American Electric Power Company, Inc. (NASDAQ:AEP) Q4 2022 Earnings Call Transcript

American Electric Power Company, Inc. (NASDAQ:AEP) Q4 2022 Earnings Call Transcript February 23, 2023

Operator: Welcome to the American Electric Power Fourth Quarter 2022 Earnings Call. . I would now like to turn the call over to our host Ms. Darcy Reese. Please go ahead.

Darcy Reese: Thank you, Brad. Good morning everyone and welcome to the Fourth Quarter 2022 Earnings Call for American Electric Power. We appreciate you taking time today to join us. 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 discuss of these factors. Joining me this morning for opening remarks are Julie Sloat, our President and Chief Executive Officer; and Anne Kelly, our Chief Financial Officer. We will take your questions following their remarks. I will now turn the call over to Julie.

Julia Sloat: Thanks, Darcy. Welcome, everyone, to American Electric Power’s Fourth Quarter 2022 Earnings Call. I’m happy to be here with all of you this morning, and I’m pleased to be joined by our recently appointed CFO, Ann Kelly, who joined our team in late November. So here we go. We’re making great progress and have a lot to share with you today, starting with the financial performance of our fourth quarter and year. I’ll provide update on our Kentucky operations sale, unregulated renewable sale and retail business strategic review. I’ll also provide insight into the regulatory and legislative front, as we work to implement important new initiatives to ensure our customers and communities needs, which are met in turn, and drives our high-quality investment proposition.

Finally, I’ll include an update — or I’ll conclude with an update on our generation fleet transformation as we continue to invest in regulated renewables and our energy delivery infrastructure, a summary of 2022 highlights and our focus for 2023 can be found on Slides 6 and 7 of today’s presentation. As you know, we have a long history of consistently delivering and exceeding our earnings guidance and 2022 is no exception. I’m very proud of the dedication and accomplishments of the entire AEP team over the past year. While we finished the year strong, I can promise you, we’re just getting started. Our robust financial plan continues to yield results. We delivered strong fourth quarter 2022 operating earnings of $1.05 per share bringing our full year 2022 operating earnings to $5.09 per share.

We’re also — we also increased our quarterly dividend from $0.78 to $0.83 per share, which we announced back in October. AEP’s teamwork-driven performance in 2022 has established a strong foundation from which we can reaffirm our 2023 full year operating earnings guidance range of $5.19 to $5.39, all while mitigating inflationary cost pressures, supply chain pressures and higher interest rates as well as constructively navigating regulatory and legislative frameworks. Formula rates in several of our state jurisdictions and in our high-growth transmission business help us to manage increased interest expense and higher costs. Importantly, as we keep customer affordability top of mind, we are actively working with our states on the economic development front to drive expansion in our service territory, and we are incorporating efficiencies and expense containment into our rate recovery filings to continue to help offset the impact of increased cost pressures.

As a matter of fact, the economic development efforts over the past several years are proving to be appreciably beneficial, and we’ll talk about normalized load in a few minutes. But to illustrate my point, I can tell you that normalized industrial sales were up 4.5%, largely as a result of those efforts, not to mention the added benefit of attracting jobs, residents and other cascading upside to our communities, all of which helps to manage customer rates given the bigger denominator. We value our stakeholder relationships, and we made steady progress on the regulatory front over the past year, including achieving constructive base rate outcomes in Arkansas and SWEPCO Texas and a favorable Supreme Court appeal related to Virginia’s last rate case and the securitization of Winter Storm Uri costs in Oklahoma.

Our resulting earned regulated ROE as of December 31 was 9.1%, which suggests we still have work to do on this front, and I’ll talk about our regulatory activity that we have underway to address this. So hang with me for a few minutes, and I’ll get there. AEP is leading the transition to a clean energy economy as we engage in one of the largest generation fleet transformations in our industry, in 2022, our 1.5 gigawatt North Central wind portfolio became fully operational with the completion of the Traverse wind farm project, which marked the beginning of our clean energy fleet transition. We’ll continue to execute on our fleet transformation strategy with the opportunity to add approximately 17 gigawatts of new generation resources between 2023 and 2032, while mitigating fuel cost volatility and creating a more diverse resource portfolio to benefit our customers.

