Business context and reporting period
American Electric Power Company, Inc. (AEP) filed a combined unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. AEP generates, transmits and distributes electricity through regulated utilities and also operates competitive generation, marketing and retail businesses. The filing includes separate reporting for several AEP utility subsidiaries.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $4.652 billion | $4.431 billion | $12.590 billion | $12.839 billion |
| Operating income (loss) | $(1.128) billion | $960 million | $631 million | $2.867 billion |
| Net income (loss) | $(764) million | $520 million | $243 million | $1.582 billion |
| Earnings (loss) attributable to AEP common shareholders | $(766) million | $518 million | $238 million | $1.578 billion |
| Basic EPS | $(1.56) | $1.06 | $0.48 | $3.22 |
The third-quarter and year-to-date losses in operating performance primarily reflect a $2.265 billion pretax impairment of competitive generation and related assets, equal to approximately $1.5 billion after tax. Excluding that unusual charge, regulated businesses remained profitable. Segment earnings attributable to AEP shareholders for the first nine months were $829 million for Vertically Integrated Utilities, $388 million for Transmission and Distribution Utilities and $208 million for AEP Transmission Holdco; Generation & Marketing recorded a $1.249 billion loss.
For the first nine months, segment gross margin—a non-GAAP measure defined by AEP as revenue less specified generation fuel and purchased-power costs—was $4.628 billion for Vertically Integrated Utilities, up from $4.464 billion, and $2.633 billion for Transmission and Distribution Utilities, up from $2.478 billion. Generation & Marketing gross margin fell to $801 million from $1.035 billion, reflecting lower capacity revenue and wholesale energy prices.
Cash flow, debt and liquidity
- Operating cash flow was $3.421 billion for the first nine months, down from $3.911 billion. The 2016 figure included the noncash impairment add-back.
- Investing cash outflow was $3.429 billion, mainly for construction and nuclear fuel; financing cash flow was $46 million, versus a $647 million outflow in 2015. Cash at September 30 was $212 million.
- Total debt was $21.318 billion, including $19.840 billion of long-term debt and $1.478 billion of short-term debt, compared with $20.373 billion total debt at year-end 2015. Debt was 55.1% of total capitalization, up from 53.2%.
- AEP reported $3.5 billion in credit-facility commitments and $2.984 billion in net available liquidity after commercial paper outstanding. Its contractually defined debt-to-capitalization ratio was 52.7%, below the 67.5% covenant limit.
- AEP paid $830 million in common dividends during the nine months. The board declared a quarterly dividend of $0.59 per share in October 2016.
Material changes, outlook and risks
- Merchant generation: AEP agreed to sell the Darby, Gavin, Lawrenceburg and Waterford plants, totaling 5,326 MW, for approximately $2.2 billion, subject to regulatory approvals and expected to close in Q1 2017. Management estimated net cash proceeds of about $1.2 billion and an after-tax gain of approximately $150 million, subject to adjustments. The remaining merchant fleet was impaired amid lower price forecasts and reduced prospects for Ohio cost recovery; additional strategic decisions could result in further losses.
- Demand: Weather-normalized retail sales decreased 0.5% year over year in Q3 and 0.4% for the first nine months. Industrial sales were weaker, particularly in manufacturing; stronger weather-related use partly offset the declines.
- Ohio regulation: OPCo’s approved power-purchase rider and proposed ESP extension remain subject to rehearing, further PUCO action and FERC-related constraints. Disputed deferred capacity and fuel-cost recovery, including potential customer refunds, could affect future earnings and cash flow. AEP did not provide a clear consolidated earnings guidance figure in the supplied filing text.
- Capital and environmental exposure: AEP estimated $2.8–$3.4 billion of investment through 2025 to address proposed environmental requirements, with costs and recovery dependent on regulation and approvals. Major plant investments and retired-plant balances also depend on regulatory recovery; disallowances or refunds could reduce results.
- Other material uncertainties include rate proceedings, the pending PJM transmission-return complaint, commodity and capacity prices, weather, financing costs, plant performance, and litigation. Management reported no material change to the risk factors disclosed in the 2015 Form 10-K.
Investor verification priorities
- Track completion terms, approvals, final proceeds and gain from the competitive plant sale, and how proceeds are deployed.
- Assess whether the merchant impairment assumptions and remaining asset values are consistent with market prices and management’s strategic plans.
- Follow PUCO rulings on OPCo’s ESP, deferred capacity costs, fuel-cost audits and potential refunds.
- Monitor cash generation, rising short-term borrowing, debt maturities and the stated liquidity and covenant headroom.
- Verify recovery of environmental, retired-plant and other regulatory assets, and the eventual cost of compliance requirements.