FirstEnergy: A 5-Star Buy at CFRA Research

05/24/2019 5:00 am EST


Christopher Muir

Senior Industry Analyst, CFRA, Equity and Fund Research

Our latest focus stock is FirstEnergy Corp. (FE) which carries CFRA Research's highest investment recommendation of 5-STARS, or Strong Buy, explains equity analyst Christopher Muir in CFRA Research's The Outlook.

FirstEnergy is a utility holding company involved in the transmission and distribution of electricity. Through its utility subsidiaries, FE owns or controls 3,790 MWs of generating assets.

As of December 31, 2018, the company operated through two core business segments: Regulated Distribution (88% of segment revenues) and Regulated Transmission (12%).

Regulated Distribution distributes electricity to more than 6 million customers within an area of 65,000 square miles in Ohio, Pennsylvania, West Virginia, Maryland, New Jersey and New York. Regulated Transmission transmits electricity for its transmission ventures and certain utilities.

As of March 31, 2018, the Competitive Energy Supply segment was de-consolidated following a bankruptcy filing. The Corporate and Other segment is a non-operating segment that includes corporate support not assigned to other segments, interest expense on FE's holding company debt and other businesses, including 1,367 MWs of unregulated coal power plants.

The company's regulated power plant facilities had a total generating capacity of 3,790 MW at the end of 2018, with coal plants accounting for 81.6% of the total and pumped storage hydroelectric 18.4%.

First Energy's transmission system owns about 24,506 miles of transmission lines. Included in the total are 12,343 miles that are owned by transmission-only subsidiaries.

Electric deliveries in 2018 totaled 151,771 MWh with residential accounting for 37% of the total, commercial-28%, industrial-35% and other-<0.5%.

On March 31, 2018, FE announced that its competitive generation subsidiary had filed for bankruptcy and that FE would become a fully regulated utility company. As a result of the bankruptcy, FE immediately deconsolidated its competitive generation subsidiary. FES plans to emerge from bankruptcy protection in September or October 2019.

On January 22, 2018, FE announced that a group of private equity investors had taken a $2.5 billion stake in the company through a $850 million common equity and a $1.62 billion preferred equity investment.

First Energy used the proceeds to pay down corporate debt, contribute to its pension fund and accelerate its utility investment plan. FE used the investors' expertise to exit its competitive generation business, thereby becoming a pure play utility.

We view the transaction favorably and see the investment by the private equity firms as a signal of confidence in FE's growth prospects and the benefits of exiting the competitive generation business.

Our Strong Buy opinion reflects our positive view of FE's capital spending program and its discount-to-peers valuation. We see the regulated capital spending helping to drive future EPS growth.

FE is now operating separately from its former competitive generation business (FES), which declared bankruptcy in March 2018. We see significant opportunities for growth in FE's FERC regulated transmission business as well as its state regulated utilities.

Our 2019 recurring EPS estimate, excluding $0.08 of net nonrecurring gains, is $2.65, up 2.3% from 2018's $2.59, which excludes $0.60 of net nonrecurring charges. We forecast 2020 EPS of $2.80, up 5.7%. We expect EPS will rise more steadily after 2019.

Our 12-month target price of $48 is 18.1x our estimate, or an 8% discount to our peer target, warranted by our projection of a below-peer three-year EPS growth rate, partly offset by an above-peer dividend yield of 3.7%.

Risks to our opinion and target price include changes in regional and national economic conditions, regulatory relationships, long-term weather patterns and interest rates.

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