American Electric Power: Near-Term Headwinds Provide Opportunity for Long-Term Investors

We are reaffirming our $97 fair value estimate for American Electric Power AEP after reviewing recent developments across several of the company’s service territories.

AEP is one of the cheapest utilities we cover, trading at a 15% discount to our fair value estimate, as of May 31, in a sector we view as 5% undervalued. AEP trades at 15.5 times our 2023 earnings estimate, compared with the 17.1 sector median. AEP’s 4.1% dividend yield is a 40-basis-point premium to the peer group.

AEP failed to close the sale of its Kentucky utility to Liberty, announcing in April that the companies had mutually agreed to terminate the agreement. While we viewed the transaction as value-neutral, we like the strategic rationale to divest a utility that has significantly underearned its regulated peer group. In the first quarter, the Kentucky utility earned just a 2.9% return on equity, well below the allowed 9.3%. AEP will have a difficult path to improving returns in Kentucky. Management plans to file a rate case in June, identify opportunities to invest in the region, and securitize retired coal assets.

AEP has experienced some regulatory pushback on its more than $2 billion of planned renewable energy projects at Southwestern Electric Power. Texas regulators recently rejected the projects, and Louisiana regulators denied approval of a recent settlement for the projects. Although this is a setback for AEP’s renewable energy ambitions, we think its lengthy backlog of transmission projects will backfill any reduction in renewable generation investment. We continue to forecast $40 billion of capital investment over the next five years. In West Virginia, management continues to work on recovering deferred fuel costs.

We expect AEP to issue up to $2 billion in equity to support its capital investment plan. At current prices, this would reduce our fair value estimate by less than $1 per share. Our expectation for AEP to achieve its 6%-7% earnings growth target is unchanged.