American Electric Power Company, Inc. (AEP)

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American Electric Power Co. Inc. (AEP)

Q3 2010 Earnings Call

October 19, 2010 8:00 am ET

Executives

Mike Morris - President, Chairman and CEO

Bob Powers - President, AEP Utilities

Joe Hamrock - President and COO, AEP Ohio

Venita McCellon-Allen - President and COO, Southwestern Electric Power Company

Charles Patton - President and COO, Appalachian Power

Paul Chodak - President and COO, Indiana Michigan Power

Stuart Solomon - President and COO, Public Service Company of Oklahoma

Nick Akins - EVP, Generation

Susan Tomasky - President, AEP Transmission

Brian Tierney - EVP and CFO

Analysts

Presentation

Mike Morris

We thank all of you for being here. This is a pretty exciting day for us, and we would hope an exciting day for our shareholders and our customers. I hope that I know most of you.

My name is Mike Morris, the President, Chairman and Chief Executive Officer of American Electric Power Company and we decided that trying to combine an analyst day and our third quarter earnings would be a better way to get a face-to-face Q&A between us and the management team of American Electric Power so that we can get into depth about whatever issues are on your mind.

I always enjoy the quarterly earnings update and learn a great deal from the questions that you ask about the things that are paramount in your mind. But it's always faceless, because of the way that we do it. And we haven't had a full-blown analyst day for a while, but for the things that EEI does, and we thought this would be a perfect way to do that.

And as it turns out for the actual EEI meeting, Brian and Bob and Nick and Venita and the team will handle all of that as we're trying to convince the Chinese that investing in carbon capture and storage is a good thing. And if you know anything about China, you know that they want us physically there to sign memorandums of understanding.

So I will not be able to go to EEI. Not that that's a big loss for you, I'm sure, but at any rate, we thought this would be an appropriate way to go about doing it.

You know, when you do things like this, and you've already read the press release on the third quarter performance, it's clear that we had an outstanding quarter. We feel very strong about how that will allow us to finish the year. We have a number of levers to pull if needed to, to make sure that we get within that narrowed guidance that we provided for you at the end of the second quarter. There are many questions about that.

And because it was the second quarter, we felt it was appropriate to be somewhat conservative. Many of you said it was after those facts, wise or conservative; it was just the better time to do that.

We now feel very comfortable about 2010 and we've shared that data with you. And of course, we're also eager to share with you 2011, 2012 and beyond where we think economic recovery will have a substantial positive impact as will Susan Tomasky's Transmission play.

As the years continue and permits come in hand, capital is put to work; the returns on the capital are almost automatic adjusters throughout almost all of our service territories. So we're kind of encouraged about where we are, and where we're headed.

Let me get through this, believe-what-you-want-to-believe story. A year ago, these were the things that were on our mind coming into 2010. How are we going to work our way through the economic challenges that face us? What we told you in 2009 was that we had forecasted some recovery in our residential, commercial, industrial space on a normalized basis.

And if we didn't see that recovery, we react to it. And of course we did exactly that. We said that we would maintain our capital discipline and throttle back from the 4 billion-odd dollars we had invested in 2006 and 2007 and the $3.5 billion in 2008 and throttle that back substantially in 2009 and 2010.

Many of you say, well, doesn't that slow down the rate machine and therefore the earnings strength of the company? And it does. But at the same time, in the regulatory pressures that we were facing, at that time we thought it was the appropriate way to go as we, jurisdiction by jurisdiction by jurisdiction, made those filings that we thought were essential to earn our rate of return, or at least reduce the regulatory lag between the time capital's invested and the time you began as investor to see the benefit of that capital invested because our customers see it on day one, and we wanted to shorten the time between when they had the advantage of it and you had the obvious earned advantage of it as well. And we did that.

And now, as you look at 2011, 2012 and beyond, you can see that we think there's room to make additional capital investments as we go. Many of you have continued to ask, how is it that anyone can manage their way through 11 jurisdictions in seven principal operating companies? And you'll get a good view of that today as you get a chance to dialogue with the operating company Presidents and Bob Powers who manages the utilities for us at American Electric Power, because that has happened now in a series of years where every year we go in with a stack of rate case increases that we expect to receive.