This will significantly contribute to AEP’s reduced carbon emissions profile and put us on a path to achieve our upgraded net zero goal by 2045. Importantly, the recent passage of the Inflation Reduction Act provides support for our clean energy goals, and this will extend our investment runway as we continue to address the needs of our generation fleet. Since assuming the role of President and now CEO, I prioritize simplifying and derisking our business profile, which has become a core standard by which we evaluate our business activity. By actively managing our portfolio and demonstrating a clear commitment to the successful execution of initiatives and transactions, we continue to deliver significant benefits to our stakeholders. As you are very much aware, we are working diligently to complete the sale of our Kentucky operations to Liberty.

You can find the related regulatory time line on Slide 8 in the presentation today. As an update, AEP and Liberty followed the blueprint provided by the FERC order and filed a new FERC 203 application on February 14 of this year, requesting a shortened comment period and expedited approval to meet the contractual April 26, 2023 transaction close date. Immediately after the filing was made, FERC issued a notice incorporating a shortened 45-day comment deadline related to the application. The shortened comment period is a good sign signaling the commission is open to considering our application on an accelerated basis. AEP and Algonquin are in regular communication discussing various aspects of the transaction, the path forward and our partnership.

We’re mindful of the April 26 date in the stock purchase agreement and are cognizant of the tight time frame given the March 31 comment period deadline. The objective of both AEP and Algonquin remains clear, and that’s to close the transaction. And both parties are firmly committed to moving forward and bringing forth the benefits of this transaction to customers. Related to our unregulated contract renewables portfolio, after strong buyer interest, we’re pleased with our announcement made yesterday for the sale of our 1,365 megawatt portfolio to IRG Acquisition Holdings, which is a partnership owned by Invenergy, CDPQ and funds managed by Blackstone infrastructure. A summary of the sale can be seen on Slide 9 of the presentation today. We’re currently targeting a second quarter 2023 close.

The utilization of the proceeds from the sale is now reflected in our updated multiyear financing plan on Slide 39, and the transaction proceeds will be directed to support our regulated businesses as we enhance the energy delivery infrastructure and transform our generation fleet. Our near-term focus remains closing on our 2 pending sale transactions Kentucky and our unregulated renewables. Once both of these transactions are complete, we plan to revisit the equity needs in our current multiyear financing plan. As we’ve been clear in the past we will use the asset sales to responsibly eliminate equity while maintaining a strong balance sheet, no change in messaging on this. And that’s important that I reiterate that. No change in the messaging.

Finally, in October 2022, we announced the strategic review of our retail business. We’re looking at this business to determine how or if it fits with the current AP portfolio and we’ll keep you updated on our progress. We’re expecting to complete the strategic review in the first half of 2023. Let me touch on our regulatory and legislative initiatives that we have underway. We remain focused on reducing our authorized versus actual ROE gap. As I mentioned earlier, our 2022 earned regulated was ?ROE 9.1% and — our 2023 earnings guidance range assumes a 9.4% earned ROE, and we are already making progress in that direction. In January, we reached the settlement and gain commission approval for our Louisiana base case, which allows us to reestablish a formula rate plan — as we advance through the year, the team will be active in completing our current base case in Oklahoma and rider recovery of the 88 megawatts of the Turk plant, which is not currently in Arkansas rates.

We also filed an electric security plan in Ohio, which will take us into 2024. Let me shift gears and provide you with an update on our deferred fuel recovery efforts that are currently underway. As we’ve previously shared with you over the past several months, we have made adjustments to our traditional cost recovery methods in a number of our states to allow for recovery while spreading the cost out for our customers to make them more affordable. In West Virginia, we continue to pursue approval of the pass-through of fuel costs under the fuel clause. We also intend to propose an alternative path to recovery of these costs under proposed legislation, if Approved, that would allow us to securitize these costs and minimize customer impact. The West Virginia Commission recently instructed its staff to finish its prudence review of the 2021 and 2022 fuel costs.

