American Electric Power Company, Inc.
Q1 2009 Earnings Call Transcript

Published: 24 Apr 2009

[Holly Koeppel:]

Thanks Mike. I’d like to start off by going over the component parts of our 2009 guidance; give you a feel for how the U.S. is expected to shapeup. Looking at the far left slide, you can see we ended last year at $1.3 billion, adjusting for known increases in interest expense and depreciation expense of approximately $200 million, as well as the tremendous success in the regulatory arena already achieve to-date, would put us at a run rate borrowing the impact of the economic environment of approximately $1.6 billion. So if conditions were normal, things would look substantially better. There are two major factors that are closing a drag on our earnings this year. The first is a reduction in industrial load and derived margins from those customers and the second and far more dramatic is the loss of off system sales margins, due to both the decline in volumes, as well as a dramatic compression in margin. Taking these factors into account, we end up right back where we started with expected earnings for the year 2009 of $1.3 billion, which is bracketed by our guidance range of $2.75 to $3.05. Touching on retail load, as you can see we are experiencing and expecting a decline predominantly in industrial load. Residential and commercial volumes are expected to remain relatively flat and in fact that is what we have seen in the first quarter. Industrial on the hand as Mike mentioned, we have experienced a decline quarter-on-quarter ’08 to ’09 of approximately 16%. We are forecasting a decline of 10% for the full year of 2009 as we started to see a drop off in the later half of the year. It’s important to note however, that due to the tariff structure or how we price sales to industrial customers, the drop off in revenue and margin is not linear or directly correlated with the drop off in load. That’s because a very large majority of our payments from these industrial customers are in a fixed charge or demand basis and a relatively modest amount is actually recovered through a volume metric or commodity rate. Therefore as you can see in the bottom left hand side of the chart, our expected retail revenues from industrial customers will be essentially flat year-on-year. This is what result’s in a relatively modest impact, as a consequence of an anticipated decline in load of nearly 5% of cost of system. Turning to off-system sales, as I mentioned this is a much larger impact on expected earnings and guidance for 2009, driven by two factors. First, fuel volume sold into the market; second, much lower margins realized on the sale. This is a function of the collapse in the dark spread or the relationship between a very low gas price and a coal price at AEP that is finally approaching market. As you know we are a very successful and large coal purchaser and have traditionally had our prices well below market. We’re gradually approaching market crisis and as our prices narrows toward market and as gas market price come in, you see the phenomena on the right hand portion of that chart, the narrow dark spread which translates into the drop that you can see on an all in realized margin forecasted for the year of only $11.40. I’d like to give you a little color around what makes up off-system sales, to help explain how challenging it is to arrive at the margin. There are three component parts off-system sales; first is by the fiscal volumes that we sell into the market. That’s the number that you typically see; that’s the denominator of the correlation that we give you to translate into off-system sales. The revenue from sales to the wholesale market has declined and we expect it to decline year-on-year by over $600 million. Last year it was over $700 million, this year it will be just over $100 million. Second component, is the fixed payment regulated by the Texas Public Utility Commission from our energy partners, wholesale or cut marketing activity, to our Texas North subsidiary for the use of the Oklaunion capacity. So this payment is fixed and known. Then the final component is the revenue derived from our marketing, trading activities, predominantly in our Eastern footprint; again, a fairly stable and relatively modest scale. I should also add that this component also includes the proceeds from our participation in wholesale power market option. As you can see, for this year we are forecasting pretty stable performance in our marketing, trading and auction activities. A very stable predictable and regulated performance for the Oklaunion payment and the entirety of the decline is associated with lower volumes and lower margins into the market. Moving on to how our capital funding plan is looking for the year, as Mike mentioned you can see that we have reduced our capital budget year-on-year substantially. We’ve also reduced it from our earlier forecast that we had provided you with and we will be at a level of just under $2.6 billion. We also plan and will precede with equity contributions to our transmission joint