Buy American Electric Power (AEP)

12/11/2009 12:32 pm EST


Jim Jubak

Founder and Editor,

With this post I’m buying American Electric Power (AEP) for my Dividend Income Portfolio. I think a modestly better economy in 2010 will increase company sales, profits, and cash flow enough to increase the dividend in 2010. (The yield is now 4.7%.) That will give income investors some protection against rising interest rates in 2010. The company certainly has room to raise the dividend since the current payout ratio is only around 60%. That’s low for a utility. (The payout ratio is the percentage of a company’s profits that are paid out to shareholders in dividends.)

In 2010 I’m looking for a big pick up in the company’s sales of electricity to industrial customers in its core Mid-West service area on a pickup in U.S. manufacturing that is, tentatively I’d admit, now under way, and in the company’s sale of out of system power to other utilities.

And there's another source of growth too.

American Electric Power’s above average (for a utility) growth potential comes from its transmission business. The company’s central location positions as a key link in any attempt to build more transmission lines to connect the country’s three now relatively unconnected regional electric grids. Interstate transmission lines are regulated by the Federal Energy Regulatory Commission (FERC), which has approved relatively higher returns on investment in an effort to fix decades of underinvestment in the national grid. Adding this growth business to American Electric Power’s other utility businesses is projected to result in earnings growth of 6% a year for the next two years, according to Deutsche Bank.

Because of its reliance on coal to generate the bulk of its electricity, American Electric Power is exposed to some risk from whatever form of carbon emissions program the United States finally adopts. (See my post December 8 post on where that policy stands this week ). I think the risk is minimal because the mostly likely outcome, a cap and trade program, will give away a high percentage of emission rights to big industries as part of the price for passing any bill. In addition the utility has tried to make lemons into lemonade by becoming a leader in efforts to develop clean-coal technologies. The company launched an effort to build two Integrated Gasification Combined Cycle power plants in 2004. The plants, in West Virginia and Ohio, are designed to turn coal into a gas that can then be cleaned before burning to remove many pollutants.

That doesn’t really tackle the carbon dioxide emissions from burning coal so the company has become a major proponent of efforts to capture carbon dioxide from coal-fired power plants and then inject it deep underground. The company received $334 million from the U.S. Department of Energy on December 4 to develop a commercial–scale plant using this technology at its Mountaineer coal-fired plant in West Virginia.

The result is, in my opinion, a relatively low risk stock with a decent yield and good prospects of future growth in that dividend.

Full disclosure: I own one share of American Electric Power that I bought in 1980 (and never sold) so that I could attend the company’s annual shareholder meetings.
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