Business context and reporting period
American Electric Power Company, Inc. (AEP) is an electric utility holding company with regulated generation, transmission and distribution businesses, alongside competitive generation and marketing and river operations. This combined Form 10-Q covers the quarter and nine months ended September 30, 2014; financial statements are unaudited. Prior-year segment comparisons were recast after a 2013 reporting-structure change. AEP also completed the transfer of Ohio Power Company’s generation assets to AGR at year-end 2013, materially changing OPCo’s business and comparability.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $4.302 billion | $4.176 billion | $12.994 billion | $11.584 billion |
| Operating income | $925 million | $875 million | $2.733 billion | $2.177 billion |
| Net income | $494 million | $434 million | $1.446 billion | $1.137 billion |
| Earnings attributable to AEP common shareholders | $493 million | $433 million | $1.443 billion | $1.134 billion |
| Diluted EPS | $1.01 | $0.89 | $2.95 | $2.33 |
Margins: Operating margin was approximately 21.5% for Q3 2014 versus 20.9% in Q3 2013, and 21.0% for the first nine months versus 18.8%. Net margin was approximately 11.5% versus 10.4% for Q3, and 11.1% versus 9.8% for the nine-month period.
- Cash flow: Nine-month operating cash flow was $3.725 billion, up from $3.040 billion. Investing used $3.081 billion, including $2.899 billion of construction expenditures; financing used $568 million. Cash increased to $194 million from $118 million at year-end 2013.
- Debt and equity: Total debt was $19.340 billion at September 30, including $1.282 billion short-term debt. Debt was 53.4% of total capitalization, down from 54.3% at year-end 2013. AEP common equity was $16.868 billion.
- Liquidity: Net available liquidity was approximately $3.086 billion, including $3.5 billion of revolving credit commitments. AEP reported compliance with its credit covenants; the contractual debt-to-capitalization ratio was 49.9% against a 67.5% limit.
- Capital spending and dividends: AEP raised its 2014 construction-expenditure forecast by $350 million to approximately $4.2 billion. It paid $736 million in common dividends during the first nine months. The board declared a quarterly dividend of $0.53 per share in October 2014.
Material changes versus the prior comparable period
- Common-shareholder earnings rose 14% in Q3 and 27% for the first nine months. Management attributed the increase largely to prior-year impairments, successful rate proceedings and increased transmission investment; nine-month results also benefited from higher market prices and sales volumes.
- Prior-year impairments included $111 million related to Turk Plant AFUDC, $33 million related primarily to Big Sandy scrubber costs, and $154 million for Muskingum River Plant Unit 5. These make year-over-year earnings comparisons less indicative of recurring performance.
- Vertically Integrated Utilities earnings increased to $219 million from $173 million in Q3 and to $651 million from $505 million for nine months. Transmission and Distribution Utilities earnings fell to $92 million from $119 million in Q3 and were approximately flat for nine months ($279 million versus $281 million).
- AEP Transmission Holdco earnings increased to $43 million from $22 million in Q3 and to $114 million from $53 million for nine months, reflecting investment growth; segment net plant increased from $1.3 billion to $2.4 billion.
- Generation & Marketing nine-month earnings rose to $378 million from $188 million, reflecting higher generation margins and the absence of the prior-year Muskingum River impairment. Corporate and Other earnings fell to $4 million from $119 million, principally because the prior-year period included a favorable U.K. Windfall Tax decision.
- Weather-normalized retail sales volumes increased 0.1% in Q3 and 0.4% for nine months. Industrial sales declined 0.7% for nine months, mainly due to Ormet’s closure; excluding Ormet, industrial volumes increased 3.8%.
Outlook, management commentary, risks and contingencies
- Outlook: The filing provides no company-wide earnings guidance. AEP expected a significant decline in AGR capacity revenues after the power supply agreement with OPCo ends in May 2015, and a further decline in PJM capacity revenues for June 2016–May 2017 based on lower auction prices.
- Ohio regulatory exposure: At September 30, OPCo had a $395 million deferred fuel balance and $409 million of deferred capacity costs. Appeals remain pending. An October 2014 independent audit recommended a potential refund methodology if fixed fuel costs were also recovered through capacity charges; the retail share of those costs is approximately $90 million annually. Management disputed the audit’s conclusions. Failure to recover deferred balances or approved rates could reduce future earnings and cash flow.
- Rate cases: Material proceedings included APCo’s Virginia case, where staff and intervenors recommended customer refunds of $15–$22 million, asset write-offs totaling $27 million and $38 million of annual additional depreciation; APCo’s West Virginia rate request; and PSO’s Oklahoma case, for which a non-unanimous stipulation was pending an order. SWEPCo’s Louisiana rate increases were subject to review, and its Texas transmission rider remained pending.
- Generation and environmental risks: AEP estimated $3–$3.5 billion of system environmental investment through 2020. The filing identified 6,533 MW of generation intended for retirement before or during 2016; the listed regulated plants had $973 million of net book value before removal costs, inventory and construction work in progress. New emissions, coal-ash and water rules could require additional spending, accelerated retirements or asset impairments. Recovery of compliance costs through regulated rates is not assured.
- Specific environmental project: SWEPCo estimated Welsh Units 1 and 3 controls at approximately $410 million, with total projects through 2020 estimated at $600 million, excluding AFUDC. It had incurred $112 million and had $84 million of contractual construction obligations at September 30.
- Legal and other contingencies: Proceedings include Rockport Unit 2 lease litigation, a PSO wage-and-hours class action, and Gavin landfill personal-injury and wrongful-death claims. AEP said it could not determine reasonably possible loss ranges for several of these matters. I&M recorded approximately $17 million for Michigan site remediation. The filing also cites nuclear decommissioning and spent-fuel obligations and a $115 million SWEPCo mine-reclamation guarantee.
- Market and financing risks: Commodity, interest-rate, counterparty and credit risks could affect earnings, cash flows or collateral needs. The filing estimated $144 million of collateral could be required under credit-rating downgrade triggers across specified contracts and guarantees. AEP’s estimated interest-rate Earnings at Risk for the next 12 months was $42 million, versus $32 million at year-end 2013.
Most important facts for investors to verify
- Whether Ohio regulators permit full recovery of OPCo’s deferred fuel and capacity balances, and the outcome of the fixed-fuel audit and related appeals.
- Final rulings and realized earnings or cash-flow effects from APCo, PSO and SWEPCo rate proceedings, including proposed refunds, disallowances and recovery riders.
- Whether environmental compliance plans, retirements and conversions proceed as estimated, and how much of the associated capital cost customers ultimately bear.
- The pace of AGR capacity-revenue declines after May 2015 and their effect on competitive-generation earnings.
- Whether operating cash flow and available liquidity remain adequate as AEP funds its elevated construction program, debt maturities and dividends.
- Developments in material litigation and environmental contingencies for which the filing does not provide a clear loss estimate.