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Are American Electric Power Company Inc’s (NYSE:AEP) Interest Costs Too High?

Chris Amalia

Investors seeking to preserve capital in a volatile environment might consider large-cap stocks such as American Electric Power Company Inc (NYSE:AEP) a safer option. One reason being its ‘too big to fail’ aura which gives it the appearance of a strong and stable investment. But, the key to extending previous success is in the health of the company’s financials. Let’s take a look at American Electric Power Company’s leverage and assess its financial strength to get an idea of their ability to fund strategic acquisitions and grow through cyclical pressures. Remember this is a very top-level look that focuses exclusively on financial health, so I recommend a deeper analysis into AEP here.

Check out our latest analysis for American Electric Power Company

How much cash does AEP generate through its operations?

Over the past year, AEP has ramped up its debt from US$21.40b to US$24.62b – this includes both the current and long-term debt. With this growth in debt, the current cash and short-term investment levels stands at US$374.3m for investing into the business. On top of this, AEP has produced cash from operations of US$4.56b over the same time period, resulting in an operating cash to total debt ratio of 18.5%, signalling that AEP’s debt is not appropriately covered by operating cash. This ratio can also be a sign of operational efficiency as an alternative to return on assets. In AEP’s case, it is able to generate 0.19x cash from its debt capital.

Can AEP pay its short-term liabilities?

With current liabilities at US$9.06b, the company has not been able to meet these commitments with a current assets level of US$4.57b, leading to a 0.5x current account ratio. which is under the appropriate industry ratio of 3x.

NYSE:AEP Historical Debt August 30th 18

Is AEP’s debt level acceptable?

Considering American Electric Power Company’s total debt outweighs its equity, the company is deemed highly levered. This is not unusual for large-caps since debt tends to be less expensive than equity because interest payments are tax deductible. Since large-caps are seen as safer than their smaller constituents, they tend to enjoy lower cost of capital. We can check to see whether AEP is able to meet its debt obligations by looking at the net interest coverage ratio. Preferably, earnings before interest and tax (EBIT) should be at least three times as large as net interest. For AEP, the ratio of 3.64x suggests that interest is well-covered. Strong interest coverage is seen as a responsible and safe practice, which highlights why most investors believe large-caps such as AEP is a safe investment.

Next Steps:

With a high level of debt on its balance sheet, AEP could still be in a financially strong position if its cash flow also stacked up. However, this isn’t the case, and there’s room for AEP to increase its operational efficiency. In addition to this, its lack of liquidity raises questions over current asset management practices for the large-cap. This is only a rough assessment of financial health, and I’m sure AEP has company-specific issues impacting its capital structure decisions. I suggest you continue to research American Electric Power Company to get a better picture of the stock by looking at:

  1. Future Outlook: What are well-informed industry analysts predicting for AEP’s future growth? Take a look at our free research report of analyst consensus for AEP’s outlook.
  2. Historical Performance: What has AEP’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.