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Solid Income Company With A Dividend Increase Coming Soon: American Electric Power

Summary American Electric Power has an excellent total return over the last 33-month test period. American Electric Power’s dividend is 3.9% and has been increased nine of the last ten years. American Electric Power can continue its steady upward trend of approximately 4% as it focuses on its $12.2 billion plan for regulated transmission and distribution assets. This article is about American electric Power (NYSE: AEP ) and why it’s an income company that’s being looked at in The Good Business Portfolio. American Electric Power Company is a utility holding company. The Good Business Portfolio Guidelines, total return, earnings and company business will be looked at. Good Business Portfolio Guidelines. American electric Power passes 10 of 10 Good Business Portfolio Guidelines. These guidelines are only used to filter companies to be considered in the portfolio. There are many good business companies that don’t break many of these guidelines but will still not be considered for the portfolio at this time. For a complete set of the guidelines, please see my article ” The Good Business Portfolio: All 24 Positions .” These guidelines provide me with a balanced portfolio of income, defensive and growing companies that keeps me ahead of the Dow average. American Electric Power is a large-cap company with a capitalization of $26.4 billion. AEP provides electric utility services to about 5.348 million customers in 11 states over a total area of 197,500 square miles. The company derived 25% of its consolidated system retail revenues in 2014 from its utilities in Ohio, 14% from Texas, 13% from Virginia, 11% from West Virginia, 11% from Oklahoma, 10% from Indiana, 5% from Louisiana, 5% from Kentucky and the remainder from other states. American Electric Power has a dividend yield of 3.9% and its dividend has been increased for nine of the last ten years. The payout ratio is moderate at 60%. American Electric Power therefore is not a growth story at this time but may be as the steady growth of the company continues. The dividend is expected to be increased at the end of October and is estimated to be increased $0.02/quarter or a 4% increase. American Electric Power income is good at $3.54/share which leaves AEP plenty of cash flow, allowing it to pay its high dividend and have a enough left over for its capital campaign I also require the CAGR going forward to be able to cover my yearly expenses. My dividends provide 2.8% of the portfolio as income and I need 2.2% more for a yearly distribution of 5%. American Electric Power has a three-year CAGR of 5% just meeting my requirement. Looking back five years $10,000 invested five years ago would now be worth over $18,255 today (from S&P IQ). This makes AEP a good investment for the income investor with its steady 4% dividend and earnings growth. American Electric Power’s S&P Capital IQ has a three-star rating or Hold with a price target of $55.0. This makes AEP fairly priced at present and a good choice for the income investor. Total Return and Yearly Dividend The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. American Electric Power did better than the Dow baseline in my 33.0 month test compared to the Dow average. I chose the 33.0 month test period (starting January 1, 2013) because it includes the great year of 2013, the moderate year of 2014 and the losing year of 2015 YTD. I have had comments about why I do not compare the total return to the S&P 500 average. I use the Dow average because the Good Business Portfolio has six Dow companies in it and is weighted more to the Dow average than the S&P 500. Modeling the Dow average is not an objective of the portfolio but just happened by using the 10 guidelines as a filter for company selection. The total return makes American Electric Power appropriate for the growth investor with the 4% dividend good for the income investor. The dividend is lower than average and covered and has been paid and increased each year for eight years of the last ten years. DOW’s 32.5-month total return baseline is 25.71% Company Name 33.0 Month total return Difference from DOW baseline Yearly Dividend percentage American Electric Power 42.15% 16.44% 3.9% Last Quarter’s Earnings For the last quarter (July 2015) American Electric Power reported earnings that beat expected at $0.88 compared to last year at $0.80 and expected at $0.80 and revenue missed by $180 million. This was a good report. Earnings for the next quarter are expected to be at $0.95 compared to last year at $1.01. The steady growth in AEP should provide a company that will continue to have slightly above average total return and provide steady income for the income investor. Business Overview American Electric Power Company, Inc. is a utility holding company. It operates in five segments. The vertically integrated utilities segment generates, transmits and distributes electricity through AEP Generating Company, Appalachian Power Company, Indiana Michigan Power Company, Kingsport Power Company, Kentucky Power Company, Public Service Company of Oklahoma, Southwestern Electric Power Company and Wheeling Power Company. The Transmission and Distribution Utilities segment transmits and distributes electricity through Ohio Power Company, AEP Texas Central Company and AEP Texas North Company. The Generation and Marketing segment’s subsidiaries consist of non-utility generating assets, a wholesale energy trading and marketing business and a retail supply and energy management business. AEP Transmission Holdco is a holding company for AEP’s transmission joint ventures and AEP Transmission Company, LLC. The AEP River Operations segment transports liquid, coal and dry bulk commodities. With electric usage increasing in the United States the diversity of American Electric Power assets should allow the company to continue its growth and safely pay a moderately increasing dividend. Takeaways and Recent Portfolio Changes American Electric Power is a income company. Considering AEP’s steady slow growth and its total return better than the Dow average, AEP is a buy for the income investor. The only negative for AEP is when the Fed starts raising interest rates that will cause rising interest expense, giving AEP a headwind for a couple of years. AEP is not being added to The Good Business Portfolio right now since there are no open slots in the portfolio the Good business Portfolio is limited to 25 positions and AEP will be considered when there is an open slot. Of course this is not a recommendation to buy or sell and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account and the opinions on the companies are my own.