And each year-over-year, we not only have been there, but somewhat above it; 2010, exactly like the many years before it. And as you look at 2011, the need for recovery in the rate cases is very, very slim, something on the order of $240 million, $250 million, about $157, $158 of it already in place that will kick in automatically on 01/01/2011. So we feel pretty comfortable about that as well.

Issues that are outstanding that probably are outside of our control, but surely inside of an envelope where we can influence them are how states go about the business of creating jobs and how the federal government goes about the business of addressing the issue of building out a robust transmission grid to handle the renewables and things that they would like to see done at the federal level as well as addressing the issue of a global challenge of how to address the United States carbon footprint as compared to the world carbon footprint. And we have been deeply involved in all of those activities.

We were a principal participant with the NRDC in crafting the Waxman-Markey, which we thought was a reasonable Bill coming out of the House. We knew it needed substantial improvement. And with the Environmental Defense Fund, and Senators Kerry, Lieberman and Graham before he dropped out, we were incredibly deeply involved, what become something that we were real advocates for at Kerry-Lieberman; it had things that truly appealed to us.

So when we look at 2010 from the lens of 2009, when we share with you the things that concern and the performance that the team at American Electric Power has experienced, and you as investors have and will experience through the rest of the year, we feel really good about where we are.

As you know, I've talked in terms of retiring from Chief Executive Officer since I actually went to Northeast Utilities 1997. Having been born on November 11, and realizing some years ago when I spent a minute looking at it as you do when you get to be middle age 50, you start thinking about, "I want to run, I'll turn 65." It looked like it's amazing. And 11/11/2011 I'll be there.

So, someone asked me the other day, "What are you going to work on in 2011?" And here are the issues. Here are the issues that we will continue to work on. Many of you were at a meeting yesterday where two of the commissioners including the Chair of the PUCL shared with you some issues that are in front of them. Obviously, those same issues are in front of us, resolution of this hearing as far as it pertains to our 2009 performance is center stage, front and center.

Papers have been filed, discussions have been ongoing. And we will see a resolution of that according to the chair of the commission before the end of the year. We told you about two or three months ago that never thought it would be resolved before the election which is now only 15 days away. And we feel as comfortable today as we did then. We have made a very strong case for the rational of the earnings that both of our operating companies and I have seen. And we think that that will come out without a great deal of impact on us as we go.

The issue will be, "Will we get enough reading in how 2009 has handled to address 2010?" Because we're convinced by 2011 the operating companies will be fully blended together in a merger activity which will be filed shortly. And we feel comfortable that that will go through without much of a hitch. The filing of a electric security plan for the year is beyond 2010, 2011 will also happen in the first quarter. We think that is the appropriate time to that. And we feel relatively comfortable about how that will unfold.

We are one of the principle commentators along with many, many others on the FERC's Notice of Proposed Rulemaking on how they finally are going to take the mantle that's essential if Transmission is going to built in this country. Two issues, one without question they are overriding opportunity to approve projects that are essential and needed without the mask of a second tier approval authority only after the States have been unable to come to resolution.

We'll probably get another step in the right direction from the 2005 legislation from the FERC and that should be helpful. But more importantly for us, and quite honestly for you as investors is the cost allocation issue, which we think the FERC will address at long last. On something that will be very similar, I would hope, to what the software's power pool has done on higher volume transmission line, higher voltage and volume. Transmission lines being allocated on a much broader sense than the lower volume lower voltage small energy delivery lines.

So we'll see how that unfolds. The comments have been given. There are many on the commission who believe the cost allocation is an issue that they clearly have fully sway over. And something that I think they'll find the kind of answers that we're interested in.

