American Electric Power Company Inc (AEP) — Q4 2016 Transcript

Thank you, John. Good morning, everyone, and welcome to the fourth quarter 2016 earnings call for American Electric Power. We appreciate you taking the time to join us today. Our earnings release, presentation slides, and related financial information are available on our website at aep.com. Today, we will be making forward-looking statements during the call. There are many factors that may cause future results to differ materially from these statements. Please refer to our SEC filings for a discussion of these factors. Joining me this morning for opening remarks are Nick Akins, our Chairman, President and Chief Executive Officer, and Brian Tierney, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Nick.

Thanks, Bette Jo. Good morning, everyone, and thank you, once again, for joining AEP’s fourth quarter 2016 earnings call. I’m very pleased to report that AEP finished the year off strong with GAAP earnings coming in at $0.76 per share and operating earnings at $0.67 a share versus $0.96 per share and $0.48 per share, respectively, in fourth quarter 2015. This brings the year-to-date earnings to $1.24 per share GAAP and $3.94 per share operating for the year compared to $4.17 per share and $3.69 per share, respectively, for 2015. So, overall, finishing up strong in 2016 due to some tax-related settlements. Of course, the GAAP difference between 2015 and 2016 was primarily driven by the write-off we took in third quarter 2016 of the mainly Ohio competitive generation. This was a year of reducing risk and volatility of earnings for the company in the future and reinforcing our balance sheet to provide a strong platform for future growth. We also increased our dividend by 5.4% in 2016 and improved our overall regulated operating ROE. As you know, we set operating guidance for 2017 at $3.55 to $3.75 per share with the $3.65 mid-point due to the rebasing after the unregulated generation asset sale and establishing a long-term future growth rate of 5 to 7%. We continue to reaffirm this guidance range and long-term growth rate. Load growth, as Brian will discuss in more detail later, was positive for the first quarter in over a year but was still minimal. We continue to watch the economy closely particularly now that we have a new presidential administration with a pro-growth agenda. President Trump’s focus on enhancing the ability for manufacturing industries to thrive and produce jobs has a significant impact on AEP’s service territory. His focus on a balanced portfolio of energy resources, including fossil fuels, also aligns with AEP’s interests. There are several key areas regarding Trump initiatives that make us optimistic concerning the future of AEP, namely focus on infrastructure development, including the electric system, strategies regarding generation resources, reduction of regulatory burdens for permitting, expansion of the US manufacturing base, security of the nation in terms of cyber and physical security, and the creation of jobs overall. All of these bode well for AEP's service territory and the economy as a whole. 2016 has been a pivotal year for AEP. Three years ago, we were discussing the daunting task ahead of us in light of Ohio's move to deregulation and there was concern whether AEP could deliver a 2016 that met our objectives of consistent earnings growth and a dividend growth trajectory which is the hallmark of our premium regulated energy company. I'm very proud of our employees, management, and Board for working together to deliver strong operating results in the face of the headwinds that occurred during the years preceding 2016. This has been a year of repositioning and derisking the company to provide a firm foundation for financial stability, earnings, and dividend growth as well as refocusing on our customers. We have come through with flying colors but as a premium energy regulated company, our work is far from done. Yes, there have been challenges, but there is no question AEP has set a firm foundation for the future and I personally feel really good about that. Regarding the disposition of the sale of the competitive generation in Ohio, the first group of generation, which we formally called the non-PPA assets, that has been sold to Lightstone should be completed very soon. We just obtained the FERC approval for transfer as well as other prerequisites for the sale and expect that to happen very soon. I want to take a moment to thank the employees of Gavin, Lawrenceburg, Darby, and Waterford, who have made those generating stations what they are today and for being patient through a process that has been challenging to say the least. The baton of leadership will soon be passed to the capable hands of Lightstone, and we wish them all the best in the future. The strategic process also continues for the remaining competitive assets formally called the PPA assets. We continue to have discussions with the other co-owners to make decisions regarding retirement, consolidation of interest, and/or sales to complete this process. We expect this process to be completed sometime in 2017. Regarding industry restructuring in Ohio, we are having discussions with utilities and other stakeholders concerning proposed legislation to allow the utilities to continue to invest in generation resources in the state of Ohio. AEP will not invest in new generation in Ohio unless we have a clear path to recover our investment, so enabling legislation is critical. Because AEP and its shareholders have already taken a write-down on these assets, our focus is forward-looking and considers the earnings capability of this company should we be successful. We expect to see results from our efforts in 2017. Notwithstanding the generation issue in Ohio, during the fourth quarter, we were successful in a global settlement with the parties on several outstanding cases. This settlement eliminates risk to AEP Ohio into the future and provides us with a clean slate in Ohio from which to continue building our positive business case around wires-related activities such as transmission, distribution, smart grid, renewables, etc. Our overall regulated ROE is currently at 10.7%, mainly driven by weather and some one-time regulatory adjustments and tax adjustments. This is a good ROE for the quarter. Generally, we focus on these being around a 10% level, so progress is being made relative to our regulatory recovery. Regarding AEP Ohio, the ROE at the end of the fourth quarter was 13.9%. This was primarily due to rate relief associated with the distribution investment program, shared savings attributed to the energy efficiency programs, and the annual transmission formula rate true-up. Other segments are doing well, with I&M achieving an ROE of 11.7%, primarily due to favorable tax conditions and increased energy usage. We will continue to focus on fiscal management and address shortfalls. To wrap up, 2016 was a very successful year for AEP. 2017 will be another transformational year. AEP must continue to reinvent itself to remain relevant to our customers by investing in infrastructure and technological innovation as well as dramatically improving the customer experience as we move to a cleaner energy future. It's a different American Electric Power, and we’re committed to meeting these challenges head-on.

