The stock market is at all-time highs. And, volatility may increase as we move through the year. You can’t eliminate the ups and downs, but with AEP stock, you can possibly smooth the ride a little.
So today, let’s dive into American Electric Power or AEP for short. Maybe AEP stock is a good place to stash some cash this year. Let’s see.
AEP Company Background
AEP calls itself a “premier regulated energy company”.
They make money primarily by producing, transmitting and selling electricity to customers in 11 states centered around Ohio in the Midwestern United States. And Texas in the South.
Source: About AEP
Profits break down by the areas shown in the chart below.
Vertically integrated means the generation, transmission and distribution of power to customers. In other words, where AEP handles the entire chain of production and supply.
While the other segments include profits where AEP handles only parts of the supply chain. This requires the company to work with other utilities that handle either generation or transmission and distribution on AEP’s behalf.
AEP Growth Strategy
Revenue and profits grow over the long run as the company invests in capital improvement projects. The cost of these projects plus a profit margin is then passed on to their customers.
However, the economics of these projects must be approved by regulators. And, it is up to AEP to effectively manage the cost of these projects without cost overruns during construction. This is the essence of a regulated utility business model.
Almost all of the company’s capital spending plans for the next several years focuses on regulated investments. So, maintaining positive relationships with regulatory decision-makers is very important.
AEP Stock Dividend Yield
AEP stock pays a forward dividend of $2.80 per share. At the recent AEP stock price, an investment in AEP shares offers a 2.7% dividend yield.
AEP Dividend Growth
AEP dividend growth has been solid and steady in recent years.
Near the end of 2018, the company announced a very substantial dividend increase of 8.1%! On the other hand, the last increase heading into 2020 was a bit more modest at 4.5%.
Related: Duke Energy dividend stock analysis
Consecutive Years Of AEP Dividend Growth
AEP management has increased the dividend in each of the last 10 years.
The annual dividend increase streak is small compared to some companies. But management is quick to point out that AEP has paid a dividend each quarter for more than 100 years!
AEP Dividend Policy Statement
I like it when a company clearly states its dividend policy. And, AEP does not disappoint me here.
The company communicates in its recent investor presentation materials that they expect earnings to grow 5-7% annually. And they intend to increase the dividend each year at a similar rate.
Also, management is targeting a dividend payout ratio of 60-70% of operating earnings.
Source: AEP events and presentations
AEP Historical Revenue Trend
Revenue growth is relatively low for AEP.
As a regulated utility, this company is not a high growth story. The underlying demand for the company’s energy products grows slowly.
Revenue growth in the very low single-digit percentages on an annual basis is common. Similar to the rate of growth within the local economies in which it operates.
AEP Stock Dividend, Earnings & Payout Ratio
Over the years shown in the chart above, earnings have grown on average a little over 5%. Dividend growth has been similar. And, the dividend payout ratio consistently runs a little more than 60% of earnings.
Management’s projections for the future are similar to how they have operated in the past. As they say, past performance does not guarantee future results. But their track record is very consistent.
AEP Free Cash Flow And Dividend Payments
The chart above gives me a reason to pause. I never like to see a company where free cash flow does not cover the dividend payments. Let alone, see negative free cash flow.
On the other hand, regulated utilities are a little different. They have large capital investment requirements. The investments sometimes consume more cash than the company generates
But, because of the predictability of their stable and regulated business, they can finance those expenditures with long term debt. Debt payments are supported by the revenues and profits the capital expenditures generate.
AEP Credit Rating
We are mainly focused on the AEP stock fundamentals, but let’s check the company’s credit rating.
According to Moody’s and S&P, AEP is rated Baa1 and BBB+.
Source: FINRA Bond Center
By looking at the above chart, we can see this is “investment grade-moderate credit risk”. Although not the highest of ratings, they are still investment grade.
And the consistency of AEP’s business gives me little concern about their ability to pay off or refinance debts as they come due.
AEP Financial Positon
In general, regulated utilities are very capital and asset-intensive. Those expenditures are mostly funded by debt.
AEP debt to equity checks in at 1.35 to 1. This is a relatively high debt load, but consistent with other regulated utilities.
AEP Dividend Safety
I base my judgment on dividend safety using the information discussed thus far.
- Business fundamentals
- Dividend payout ratios
- Historical dividend track record
- Credit ratings
- Financial position
I consider AEP’s dividend safe from a reduction for the foreseeable future.
However, I will keep an eye on cash flow, credit ratings and debt levels for any signs of deterioration that could put the dividend at risk going forward.
AEP Dividend Growth Projection
Since I live off dividends, I forecast my future dividend income.
To do this, I make a dividend growth projection for each of my dividend stocks. The projection also sets an expectation from which I can compare future dividend increases. To make my forecast, I look at…
- Historical dividend growth
- Dividend payout ratios
- Management’s dividend policy when provided
- Business fundamentals
- Company growth strategy
AEP makes it pretty easy for me in this case. They expect 5-7% annual earnings growth. And, they have stated their intent to increase the dividend by a like amount.
So, My AEP annual dividend growth forecast is 6%.
AEP Stock Valuation
Let’s look at AEP’s stock valuation from a few different angles.
AEP Dividend Discount Model
The single-stage dividend discount model considers several factors I have discussed thus far.
- Current annual dividend payment – $2.80 per share
- Projected dividend growth – 6%
- My desired annual return on investment – 9%
Using these assumptions, the dividend discount model calculates the fair value at $99 per share.
Morningstar Fair Value Estimate
The investment analysis firm Morningstar believes the fair value of AEP stock to be $79 per share.
AEP Stock Price To Earnings Ratio
AEP’s stock price to earnings ratio checks in at nearly 24 times the projected 2020 earnings.
On a price to earnings basis, the stock looks overvalued. As a comparison, the S&P 500 has a forward price to earnings ratio of 18 times.
However, such a reliable and consistent company like AEP often fetches a premium price.
Utility Forecaster Investment Newsletter
The Utility Forecaster investment newsletter follows the utility industry very closely. That publication has a target buy price at $99 per share or less.
Source: Utility Forecaster
AEP Stock & Dividend Analysis – Conclusions
I like the income and stability that solid regulated utilities bring to an investment portfolio. AEP stock has performed well recently, turning in solid gains during 2019 and again to start off 2020.
AEP stock is one of my smaller positions. So, I would like to add to it over time.
On the other hand, the stock looks overvalued to me. Or, at the very best, fully valued.
Also, I want to keep an eye on the company’s cash flows and debt levels. To make sure any deterioration does not negatively impact dividend safety.
So, I won’t be adding to my shares until I see a pullback in the stock price. I would take a closer look at buying more AEP stock between $85-90 per share.
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