 0.4%.
- Segment earnings attributable to AEP common shareholders increased for Vertically Integrated Utilities ($299 million versus $278 million), AEP Transmission Holdco ($36 million versus $24 million), Generation & Marketing ($187 million versus $163 million), and River Operations ($11 million versus $3 million). Transmission and Distribution Utilities were unchanged at $97 million.
- Vertically Integrated Utilities’ off-system sales margins declined $72 million, primarily from lower market prices and volumes. Generation & Marketing benefited from stronger trading and marketing, partly offset by lower generation capacity revenue.
- Operating cash flow rose to $1.257 billion, supported by higher net income and working-capital movements. Investing outflows increased, mainly due to construction spending on environmental, distribution and transmission projects. Financing outflows included $260 million of common dividends and a $491 million reduction in short-term borrowing.
- Long-term debt, including amounts due within one year, was $19.229 billion; short-term debt was $855 million. AEP had $3.5 billion of revolving credit commitments, plus $190 million cash, offset by commercial paper and letters of credit, leaving $3.5 billion net available liquidity. The revolving credit covenant limit is 67.5% debt to capitalization; the contractually defined ratio was 50.8%, and AEP reported compliance.
Outlook, risks, contingencies and unusual items
- No quantified company-wide earnings guidance was provided in the supplied filing text. Management cautioned that quarterly earnings are not necessarily indicative of full-year results.
- AEP was evaluating alternatives for its merchant generation fleet, potentially including continued ownership, a regulated-affiliate power agreement, a spin-off or a sale; no decision or timetable had been set. It was also evaluating continued ownership or sale of River Operations and did not expect a loss from a potential river-operations sale.
- AEP expected a significant decline in Generation & Marketing capacity revenues after the power supply agreement with OPCo ends in May 2015, with a further decline in June 2016–May 2017 based on PJM auction prices.
- Management estimated AEP System environmental investment of approximately $2.8–$3.3 billion through 2020. The registrant subsidiaries’ estimated portion was $1.83–$2.05 billion. These estimates and recovery are subject to regulatory requirements, project costs and approval to recover expenditures from customers.
- AEP planned retirements of approximately 6,533 MW of generation capacity before or during 2016, including several units expected to retire in Q2 2015. The listed regulated plants had $965 million of net book value before cost of removal, inventory and construction work in progress. The filing warns that disallowed costs or unrecovered investment could reduce earnings and cash flow.
- The EPA’s coal-combustion-residual rule was published in April 2015, after quarter-end. AEP had not quantified the expected increase in asset-retirement obligations and expected to record an increase in Q2 2015. Management also anticipated significant future costs to upgrade, close or replace coal-ash facilities.
- OPCo recorded a $434 million deferred capacity-cost balance at March 31, 2015. In April, the PUCO approved continued recovery through a modified rider, but the final balance is subject to audit. A separate audit raised potential fixed-fuel-cost refund questions; management disputed the findings. OPCo’s new ESP was approved with modifications, and rehearing was granted in April.
- Other material regulatory uncertainties include APCo’s West Virginia rate case, Virginia’s freeze of APCo base rates until after a 2020 review, I&M’s proposed transmission and distribution investment recovery plan, and pending challenges concerning SWEPCo’s Turk Plant cost recovery. Potential disallowances and refunds could adversely affect results.
- Legal and operational exposures include remaining Rockport Unit 2 lease-related claims, a PSO overtime class action, and litigation alleging exposure to coal-combustion waste at the Gavin landfill. Management stated it could not determine reasonably possible loss ranges for certain cases.
- Other risks cited include environmental regulation and litigation, commodity and interest-rate exposure, counterparty credit risk, weather, fuel availability, regulatory recovery, and market volatility. The filing reported no material changes to the risk factors in AEP’s 2014 Form 10-K.
Most important facts for investors to verify
- Whether Q1 earnings growth is sustainable given the decline in weather-normalized sales and off-system sales margins, and the approaching reduction in merchant capacity revenues.
- Final regulatory outcomes for OPCo deferred capacity costs and fuel-cost audits, as well as key pending rate cases and the recoverability of regulatory assets and plant investments.
- The eventual cost, timing and customer rate recovery of environmental compliance, including the coal-ash rule’s effect on asset-retirement obligations and planned unit retirements.
- Debt maturities, refinancing needs, liquidity availability and the impact of capital spending and dividends on cash balances and leverage.
- Whether AEP makes a strategic decision on the merchant generation fleet or River Operations, and any resulting charges or effects on earnings and cash flow.