How the Case for Owning American Electric Power for the Next Decade Has Changed
AEP’s valuation metrics also have risen along with the broader utility leaders over the past decade. These stocks have become defensive safety trades whenever the stock market is weak or when long-term Treasury yields head rapidly lower. Investors are still throwing money into these stocks during any period of uncertainty, but there seems to be more market-risk and sector-specific risk heading into 2020.
With a good portion of the country honed in on climate issues, AEP and other utilities could face drastically higher environmental and regulatory costs in the next decade, if the economy becomes more demanding than it was under the Obama administration. AEP and other utilities also have benefited from the cut in corporate tax rates, which plays right into dividends and excess income that can be reinvested. And in 2010, AEP was valued at only about 12 times expected earnings per share, versus about 21 times forward earnings heading into 2020. That is a major safety premium, and it means that the sector went from being valued at a market discount to a market premium.
AEP provided power generation, transmission and distribution services to more than 5.0 million customers in 11 central states back in 2010. Its footprint has grown to almost 5.4 million customers in 2019 in the same coverage areas. The regulated utility and transmission player has maintained a diversified strategy of its power generation over time from coal and natural gas, along with hydro, wind and solar.
Back in 2010, AEP’s coal and lignite exposure accounted for 80% of AEP energy generated, and it was 65% of AEP’s generating capacity. In 2010, its 2020 projection of AEP generating capacity was for 52% to come from coal/lignite. Its energy generation in 2019 was noted as having coal-fueled power plants account for roughly 47% of generating capacity, and natural gas represents about 28% and nuclear energy represents about 7%, with the remaining capacity coming from wind, hydro, pumped storage and other sources (14%), as well as energy efficiency (4%).
In 2018, AEP announced new intermediate and long-term CO2 emission reduction goals. It was targeting a 60% intermediate coal reduction from 2000 CO2 emission levels from AEP generating facilities by 2030. Its long-term goal is for an 80% reduction of CO2 emissions from AEP generating facilities from 2000 levels by 2050. AEP said in its 2018 annual report that its total estimated CO2 emissions in 2018 were approximately 69 million metric tons, a 59% reduction from AEP’s 2000 CO2 emissions of approximately 167 million metric tons.
An attractive portion of AEP is that its center-of-America footprint comes with less natural disaster risk than companies located in Florida, solely on the Gulf of Mexico, or just along the eastern seaboard. That implies that it has less risk around the would-be or actual infrastructure damage from climate change and storms. That said, this issue may still be a longer-term one than many investors are willing to debate about using today’s dollars and cents. More recently, American Electric Power was recognized by 2020 Women on Boards for having 20% or more board seats held by women, and the company has been active in diversity and inclusion efforts.
AEP is deemed to have a safe dividend for the current economic snapshot, and that should hold up even in the next economic downturn, barring any drastic changes or unforeseen issues. With an annualized per share payout of $2.68 in 2019, AEP’s consensus earnings estimates are $4.13 per share in 2019 and $4.40 per share in 2020.
Investors also have to consider what is happening with other major electric utilities and wholesale power generation leaders. Valuations are higher against earnings by almost all historical standards for the group as a whole. Investors have bid up the shares to the point that they are now forcing new investors to take lower dividends than used to be expected. Many sector leaders, like NextEra (the former FPL) and Duke, may be considered as having riskier geographic footprints if storms become more frequent or more powerful. Investors should know better than to chase certain west coast power utilities (like PG&E) that are rightfully at risk of facing endless billions on billions of dollars in liabilities from forest fires on top of past environmental issues.