AEP - American Electric Power: Lock In This Undervalued 4% Dividend Yielder

2023-08-15 10:22:55 ET

Summary

• American Electric Power is a large electric utility in the US, serving 5.6 million customers across 11 states.
• AEP is aiming for 7% annual earnings growth.
• Despite recent declines in share price, AEP offers a 4% dividend yield and has a potential 20%+ price upside.

While investing in utilities may lack excitement, this very trait makes them ideal vehicles for successful long-term wealth accumulation. I'm sure you heard people say "the more boring the business, the more profitable it is"? Well this statement applies here. Everyone needs power!

I believe this is the perfect time to get into an undervalued utility play and capture a nice 4% yield as well as the potential 20%+ price upside.

Overview

American Electric Power ( AEP ) stands out as one of the largest electric utilities in the United States, serving 5.6 million customers across 11 states. Its robust reputation is grounded in its vast asset base, valued at $94 billion, featuring 40,000 miles of transmission lines and a market cap of $45B. The company's proactive investment in infrastructure and expansion efforts reflect its commitment to serving customers efficiently.

AEP's ambitious plans entail constructing 17 gigawatts of renewable energy by 2032, nearly doubling its initial target from 2020.

Looking forward, AEP's management projects a respectable 6% to 7% annual operating earnings growth, a noteworthy rate for a utility company. The average growth for utility companies in the U.S are about 1.4%. So management's outlook on growth is something that stands out.

While I am unable to locate any specific plans for expansion beyond the states displayed on the map, I do think that since AEP is currently only operating in 11 states that they have ample room for growth of their business.

Valuation

As of the year-to-date, AEP shares have experienced a decline of nearly 15%. Utilities as a whole has slumped but I think entry here would be beneficial in the long run for the following reasons.

• Management projected 7% annual earnings growth implies potential annual returns of over 10% when including the 4% dividend.
• The dividend is safeguarded by a 66% payout ratio, aligned with management's target range of 60% to 70%.
• AEP has achieved 13 consecutive years of dividend growth with an average growth rate over 6% a year.
• Forward PE ratio of 15.55 below the industry mean of 22.4

AEP's current price target of $96 represents a 21% upside from the current price level.

Using the estimated earnings per share results for 2023 ($5.27), we can see that the fair value of the stock is around $97/share which represents a 21% upside which aligns with the previously mentioned price targets.

I find alignment with this price target if management can continue to abide by their estimated 7% annual earnings growth. In my opinion, the price range of $80 to $85 presents an opportune entry point for dividend-oriented, long-term investors who seek conservative, counter-cyclical exposure within the utility sector. I like to have a portion of my investments in sectors still play beneficial roles in people's lives during times of economic uncertainty and spending slows.

As you can see, over the last 10 years AEP has outperformed the utility sector as a whole. I fully expect this price movement to continue as management continues to hit their annual 7% growth goal.

Q2 Results - Any Risks?

In AEP's most recent earnings call presentation , there were some slight disappointments with the Operating EPS of $1.13 compared to the prior year's $1.20. The price fell after the earnings call but I believe that the following statement helps alleviate some of the stress:

The year-over-year decline reflects the timing of higher interest rates in the reversal of last year's second quarter 2022 favorable weather. Today we're pleased to reaffirm our 2023 full year operating earnings guidance range of $5.19 to $5.39 with a $5.29 midpoint and long-term earnings growth rate is 6% to 7%.

I think the short term results are over shadowed by the projected cash flow moving forward through 2027. We can see that by 2027, AEP's management forecasts that cash from operations is due to grow by approximately 40% from the current level.

Dividend Growth

We can see that the dividend growth is currently B-rated. I think this is fair since most of the dividend growth metrics do outperform the sector average while simultaneously lacking in any type of highly attractive growth.

For me, a 6% 5-year dividend growth rate is totally acceptable for a stock that's only yielding 4%.

Going back to the projected 6%-7% annual growth, we can expect dividend payments to also accelerate alongside earnings. I plan to collect my 4% dividend while I hold and also capture the price upside when the utility sector starts it's recovery.

Shifting Weather Trends

The recent $20 billion investment by Intel ( INTC ) in two chipmaking plants in Ohio as well as the Nucor ( NUE ) investment in West Virginia serves as a clear illustration of the anticipated future surge in electricity demand that AEP is poised to witness. I also like that they have some exposure to the exploding EV market through their GM & Samsung investments in Indiana and Michigan.

The summer months this year have experienced milder weather conditions compared to the norm, contributing to lackluster price movements in both AEP and the utility sector, in contrast to the more dynamic shifts seen in the S&P.

Addressing insights from the Q2 2023 earnings call ,

It's worth noting that the weather throughout 2023, year-to-date, has been the mildest recorded for the AEP system over the past three decades.

Recent reports are confirming that the heat is starting to increase throughout the country and I believe the shifting weather patterns are contributing to the mixed outlook. As the heat rolls in from the west, it wouldn't be surprising that AEP has better than expected results for the rest of the year. I highly doubt that we miss the hot weather altogether this year and rather, the heat is just delayed compared to the timing we are accustomed too.

In my opinion, the shifting weather norms have masked the potential here that AEP displays with its exposure to strong business investments.

Conclusion

In conclusion, while investing in utilities may not offer the same excitement as some other sectors, their stability and reliability make them a prime choice for long-term wealth accumulation.

AEP's proactive investment in infrastructure and commitment to renewable energy initiatives position the company for sustained growth. Its ambitious goal of constructing 17 gigawatts of renewable energy by 2032 showcases its dedication to the energy transition. Management's projection of a 6% to 7% annual operating earnings growth rate, a significant figure in the utility sector where the average growth is around 1.4%, further highlights AEP's potential.

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