Business context and reporting period
American Electric Power Company, Inc. (AEP) filed this combined, unaudited Form 10-Q for the three months ended March 31, 2018. AEP is an electric utility holding company with regulated generation, transmission and distribution businesses, transmission-only operations, and competitive generation and marketing activities. Comparisons are with the first quarter of 2017 unless stated otherwise.
Financial results and liquidity
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $4.048 billion | $3.933 billion |
| Operating income | $706 million | $1.086 billion |
| Net income | $457 million | $594 million |
| Earnings attributable to AEP common shareholders | $454 million | $592 million |
| Diluted EPS | $0.92 | $1.20 |
| Operating margin | 17.4% | 27.6% |
| Net margin | 11.3% | 15.1% |
| Cash from operations | $802 million | $807 million |
| Construction expenditures | $1.906 billion | $1.366 billion |
Operating and net margins are calculated from reported operating income and net income divided by revenue. Cash from operations less construction expenditures was approximately negative $1.104 billion in Q1 2018. Ending cash, cash equivalents and restricted cash totaled $316.5 million, including $183.4 million of cash and cash equivalents.
At March 31, total debt was $24.120 billion, including $21.461 billion of long-term debt and $2.659 billion of short-term debt. Debt-to-total capitalization rose to 56.5% from 55.5% at year-end 2017. AEP reported $1.297 billion of net available liquidity under its credit facility and cash resources; its $3 billion revolving credit facility matures in June 2021. The covenant debt-to-capitalization measure was 54.8%, against a 67.5% limit. AEP declared a quarterly dividend of $0.62 per share in April, compared with $0.59 per share for Q1 2017.
Retail sales volumes, adjusted for weather, increased 1.5%; industrial, residential and commercial volumes rose 2.5%, 1.4% and 0.5%, respectively.
Material changes versus the prior period
- Common-shareholder earnings fell to $454 million from $592 million. A key comparison is the $226.5 million pretax gain recognized in Q1 2017 from the sale of merchant generation assets; there was no comparable gain in 2018.
- Transmission investment supported higher results at AEP Transmission Holdco: segment earnings rose to $104 million from $72 million, and transmission property, net, increased to $7.247 billion from $5.545 billion year over year.
- Generation & Marketing earnings declined to $18 million from $186 million, reflecting the prior-year asset-sale gain as well as lower generation, trading and marketing margins.
- Vertically Integrated Utilities earnings increased to $231 million from $220 million; Transmission and Distribution Utilities earnings increased to $125 million from $119 million. Weather-related usage and rate proceedings contributed, while higher operating, maintenance and depreciation costs partly offset gains.
- Investing cash flow shifted to a $1.928 billion use of cash from $776 million provided in Q1 2017, mainly because the prior period included $2.160 billion of merchant-asset sale proceeds and current construction spending was higher.
Outlook, management commentary and key risks
- Tax reform: The federal corporate tax rate fell from 35% to 21%. AEP recorded an estimated $120 million provision for customer revenue refunds in Q1; amortization of certain excess deferred taxes reduced income tax expense by $17 million, with an offsetting estimated customer-refund provision. Management said tax reform was not expected to materially affect net income, but anticipated lower future cash flows, including from reduced bonus depreciation and customer refunds. Tax reform estimates remained provisional, with analysis expected to be completed in the second half of 2018. At March 31, AEP reported approximately $4.4 billion of excess accumulated deferred income taxes and an incremental $1.2 billion liability related to their pretax presentation.
- Regulatory exposure: A proposed FERC settlement for PJM transmission rates would set a 9.85% base ROE (10.35% including the RTO adder) and require a $50 million customer refund. FERC action was pending; intervenors and FERC staff proposed larger refunds of $184 million and $175 million, respectively. Separate SPP transmission and SWEPCo power-supply ROE complaints also remained unresolved.
- Major projects and approvals: The proposed Wind Catcher project is estimated to cost $4.5 billion and remains subject to state approvals amid opposition and ongoing settlement discussions. An Oklahoma administrative law judge recommended denying PSO’s preapproval request. AEP’s wind repowering at Desert Sky and Trent was underway, with completion expected in 2018; AEP reported $131 million incurred against its $232 million share of estimated capital costs.
- Storm recovery: AEP Texas estimated Hurricane Harvey costs of $325 million to $375 million, including capital spending. By March 31, it had recorded $105 million of incremental storm expenses as a regulatory asset and $186 million of storm-related capital expenditures, and received $10 million in insurance proceeds. Recovery proceedings and further insurance reimbursement were not yet resolved; unrecovered costs could adversely affect results and cash flow.
- Other exposures: AEP continued evaluating alternatives for remaining merchant generation assets, with no decision timetable; any sale or wind-down could cause further losses. Environmental compliance, plant cost recovery, the Rockport Unit 2 lease litigation and consent-decree proceedings, OVEC obligations, and ordinary-course litigation could affect future earnings, liquidity or financial condition. Management estimated AEP System environmental investment of $2.1 billion to $2.7 billion through 2025.
- Management targets: AEP announced goals to reduce generating-facility CO₂ emissions 60% from 2000 levels by 2030 and 80% by 2050. It projected 2018 emissions of approximately 90 million metric tons, 46% below 2000 levels. The filing provides no companywide EPS or revenue guidance for 2018.
Important facts for investors to verify
- Whether the FERC approves the PJM ROE settlement, and the final refund and rate outcome, including rulings on SPP-related complaints.
- Progress and cost recovery for Wind Catcher, Harvey storm costs, and other large capital and environmental projects.
- The final measurement of tax-reform impacts and the timing and amount of customer refunds and excess-tax benefits returned through rates.
- Future cash generation, construction spending, short-term borrowing and available liquidity as leverage increases.
- Whether AEP’s operating earnings trends improve when compared with Q1 2017 without the merchant-sale gain, and whether competitive-generation and trading margins stabilize.