This Utility Is a Play on the Shale Revolution

When many think of the shale revolution currently going on in the United States, the utilities sector is not usually the first thing that comes to mind. However, this utility offers interesting growth prospects because it is exposed to some of America's most prolific shale plays.

May 28, 2014 at 2:02PM

The utilities sector is rarely the place one looks to find exposure to the shale revolution going on in the United States. However, a utility with industrial exposure to shale drilling areas could be a good, low-risk way to partake in one of the best growth stories of our generation. 

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Source: Wikipedia commons

With both industrial and residential exposure to the Utica in Ohio and the Barnett, Permian, and Eagle Ford in Texas, American Electric Power (NYSE:AEP) fits this bill perfectly. American Electric Power, or AEP, is one of the largest regulated utilities. AEP is America's eighth largest utility by market cap and generates almost 38,000 megawatts of capacity. In addition, AEP is the largest owner of electric transmission lines with nearly 39,000 miles. AEP serves more than 5.3 million customers in 11 states as a regulated utility. Ohio is the company's largest market and Texas its second-largest. 

Aep Shale

Investor relations

As the charts above show, AEP's shale-exposed counties provide major industrial sales growth. In particular, Southern Texas is showing year-over-year industrial sales growth of between 20% and 40%. Industrial power is the driving factor behind AEP's target of 4% to 6% earnings growth. Such growth is difficult to come by among utilities and other low-risk investments.

For example, while major New York utility Consolidated Edison (NYSE:ED) does not provide a long-term earnings growth forecast, consensus expectations are for Consolidated Edison to increase earnings by slightly more than 2.5% per year. Duke Energy (NYSE:DUK), the largest utility in the country by market cap, also expects 4%-6% long-term earnings per share growth but has downside in the possible ramp-up in costs to handle the cleanup of its Dan River coal ash incident. While there are other steadily growing utilities out there, AEP is a solid choice among them. 

AEP is a profitable company, too. In 2013, AEP achieved a 9.9% return on equity. This compares fairly well with Consolidated Edison's 10% and Duke's 6.5% in 2013. Unsurprisingly, AEP's Ohio Power and AEP Texas subsidiaries lead, each with returns of more than 13%. 

Valuation
Valuations among utilities have been steadily rising since the 2009 bottom and have been further buoyed by quantitative easing from the Federal Reserve and the lower interest rates that have ensued. AEP has been no exception to this rule: The stock now sits at 15.5 times trailing earnings, which is far higher than its average price-to-earnings ratio of 13.3. In addition, AEP's dividend yield is a fairly low 3.9%. 

Investors who are highly risk-averse may invest in AEP because despite its relatively low dividend yield, that yield should grow by between 3% to 4% over the long term. Such growth makes AEP a superior investment to a bond with a similar yield at this time. Still, AEP does not have a great valuation right now; value investors should therefore keep an eye on the company but not buy right this moment. 

Bottom line
As a utility and a low-risk investment, AEP is a good choice. The company has solid growth prospects without the headline risk of some others, and its dividend should grow along with earnings per share. In addition, the company's 9.9% return on equity compares favorably to its peers.

Because AEP is a utility well exposed to the shale revolution, it is also one of the best long-term U.S. utility choices available. While valuations are somewhat reasonable, those looking for good value should simply add AEP to their watchlist and wait for a better time.

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