The state legislature continues to move the securitization legislation forward with the Commission Chair recently testifying in support before the lawmakers. I’ll conclude my remarks with an update on our regulated renewables strategy and execution. Our capacity needs continue to drive us forward on the regulated renewables front, and we continue to work with our regulators, policymakers and other key stakeholders to ensure a durable and sustainable transmission — transition to a clean energy economy in our vertically integrated state. The recently enacted Inflation Reduction Act will help us advance our goals in this area and will provide additional value to our customers as we seek to acquire resources consistent with our plan. We’ve made considerable progress on SWEPCO’s 999-megawatt renewables application, which represents a $2.2 billion investment for AEP.

Parties filed a unanimous settlement in Arkansas on January 27 and for a portfolio of owned wind and solar resources. A hearing was held in Texas in January, and we continue to have constructive settlement dialogue with parties in Louisiana, and the hearing date has been formally extended to March 21 to accommodate this. We look forward to receiving the commission’s orders, which are expected in the second quarter of 2023 on Louisiana and the third quarter of 2023 for Texas. In November of 2022, PSO made a regulatory filing in Oklahoma to own 995.5 megawatts of solar and wind projects representing a $2.5 billion investment. A procedural schedule was issued last month which includes a hearing date in April and an expected commission order in the third quarter of this year.

Separately, we’re also seeking to acquire the 154-megawatt wind facility in Oklahoma from EDF. FERC approved this acquisition on February 16, and we’re pursuing rate recovery of this investment through the ongoing PSO base rate case. The project is already in service and will provide immediate capacity for PSO’s customers. Our regulated renewables goals are aligned and supported by our integrated resources plans. In accordance with those plans, we issued request for proposal in 2022 for wind, solar and other resources at APCo, INM and once again at SWEPCO. We anticipate making the related regulatory funds to acquire additional resources under these RFPs throughout 2023. We continue to see rapid changes in our industry and increasing need and demand from customers and communities across the United States.

At the end of 2022, as I prepared to assume my new position at AEP, the team and I dedicated a considerable amount of time and energy to determining how AEP would continue to deliver safe, clean, affordable and reliable energy and how we could deliver this energy faster and more efficiently to our customers while generating enhanced value to our stakeholders. Our long-term earnings growth rate of 6% to 7% is underpinned by a robust $40 billion capital investment plan for 2023 through 2027, which includes $15 billion in transmission and $9 billion in regulated renewables investments. As evidenced by our fourth quarter and full year 2022 performance AEP has had a long-standing track record of consistently delivering on our strategic objectives, our transformation strategy is working and the investments we’re making continue to support our positive earnings growth and results.

Now please join me in welcoming Ann to her first AEP earnings call. I’ll leave you in her very capable hands as she provides insight and perspective into our performance drivers for 2022 and the details supporting our financial targets. Ann?

Ann Kelly: Thank you, Julia and Darcy. It’s great to be with you all this morning and thanks for dialing in. I’ll walk us through our fourth quarter and full year results, share some updates on our service territory load and our outlook for 2023 and finish with commentary on credit metrics and liquidity as well as some thoughts on our guidance, financial targets and portfolio management. So let’s go to Slide 10, which shows the comparison of GAAP to operating earnings for the quarter and year-to-date periods. As Julie mentioned, we had a strong operating results in both the fourth quarter and for the full year. GAAP earnings for the fourth quarter were $0.75 per share compared to $1.07 per share in 2021. GAAP earnings for the year were $4.51 per share compared to $4.97 per share in 2021.

For the quarter, I’ll mention that we have reflected additional charges related to the expected sale of Kentucky Power and Kentucky Transco as nonoperating costs. This is largely a result of the delay in the closing from the need to file a new 203 application with the FERC. There are detailed reconciliations of GAAP to operating earnings on Pages 18 and 19 of the presentation today. Today, I’m going to focus more on our full year results, but I did want to provide a few highlights on the fourth quarter as we show on Slide 11. Operating earnings for the fourth quarter totaled $1.05 per share compared to $0.98 per share in 2021. This is a $0.07 or 7% increase year-over-year. While we had a lot of puts and takes, our vertically integrated and T&D utility segments continued to perform well, resulting from rate changes, transmission revenue and some favorable weather.