ventures; predominately the electricity transmission Texas venture of just under $50 million. The dividend line shown has been adjusted for our recent equity issuance. You can see that our cash forces and uses, that our cash from operations is remaining relative flat. The proceeds from sale of asset sales, I wouldn’t want to mislead you and have you think we’re selling assets that are reflective of the payments from partners associated with the Turk Power Plant construction at SWEPCo, as well as the payments received for contribution of assets into ETT transmission asset. Finally, you see our common stock proceeds as well as our change in debt. We expect end of the year with the cash balance of $200 million, consistent with past years. Moving onto the quarter end, our first quarter 2009 GAAP earnings were $0.89 per share. There were non-ongoing earnings adjustments in this first quarter, but when compared to last year’s ongoing earnings, our GAAP earnings were $163 million higher than ongoing related to the settlement with Tractebel Energy Marketing. So ongoing earnings from utility operations decreased quarter-on-quarter by $66 million and we ended the quarter at $0.89 per share. The primary drivers on our first quarter lines are retail rate release, primarily at Appalachian Power and Ohio companies, as well as to west at PSO. As I mentioned earlier, we have substantially reduced off-system sales, which resulted in reduced off-system sales sharing or contribution back approximately $50 million. We also last year had a favorable variance related to a coal contract amendment of $58 million. It’s important to point out that our load contraction resulted in only about a $6 million impact from industrial load, primarily in our Eastern footprints at I&M and our Ohio companies. Weather was not a factor year-on-year in the quarter. Turning to Off-System Sales, the total decrease of $136 million is entirely due to lower fiscal volumes and much lower margins. Our trading and marketing activities were up $10 million quarter-on-quarter and therefore our volume metric decrease was nearly $150 million on the quarter. The volumes were lower by nearly 70%; margins were lower by nearly 80%. Other operating revenue is substantially higher, due almost entirely to the accidental outage insurance payment, associated with our Cook Nuclear Plant outage. It’s important to note here that the team successfully resolved the extent to which a portion of this payment is attributed to customers of Indiana Michigan Power, in order to offset higher fuel costs that they’ve incurred. This matter was settled in the first quarter. We now can proceed with certainty. 40% of this amount is credited to customers in the fuel cost, 30% is retained by the company, so a net, approximately $30 million of the $54 million of proceeds received in the first quarter will flow through as pre-tax earnings. O&M, a fairly modest increase, due almost entirely to the treatment of storm cost. As you will recall last year, we received a very favorable rate treatment in Oklahoma. The ability to defer and amortize over $70 million of storm costs. This year we had another storm in Oklahoma and that cost us nearly $40 million and the net of the two is more than the $56 million increase in the quarter. Moving on to interest expense and preferred dividend; we see an $11 million increase nearly sue as you would expect to increase long term debt outstanding and a slightly up tick in the rate that we’re currently paying. Operating income and deductions is $10 million lower due to a decrease related to an income tax refund from the IRF. Moving down to the green box, our River Operations; the bulk of the change of $4 million, the improvement is associated with the sales of two turbots. We are seeing reduced volumes and slight pressure on freight rates that has been offset essentially entirely by reduced fuel cost and so it’s a steady to go with there. Finally, the effective tax rate was slightly lower. The first quarter of 2009 was 32.9%; last year it was 33.6%. This is due in major part to the migrations of FIN18, which is the recording of estimates for tax purposes; and last but not the least, shares outstanding in the quarter increased by $6 million. Our weighted average shares outstanding in the first quarter of last year were 401, this quarter 407. Moving on, this provides you a snapshot of where the balance sheet looked at the end of the quarter. The last bar showing a debt to total capital of 63.1% and on a pro forma basis, after reflecting the effect of the equity issuance, assuming all proceeds for used to offset debt, which results in a debt to total cap of less than 58%. On the right hand side of the page, you can see liquidity is strong. At the end of the quarter we had cash and cash investment of $1.1 billion. The draw on the credit facilities remaining was down to just under $1 billion and as Mike mentioned earlier, we are using the proceeds to retire debt. Our value liquidity at the end of the quarter remains strong at $3.2 billion. With that, I’d like to open it up for question. Thanks.

