Credit analyst wants cashflow stability in AEP before consideration

By Ronda Fears

Nashville, Tenn., Oct. 11 - Carol Levenson, director of research at Gimme Credit, said there would have to be a vast improvement in cashflow stability before she can recommend American Electric Power paper.

AEP (Baa1/BBB+) on Thursday again lowered its earnings guidance for the year and its stock closed up nearly 20%.

At one point during Thursday, the stock was down another 15% to a new 52-week low but that was before AEP declared it was scaling back its trading business, which Levenson said is a move that should please both stock and bond investors.

"Although AEP is not one of the energy merchants on the credit quality critical list, its significant trading activities disqualified it from our list of 'safe' utilities," Levenson said.

"We noted in June the best a bondholder could hope for with this credit was stability, not improvement."

AEP has taken a host of balance-sheet-enhancing actions this year, completing two major asset sales that raised cash and removed considerable debt from the books and issuing nearly $1 billion in equity and convertibles.

"The earnings warning was not all that material, representing at the low end a 12% shortfall from the high end of previous guidance," Levenson said.

"We note, however, that the continuing lack of visibility is much more disturbing, as these earnings warnings seem to be occurring on a quarterly basis."

The company now sees flat earnings for next year, which was probably a disappointment to those still clinging to the deregulation business model.

Management was vague, though, about exactly how it would downsize its trading activities.

"In particular, we'd like to see specific numbers as to capital supporting this business both before and after the cutback, as well as expected earnings and cashflow contributions relative to the company as a whole," Levenson said.

In the first half of 2002, cashflow (adjusted net income plus depreciation and amortization) was $1.1 billion but cashflow from operations (including working capital changes and other asset and liability movements) was only $100 million.

Yet, she noted, AEP's current prediction of breakeven free cashflow this year rests upon the dubious assumption that cashflow will equal cashflow from operations for the year.

"We also note preliminary liquidity information disclosed yesterday indicates a billion dollar drop in liquidity since the end of June, despite the CitiPower sale," Levenson said.

"Furthermore, $4.5 billion of the company's $5.5 billion in credit facilities expire within the next 12 months, an unsettling situation for a company whose short-term debt was $4.5 billion at the end of June."

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