We did see a $0.03 decline in our normalized retail margin, but that was due to a change in sales mix as low as favorable for the quarter. I’ll discuss load in more detail in a couple of minutes. We were also able to support an increase in our O&M expenses as a result of the strong earnings that we were seeing. Transmission Holdco was favorable by $0.03, even after factoring in the loss the Ohio RTO adder as we continue to see the benefits of our investments. Generation and Marketing produced $0.16 per share, up $0.10 from last year, driven by increased retail energy margins and favorable generation performance, primarily driven by fewer average days year-over-year. And finally, Corporate and Other was down $0.05 per share driven by increased interest expense and investment losses, partially offset by favorable income taxes.

Now let’s have a look at our year-to-date results on Slide 12. Operating earnings for 2022 totaled $1.09 per share compared to $4.74 per share in 2021. This was an increase of $0.35 per share or 7%. Looking at the drivers by segment. Operating earnings for vertically integrated utilities were $2.56 per share, up $0.30. Due to rate changes across various operating companies, favorable weather, increased transmission revenue and also increase normalized load. Offsetting these favorable variances were higher O&M, increased depreciation expense and increased interest expense. Once again, the change in accounting around the Rockport Unit 2 lease results in $0.23 of favorable O&M offset by $0.23 of unfavorable depreciation. In the Transmission & Distribution Utilities segment, earned $1.16 per share, up $0.06 from last year.

Favorable drivers in this segment included rate changes in Texas and Ohio, favorable weather and increased normalized retail load and transmission revenue. Offsetting these favorable items were unfavorable O&M and depreciation. With the favorable weather and other items that we experienced in 2022, we were able to responsibly deploy additional O&M in both utility segments to spend on items like increased vegetation management to improve system reliability. The AEP Transmission Holdco segment contributed $1.32 per share, down $0.03 from last year. Favorable investment growth of $0.12 was more than offset by an unaffared true-up of $0.04, the loss of the RTO adder in Ohio and increased income taxes. Remember, our 2022 guidance had this segment down by $0.08 year-over-year as a result of the investment growth being more than offset by the annual true-up to some unfavorable comparisons for taxes and interest.

Generation and Marketing produced $0.50 per share, up $0.24 from last year. The positive variance here is primarily due to the sale of renewable development sites, improved generation performance in land sales in the generation business, improved retail margins and increased wholesale margins stemming from favorable market conditions. And finally, Corporate and Other was down $0.22 per share, driven by investment losses unfavorable interest in increased O&M, partly offset by lower income taxes. The investment losses continue to be impacted by the year-over-year comparisons for our ChargePoint investment that we exited in the third quarter. As we mentioned earlier, we are reaffirming our guidance range for 2023. For convenience, we’ve included an updated waterfall on our actual 2022 results to the midpoint of our guidance for 2023 on Slide 36.

While the variances changed due to the 2022 actual results, there is no change to our 2023 segment or overall guidance. We are confident that our regulatory actions to provide timely returns on our distribution and renewable investments, continued investment in transmission assets, the impact of economic development efforts and prudent O&M management will offset headwinds such as rising interest rates and inflationary pressures. Now turning to Slide 13, I’ll provide an update on our normalized load performance. Overall, 2022 was a remarkable year for normalized load growth across the AEP service territory. Despite the Federal Reserve’s intentional actions to slow down the economy, AEP experienced its strongest weather-normalized load growth in over 15 years with 2.8% annual growth.

The most impressive part is that this is experience on top of a recovery year. As a reminder, 2021 was the strongest year for AEP’s normalized growth in over a decade until 2022. The growth in 2022 was spread across nearly every operating company in every major retail class. Starting in the lower right corner of the slide, normalized retail sales increased by 1.9% in the fourth quarter and ended the year up 2.8% compared to last year. For the quarter, the growth in commercial and industrial sales will more than offset the modest decline in residential sales. Looking forward, you will see that we are expecting growth of 7% to 10% in 2023. The story is changing somewhat to further remove away from the pandemic. In 2022, the boost from fiscal policy overwhelmed the Federal Reserve’s efforts to constrain the economy through monetary policy.