[Mike Morris:]

Thanks Holly. Now you’ll get to see how we typically hand all these Q-and-A things. Because we’re recording this, put your hand up, we’ll get you a microphone and we’ll go from there.

[Unidentified Participant:]

Hey Mike, I know I need to ask this question because it’s hard enough to get you not to spend money, but how do you think about prioritizing capital for ‘10 and ’11 if you guys see a recovery as far as how you put money to work above the $1.8 billion? What markets look most compiling and how do you think about pursuing additional investment?

[Mike Morris:]

I want to make sure I understood the question. The $8 billion has got a couple of projects in it that we is incredible important, because they do a number of very important things not only for our customer, but for our company. So we’re continuing to build out the installed plant; we’re continuing to build out the Turk station. The Turk station is an ultra super critical plant. The first one being built in America, we think it’s very important technology advancements. So, the three states Texas, Louisiana, Arkansas, are all in agreement with going forward and undertaking that activity. We are also continuing to fully fund the carbon capture and storage activities at our mountaineer station in West Virginia for the obvious reason that we think no matter what might come out of Washington, someone has to demonstrate the integrated concept of capturing storage and we think that’s clearly us. We’re in that space and we’re going to do it. All of the other capital is typically dedicated towards interestingly enough, even though the U.S. economy is flat and even though you don’t see population numbers in some of areas where we do business, you’re still seeing our service territories expand. So our minimal build on the outskirts of the town like Tulsa needs to have an extension of the fiscal facilities to get that done. So almost every dollar of capital investment going forward in 2010, 2011 are dedicated toward projects that we know need to be funded and activities that are being driven by the desires of the instate regulator. Should the economies improve? The list of projects that we have to go back into the investment mode is substantial. Should the economy continue to rock along and we need to cut back further? Well we might face those difficult issues of delaying the final construction of one of the operating power plants and that’s a realty that we talked about and a realty that we’re prepared to adjust to if we need to.

[Unidentified Participant:]

I guess maybe the question is that, if you see an economy recovery and you think about putting more capital back to work, how do you prioritize where that capital goes in other jurisdictions where the returns mechanism are more compelling to forecast.

[Mike Morris:]

Yes, our whole capital plan is typical driven towards that; to the jurisdictions where we receive better rates of return; to jurisdictions where the regulatory lag is less dramatic. So I expect what you would see is we will continue aggressively on some of the environmental build outs on the various plant inside of that eastern footprint, where that treatment has been very, very solid.

[Unidentified Participant:]

Now my question regarding page 10 and 11 of your presentation which has the earned ROE’s and the CapEx by operating company. By looking at page 10, it appears that the earned ROE’s at Texas Wires, PSO, SWEPCo, Kentucky Power, Appalachian Power, are all below 10%, sometimes significantly so; but when we look at page 11, I see that you’re investing in 2010 after the CapEx cuts about $1 billion of incremental CapEx into those operating companies. Now, we just raised $1.7 billion of the P/E multiple about eight, earnings yield about 12, you’re putting a bowing into these companies that are earning less than 10; isn’t this just going to destroy shareholder values as long as that continues?

[Mike Morris:]

Sure, as long as it continues that would be the case. So where are we with the major capital investments at SWEPCo; it has to do with the power plant that I just spoke to. There are in all of those jurisdictions, the wind treatment process have ultimately weighing that capital into the rate base with an earnings cycle on it, that’s why SWEPCo substandard earnings. The same is true with Appalachian Power. There it’s the Virginia law that we and Dominion put in place a few years back, that will allow for a substantial up-tick in calendar year 2010 for the Virginia side of the Appalachian Power. So you’ll see here that those returns on equity should bounce back into the zone that tells you why would we be putting capital into those particular undertaking.

[Holly Koeppel:]

In fact in Virginia we’re allowed to look forward and is a fully forecasted test here including an anticipated return on those expected investment.

[Mike Morris:]

You may remember that the Virginia regulatory model is such that your returns on equity are pretty much pre-forecasted in a basket of equity returns by enabling utilities. So I think you’re going to see some pretty reasonable rates of return on equity at Appalachian, Virginia.

[Unidentified Participant:]

I just wanted to sort of follow-up on the P/E ENEC case in West Virginia. It’s a fuel case; you think it would be pretty straight forward by the time it’s going to be all that straight forward. Is that just because of the environment and the fact of the prices going up a lot or is there anything else and is there a possibility of maybe a settlement there or kind of just touch a little bit on what’s going on there?

[Mike Morris:]

Sure, so the ENEC case in West Virginia, Appalachian is [Inaudible] and that its happened year-to-year, it’s pretty much in automatic adjustment. The conversations with the West Virginia regulator are quite straight forward. You know that we can even smooth it out ourselves, rather than trying to recover all in a single step and when we would typically implement that in the not to distant future, they said, “Let’s weigh a while, so we can get our arms around all of the pieces to make sure that your math is right; that these were cost that you had incurred or will incur as we make that ENEC adjustment.” I don’t think you’ll find any difficult with that at the end of the day. It’ll happen a little later than we thought that it would, but I think it’ll be implemented to the entirety of what was filed. There is no major push back; it’s just the regulator saying, “Wow, this is a really big number. We need more time to make sure we’re comfortable with it.”

