By Vonn Johnson,
Hall Street Fund President
American Electric Power (NYSE: AEP), one of the largest electric utilities in the nation serving over 5 million customers, generates, transmits, and distributes electricity to customers in 11 states.
They own 38,000 megawatts of generating capacity. They have the largest electricity transmission network that stretches 40,000 miles long. In the Hall Street Fund’s criteria for investing this semester, the group is using a bottom up value investment approach.
We looked for stocks that had high dividends, low risk, and are undervalued compared to its competitors using valuation metrics.
We looked to get in at $40.00/share and exit or re-evaluate the stock at $46.00/share, to be determined. Historically, there has been resistance at $46, and has only crossed $50 four times since 1985 according our Risk Management head, Jacob George.
When people invest in companies like American Electric Power, an electric utility, they are more concerned with the dividends like we are. We were looking for dividends that had a high yield compared to their stock of about 3 percentage or higher, a payout ratio of 75 percentage or less of their earnings per share, and steady and significant growth year over year.
AEP meets all three criteria. Right now it is paying a dividend of $0.49/share owned, on a quarterly basis. It sports a yield of 4.48 percentage of its share price, and a payout ratio of 76 percentage (slightly higher than we want but close enough).
The company’s dividends have been paid out since its inception in 1910 and do not fluctuate wildly in recent years. There is an exception in recent years.
The company’s dividends were as high as $0.60/share owned on a quarterly basis for quite some time before the end of the first quarter of 2003. Afterwards it declined to $0.35/share quarterly and has since been climbing its way back; an increase of 40 percentage from the point of decline, but still is $0.11 below its highest dividend paid.
Since the decline, the company have been increasing their dividend by an average of 4.9 percentage annually, the most recent raise being 4.2 percentage. We expect the company to continue along this path back to $0.60/share owned quarterly; the next raise should be around $0.51/share quarterly.
We chose AEP for a fundamental reason in terms of their business model. The company relies on using an assortment of fuel sources when it comes to generating electricity.
The company’s generating fleet is mostly coal-fired plants accounting for 60 percentage of the fleet, 23 percentage of the fleet is natural gas, the rest goes to nuclear at 5 percentage, hydro, wind, and other sources making up the remaining 12 percentage. The EPA recently issued a proposal in March 2012 to regulate CO2 emission from new fossil fuel-fired electricity.
The rule creates a new source performance standard of 1,000 pounds of CO2 per megawatt hour of electricity generated. According AEP and their Annual Report for 2012 on page 12, this is, “substantially below the emission rate of a new pulverized coal generator or an integrated gas combined cycle unit that uses coal for fuel.”
Most natural gas units can meet this standard. Which is why AEP is investing $4-$5 billion dollars in converting coal units to natural gas units from now until 2020. That adds up to about a 6.5 percentage increase of the 23,700 megawatts that are generated by coal now being converted to natural gas.
This maybe only the beginning as EPA regulations may get tighter in the future on CO2 emissions, clean energy initiatives take flight, and natural gas becomes the go to source for fuel.
Natural gas is becoming cheaper thanks to new technology like hydraulic fracturing, or fracking, and companies other than AEP are using natural gas more in order to generate electricity according to a report from the Energy Information Agency (EIA) called “Competition between coal and natural gas in the electric power sector.”
Natural gas has its advantages over coal in the long run including meeting EPA regulations in regards to CO2 and lowering generating cost of electricity, and we see, just like the EIA that natural gas may take over for coal as the go to fuel source for power companies.
A version of this article appeared in the Tuesday, Sept. 24 print edition.
Contact Vonn at