Nick will share with you our approach to how we're going to handle the issue of environmental policies. I think you're beginning to see particularly from our friends in Texas as only they can do, thumbing their nose at the Federal EPA and saying, "Have you even thought of the magnitude of the many steps that you take? Have you even done an analysis of the financial impact on the U.S. economy of all of these individual rules that you are putting out?"

The answer to that of course is 'no', are you kidding me, we do each one as a one off. And each one of them has almost no impact on GDP, but collectively they do. The Environmental Protection Agency is in fact a controllable organization. Many of you might not believe that to be the case. It is. And no matter where the elections go in November, I think the EPA is going to have to step back for a moment. Take a break, and take a look at that issue.

We've made some very pointed testimony on the transport rule. Not that they were only concerned about it and how it affects us, that's a plus; the day that they intend to do it, to pass a final rule, mid 2011. And demand that you deploy technology January 1, 2012, even they can't do that. Of course they couldn't get it out by 2022, but that's a side matter.

I thought that might just get a chuckle out of you, I want to make sure you're all still awake. But at any rate, the fact of the matter is we think that they'll slow down in the process and ultimately go forward, do things that make sense, allow for America continue to burn it's most prevalent fuel, unless Shell gas swamps coal eventually some day. It could happen, might not.

Coal's going to play, you've heard me say that far too many times; in the world and in the United States it will be cleaner, it will be better. We will make those capital investments on the plant where that makes sense, and we'll recover those capital investments and show those results to you, our shareholders.

Succession planning and transition, I'm not spending a nickels more with the time on that. The Board is in deep deliberations. They have excellent internal candidates. They are doing their governance due diligence requirement to look outside as well. By the end of the year, we will have selected someone to be President of American Electric Power. And that someone, presuming everything works, as I would expect that it will, will be named Chief Executive Officer November the 11 of 2011.

And then, most importantly, today's discussion on long-term growth and capital allocation plans and the team, Brian in particular will take you through a great deal of that with granularity. And we're quite excited about the opportunities that we see in front of us, when we look at the company in 2011. So let's go to that Slide now.

What you saw in our press release of third quarter 2010 earnings was that the economy continues to be a bit sluggish, but improving. Our industrial sales on a weather-adjusted basis have been good. Our commercial sales on a weather-adjusted basis had been flat, and our residential sales on a weather-adjusted basis had been up some. Having said that, the weather of course has been very good to us in all utilities and a great deal of Corporate America during the third quarter, and we're reflecting that as we go.

And that brings us to a free focused view of how to allocate capital. As I said earlier on, we'll be bumping up the capital spend in 2011 to this $2.6 billion that you see on the Slide. That's intended to take full advantage of the opportunities that we see, some of it in generation, a lot of it in distribution, as we have tremendous capital needs throughout the entirety of the 11-state footprint.

As you know, equity capital invested in the wires business is almost rarely challenged, and usually treated very fairly in the rate of return and the rate recovery process. We'll bump that capital spend up in 2012, because we think the cash flows will come along as well. And because we have excess capital on hand today, as you know from the press releases of this morning, we will recommend to the Board of Directors this calendar year to have a 9.5% increase in the dividend that we pay to our investors. Because we think, in these restricted times, giving you back capital by way of dividend increases is an important way for you to continue to feel comfortable about your investment in American Electric Power.

This keeps us well within our 50% to 60% guidance of payout ratios, which tells you, I hope, and surely us, that there's continued room for improvement as we go. Some of our colleagues who are in the yield range that we'll now be in are with huge payout ratios that at the long run aren't sustainable without some kind of different approach toward their capital structure, and we feel comfortable about doing that.

And because the pension activity has been affected by the overall performance of the stock market, we have pre-funded much of it in 2010. We'll do some additional cash investments in 2011. And I think that that also takes care of the financial impact of having to fund it in a much larger sense with an impact on earnings per share that ultimately would have an effect on the share price. We think this is a reasonable way to balance our employees' concerns about the funded status of pensions, as well as our investors' concerns about seeing to it that we'll be able to manage the capital requirements and the cash flows that are essential for the company to continue to be successful.

Read the rest of this transcript for free on seekingalpha.com