[Unidentified Participant:]

Then on the off-system sales, I’m a little bit not completely clear why volume is down, is it because the price is down and they have got dispatch or is it DC Cook or…

[Holly Koeppel:]

It’s an interesting event and as you know, we got this up last year as Cook station was offline. It has very little of anything to do with the off-system sales. The off-system sales has everything to do with the United States economy. We were talking about at it this morning. If you look back at 2002, it was the last time the natural gas prices were in fact lower than they are today and our coal fleet dispatch just fine thank you. In this cycle our coal plant is not dispatching and quite honestly, combined cycles, a well priced gas supply, gas plants aren’t dispatching the off-system market either. So it just is a volume downturn throughout the entire Eastern quarter of the United States that we serve and have served as you know goes on and off-system for a long, long time.

[Unidentified Participant:]

Then just the forecasted 2009 industrial sale, that includes GM shutting down, that includes all the ancillary impact. I mean just sort of what’s in that forecast if you could just be little bit more..

[Mike Morris:]

We spend an enormous amount of time in the plants of our industrial customers, because of the volume that they require and it gives us a pretty good look at what the overall demand on system will be, which also put into our marketing group kind of a portfolio of opportunities on what the volume is for our system sale. So we got in there, the reality that our customers if shared with us. When we look at the yesterday GM announcement, we sold one Hummer facility that obviously will be impacted by that. I was encourage to hear the GM equal announcement yesterday at the Singapore, Auto Show; that they’ve comes up with a new engine modification that put in the Hummer, they quickly will start getting Hummers with a hybrid electric at 400 mile range and about 40 miles a gallon. So, you might still be able to buy your Hummer three, which they make at that plant that we serve and feel better about your gas mileage. That will be a 2010 or 2011 event. The point I’m trying to make Paul, is that we spent a great deal of time in it; not that it matters to you, but it does matter to me. Year-after-year-after-year we win the Edison Electric Institute award for customer satisfaction in our commercial industrial space. We never got away from that interface of in the field people working with customers at the point of consumption and its pay dividends for self. I’m not Gilbert who does that work for us in a very macro sense. If you look back and I believe that we didn’t see the downturn that we’re seeing now; but if you look back over the year’s that I forecast, they have always been inside of a 1% range. So I think we feel pretty comfortable about the numbers that we put in front of you for the spread that we’ve got on guidance for 2009.

[Unidentified Participant:]

Thank you, Mike. Given the downturn in the economy and lower expected load growth, have you changed you coal inventory strategy at all?

[Mike Morris:]

I’ve never changed my coal inventory strategy too much, but the fact of the matter is with some of the downturn, as you expect us to do we’re going back on the relationship that we’ve built over a number of years and saying to our suppliers “Everybody calm down here. We’re going to have to theorize and work on a mutual agreed to, going forward plan for the next so many months, while this downturn is out there.” We’ll take an opportunity if we get one to put coal in the marketplace and the most importantly we’re just simply working with the very same producers who came to us at a $150 a ton and said, “Hey we can deliver as much to you, because we’re going to deliver a lot to the market.” We allowed some of that to happen back then and the mutual relationship that we’ve always build with out supplier and we’re going to get the benefit of that other turn on.

[Unidentified Participant:]

Can you refresh us on the quest process in Texas, more importantly what your view is of how much just broadly, not just for AEP, how much broadly get build over the next five to six years, whether it’s actually conceivable given permitting process, for the participants to get that done in that time frame and what your total expected investment over the next four or five years in cress project; whether it’s at the actual sub or whether it’s at the JV?

[Mike Morris:]

I would expect that when you say “could I update you on the cress process,” I chuckled a bit, because I don’t think anybody could. Maybe the chairman could, but it’s been a long and difficult undertaking, but I would argue that it’s conclusion which really came out with finality just about a week ago. It looks like $6 billion where the team gets built; about $1 billion of it will be ours; about $800 million of that will be inside of the ETT partnership and ultimately, we expect the $200 million or so that’s assigned to our two operating Texas companies will be transferred to that partnership. I think the other players when you follow it, maybe not all of them, but clearly this is a pretty serious investment opportunity and permitting in Texas is really pretty straight forward. So I think you’re going to see some of that happen in a very short period of time. Holly you might want to add to that if you got any.

[Holly Koeppel:]

Yes, it pretty much covers the water front. The important thing is the preemption authority vested with the utility in Texas makes that easy to get it done. They have the regulatory regime that makes it work.

[Unidentified Participant:]

Mike and Holly, in the presentation you show quarter earnings growth of 2% to 4% and you talk about a net $600 million rate base investing and if I just do kind of the simple calculation and assume for the timely recovery, that’s about $0.06 or 2%. So what bridges is the gap between the low end of that growth forecast and the upper end?

