American Electric Power (AEP -1.84%), also known as AEP, is a traditional regulated utility. It is kind of a boring company in many ways, even though its 4.3% yield and an over-decade-long streak of annual dividend hikes might be particularly attractive to conservative income investors. However, there is an interesting trend taking shape that is legitimately exciting when it comes to electricity demand. Here's what's going on and why it should be on your radar.
Big and boring with a focus on reliable
With a market cap of $42 billion, AEP is one of the largest publicly traded utilities in the United States. It serves close to 5.6 million customers across 11 states, including Arkansas, Indiana, Kentucky, Louisiana, Michigan, Ohio, Oklahoma, Tennessee, Texas, Virginia, and West Virginia. As a regulated utility, AEP has a monopoly in the areas it serves, but it has to have its rate increases and investment plans approved by the government.
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There's a trade-off here. Generally speaking, regulated utilities grow slowly because of government oversight. But the growth is fairly predictable, as the spending and rate increases tend to occur no matter what is happening on Wall Street or in the economy once they are approved. The key to all of this is that regulators want to ensure that the utility provides its customers with reliable and affordable power.
There are a number of factors that go into achieving that. On a basic level, AEP has to ensure the assets it owns are in working order with basic maintenance. Then it has to monitor customer levels since more customers means more demand. That could require the utility to build new power plants. And third, and more recent, it needs to keep up with the world's shift toward cleaner energy. All of these factors are easy wins when it comes to getting spending approved.
But there's a fourth issue that's been popping up lately: increasing use from certain types of customers. In the case of AEP, commercial customers. It's a pretty exciting development.
The internet is a hungry beast
Residential demand in AEP's business was down roughly 0.9% through the first three quarters of 2023. That's not great, but it tracks with two trends. Longer-term, there has been a shift toward more efficient use of electricity (think LED lighting), and shorter term, more people are switching from "work from home" to "work from work," which inherently reduces residential electricity use. Industrial demand was up roughly 1.3% through the first nine months, helping to offset the drop in residential demand.
But the big change was in commercial demand, which rose a huge 7.7%. Part of that is more people working from work, but there's another piece that investors will want to monitor closely. In fact, at least partly thanks to this one factor, demand is expected to be three times greater than originally projected in 2023. The cause of this big upside surprise? Commercial demand from data centers, specifically in Ohio, Texas, and Indiana.
Data centers are the backbone of the internet and help support the increasingly mobile world. As more people stream video on the go through their mobile devices, demand for data centers is likely to increase even more. Also pushing up demand for data centers is the headline-grabbing artificial intelligence trend. Data centers use a lot of electricity to both operate the technology inside the building and to cool it. It is highly likely that demand will continue to grow as the world gets more and more digital in the future. So there's potentially even more upside here in the years ahead.
AEP could see good news for years
More demand means more revenue for AEP right away. It also means more capital spending, which supports higher rate growth over time. So data centers are really a big win for the utility. With the pullback in AEP's stock since interest rates started to rise roughly a year ago, conservative investors might want to take a closer look while it appears to be on the sale rack (shares are lower by around 25% from their 2022 highs).
Indeed, there are some exciting things taking place within the areas the utility serves. This could lead to an uptick in demand for the power it sells and, in turn, that should result in ongoing strong business performance. Solid dividend growth, which has averaged in the mid-single digits over the past decade, is the likely outcome, which conservative income-oriented shareholders should greatly appreciate.
