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Company is strategically making all correct decisions and augmenting its power assets portfolio. ROE will improve in future, driven by rate increases and costs savings. AEP’s attempt to increase regulated operations will provide cash flow stability and will support dividend growth. American Electric Power (NYSE: AEP ) remains a compelling investment prospect for investors. The company has been making correct strategic decisions to strengthen its business operations and improve its risk profile. The company has been working to improve its earned ROE, increasing its regulated business operations, and scaling down its un-regulated operations, which I think will augur well for its stock valuation. Recently, AEP filed a settlement agreement with the Public Utilities Commission Ohio (PUCO), regarding its proposed Power Purchase Agreement (NYSEARCA: PPA ) plan for its 3GW of merchant power generating assets; I think this is a positive development, as it would provide more stability to its revenues, earnings and cash flows. Moreover, the company might plan to sell its remaining 5GW of merchant assets, not included in the PPA plan, which will allow it to use sale proceeds to make more investments in regulated transmission business. In addition, the stock valuation stays attractive, as it is trading at discount to its peers. Growth Catalyst AEP has been aggressively working to strengthen its business by increasing its regulated business exposure. In this regard, the company filed an agreement with PUCO, and PUCO is expected to provide a ruling on the settlement agreement in early 1Q2016. The agreement calls for 8-year PPAs at a 10.4% ROE for its 3GW of merchant power generation. In addition, the agreement includes converting coal plants to gas, building 900MW of renewable energy portfolio and up to $100 million in customers’ credit over the 8-year period. The agreement will provide stability to the company’s merchant power assets, as in the past these assets performance was negatively affected by low and volatile power prices. The agreement filed by AEP is very similar to the recent settlement agreement for FirstEnergy (NYSE: FE ). Other than the recent agreement filling for its 3GW of merchant assets, I think the company will opt to sell its remaining 5GW of merchant assets, not covered under a settlement agreement, to become a full regulated utility company. The sale of the remaining 5GW of merchant assets will not only provide stability to the company’s revenues and earnings, but will also give AEP an opportunity to use the sale proceeds to the sale to reinvest in the business, and grow its regulated operations. If the company opts to sell its remaining 5GW of merchant assets, it could generate $1.8-$2.35 billion in sale proceeds, which it could re-invest into its regulated transmission business. Also, the company can use the sale proceeds to buyback shares, but I think, this is an attractive option, as redeploying sale proceeds to expand regulated operations as it will strengthen its business model. In the long run, the company could also consider to undertake acquisitions, which will provide offer incremental transmission business opportunities. In addition, if the company opts to sell its 5GW merchant assets and re-invest proceeds in transmission business, long-term earnings could grow in a range of 5%-7%, better than its management long-term earnings guidance of 4%-6%, which is based on its transmission planned capital investments of $5.7 billion over the next three years. AEP has a plan to make capital investments worth $13 billion over the next 3 years, out of which 96% will be directed at regulated operations, which will strengthen its regulated business, and increase its regulated rate base. The graphs below displays planned capital investments and regulated rate base growth for AEP. (click to enlarge) Investors Presentation Separately, the ROE of the company is likely to improve in the coming years because of rate increases. The company received $45 million and $99 million rate increases at its two subsidiaries, Kentucky Power and APC’s, respectively. In additions, the company’s earnings growth will be supported by its on track cost savings measures; it is expected to save $205 million in costs, as displayed below. Investors Presentation Summation AEP is strategically making all correct decisions and augmenting its power assets portfolio in a way that will strengthen its long-term performance. The company’s ROE will improve in the future, driven by rate increases and costs savings. Also, the company’s attempt to increase its regulated operations will provide cash flow stability and will support its dividend growth; AEP offers a yield of 4.1%. Furthermore, the stock valuation currently remains compelling, as it is trading at a forward P/E of 15x , versus the industry average forward P/E of 16x . I think the stock valuation will expand, and the valuation gap will close as AEP will evolve into a fully regulated utility company. Scalper1 News
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