Thank you, Nick, and good morning, everyone. I will take us through the financial results for both the quarter and the year. Operating earnings for the fourth quarter were $0.67 per share or $330 million compared to $0.48 per share or $233 million for 2015. All of our regulated segments experienced growth for the quarter compared to last year, as did our competitive generation and marketing business. The growth in our regulated businesses was driven by positive weather impacts, a lower effective tax rate, and rate impacts that reflected increased investment to serve our customers. The quarterly comparison was negatively impacted by a global regulatory settlement that we recently filed in Ohio. However, this settlement closes 17 cases and largely clears the deck of lingering historical rate cases. Hearings on the settlement were earlier this week, and we expect an order before February 28. This agreement covers several significant issues, providing us a healthy AEP Ohio wires company with little financial overhang. For the quarter, the Generation and Marketing segment improved $0.08 per share over last year, due to lower depreciation expenses from the competitive units, as well as increased earnings from our retail business. Corporate and Other was down $0.01 per share largely from the sale of our River Operations business in 2015. Turning to our annual operating earnings, they were $3.94 per share or $1.9 billion compared to $3.69 per share or $1.8 billion in 2015. The growth in our regulated segments was driven by rate changes from incremental investments, increased earnings in our transmission business, a lower effective tax rate, and favorable weather. Our employees were well-prepared for the revenue challenges associated with the full transition to the market in Ohio. Looking at the normalized load performance, our normalized retail sales grew by 0.3% for the fourth quarter. This was the first quarter in over a year where we experienced growth in overall retail sales. For the year, our normalized retail sales declined by 0.2% due to lower industrial sales, partially offset by growth in commercial sales. In summary, we have experienced improvement toward the end of 2016 that we expect to carry into 2017.

Thanks. Great end of the year, guys. Good numbers. I only have one question and 27 parts on tax reform. The $2.2 billion cash coming in, you gave us $1.1 billion paying down CP, $0.5 billion for another tranche of debt and $200 million for another tranche, so that does leave some excess cash. Should we assume that gets consumed in a normal course of business for capital and dividends?

It does, Greg. We also anticipate being a taxpayer due to the transaction, so we expect quarterly tax payments as well, which would begin in the first quarter.

And just to be clear on your comments you made on tax, out of the gate if reform were to take the form that you use as your base case there, there would initially be a headwind associated with the return of rate base capital. But you think that you could find enough customer-friendly projects to invest in that would offset that? I just want to be clear that's what you are saying.

We do, Greg, and we believe that for our capital spend it would be a fairly modest percentage increase.

Thank you. Good morning. Brian, can you just quantify what were the drivers for the lower-than-expected tax in the fourth quarter? And what's the effective tax rate we should assume for 2017 and beyond?

Overall, the tax impact for the year was $0.17 when you include corporate and other, but when not breaking it out by segment, the impact comes down to about $0.13 per share. The composition of that difference includes the resolution of prior period audits, a Texas policy change allowing for a lower taxable income, and some tax planning initiatives that yielded favorable outcomes. We anticipate an effective tax rate of 35% going forward.

Yes. I mentioned AEP is moving forward with a clean slate, so we are primarily focused on the ability to invest in new generation. We want provisions that allow for both renewable energy and natural gas resources. Our goal is to enhance the regulatory path for recovery of these investments. We expect these discussions to develop quickly as we move forward.

It’s the latter, Ali. The $0.09 we had expected, given the March 31 sale, will be less. We will need to try to find ways to offset that, but we’re still within guidance.

Good morning, guys. Just a quick question on sales. Brian, you mentioned you were feeling more optimistic about 2017. However, when I look at the analyst day, your forecast seems to be a little lower than expected. Can you reconcile that optimism with your current forecast?

Relative to the past. The regional economies showed significant improvement toward the end of 2016, particularly in oil and gas areas. If prices remain stable or improve, we expect continued growth into 2017, especially in the industrial sector.

Well, thank you, everyone, for joining us on today’s call. The IR team will be available for any additional questions you may have. John, please provide the replay information.