Why did AEP's net income jump so much in 2001?

Most of the increase reflects the absence of 2000 charges, which included a $319 million net income reduction from an adverse federal court ruling disallowing COLI interest deductions, CSW merger costs, and Cook Plant restart expenses. The underlying improvement came from growth in the wholesale marketing and trading business and from controlled operating and maintenance costs in energy delivery.

How much of AEP's revenue comes from trading, and what are the risks?

Revenue is dominated by wholesale activity: electricity marketing and trading contributed about $41.5 billion and gas marketing and trading about $14.4 billion of the $61.3 billion total. Trading earnings are volatile and depend on market prices and liquidity. Mark-to-market gains were about $257 million, roughly 3% of net revenues, and most unrealized gains are expected to be realized in 2002.

Is AEP's balance sheet getting stronger or weaker?

Mixed. Total assets fell and the dividend payout ratio improved substantially, but long-term debt rose to about 50% of capitalization, and common equity to total capitalization slipped to 33%. Management plans to issue common and mandatory convertible preferred stock and sell non-strategic assets in 2002 to address this, and credit ratings are currently stable.

What regulatory or legal issues could materially affect AEP?

Key issues include the January 2002 appeals court remand of the SEC's approval of the CSW merger under PUHCA, the Clean Air Act New Source Review litigation with potential civil penalties, NOx reduction compliance costs of roughly $1.6 billion, the pending FERC and SEC approval of the corporate separation plan, and the delayed or uncertain state restructuring in Texas, Ohio, and West Virginia. Management believes the merger meets PUHCA requirements, but outcomes are uncertain.

Will the $2.40 dividend be sustainable?

AEP maintained the $2.40 annual dividend in 2001. Earnings covered it, with payout falling to about 80% from 289% in 2000, and management expects further payout improvement from earnings growth in 2002. Sustainability will depend on continued trading profits, successful asset sales, and the outcome of regulatory and litigation matters.

AEP 10-K FY2001 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 29, 2002. Cited figures are marked; the original filing is the authoritative source.

American Electric Power (AEP) reported 2001 results that rebounded sharply from a difficult 2000, with net income of $971 million^a, or $3.01 per share, versus $267 million ($0.83 per share) in 2000.

The improvement was driven mainly by the growth of AEP's wholesale marketing and trading business, which lifted total revenues to $61.3 billion^b (up 67%), and by lower operating and maintenance costs in the energy delivery business. The 2000 comparison was depressed by a $319 million charge from an adverse court ruling disallowing interest deductions on its corporate-owned life insurance (COLI) program, merger costs from the CSW combination, and Cook Plant restart costs. Earnings before extraordinary items were $1.0 billion, and the fourth quarter was weaker due to mild weather and the economic slowdown.

The filing also highlights significant balance-sheet and strategic changes. Total assets fell to $47.3 billion^c from $53.4 billion as energy trading contracts declined, while the company spent heavily on acquisitions, including the Houston Pipe Line, Quaker Coal, MEMCO barge line, and about 4,000 MW of UK generation. Common equity to total capitalization fell to 33%, and management plans to strengthen the balance sheet in 2002 through common and mandatory convertible preferred stock issuance and asset sales.

The dividend payout ratio improved to about 80% from 289% in 2000, and the $2.40^d annual dividend was maintained. Investors should weigh several risks: a large share of earnings depends on volatile energy trading (mark-to-market revenues were about $257 million, roughly 3% of net revenues), a Court of Appeals ruling in January 2002 remanded the SEC's approval of the CSW merger, the company faces substantial NOx and Clean Air Act litigation and compliance costs (about $1.6 billion for NOx-related capital), and the planned corporate separation and ongoing state restructuring introduce uncertainty. Credit ratings are stable but rating agencies are scrutinizing off-balance-sheet structures in light of the Enron bankruptcy.

02—Key points

Key Highlights

Net income rose to $971 million ($3.01 per share) from $267 million ($0.83 per share) in 2000, helped by the non-recurrence of the 2000 COLI charge and merger costs.
Total revenues increased 67% to $61.3 billion, driven by electricity trading volume up 48% to 576 million MWh and gas trading volume up 178% to 3,874 Bcf.
Total assets declined to $47.3 billion from $53.4 billion, while acquisitions in 2001 totaled roughly $1.65 billion (Houston Pipe Line $727M, MEMCO $270M, Quaker Coal $101M, and UK generation).
Common equity to total capitalization fell to 33% from 34%, and management plans common and mandatory convertible preferred issuances in 2002 to strengthen the balance sheet.
Dividend payout ratio improved to 80% from 289% in 2000; annual dividend held at $2.40 per share.
Litigation risk includes the January 2002 D.C. Circuit remand of SEC approval of the CSW merger and pending Clean Air Act New Source Review and NOx matters, with NOx compliance costs estimated at about $1.6 billion.
Earnings are exposed to energy trading volatility and to the loss of fuel-clause protection in Ohio and ERCOT Texas, with a planned corporate separation into regulated and unregulated holding companies.

03—Questions

Frequently Asked Questions

Why did AEP's net income jump so much in 2001?
Most of the increase reflects the absence of 2000 charges, which included a $319 million net income reduction from an adverse federal court ruling disallowing COLI interest deductions, CSW merger costs, and Cook Plant restart expenses. The underlying improvement came from growth in the wholesale marketing and trading business and from controlled operating and maintenance costs in energy delivery.
How much of AEP's revenue comes from trading, and what are the risks?
Revenue is dominated by wholesale activity: electricity marketing and trading contributed about $41.5 billion and gas marketing and trading about $14.4 billion of the $61.3 billion total. Trading earnings are volatile and depend on market prices and liquidity. Mark-to-market gains were about $257 million, roughly 3% of net revenues, and most unrealized gains are expected to be realized in 2002.
Is AEP's balance sheet getting stronger or weaker?
Mixed. Total assets fell and the dividend payout ratio improved substantially, but long-term debt rose to about 50% of capitalization, and common equity to total capitalization slipped to 33%. Management plans to issue common and mandatory convertible preferred stock and sell non-strategic assets in 2002 to address this, and credit ratings are currently stable.
What regulatory or legal issues could materially affect AEP?
Key issues include the January 2002 appeals court remand of the SEC's approval of the CSW merger under PUHCA, the Clean Air Act New Source Review litigation with potential civil penalties, NOx reduction compliance costs of roughly $1.6 billion, the pending FERC and SEC approval of the corporate separation plan, and the delayed or uncertain state restructuring in Texas, Ohio, and West Virginia. Management believes the merger meets PUHCA requirements, but outcomes are uncertain.
Will the $2.40 dividend be sustainable?
AEP maintained the $2.40 annual dividend in 2001. Earnings covered it, with payout falling to about 80% from 289% in 2000, and management expects further payout improvement from earnings growth in 2002. Sustainability will depend on continued trading profits, successful asset sales, and the outcome of regulatory and litigation matters.

04—Continue

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