Business context and reporting period
American Electric Power Company, Inc. (AEP) filed this combined Form 10-Q for the three months ended March 31, 2017. AEP is an electricity generation, transmission and distribution holding company; the filing also reports results for five separately registered utility subsidiaries. All figures below are for AEP consolidated unless otherwise stated.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $3.933 billion | $4.045 billion | Down 2.8% |
| Operating income | $1.097 billion | $892.9 million | Up 22.9% |
| Net income | $594.2 million | $503.1 million | Up 18.1% |
| Earnings attributable to AEP common shareholders | $592.2 million | $501.2 million | Up 18.2% |
| Diluted EPS | $1.20 | $1.02 | Up $0.18 |
| Operating margin | 27.9% | 22.1% | Approximate, calculated as operating income/revenue |
| Net margin | 15.1% | 12.4% | Approximate, calculated as net income/revenue |
Operating cash flow was $806.8 million versus $799.9 million. Investing activities provided $844.8 million, principally because of $2.160 billion in proceeds from the merchant-generation sale, partly offset by $1.366 billion of construction expenditures. Financing used $1.687 billion, including $1.336 billion of net debt retirements and $291.4 million of common dividends. Cash ended the quarter at $175.0 million.
At March 31, 2017, total debt was $20.772 billion, down from $22.104 billion at year-end 2016; debt represented 54.0% of total capitalization, compared with 55.9%. AEP reported $2.711 billion of net available liquidity after commercial paper borrowings, based on $3.5 billion of credit facilities and $175 million of cash. A $750 million receivables securitization commitment, expiring June 2018, is another stated funding source. The board declared a quarterly dividend of $0.59 per share in April.
Material changes versus the prior period
- Revenue fell despite higher reported earnings, mainly reflecting the sale of competitive generation assets and lower weather-related usage. Weather-normalized retail sales volumes declined 1.2% year over year.
- Q1 earnings included a $226.5 million pretax gain on the sale of four merchant plants. The sale closed in January for approximately $2.2 billion; net proceeds were approximately $1.2 billion after taxes, debt repayment and transaction costs. AEP used proceeds mainly to reduce debt and invest in regulated and contracted renewable businesses.
- Transmission growth was significant: AEP Transmission Holdco earnings attributable to AEP increased to $71.8 million from $43.9 million, primarily due to higher formula-rate transmission revenue and continued investment.
- Generation & Marketing earnings attributable to AEP rose to $186.2 million from $70.7 million, principally because of the sale gain, partly offset by lower generation margins following asset dispositions. The segment also recorded $11.2 million of asset impairments and related charges.
- Vertically Integrated Utilities earnings declined to $219.5 million from $277.6 million, largely due to lower weather-related retail usage and higher operating, depreciation and interest costs. Transmission and Distribution Utilities earnings increased to $119.1 million from $107.5 million.
Outlook, commentary and key risks
The filing does not provide a clear quantified full-year earnings or revenue guidance figure. Management said it continues to assess strategic alternatives for remaining merchant-generation assets. AEP agreed to sell its 25.4% interest in Zimmer Plant and acquire Dynegy’s 40% interest in Conesville Unit 4; closing was expected in Q2 2017, subject to FERC approval, with no material financial impact expected. Management also continues a strategic review of the 48 MW Racine hydroelectric plant.
- Regulatory and cost recovery: Pending rate proceedings could affect allowed revenues and recovery of investment. A FERC complaint seeks to reduce certain PJM transmission returns on equity from 10.99% to 8.32%; AEP’s revised transmission formula rates were accepted effective January 1, 2017, subject to refund and further proceedings. OPCo’s proposed Ohio electric security plan extension through May 2024 had a hearing scheduled for June 2017.
- Generation investment and environmental compliance: AEP estimated $4.3–$4.9 billion of investment to meet existing and proposed environmental requirements from 2012 through 2025. SWEPCo estimated approximately $850 million of Welsh Plant environmental investment through 2025. Recovery and final requirements remain subject to regulatory and legal outcomes.
- Turk Plant and other regulatory exposure: SWEPCo’s Louisiana Turk Plant rates have been collected subject to refund pending a prudence review, with a hearing scheduled for September 2017. AEP also identified potential disallowance or refund exposure in other rate proceedings, without quantifying a reasonably possible loss range in several cases.
- Rockport litigation: In April 2017, the Sixth Circuit reversed certain dismissals in litigation involving Rockport Unit 2 lease obligations and remanded the case. AEP and I&M planned to seek rehearing; management could not estimate a reasonably possible loss range.
- Nuclear supplier risk: Westinghouse filed for Chapter 11 reorganization in March 2017. I&M’s Cook Plant fuel fabrication and other contracts are involved; a disruption could significantly affect operations and potentially cause a temporary shutdown while alternative suppliers are sought.
- Other uncertainties: Management cited weather and load, fuel and commodity prices, financing costs, plant availability, environmental regulation, litigation, and the ability to recover costs through rates as factors that could affect results. AEP stated that it believed existing liquidity was adequate.
Important facts for investors to verify
- How much of the reported earnings increase is recurring versus attributable to the $226.5 million pretax generation-sale gain, and how proceeds were applied.
- Progress and final outcomes in the FERC transmission-rate complaint and proceedings, Ohio ESP extension, SWEPCo Texas rate case, and Turk Plant prudence review, including possible refunds or disallowances.
- The eventual financial and operational consequences of Rockport Unit 2 litigation and Westinghouse’s reorganization for Cook Plant fuel and services.
- Whether remaining merchant-generation dispositions close as expected and whether strategic alternatives or environmental obligations create additional impairments or losses.
- Whether liquidity, debt reduction and capital spending remain consistent with the reported financing position and regulated investment plans.