In 2023, we expect the fiscal boost to date given the congressional changes after the election, while the Fed’s efforts to tame inflation remain in place. We expect this to result in a slight moderation of economic growth for the balance of this year. Moving to the upper left corner, Normalized residential sales decreased by 0.8% in the fourth quarter but finished the year slightly above 2021. For the quarter, residential customer counts increased by 0.4%, but this was offset by a 1.2% decline in weather normalized usage. This is not surprising when you consider the impact that higher inflation, energy costs and interest rates on customers’ disposable income to end the year. You will notice that we now expect residential sales to decrease by 0.5% in 2023 for the same reason.

Moving right, weather-normalized commercial increased by 5.4% for the quarter and ended the year up 4.2% compared to 2021. The growth in commercial sales was spread across nearly every operating company. fastest-growing commercial sectors, professional scientific and tech services that includes data centers, which — where load was up nearly 30% compared to last year for both the quarter and the year-to-date comparisons. The outlook for 2023 is showing a modest 0.6% growth. While we do see momentum in this class driven by economic development, the sustained impact of the labor shortage inflation high interest rates and energy costs will act as a headwind in 2023. Finally, focusing on the lower left corner, you see the industrial sales growth moderated in the fourth quarter, up 1.5% and while the year ended 4.5% above 2021.

Industrial sales increased at most operating companies in many of our largest sectors. We continue to experience robust growth in the oil and gas sectors, which were up 6% compared to the fourth quarter of 2021. Outside of oil and gas, which tends to run countercyclical to the rest of the economy, we did notice softer industrial sales growth consistent with many of the economic indicators. As you know, the ISM manufacturing index fell below 50 in the fourth quarter, which is a sign of an industrial contraction. The combination of sustained inflation, supply chain disruptions, increasing borrowing costs, strong dollar and elevated energy costs have formed significant challenges for domestic manufacturing. Fortunately, AEP’s past economic development activities are providing an offset and are keeping AEP’s industrial sales growth in positive territory.

You see that the outlook is showing industrial sales growth of 2.1% in 2023, which is largely attributable to the consistent economic development activities from the past. I’ll provide additional detail on the impact of these efforts in the next slide. To summarize, the AP service territory experienced a remarkable year for load growth in 2022 despite the inflationary pressures on wages and energy and a federal reserve that was intentionally trying to slow down the economy. We are finally seeing evidence that these measures are starting to have an impact, which will result in slower growth in 2023. Fortunately, AEP’s disciplined commitment to economic development should keep our load growth in the black moving forward. For example, absent economic development, our loan growth would have been essentially flat in the fourth quarter and up 1.1% for the year.

Turning to Slide 14, I want to highlight how our commitment to economic development is helping to sustain load growth even in the face of challenging economic conditions. The chart on this slide illustrates why the strategy is so important to us. The blue bars on this chart show the growth of gross regional product for the AEP service territory over the past year. You can see that it has been slowing over the period. And in fact, for the fourth quarter, growth in AEP’s GRP was slightly negative compared to the fourth quarter of 2021. However, the green bars here show our industrial sales growth over the same period. You’ll notice they have been resilient throughout 2022 without any help from GRP. A lot of the growth in industrial load that we are seeing today is a consequence of economic development projects from previous years.

And our focus on economic development is not just about the additional load that we report to you on a quarterly basis. We are also focused on attracting employers to the service territory. We know that adding new loading customers are a key strategy to providing value to all customers. This allows us to continue to prioritize investments that will improve the customer experience while mitigating the rate impacts on our customer base. By making this a key component of our strategy, AEP is helping to mitigate the impact of the economic downturn on our customers, communities and shareholders. And AEP’s economic development team has a proven track record of helping to bring these new customers to our service territory with an emphasis on jobs and load.

In fact, the AEP service territories added over 141,000 jobs in 2022. Let’s move on to Slide 15 to discuss the company’s capitalization and liquidity position. Taking a look at the upper left quadrant on this page, you see our FFO-to-debt metric stands at 13.2%, which is a decrease of 1.3% from the prior quarter. The primary reason for this decrease is the impact on both FFO and short-term debt from a decrease in our mark-to-market collateral positions associated with the decline in natural gas and power prices. as well as a continued increase in our deferred fuel balances. We remain committed to our targeted FFO-to-debt range of 14% to 15%, and we plan to trend back into that range near the end of 2023 as we continue to work through the regulatory recovery process of our deferred fuel balances, which can drive some volatility in the metrics.

