Business context and reporting period
American Electric Power Company, Inc. (AEP) filed this unaudited combined Form 10-Q for the quarter and nine months ended September 30, 2017. AEP is an electric utility holding company with regulated generation, transmission and distribution businesses and competitive generation and marketing operations. The filing also covers six separately reporting subsidiaries; figures below focus on consolidated AEP unless stated otherwise.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $4.105 billion | $4.652 billion | $11.615 billion | $12.590 billion |
| Operating income (loss) | $986.5 million | $(1,127.9) million | $2.828 billion | $631.2 million |
| Net income (loss) | $556.7 million | $(764.2) million | $1.527 billion | $242.8 million |
| Earnings attributable to AEP common shareholders | $544.7 million | $(765.8) million | $1.512 billion | $237.5 million |
| Basic EPS | $1.11 | $(1.56) | $3.07 | $0.48 |
- Margins: Consolidated gross margin is not presented as a single GAAP measure. AEP’s non-GAAP segment gross margin was $1.614 billion for Vertically Integrated Utilities in Q3, down from $1.698 billion; Transmission and Distribution Utilities reported $898.9 million, down from $955.9 million. AEP Transmission Holdco reported revenue of $178.5 million versus $132.4 million.
- Cash flow: Nine-month operating cash flow was $3.124 billion, compared with $3.421 billion. Construction expenditures were $3.778 billion. Investing cash outflow was $1.677 billion, including $2.160 billion of proceeds from the merchant-generation sale. Financing cash outflow was $1.314 billion, including $875 million of common dividends.
- Debt and liquidity: At September 30, total debt was $21.781 billion ($20.722 billion long-term debt, including current maturities, and $1.059 billion short-term debt). Debt-to-total capitalization was 54.6%, down from 55.9% at year-end 2016. Cash and equivalents were $343.9 million; net available liquidity was approximately $3.049 billion, including a $3 billion revolving facility due June 2021. Management stated that liquidity was adequate.
- Dividend: AEP declared a quarterly dividend of $0.62 per share in October 2017. Dividends declared during the first nine months were $1.77 per share.
Material changes versus the prior comparable periods
- Quarterly earnings moved from a substantial loss to profit chiefly because the prior-year quarter included a $2.3 billion pretax impairment of merchant-generation assets. The 2017 quarter also benefited from transmission investment; lower generation revenue following asset sales and weaker weather-related usage partly offset those effects.
- Nine-month earnings increased substantially, reflecting the prior-year impairment, a $226 million pretax gain on the 2017 merchant-generation sale and higher transmission earnings. These benefits were partly offset by reduced generation revenue after divestitures, lower weather-related and weather-normalized sales, and lower wholesale revenues.
- Total revenue declined year over year in both periods, primarily reflecting the sale of competitive generation assets and lower utility sales. Weather-normalized retail sales volumes decreased 0.7% in Q3 and 0.4% for the nine months; industrial volumes rose 1.7% and 1.6%, respectively.
- AEP’s January 2017 sale of 5,329 MW of competitive generation assets closed for approximately $2.2 billion, producing about $1.2 billion net cash proceeds after taxes, debt repayment and fees. Proceeds were used mainly to reduce debt and fund regulated and contracted renewable investments.
Outlook, management commentary, risks and unusual items
- The filing provides no consolidated earnings guidance figure. Management continues to assess alternatives for remaining merchant-generation assets, including sale, transfer or winding down coal operations; it warns that alternatives could cause additional losses.
- Hurricane Harvey caused outages in AEP Texas’ service area. Estimated total costs were $250 million to $300 million, including capitalized costs, with approximately $90 million of operating and maintenance expense. About $73 million of incremental storm expense was recorded as a regulatory asset; management considered recovery probable but had not estimated potential insurance recoveries. Failure to recover costs could adversely affect results and cash flows.
- The proposed Wind Catcher project comprises approximately 2,000 MW of wind generation and a roughly 350-mile transmission tie-line, with estimated investment of $4.5 billion. Required state regulatory approvals remained pending; hearings were scheduled for the first quarter of 2018. APCo also sought approval to acquire two wind facilities totaling approximately 225 MW.
- Regulatory recovery and rate proceedings are significant uncertainties. Notable exposures include a PSO rate case in which recommendations and potential disallowances/refunds could produce a combined impact of up to approximately $163 million; a Louisiana Turk Plant prudence review with potential pretax write-offs of $50 million to $80 million and refunds of $15 million to $27 million; and pending Ohio rate-plan, earnings-refund and transmission-return matters.
- Environmental compliance investment for AEP’s generating fleet was estimated at $2.2 billion to $2.8 billion for 2017–2025. SWEPCo estimated up to $850 million, excluding AFUDC, for Welsh Plant environmental requirements through 2025. Regulatory changes, disallowances or accelerated plant retirements could impair recovery.
- I&M’s Cook nuclear plant depends on Westinghouse for important services and fuel fabrication. Westinghouse’s Chapter 11 reorganization created uncertainty; disruption could affect plant operations. AEP also faces Rockport Unit 2 litigation, and management could not estimate a reasonably possible loss range.
- Other unusual items include a $93 million customer refund recorded in connection with the Ohio Global Settlement and a $10.6 million nine-month asset impairment charge in 2017, compared with $2.265 billion in 2016.
Important facts for investors to verify
- Whether reported earnings improvement is sustainable after adjusting for the prior-year impairment, asset-sale gain, tax effects and other one-time items.
- Final recovery outcomes and possible refunds or disallowances in the PSO and Turk Plant cases, Ohio proceedings, and FERC transmission-return complaints.
- Harvey restoration costs, insurance recoveries and regulatory recovery, and the final effect on AEP Texas.
- Approvals, cost estimates, financing and expected returns for Wind Catcher and other renewable projects.
- Capital spending, debt maturities, liquidity and dividend capacity, particularly as major transmission and environmental investments proceed.