Is a Leprechaun Playing Tricks on Us this Year? Despite a Solid Finish to 2022, Why the Recent 2023 Slump?

AEP ended 2022 on a high note and management reaffirmed the 2023 guidance and long-term earnings growth rate of 6-7%. However, stock price in YTD 2023 so far has been a bit rocky. This Street Wise edition will provide insights into recent stock price behavior specific to the utility sector.

AEP’s 2022 Strong Performance

AEP finished 2022 with a solid performance delivering YTD 2022 operating earnings of $5.09, beating analysts’ estimates. Strong load growth, favorable weather and continued investment in AEP’s regulated utilities and transmission drove the positive results. In addition, management reaffirmed 2023 operating guidance of $5.19-5.39 and the long-term earnings growth rate of 6-7% underpinned by a robust 5-year capital plan. Lastly, management reiterated the commitment to simplify and de-risk the business by highlighting updates to the signed agreement for the sale of contracted renewable assets and the Kentucky operations sale expected to close following FERC approval. Analysts and investors were upbeat on another strong earnings beat and our 2023 outlook. They were also pleased by management’s ability to successfully execute the contracted renewables transaction.

Andrew Weisel of Scotia summarized, “We’re impressed with another strong earnings beat, elongating AEP’s track record as one of the best at beating guidance and consensus forecasts. We remain confident in our estimates for 2023+, which are at or near Street-highs for all years. We’re also impressed with the announced sale of contracted renewables for $1.5B, supporting the balance sheet without a notable impact to EPS.”

AEP’s stock price finished 2022 up 6.8%. Comparatively, the UTY Index (Philly) was down 2.4% YTD, the S&P Electric Utility Index was down 0.8% YTD and the S&P 500 was down 19.4% YTD.

With such a strong performance in 2022, one may wonder what caused the recent slump in the stock price YTD 2023. To answer this question, we need to look at the macroeconomic impact of a rising interest rate environment and its effect on the utility sector as a whole.

Interest Rates are Everything – Again

In general, interest rate volatility directly influences utilities because utility stock performance has an inverse relationship with interest rate activity. As interest rates fall, utility stock prices typically increase. As interest rates rise, utility stock prices usually decline. This is due to the corresponding yields available on government bonds. With rising interest rates, government bonds can be more attractive to some traditional investors. Additionally, the capital-intensive nature of the utility industry means utilities rely on debt for funding. When interest rates rise, the cost of doing business is higher for utilities since borrowing costs increase.

This inverse relationship broke starting in 2020. Despite the collapse in interest rates, utilities underperformed in 2020-2021 due to the impacts of working from home and investors’ attraction to technology stocks. In 2022, due to economic uncertainties, investors strengthened their positions in utilities despite rising interest rates. This could be attributed to investors’ flight to safety with rotations out of the risker technology stocks and into defensive stocks such as utilities, which typically deliver stable earnings and consistent dividends. The strong performance in 2022 drove utilities’ prices up and investors viewed utilities as expensive relative to bonds, resulting in the reversion witnessed at the beginning of 2023.

We are now back where we started, utilities trading with a high correlation to the inverse of interest rates. Steve Fleishman of Wolfe Research summed it up as follows, “Utilities underperformance continues. Earnings season wasn’t as bad as feared and relative earnings estimates vs. the market are actually improving. This is clearly a macro shift away from defensive, as utilities are at the bottom of the heap. The high-interest rate environment remains a clear headwind for the sector.”

Although 2023 has been a rocky start, management is optimistic about AEP’s 2023 outlook, including another year of projected retail load growth and confidence in our teams’ strong ability to execute on investments in regulated utilities and transmission.

On March 3, 2023, AEP’s stock closed at $89.09, down 6.2% YTD. Comparatively, the UTY Index (Philly) was down 7.5% YTD, the S&P Electric Utility Index was down 7.3% YTD and the S&P 500 was up 5.4%. In addition, the 10-year yield moved above 4% in March 2023 for the first time since November 2022.

Upcoming Events

Over the following weeks, Investor Relations will accompany AEP Management Team in conducting one-on-one meetings with investors at the JP Morgan conference in Chicago on April 5 and the Credit Suisse conference in New York City on May 17.

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Watch for future Street Wise editions discussing earnings, regulatory updates and market trends related to AEP and the electric utility industry.

AEP closed at $89.09 March 3, posting a total return of -3.59% since Feb. 17. During the same period, the S&P Electric Utilities Index total return was -2.94%, and the S&P 500 Index total return was -.75%.