Allegheny Energy, Inc. (AYE) reported financial results for the 1st quarter of 2009.

Adjusted net income for the 1st quarter of 2009 decreased by $22.0 million compared with the year-ago period.

Adjusted operating revenues increased by $49.8 million in the reported quarter, reflecting higher generation rates in Pennsylvania and Maryland, increased purchased power cost recovery in Virginia and higher sales to third parties. These benefits were partially offset by reduced generation volume due to lower power plant availability and less demand.

Adjusted EBITDA for the 1st quarter of 2009 was $328.2 million, an increase of $5.1 million compared to the same quarter of the prior year. AYE continues to benefit through its stable and regulated electric power operations.

In addition, the company has consistently paid quarterly dividends after reinstating them in December 2007, which was previously suspended in December of 2002 as the company was in severe financial distress.

Furthermore, the company recently received investment grade credit ratings from Moody, Fitch and Standard & Poor’s.  

Going forward, AYE’s positive investment factors include higher generation rates in Pennsylvania and Maryland, higher residential usage, approvals for transmission projects, and steady progress with scrubbers. Looking ahead, we expect that the company’s regulated delivery utility business will provide steady earnings growth while disposal of retail distribution operations in Virginia has provided much needed liquidity.

However, higher environmental-related capital expenditures, emission and hedging costs, higher taxes, lower commodity prices and higher coal prices, and a substantial interest burden on account of expansion plans and coal costs remain pockets of concern.

Reinstatement of the company’s quarterly dividend is certainly a positive; although it currently yields a relatively unattractive 2.1%, which is lower than the electric power utility industry average yield of 5.1%. Moreover, we believe the sustainability of the dividend is supported by higher operating cash flows as well as reasonable projected earnings payout ratios.  

AYE currently trades at 11.5x and 9.5x, respectively, our 2009 and 2010 earnings per share estimates — within the upper-end of the range of its comparable diversified energy utilities peers — yet below the electric power utility industry average multiple, which is justified by significantly above industry average long-term growth expectations.  Likewise, AYE trades at the upper-end of the ranges of its industry peers based upon relative multiples of sales, cash flow and book value.

Nevertheless, given the successful status of the turnaround and long-term projected EPS growth rates among the highest of all utilities and many times greater than growth expectations for the broad industry, we maintain a BUY recommendation on AYE with a six-month target price of $31.75, representing 12.9x and 10.7x, respectively, our 2009 and 2010 EPS estimates. Price appreciation to our near-term valuation target, coupled with a $0.15 per share quarterly dividend — which we consider being sustainable and secure based upon projected dividend payout ratios of 24.4% and 20.2% of our projected 2009 and 2010 EPS estimates — represents annualized total return potential of 28.1%.

Headquartered in Greensburg, Pennsylvania, Allegheny Energy, Inc. is engaged in both regulated electricity and natural gas distribution utility operations, as well as in the unregulated wholesale energy markets.

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