After releasing fourth-quarter and full year earnings for 2012 on Friday, American Electric Power (NYSE:AEP) opened the short week with a bang. Significant writedowns weren't quite the surge protector one might have expected, as the company's share price leaped out of the gates Tuesday morning to touch its new 52-week high of $45.68. This movement continues the upward momentum from a recent low of $40.96 back in mid-November. So why has the climb continued in the face of a reported 92% drop in quarterly earnings from last year's same quarter? Because, operationally, the company continues to perform well in light of the fact that it is the largest coal-fired power generator in a country that has witnessed substantial coal-to-gas switching in the utility space.
Enough with the non-cash charges
Cast aside the effects of the writedowns -- $0.45 per share to be exact -- and AEP trumped last year's quarter by $0.10 per share. In fact, every segment of the company's operations bested its 2011 brethren's operating income except for the AEP River Operations, which fell 82% due to issues outside of its control (i.e., the record 2012 drought that affected river conditions and crop yields). Buoyed by this performance, management felt comfortable increasing its payout ratio range from 50%-60% to 60%-70%, which is more in line with its peers. This has to be a welcoming sign for investors, given the trying environment that has manifested in the form of weak demand growth.
Removing coal from AEP's stocking
Currently, 65% of the Ohio-based utility's generating capacity is weighted toward the recently maligned fossil fuel. Realizing that such a high emphasis on coal might lead to higher costs down the road to comply with unforeseen environmental regulations and put his company at a disadvantage, CEO Nick Akins plans on removing a few rail cars from his coal orders in the future. By 2020, he hopes that its reliance on coal will be reduced to around 50%, leaving AEP in a much more balanced position than it is currently in. Until that time, it plans to be a prime supplier of power to the very same shale gas producers that are attempting to make coal obsolete.
Throughout the Marcellus and Utica shale regions and extending into Oklahoma, AEP expects shale producers to demand around 100 gigawatt hours of power per month in 2013. Based on the company's location, it could become a prime beneficiary of increased shale activity in this way. All the while, it will be working on taking advantage of the low prices as well through the retiring of more than 5,400 megawatts of coal-fueled generating capacity over the next three years. This excludes any potential coal-to-gas conversions. These closures have helped reduce expected spending on environmental upgrades over the 2012-2020 period from $6 billion-$8 billion to $4 billion-$5 billion. This reduction could have prompted management's confident decision to raise its dividend payout ratio.
Joining the clean energy movement
These decisions fall in line with what the broad majority of the utility sector has been actively pursuing over the last year. Look at Southern (NYSE:SO). Here is a company that had materially trimmed its dependence on coal by Nov. 2012, but that still relies on coal for 47% of its total power generation, according to its 2012 fourth-quarter earnings release. Due to this dependence, Southern is working feverishly on technology for coal gasification in an attempt to cleanse the process of burning coal to generate electricity.
Compare Southern's portfolio to that of two of its larger competitors, Duke Energy (NYSE:DUK) and Exelon (NYSE:EXC), and it's clear that both AEP and Southern have a long way to go before they can begin to consider themselves a provider of clean energy. Duke Energy is working on staying ahead of AEP and Southern by retiring as much as 6,800 megawatts of coal- and oil-fired units. It expects over half of this total to be offline by the end of 2013. Exelon, on the other hand, leads the pack of major utilities on this front; 95% of its portfolio comes from a clean source, the bulk of which is produced from nuclear reactors with solar growing as an important component.
Bottom line for AEP
All in all, it was a positive quarter and year for AEP, but some major changes are likely in its future. With many of its peers reporting slow or negative growth in 2013, its operating growth was clearly well received by the investment community. However, in order to maintain the pace at which its competitors have bought into the clean energy movement, AEP will likely have to assign a greater portion of future cash flows to capital investments or risk incurring fees from the unpredictable Environmental Protection Agency. From an outsider's perspective, I hope that management takes matters into its own hands rather than rely on the mercy of the government.