Can a Dividend be Dirty? AEP’s 5% Yield is Covered in Coal Dust

Talk about a bargain: American Electric Power (AEP) offers a dividend yield of almost 5% and the shares are selling at a PE ratio below 10.

AEP Dividend Yield Chart

AEP Dividend Yield data by YCharts

But as the largest owner of coal-fired power plants, generating about 67% of its 36,500 MW of electricity from the sooty stuff, AEP shares face potential earnings trouble ahead. The company will have to spend upwards of $7 billion, based on its current assessment, between 2010 and 2020 to comply with environmental rules on emissions and to convert some of its plants to natural gas from coal, according to its most recent 10-K filing.

No saying that can’t go higher, as the regulatory noose around coal tightens.

Coal, of course, isn’t just dirty. It’s expensive these days when compared to natural gas. All that fracking and drilling produced a gas glut, driving prices for the fuel down about 50% in the last six months. As a result, it’s expected that coal-produced electricity will fall to about 40% of the country’s output in 2012 from 42.2% in 2011 – and its lowest percentage in more than two decades.

Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts

Much if not all of this news is priced into AEP shares. At current earnings levels, it has good dividend coverage, paying out about 50% of its profits to shareholders. The stock has lagged the broader market so far this year. The power generating industry overall has been surprisingly flexible in switching fuels. If AEP can do so, too, perhaps these shares are cheap. If not, the dividend is huge for a good reason.

AEP Chart

AEP data by YCharts

Michael McHugh is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings, stock screener and portfolio strategies.



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