American Electric Power Stock: A Great Utility To Boost Passive Income (NASDAQ:AEP)
American Electric Power (AEP), the largest utility in the portfolio, is poised to outperform the S&P in the coming years. As a utility company, AEP offers reliable dividends and is well-positioned for long-term growth. With water, electricity, and natural gas as essential services, the demand for these utilities remains steady regardless of economic conditions. Additionally, population growth further increases the demand for utility services.
AEP boasts stable financials, making it an attractive investment for passive income. With an EPS payout ratio of 63%, below the rating agencies’ safe threshold of 75% for utilities, and a debt-to-capital ratio of 55%, lower than the preferred 60%, AEP holds an A- credit rating from S&P. This rating reflects a mere 2.5% probability of bankruptcy in the next 30 years.
The current valuation of AEP is also appealing, with the stock trading at a 14% discount to its fair value. Based on historical dividend yield and P/E ratio, each share of AEP is estimated to be worth $96 compared to the current share price of $82. If AEP reaches fair value and meets analyst growth expectations, it could generate substantial total returns over the next decade.
In its recent financial results for the third quarter ended September 30, 2023, AEP reported a 3.3% decline in total revenue to $5.3 billion. However, this was largely attributed to mild weather conditions during the quarter and is considered acceptable in this context. In fact, weather-normalized retail sales volumes increased by 2.1%, driven by a 7.5% growth rate in commercial sales and a 0.6% increase in residential sales.
Despite lower demand for electricity, AEP’s operating EPS rose 9.3% to $1.77, surpassing analyst expectations. This positive performance was supported by a significant decrease in operating expenses, resulting from lower purchased electricity and fuel expenses. While higher interest expenses offset some of the increase in operating income, AEP’s interest coverage ratio remained stable at 2.4.
AEP’s robust financial position enables it to fund its capital spending forecast of $40 billion for 2023 through 2027, which aims to drive 6% to 7% annual operating EPS growth. The company’s consistent dividend growth is also notable, with a 6% increase in the quarterly dividend per share in October.
While AEP presents an attractive opportunity, it is important to consider the potential risks. As a regulated utility, AEP’s growth prospects depend on securing regulatory approval for rate adjustments. Delays or denials in such approvals could impact the company’s operating results. However, AEP’s operations are spread across 11 states, minimizing the impact of unfavorable regulatory outcomes.
Furthermore, the Cook Plant, AEP’s asset consisting of two nuclear generating units, poses a potential risk. Any major incident at this plant could have devastating consequences for the surrounding area, potentially exceeding the company’s insurance coverage.
Despite these risks, AEP’s current blended P/E ratio of 15.4 suggests favorable growth potential. Analysts project nearly 22% cumulative total returns for AEP through 2025, significantly outperforming the cumulative total return expected from the SPDR S&P 500 ETF Trust (SPY).
In conclusion, American Electric Power (NASDAQ:AEP) demonstrates strong fundamentals, a stable financial position, and appealing valuation. The utility company’s commitment to dividend growth and investment in capital spending bodes well for future earnings growth. While risks exist, AEP’s diversified operations and favorable financial metrics position it as an attractive investment for passive income seekers.