Invest In Utilities Since The Fed Remains Dovish

Summary Utility stocks are often discarded as boring but provide stable income through dividends. The Fed decided not to raise interest rates in their September meeting but indicate by the end of the year would be appropriate. Utilities should be held in a diversified portfolio as an alternative to long duration bonds. This was supposed to be the month. The first time since 2006 the Fed raised interest rates. It turned out to be another case of the Fed getting cold feet. After all, the rest of the world’s central banks continue with their easy monetary policy. The case has been made that 25 basis points won’t make a difference so why not raise rates? On the other side of the argument, if 25 basis points doesn’t make a difference, why risk blowing up the stock market over it? The Fed’s statement was dovish indicating that we could continue to see interest rates held near zero into next year. The market believes the Fed will not move this year as indicated by Bloomberg’s world interest rate probability monitor. Bloomberg currently shows the market indicating an 18% probability of a rate increase in October and 43% of an increase in December. These figures were at 44% and 64% respectively prior to the Fed meeting earlier this month. Yellen gave a speech last week stating she still believes it would be appropriate to raise rates by the end of the year. If the Fed is in fact data dependent, what will change in the next two and a half months in the data that will significantly change the Fed’s view that it’s time for liftoff? The answer is nothing. So investors continue on with no clarity from the Fed. The Fed presidents meet and decide not to raise rates and then the next week give speeches indicating that a rate increase would be appropriate. It makes no sense. Why utilities make sense now This confusion over the Fed lead me to the utility sector. The dividend yield of the S&P 500 Utilities index is currently 3.66% versus the 30 year treasury yield at 2.96%. That’s an extra 70 basis points in yield for holding utilities for just one year as compared to holding the treasury for 30 years. This is not a new trade as utility yields have been relatively attractive for some time. Utilities provide stable income for portfolios as they tend to trade more like bonds but I see less downside risk for utility stocks if the Fed were to raise rates. My thought is as rates increase, the cost of capital used for stock valuation will also increase which will lower stock prices. The safety of utilities will be a safe bet for stock investors as volatility increases around the rate increase. Stock investors will seek the stability of utilities which would increase the value of the sector and it should outperform. On the other side, if the Fed continues to keep rates low into next year, utilities provide a relatively decent yield as compared to bonds and much better than leaving money in the bank to lose value in real terms after factoring in inflation. Even if the Fed does raise rates, they have indicated the pace will be slow. Utility Index ETF’s provide better diversification An easy way to add utility exposure is to buy a utility index ETF such as (NYSEARCA: VPU ), (NYSEARCA: IDU ), or (NYSEARCA: XLU ). These funds provide exposure to the respective index the ETF tracks which pay around a 3.6% dividend yield (each fund yield is slightly different depending on holdings). Using an ETF is also an easy way to diversify your utility holdings so you don’t have concentrated exposure to one utility in case there are problems. There are many regulatory factors to consider with individual utility companies and the states they operate in. The capital structure of these companies and their subsidiaries can be pretty complicated as well. If you don’t have the time and patience to take a deep dive into an individual stock, then an ETF would be the way to go. PEG looks relatively attractive Looking at the relative value metrics of the utility sector and the stock that stands out to me is Public Service Enterprise Group (NYSE: PEG ). While PEG does not pay the highest dividend yield, the P/E and EV/EBITDA ratios are below the sector average. An important consideration for a utility is the dividend coverage ratio. PEG has a coverage ratio of 1.75x which is above the average of 1.42x. This is a direct result of the lower debt profile of PEG. With less income going towards interest payments and debt, this leaves more cash flow available for equity. The utility industry is characterized by high debt loads due to the considerable size of the capital expenditures required to maintain their plant assets. PEG has one of the most attractive debt profiles with just 26% total debt to assets and 69% debt to equity. Name Mkt Cap – USD EV/TTM EBITDA EV/EBITDA FY1 P/E Dividend Yield Average 26.02B 8.78 9.01 15.59 3.98% DUKE ENERGY CORP (NYSE: DUK ) 48.67 8.62 9.54 17.35 4.54% NEXTERA ENERGY INC (NYSE: NEE ) 45.41 9.27 10.13 17.96 3.08% DOMINION RESOURCES INC (NYSE: D ) 41.64 13.85 12.4 20.14 3.63% SOUTHERN CO/THE (NYSE: SO ) 40.09 10.97 9.88 16.22 4.84% AMERICAN ELECTRIC POWER (NYSE: AEP ) 27.47 8.67 8.68 15.37 3.79% P G & E CORP (NYSE: PCG ) 25.89 8.74 8.25 13.46 3.44% EXELON CORP (NYSE: EXC ) 25.42 5.81 7.37 10.93 4.20% PUBLIC SERVICE ENTERPRI 20.69 6.33 7.23 14.19 3.77% Source: Data from Bloomberg Conclusion While the Fed keeps investors confused about the timing of the first interest rate increase, it makes sense to remain defensive with portfolios. Lower inflation due to cheap oil means the Fed will be slow with the interest rate hike. Dividend paying utilities seem to be a better play versus other stock sectors as the stable income provides some downside protection while being a more attractive option to long duration bonds.

