American Electric Power: The Un-Enron


By Heesun Wee A couple years ago, back when Enron wasn't bankrupt and former CEO Jeffrey Skilling was Wall Street's darling, American Electric Power (AEP) couldn't get much respect.

Sure, the big utility had an energy-trading operation, but it was small compared to Enron's. AEP also often found itself explaining its foothold in the traditional utility business -- generating and delivering electric power to its customers. That was the sort of plain-vanilla stuff many analysts considered a diversion. The real growth and action was in energy trading.

LAST LAUGH. Today, AEP is enjoying the last laugh. Enron seems to have been no more than a house of cards and AEP is now the U.S.'s largest energy trader. "Clearly [AEP] will be a long-term survivor in the energy sector because of [its] assets, size and solid balance sheet," says David Burks, an analyst who follows the company for Hilliard Lyons. Admirers like Burks believe AEP's recent stock retreat represents a buying opportunity. The company's share price sank to a 52-week low of $22.74 in the days after a July 18 earnings warning, down 53% from its yearly high of $48.90 reached in September, 2001. Shares have since recovered to close at $32.65 on Aug. 9, 2002.

That's still only 10 times the street's average 2002 earnings-per-share projection of $3.16. Another of AEP's attractions is its plan to maintain a high annual dividend of $2.40 per common share. That's an annual return of roughly 7.5% -- nothing to scoff at in this market.

Of course, AEP hasn't entirely escaped the power industry's current blues. With the economy slowing, power supplies have outstripped demand -- prime conditions for lower prices. AEP missed second-quarter earnings expectations by a mile: On July 25, it reported that its net income tumbled 90% in the quarter, to just $21.9 million (7 cents per share), on revenues of $15.2 billion. That's down from earnings of $231.8 million (72 cents a share) on revenues of $14.1 billion for the same period a year ago.

NO SCANDALS. The weak second-quarter results this year reflect losses from natural-gas trading and marketing, as well as a one-time $159.7 million charge related to the divestiture of two utilities, one in Britain and one in Australia. AEP will use the estimated $1.1 billion in proceeds from the sales to reduce debt.

Still, AEP has lots of factors working in its favor besides its seemingly cheap sticker price. It owns a massive fleet of power plants with capacity of 38,000 megawatts, making it the largest generator in the U.S. It also is the nation's fourth-biggest barge operator, hauling commodities such as grain and coal. That's in sharp contrast to Enron, which deliberately reduced hard assets on its balance sheet. Today, however, AEP's books look sound, analysts say, and the company isn't mired in informal inquiries and investigations with the Securities & Exchange Commission related to accounting and trading activities -- as are rivals Dynegy (DYN) and Mirant (MIR).

AEP traces its roots to the early 1900s, when the company was known as American Gas & Electric or AG&E, a group of small utilities. Over the decades, AG&E has acquired utilities and installed dozens of new generating units. In 1958, AG&E changed its named to American Electric Power, and, in 1980, moved its headquarters from New York City to Columbus, Ohio, where the company remains. In June, 2000, with the completion of its merger with Central & South West Corp., AEP catapulted itself from being a smallish Midwest player to a major powerhouse, with operations in 11 states, from Michigan to Texas. The company also has footholds in Australia, Brazil, China, Mexico, Britain, and Europe.

TOP TRADER. Despite the current downtrend in power prices, AEP plans to continue snatching up quality assets in the U.S and expanding globally. For example, AEP has moved into coal and power markets in Scandinavia. Management also has expressed interest in expanding its interstate U.S. natural-gas pipeline system, and may add more power generation and break into the Northeast, Southeast, and Pacific Northwest.

AEP also retains high hopes for its energy-trading operation, which it first launched in 1997. As of the first quarter of this year (the most recent data available), AEP had moved into the top spot nationally, with a 9% share of the U.S. electricity and natural-gas trading market, estimates Bill Hieronymus, vice-president of consultancy Charles Rivers Associates. Other leading energy traders behind AEP include, in order, Reliant (REI), Duke (DUK), and El Paso (EP).

Meanwhile, rivals continue to drop out of the business. On Aug. 6 Aquila (ILA), another leading trader, said it would shut down its trading business because it could not find a business partner to help it fund its trading operation.

GENERATING AN ADVANTAGE. By contrast, AEP reaffirmed its energy-trading business. "We remain committed to our strategy that focuses on our balanced portfolio, including our wholesale energy businesses and assets," said E. Linn Draper Jr., AEP's chairman and CEO, in a prepared statement after the July earnings announcement.

Sticking by energy trading may seem odd, given the current negative sentiment toward the business, but Hieronymus says it makes sense in AEP's case. A lot of the company's trading revenues come from selling surplus power from its own plants. And that's less risky than pure trading, notes AEP spokesman Pat Hemlepp, because fixed costs are known and the company is less likely to be hit by price swings. Adds Douglas Fischer, a senior electric-utilities analyst for AG Edwards & Sons: Trading "will help them over the long-term to maximize the value of their physical assets."

Investors still skeptical about AEP's exposure to energy trading can take comfort in the fact the bulk of earnings -- 60% -- comes from its stable utility business, with a big chunk of the remainder derived from the sale of power in the wholesale market.

THE ENERGY ALTERNATIVE. For all of AEP's positives, though, there's no escaping the depressed trend for power prices, which puts pressure on profits from wholesale trading and marketing. If the economy continues to falter, some experts don't expect power prices to rebound until 2005.

At a time when so many utilities are selling assets at bargain prices to shore up their balance sheets and keep creditors and investors happy, AEP can be perceived as a very solid alternative. Wee covers the energy markets for BusinessWeek Online in New York


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