Over the past five years, American Electric Power Co. Inc. (AEP) — the $33.1 billion Ohio-based utility holding company — has undertaken a strategic shift toward fully regulated operations, explains Ari Charney, editor of Investing Daily's Utility Forecaster.
The emerging utility giant serves 5.4 million customers across 11 states, primarily in the Midwest and Southwest. While AEP has more than 26,000 megawatts of generating capacity, its most attractive utility asset is its 40,000 mile transmission network, the largest in the U.S.
With the rise of renewables and distributed power generation, transmission is one of the utility assets that’s most likely to survive and thrive during the sector’s technological revolution. Indeed, all those new forms of generation need connections to the grid.
Further, interstate transmission assets earn FERC-regulated returns, which tend to be higher than returns authorized by state regulators. That’s because the buildout of the grid is costly—averaging about $1 million per mile—and the feds want to make sure utilities are properly incentivized to do it.
Now that its strategic shift toward fully regulated operations is largely complete, AEP is free to focus on investing and upgrading its regulated assets. And transmission is a big part of the company’s three-year $17.7 billion spending plan.
Get Top Pros' Top Picks, MoneyShow’s free investing newsletter »
In fact, the wires — transmission and distribution — account for nearly three-quarters of AEP’s capital budget. That should help drive above-average earnings and dividend growth of 5% to 7% annually.
Meanwhile, AEP has relatively low leverage compared to its peers. With a stronger balance sheet than many of the other utility giants, AEP won’t have to make any dilutive equity issuances this year to offset the decline in cash flows due to tax reform.
Further, low leverage gives AEP the scope to make a sizable acquisition without compromising its credit rating. AEP is one of the only utility giants that has yet to make an acquisition during the sector’s recent deal frenzy.
Acquiring a small, regulated electric or gas utility could help boost AEP’s earnings toward the top of its targeted range. With the cost of borrowing still relatively low and utility valuations more reasonable, this could be the year to make its move.
But even without such an acquisition, AEP’s capital plan gives it plenty of earnings power. With a forward yield of 3.7%, AEP is a new addition to the Income Portfolio and a buy below $70.
