American Electric Power: An Ideal Utility for the Trump Presidency

 | Dec 07, 2016 | 11:00 AM EST
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aep

By now a lot has been written about a Trump presidency, but as with many things with the president-elect, it's difficult to look back in history to come up with a "game plan" for this incoming administration. These are very uncharted waters.

Two weeks ago I highlighted the "great migration" thesis some investors subscribe to, in which money migrates from bonds to economically sensitive stocks. Since then, the bond market has mellowed out and yields have stayed put. Have a look at the long-term Treasury bond ETF, for an example.

In light of this, investors should stick to the basics and look at companies on a case-by-case basis, as opposed to any sweeping thesis. We may know more in the coming months, but for now, a look at individual companies' fundamentals may be the most sensible approach.

Today, consider one of the country's larger utility companies, American Electric Power (AEP) . I like AEP (an Action Alerts PLUS holding) in this environment for a few reasons. First, it has a solid plan to grow earnings by mid-single-digits for the rest of the decade, which should translate into comparable dividend growth.

Second, and perhaps more importantly to this environment, AEP operates heavily in areas exposed to shale drilling and coal mining. While AEP will soon be almost entirely a regulated transmission and distribution business, the company provides electricity to both coal miners and shale drillers, and is strongly linked the greater economy in those areas. A look at AEP's industrial map illustrates this nicely.

Ignore the performance in industrial sales by geography in this chart for a moment and instead look at the company's regional exposure. AEP's service territory includes much of the Ohio, Indiana and Michigan portions of the "Rust Belt." AEP is also a big service provider in Kentucky and West Virginia, the heart of coal country. Finally, AEP's service territory in Texas includes much of the Permian and nearly all of the Eagle Ford shale oil plays.

On his first speech as President-elect, Trump promised to "cancel job-killing restrictions" on production of American energy, specifically those on shale energy and coal. Call me an optimist, but I believe that, in a more free-market environment, both coal and natural gas will be very competitive sources of electricity.

If Trump can make good on his promises, and at this point I believe he will, then these regions are going to perform a lot better relative to how they used to be doing. That would be a big boost to AEP's earnings, and ultimately, to the dividend as well.

The best thing about AEP right now is that it isn't too expensive. About five months ago the shares were up at $70, but they've since come down to $59, with a yield of 4.0%.

According to data from FAST Graphs, a service which I subscribe to, the stock has traded at an average 13.9x earnings over the last 10 years. Currently, AEP trades at 15.6x, so AEP is still not trading at a discount, but I think that's OK, because the upward catalyst could be very strong if the decline in coal mining can be stopped and if shale drilling turns around.

AEP's solid dividend growth ahead should shield it from downward action if the bull market in bonds has indeed come to an end. Furthermore, its exposure to some of the industrial heartland, and areas of heavy shale drilling could benefit from a Trump presidency.

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