You can see our liquidity summary on the lower left quadrant side. Our 5-year $4 billion bank revolver and 2-year $1 billion revolving credit facility support our liquidity position, which remains strong at $2.6 billion. The $1.1 billion change from last quarter is mainly due to an increase in commercial paper outstanding for the reasons I mentioned earlier. On a GAAP basis, our debt-to-capital ratio increased from the prior quarter by 1.5% to 62.9%. On the qualified pension front, our funding status remained strong, ending the quarter at 102.4%. While assets performed as expected during the quarter, the primary driver for the funded status decreased was due to an increase in the liability caused by changes in actuarial assumptions influenced by the rising interest rate environment in 2022.

Now turning to Slide 16. I’ll give a quick recap of today’s message. First, we are focused on execution. The Kentucky transaction is back in front of the FERC and Liberty and AEP are committed to moving forward with this transaction. We just announced the agreement to sell our unregulated contract renewables portfolio and are working through the strategic review of the retail business. Each of these actions will help us to simplify and derisk our business. Even as we worked on these initiatives, we didn’t take our eye off the ball of managing the business. We finished 2022 with solid earnings and made significant investments to support our customers even with the backdrop of supply chain challenges and inflationary pressures. We continue to be committed to our long-term growth rate of 6% to 7% and continued dividend growth and a strong balance sheet while derisking the company, focusing on the customer and actively managing the portfolio.

We really appreciate your time and attention today. I’m going to ask Brad to open up the call so that we can answer any questions that you may have.

Operator: . And we’ll first go to Shahriar Pourreza with Guggenheim Partners.

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Q&A Session

Shahriar Pourreza: So a couple of quick ones here. Looking at just the West Virginia fuel cost recovery, hearings were obviously held in 4Q, and there was a discussion about moving to quarterly time periods as well as securitization. I guess, can you give us maybe an update on how you’re looking at the situation where we might be headed from here? There’s a lot of moving pieces I guess. So how is the dialogue going? And sort of any sense of bill impact ranges, especially with the recent gas price collapse?

Julia Sloat: Yes. I still appreciate the question because shares, I’m sure you can imagine, it is absolutely top of mind for us. And as Ann mentioned in her comments, top of mind from a CFO perspective, most definitely. As you know, we did get an order. The staff is going through its paces as we had to work through the prudency review. And in the background, what’s playing is a legislation that could potentially accommodate securitization of the dollars we have outstanding, our fuel balance in West Virginia $520 million — so it’s not insignificant and it’s extremely important to be able to digest this in a way that can accommodate customer rates. So we’re hoping that we’ll be able to be in a position we’ll be able to utilize the securitization legislation, if approved, to be able to smooth this out and take care of customer needs in terms of the bill in path. And I don’t know, Ann, do you have any other thoughts on that, how we might do that?

Ann Kelly: Yes. No, it’s absolutely right. I mean utilizing the securitization allows us to spread it out over time and minimize and actually keep our customer rates relatively flat, which is really the intention. Now this will take some time. It will be effective in June, and we need to commission the order. So we would expect the securitization to take place in the first half of 2024.

Shahriar Pourreza: Got it. Okay. Perfect. And then just lastly, on the financing needs. Obviously, we’ve noticed that you now include both the $1.2 billion expected cash proceeds from Kentucky as well as I think for the first time, the expected $1.2 billion from the contracted renewable sale. I guess looking at the sources and uses, why wait to update your funding needs on the equity side, especially if you’re including the proceeds already. Is there anything we should be thinking about here?

Julia Sloat: No hidden message there at all, Shahriar. We want to make sure that we get both of these transactions in the bag, get them taken care of and then we’ll recalibrate. And as you know, our objective is twofold. We want to make sure we have a strong balance sheet because we don’t want anybody worried about any dilutive otherwise actions that we would have to take. So that’s first and foremost. So top of mind for us is making sure that balance sheet is in check. And as you know, we put out a target goal for FFO to debt of 14% to 15%. That being said, to the extent that we will then be able to eliminate future equity needs, we don’t have a significant amount of equity financing when you look out over the horizon. But if we’re able to kind of pull that back a little bit and still hit the objective on the strong balance sheet, we’ll absolutely do that.