We are raising our rating on FirstEnergy Corp. (FE), a diversified energy company based in Ohio, to "buy" from "hold", suggests Jacob Kilstein, an analyst with the leading independent Wall Street firm, Argus Research.
Our upgrade reflects the stock’s favorable valuation and our view that the coronavirus will increase investor interest in utility stocks.
We are setting a target price of $44. As more people work at home (and spend more leisure time at home) due to the pandemic, we expect demand for electricity and gas to remain constant or grow on the residential side, but to decrease on the industrial side.
We believe that investors will gravitate to high-yield stocks such as utilities as the Fed lowers interest rates. Over the past five years, FE shares have shown a strong inverse correlation to the 10-year Treasury yield, so that when interest rates rise, FE shares tend to fall.
The company recently raised its quarterly dividend by 2.6% to $0.39 per share. The increase was the second in 2019. FE had previously not raised its dividend since 2014, when it reduced its quarterly payout by 35% to $0.36.
The shares trade at a discount to the peer group, which we think is no longer warranted given the company’s cost cutting and long-term emphasis on cash flow growth. Management is working to transform the company into a regulated utility, which should provide more stable earnings and cash flow.
FirstEnergy shares appear favorably valued at current prices near $39. Over the past 52 weeks, the shares have traded between $36 and $49.
On a fundamental basis, FE trades at 15.4-times our 2020 non-GAAP EPS estimate, near the midpoint of its five-year historical range of 10.1-20.9 (the P/E was toward the top of the range before the coronavirus selloff), but below the peer median of 16.6.
We think the discount is no longer appropriate given the company’s recent dividend hikes and emphasis on cash flow improvement.
In addition, in a lower interest rate environment, we think that investors will gravitate to high-yield stocks such as utilities. The current yield of about 4.0% is above the peer median of 3.8%. Our target price of $44 implies a projected 2020 P/E of 17.6, slightly above the peer average.