01—Abstract
Summary
Summary of the 10-K filed February 23, 2018. Cited figures are marked; the original filing is the authoritative source.
American Electric Power (AEP) reported 2017 earnings attributable to common shareholders of $1.91 billiona ($3.88 diluted EPS), up sharply from $611 million ($1.24) in 2016, when results were depressed by a $2.26 billion pretax impairment of merchant generation assets.
Revenue declined to $15.42 billionb from $16.38 billion, largely because of the January 2017 sale of 5,329 MW of merchant generation (Gavin, Waterford, Darby and Lawrenceburg plants) for about $2.2 billion, which produced a $226 million pretax gain. Earnings growth was driven by rate case outcomes across jurisdictions and transmission investment at AEP Transmission Holdco, which grew earnings to $352 million from $266 million. The balance sheet remains heavily levered, with debt at 55.5% of total capitalization and long-term debt of $21.2 billion.
Construction expenditures rose to $5.7 billionc in 2017 and are budgeted at about $6.0 billion for 2018 and $11.7 billion for 2019-2020 combined, weighted toward transmission and distribution. Cash flow from operations was $4.27 billion. Dividends were raised to $2.39 declared per share for 2017, and a $0.62 quarterly dividend was declared for 2018, with a payout ratio of about 61%.
The filing is dominated by regulatory and policy risk. Tax Reform reduced the federal rate to 21%, creating about $4.4 billiond of excess deferred taxes to be returned to customers. Management expects no material hit to future net income but a reduction in future cash flows.
Other open items include FERC complaints seeking to cut transmission base ROEs, pending rate cases in Indiana, Michigan and Oklahoma, the Wind Catcher wind project (about $4.5 billion), the Rockport Plant Unit 2 litigation, and the OVEC power contract exposure. Management also set new CO2 reduction goals of 60% by 2030 and 80% by 2050, measured against 2000 levels.
02—Key points
Key Highlights
- GAAP earnings attributable to AEP common shareholders rose to $1.91 billion ($3.88 diluted EPS) from $611 million ($1.24) in 2016, which had included a large merchant generation impairment.
- Merchant generation exit: the January 2017 sale of 5,329 MW of plants for roughly $2.2 billion produced a $226 million pretax gain and about $1.2 billion of after-tax net proceeds used to reduce debt and fund regulated investment.
- Transmission growth: AEP Transmission Holdco earnings rose to $352 million from $266 million, supported by $5.5 billion of State Transco assets in service and about $4.3 billion of additional planned transmission investment through 2020.
- Capital plan: 2017 construction expenditures were $5.7 billion, with budgets of about $6.0 billion for 2018 and $11.7 billion for 2019-2020 combined.
- Tax Reform impact: a federal rate cut to 21% led to about $4.4 billion of excess ADIT, mostly to be returned to customers; management expects little net income effect but lower future cash flows.
- Leverage and liquidity: debt-to-capital was 55.5%, long-term debt $21.2 billion, $2.3 billion of net available liquidity, and a $0.62 quarterly dividend declared for 2018.
- Key regulatory and legal exposures: FERC complaints seeking to lower transmission ROEs, Wind Catcher (about $4.5 billion, approved in pending state proceedings), Rockport Unit 2 litigation, and OVEC counterparty and liquidity risk.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2017filed February 23, 2018Financial Statements
FY2017 against FY2016
| Line item | FY2017FY2016 | Change |
|---|---|---|
| Revenue | $15.42B$16.38B | −5.8% |
| Operating Expenses | $11.90B$15.22B | −21.8% |
| Operating Income | $3.52B$1.16B | +202.9% |
| Interest Expense | $895.00M$877.20M | +2.0% |
| Net Income | $1.91B$610.90M | +213.1% |
| EPS (Basic) | $3.89$1.24 | +213.7% |
| EPS (Diluted) | $3.88$1.24 | +212.9% |
| Shares Outstanding (Basic) | 491.81M491.50M | +0.1% |
| Shares Outstanding (Diluted) | 492.61M491.66M | +0.2% |
05—Questions
Frequently Asked Questions
Why did AEP's earnings jump so much in 2017 compared with 2016?
The 2016 results included a roughly $2.26 billion pretax impairment of merchant coal and wind assets, which reduced 2016 earnings to $611 million. In 2017 there was no comparable charge, and earnings also benefited from a $226 million pretax gain on the sale of merchant plants, rate case increases, and higher transmission earnings. Some of 2017's gains are one-time items, so underlying growth is smaller than the headline change.
What does the sale of merchant generation mean for AEP's future earnings?
The sale removed about 5,329 MW of competitive generation that faced weak power prices and costly environmental compliance, and it freed about $1.2 billion of after-tax proceeds to reduce debt and invest in regulated assets. AEP still holds remaining merchant coal units and says it may sell them or wind them down, which could bring additional losses. Investors should expect less exposure to wholesale power prices but also less generation revenue.
How much will AEP invest and where is that capital going?
AEP forecast about $6.0 billion of construction spending in 2018 and $11.7 billion over 2019-2020 combined. Spending is concentrated in transmission (for example, AEPTCo and the State Transcos), distribution, and required environmental upgrades. Much of this investment is recovered through FERC formula rates or state rate riders, which supports rate base growth but also raises borrowing needs.
What are the biggest risks to AEP's regulated earnings and cash flow?
The main risks are: (1) FERC complaints seeking to cut the base ROE on PJM and SPP transmission rates, which could force refunds; (2) Tax Reform, which lowers cash flow even though it is expected to be neutral for earnings; (3) state rate case outcomes, including pending I&M cases in Indiana and Michigan and PSO's Oklahoma case; (4) litigation over the Rockport Unit 2 lease; and (5) OVEC exposure if a counterparty defaults. The filing also notes that the cost of environmental compliance and coal plant retirements may not always be recoverable.
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