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What Does American Electric Power’s Current Valuation Indicate?

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May. 2 2016, Published 10:35 p.m. ET

AEP: Market performance

The slower-than-expected rate of interest rate hikes stimulated the sharp rise in utilities in 2016. The capital-intensive utilities (JXI) sector was sensitive to the interest rate developments from 2015. Last year, utility stocks were subdued due to expectations that interest rates could head higher.

This brought them to an attractive valuation, which triggered the rally. In this rally, American Electric Power (AEP) has gained more than 7% since the beginning of 2016 and nearly 10% in the last year. Hybrid utility giant Exelon Corporation (EXC) has gained nearly 30% so far in 2016.

American Electric Power and FirstEnergy (FE) closed down by 2.5% and 11%, respectively, on April 28 when federal regulators blocked income guarantees for their power plants. The chart above shows American Electric Power’s outperformance over utilities during the last year.

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Valuation

As of May 2, 2016, American Electric Power (AEP) is trading at an EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) valuation of 9.8x. AEP’s five-year historical EV-to-EBITDA average is 8.8x. The industry average EV-to-EBITDA is around 10.6x. EV-to-EBITDA is a valuation metric used to indicate whether a stock is overvalued or undervalued, regardless of its capital structure.

By comparison, Duke Energy (DUK) is trading at a multiple of 10.6x, as is Southern Company (SO). Xcel Energy’s (XEL) ratio stands at 10x.

American Electric Power’s forward EV-to-EBITDA is 9x. The lower forward multiple compared to the current multiple indicates expectations of a higher EBITDA for AEP in 2016.

Still, the rate hike scenario is clearly in the favor of utilities, given the Fed’s dovish stance. This bode well for utilities to rally further, although their overvaluation remains a concern.

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