Why American Electric Power’s Recent Rally Will Continue, In 4 Charts

Summary Oversupply in the natural gas market will keep prices under pressure, and this will act as a catalyst for AEP since it is increasingly using the fuel for power generation. The company’s increasing usage of natural gas and other renewable sources will help it reduce costs by 13% this year and 28% next year as compared to 2014 levels. American Electric will benefit from an increase in retail electricity prices and an increase in electricity consumption going forward, which will allow it to arrest the decline in its top line. AEP’s valuation indicates bottom-line growth going forward while its payout ratio of 59% and aggressive cost reductions will allow it to sustain its dividend. Utility company American Electric Power (NYSE: AEP ) has gained some momentum in the past one month after releasing its second-quarter results at the end of July, with the stock gaining almost 3%. This is despite the fact that American Electric had posted mixed results , as its top line declined year over year and missed the consensus estimate by a wide margin. However, the company’s bottom-line performance was stronger than expected, which can be attributed to costs of electricity generation. Looking ahead, I believe that the company will be able to sustain its recent momentum going into the remainder of the year. Let’s see why. Lower natural gas prices will lead to better margins On account of massive oversupply in the U.S. natural gas market, the price of the fuel is not expected to rise anytime soon. There is news that the U.S. is considering increasing the exports of LNG, which could lead to higher prices. But, in the short run, the oversupply in the market will keep prices down. For example, on July 31, natural gas inventory stood at 2,912 Bcf, which is 23% higher than the prior-year period. The EIA believes that this level of inventory will go up to 3,867 Bcf at the end of October, up 1.8% as compared to the five-year average. Thus, higher inventory will keep natural gas prices, which are already down 11% in 2015, under more pressure. This will help American Electric to improve its margins going forward, as natural gas has turned into the largest source of electricity generation in the U.S. Given the dynamics in the natural gas market, it is not surprising to see why American Electric will increase the use of the fuel in electricity generation. As shown in the following chart, apart from natural gas, American Electric will use more renewable resources to eliminate extra costs associated with coal. (click to enlarge) Source: Investor relations As a result, by reducing its dependence on coal and using more of natural gas along with other energy sources, American Electric’s costs are expected to decline 13% this year and 28% next year as compared to 2014 levels, as shown below. Source: American Electric Higher electricity retail prices and demand will aid revenue growth The EIA expects the retail price of electricity in the U.S. for the residential sector to average 12.8 cents per kilowatt hour in fiscal 2015. This is approximately 2.5% higher than the average price in fiscal 2014. Also, it is expected that the retail price for commercial as well as industrial sectors will grow by 2% and 0.4%, respectively, in fiscal 2015. More importantly, the trend is expected to continue going into 2016 as well, with prices in all three sectors expected to rise. This is shown in the following chart: Source: EIA Along with the improvement in electricity rates, consumption is also slated to increase this year. For instance, residential consumption is expected to average 1,044 killowatthours per month during June, July, and August. This is about 3.7% higher than the consumption level last year. The increase in the consumption level will be driven by an expected 14% increase in summer cooling degree days in 2015. All in all, retail sales of electricity to the residential sector during 2015 are expected to grow by 0.4% from 2014 levels. In addition, American Electric expects reasonable sales growth for its commercial as well as industrial retail classes. The following illustrates its sales estimates for the fiscal-year 2015: (click to enlarge) Source: Investor presentation Hence, American Electric is well positioned to benefit from both an increase in electricity consumption and higher pricing. This will allow the company to improve its financial performance going forward. Valuation and takeaway Apart from strong end-market prospects, American Electric also has an impressive valuation that indicates earnings growth in the future. Its forward P/E of 15.4 is lower than the trailing P/E of 16.1, indicating positive bottom-line growth going forward. Additionally, the company carries a strong dividend yield of 3.60% at a payout ratio of 59%. Now, American Electric Power is reducing its costs by using natural gas while it will also benefit from better demand and pricing conditions. As a result, the company should be able to sustain its dividend in the future. Thus, according to me, investors should continue holding American Electric Power as the stock’s recent run will continue going forward. 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.