Investing

Why American Electric Power and Kansas City Southern Are New Top Picks for 2018

Jon C. Ogg

Published: December 5, 2017 10:35 am

Last Updated: January 12, 2020 5:45 am

As 2017 comes to an end, investors have to be wondering what on earth to do with their investments in 2018. The Dow is up a whopping 23% so far in 2017 and the S&P 500 is an impressive 18% higher. Some investors must be worried about a pullback, with the theory that the market can neither rise forever nor rise in a straight line. Other investors remain bullish about the market, and they are looking for new ideas or support of a bullish view on existing holdings.

The one trend that investors have reaped massive rewards from for more than five years now is to buy the market and the top stocks on every big pullback. Merrill Lynch’s Equity & Quant team recently released its Top 11 Stocks for 2018. This list was very broad and inclusive, but Merrill Lynch also has its prized US 1 list that gets updated over the course of each year. Two more companies were just added to the prized US 1 list, and those additions were made several after the firm’s preliminary top 11 stocks for 2018 were released.

The US 1 list is in many ways similar to the Conviction Buy list of Goldman Sachs and is similar to “Top Picks” and “Focus” lists from other top investment banking firms. As far as what the list targets, it represents a collection of Merrill Lynch’s best investment ideas within its own Buy rating universe, and that list is managed with a goal of providing superior investment performance over the long term. Its return to-date in 2017 (as of November 30) was up 15.7%.

24/7 Wall St. has included some detail about each analyst call for adding the names to the US 1 list. We have also included trading data, what the implied upside would be and how that compares to the consensus analyst target price from Thomson Reuters.

American Electric Power Corp. (NYSE: AEP) was added to the Merrill Lynch US 1 list on December 4. The firm’s Julien Dumoulin-Smith has a Buy rating and the price objective is $83 per share. That represents implied upside of only about 8% on the surface, but its dividend yield of 3.2%, and a likely dividend hike in 2018, have to be considered for total return calculations.

When AEP was added to the US 1 list, that $83 price objective actually had been raised from $79 in the call. The firm called AEP its top pick in the utility sector due to how well it executes on its growth plan and because the company remains well positioned across opportunities. Merrill Lynch also now has the official highest analyst target price among all sell-side research targets.

Merrill Lynch noted that the wind catcher testimony is due out starting the first full week of December, and that this is key to watch. The report noted that substantially lowered wind equipment costs only improve the forecasted savings to customers as interveners closely scrutinize this project, and the timeline necessary to finish such a substantial project with 100% PTCs makes competitor projects much harder to come by the scale necessary to compete with the project economics.

American Electric Power provides power generation, transmission and distribution services to more than 5.4 million retail customers in 11 states. Merrill Lynch’s most investment rationale on AEP said this:

AEP remains one of the best-run utility holding companies in the country, in our view, with limited execution risk and potential upside from both improving regulatory regimes and renewable capex in the outer years. The core utility businesses have largely de-risked compared to peers and still have room to improve further, in our view.

AEP shares were last seen trading closer to $76.50, in a 52-week range of $59.01 to $78.07. The consensus analyst price target of $75.00 suggests that the stock might need a breather, or that analysts are going to have to juice up their published price targets in the coming weeks.

Kansas City Southern (NYSE: KSU) was a new addition to the US 1 list at Merrill Lynch as well, being added on the same December 4 date. The firm’s Ken Hoexter has a Buy rating and a $122 official price objective. That may only imply upside of about 8%, but total return investors have the 1.3% dividend yield to add on top of that appreciation target. Merrill Lynch is well short of the official street-high price target of $130.

The report noted that Kansas City Southern has resumed its top growth status in rail transports and there may be a sizable opportunity for 2018. Its 5.7% carload growth in the quarter is said to be the fastest growth in the sector, but the stock is valued at a discount to peers because of the overhanging risks from NAFTA, coal and regulatory pressure.

Before thinking that the $122 target is a line in the sand, Hoexter doesn’t think so. Further upside could be seen up to $140 per share out into 2019, based on higher volumes, margins and taxes.

Kansas City Southern was last seen trading at $112.75, in a 52-week range of $79.05 to $114.85 and with a consensus analyst target price of $115.71.