[Holly Koeppel:]

Well David, if you look how net P&E has grown. The property plant and equipment rate base has grown as you see about in the slide, 10.7%. Our earnings growth rate has been 6.9%, so as Mike alluded to earlier, we have bio waves, some reasonably anticipated rate release. As you pointed out those returns will come up and it will allow earnings to grow, just earning a return, the appropriate return on what’s already been invested, as well as the incremental investments that yield for 2%.

[Unidentified Participant:]

So, it’s the true up of previous investments you had?

[Mike Morris:]

That goes back to the question that you asked. If you look at slides 10 and 11, most typically the driver for a rate case is are you earning your authorized rates of return or not. So inside of that envelope we’ll make filings in cases where we’ve not put a lot of capital work; just simply because we think its time to up-tick the overall rate of return that you’re earning inside of that jurisdictions. So, those are the ranges that you’ll see between the two to four. The economy comes back when you see the much wider range of four to eight, which is driven by again a more robust price profile in the on-system market, as well as demand profile in the on-system market, as well as a recovery in industrial sales inside the regulated envelope.

[Holly Koeppel:]

If I could take a moment, housekeeping matter. For those of you on the phone, if you would like to ask a question on the webcast, please click on the Q-and-A link above the slide window.

[Unidentified Participant:]

I just wanted to talk about the OSS for a second and just follow-up, thinking about going forward and trying to forecast that a little bit, any metrics, any hubs, any way to think about it broadly for ’09 and ‘10. I mean you guys clearly related out now, but should the gas markets recover, power markets I mean, any guidance?

[Holly Koeppel:]

I’ll point you to how you may want to take a view on the widening of the dark spread and our leverage to that. Based on the data here, you can look back to what we stated as our underlying coal cost infused AEP’s in prior dark spreads are historic years. Volume metrically we’ve given you a view on how many megawatts will clear the market and I’ll let you form your own view as to the forward curve, but mathematically that would be a reasonably sound approach. So it’s all about the dark spreads and a multiplication.

[Unidentified Participant:]

Then just one second question with regards to the cash flow deferrals. I mean clearly you can’t touch on it too much at this point, but any sense of a range? You gave at 2011 cumulative, but for perhaps 2009, 2010, maybe at APCo; I mean just can you give maybe a little more granularity there?

[Holly Koeppel:]

Yes, I believe publicly we have stated that our Appalachian deferrals could be in excess or we expect them to be in excess of $400 million. The Ohio deferrals, I believe there is a chart in the back of your package, but there will be nearly a quarter billion dollars this year and they will grow over the period through 2011 to just under $500 million, and for Ohio I’d refer you the page 30.

[Unidentified Participant:]

I’m just trying to get a general sense that I know your retail demand is down, but we have some auctions happening and your other service territory to the south taking a pretty high rate versus you. There’s no chance that you can sell into those auctions to get some of those customers, the way you are situated.

[Mike Morris:]

I think you all have seen the outline of the requirements for the AEP auction which will happen in the not to distant future. If we were to participate and if we were to be successful, we can talk to you about that our May 18 and up until that time, we can’t tell you whether we intend to or don’t intend to, nor can we tell you whether we think or don’t think we’ll be successful, but as they say in advertising, watch the space.

[Unidentified Participant:]

But that is not included in your forecast, is that correct?

[Mike Morris:]

There would be nothing build into our forecast that we don’t feel comfortable about being accurate and as you know we’re relative conservative people.

[Unidentified Participant:]

Do you guys or maybe Turk or someone have any thoughts on where an auction might clearly have a range, a sense of where the price might be…?

[Mike Morris:]

Yes, of course we do. We’re now wondering about the share review or anyone else.

[Unidentified Participant:]

You had a few things that can come up after you gave your revised guidance. I don’t know if you had factored in this deferral in Virginia, the Century Aluminum in West Virginia, I guess and also I think this coal issue you mentioned, that maybe you’re going to be reselling coal at a price below what you paid for it?

[Mike Morris:]

Obviously we won’t sell anything at a price below what we paid for; no you can’t make that up in volume.

[Unidentified Participant:]

Do you have any sense of where your guidance will fallout this year; will it be towards the upper end, lower end…?

[Mike Morris:]

Well, one of the views of our guidance is that; they taught me this when I was a little boy at a catholic school, that if you have two numbers together and divide by two you get right in the middle of it. You can do that I bet. So listen, as we always say at the end of these things, we appreciate your time, particularly in a day like today. We appreciate the physical opportunity to see you. This maybe a new model that we may want to try on a couple of occasions, because this is most enjoyable to feel the questions than more of them just in oral sense. Thanks for being here and thanks a lot for your time, your attention and your investments.