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Summary AEP’s regular transmission business investments will help it expand its rate base. The company is likely to sell competitive assets, which will support capital investment plan. AEP’s on-track cost saving efforts will improve its profit margins. American Electric Power (NYSE: AEP ) has been taking the right measures to address industry challenges. The company’s growth efforts will portend well for its future financial performance. AEP’s hefty growth investments to expand and strengthen its transmission business will positively affect its ROE and allow the company to increase its regulated rate base. Also, rate hikes will better the company’s cash flows, top-line and earnings growth in the years ahead. Moreover, recent rate case approvals at Kentucky and West Virginia will positively affect AEP’s future earnings growth. Given the strong growth potential, I believe AEP’s shareholders will continue to enjoy cash returns in the form of dividends. Furthermore, based on my price target of $69 for AEP, the stock offers price appreciation of 19%. Strong Growth Opportunities at AEP Utility companies are keenly investing in their infrastructure development in order to capitalize on the growth potential of the industry. As far as AEP is concerned, the company, like all other utility companies, has escalated its scale of transmission investments in order to maximize its growth opportunities by utilizing the strong potential of regulated transmission operations. The company has acquired a dominant stake in leading U.S.-based transmission projects and its management feels that there is still a lot of work left on the transmission business side, due to which it constantly allocates a huge portion of its CAPEX to transmission-related projects. Year-to-date, AEP has around 2,000 ongoing transmission projects of both small and large scale. And it plans to take in more projects in future, by spending around $5.2billion on transmission-related projects in 2015 to 2017. These transmission-related investments offer huge growth opportunity for the company by means of rate base expansion, which will ultimately better its ROE, top-line and cash flows in the years ahead. AEP recently got rate increase approval from regulators; AEP got rate case increase approval in West Virginia and Kentucky for $75 million and $45.4 million , respectively. Owing to the recent rate increases and due to the strong potential of its transmission investments, I expect the company’s earnings to grow decently in the years ahead. Moreover, I believe that if AEP moves ahead with its plan to sell 7,900MW competitive business assets, it will have sufficient cash available in future to fund its transmission investments. Currently, the decision to sell the company’s competitive assets is on hold due to the pending PPA decision and due to the pending results of the PJM capacity auction. The company has asked regulators to finalize their decision on the PPA by October 1st in order to help it have a clear picture about the future of its competitive assets. Given the fact that Ohio’s deregulated market has placed AEP’s competitive assets at a disadvantage to its peers, I believe the company will go on with the idea of selling its competitive assets. If the company decides to sell its competitive assets, AEP will have a broader regulated asset base, comprising of rapidly growing transmission business, which will portend well for its long-term growth potential. Also, analysts are expecting a healthy next five-years growth rate of 4.93% for AEP, as shown below. Source: Nasdaq.com Furthermore, AEP is making regular efforts to address the growing concerns over environmental pollution. In this regard, the company has already closed 5600MW of its 10 coal fired plants across five different states and expects to close one more plant of 998MW in 2016. Given the fact that recent “Clean Power Plan” from Obama demands a 30% cut in carbon dioxide emission from power companies, I believe the company’s decision of actively closing its coal-fired plants will improve its image and positively affect its cost structure. AEP is already working on an attractive costs saving plan “Lean Deployment”, under which it is actively seeking to lower its cost burden and improve its profit margins. Investors Remain Rewarded At AEP The company has a strong history of making attractive cash returns to shareholders in the form of dividends. Earlier this month, AEP had announced a quarterly dividend payment of $0.53 per share. The stock offers a dividend yield of 3.63% and has a modest payout ratio of 59% . Given the company’s strong fundamentals, AEP’s management has affirmed their commitment to consistently increase dividends in the years ahead, and AEP targets long-term payout ratio to be in a range of 60% to 70% . Analysts are also expecting the company’s book value and cash flows per share to increase in 2016 and 2017, as shown in the chart below. Source: 4-traders.com Uplifted Guidance For 2015 Based on the company’s strong results in the first half of 2015 and due to its on-track strategic growth efforts, AEP’s management has uplifted the earnings guidance for 2015. As per the updated guidance, the company’s EPS for full year 2015 is expected to be in a range of $3.50 to $3.65 , up from the previously issued guidance of $3.40 to $3.60. AEP also raised its CAPEX guidance for 2015 by $200 million for 2015. Price Target I reiterate my previously calculated price target of $69 for AEP, which was calculated using the dividend discount method. In calculating this price target, I used cost of equity of 6% and nominal growth rate of 3%. The stock offers potential price appreciation of 19% based on my price target. Risks The ongoing development programs at the transmission business side of the company might result in cost overruns or delays, due to potential laxness in execution projects by AEP’s management. Furthermore, tightening environmental compliance regulations, unforeseen negative economic changes and adverse weather conditions are key risks that might hamper the company’s future stock price performance. Conclusion I reaffirm my bullish stance on AEP due to its strong business fundamentals. The company’s regular transmission business investments have placed it on a strong top-line growth-generating path by enabling AEP to expand its rate base. Also, the company is most likely to sell its competitive assets, which will not only support AEP’s capital investment plan, but will also broaden its regulated asset base, which will strengthen its cash flow base in the years ahead. Moreover, I believe AEP’s on-track cost saving efforts will improve its profit margins. Given the strong growth potential of the company’s attractive strategic growth initiatives, I believe its cash flows will improve, which will support its dividend growth in future. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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