In the past three months FirstEnergy (NYSE: FE) shed nearly 15% of its value (between November and January). This stock’s decline is mostly attributed to the uncertainty around the company’s dividend paycheck. But beyond the potential drop in dividend payment, is the company doing well for its industry? After all, leading analysts in Wells Fargo and Goldman Sachs have recently upgraded the company. Looking forward, is the company still worth owning? Let’s try to tackle these questions starting with the recent developments in the utility market.
The electricity market is powering down
According to latest Energy Information Administration update, between July and October, electricity prices remained higher than last year’s by roughly 1% to 4%. The chart below shows the changes in the prices of electricity between 2010 and 2013.
As you can see, the price of electricity peaked in July — the highest level in recent years. Due to the elevated electricity prices, the profit margin of some utility companies such as Exelon (NYSE:EXC) and Duke Energy (NYSE:DUK) have risen during the third-quarter.
The chart below shows the changes in the profit margins of the above-mentioned companies.
Both Duke Energy and Exelon improved their profit margin during the third-quarter (year over year) while FirstEnergy did not. For Duke Energy and Exelon the rise in prices improved their profit margins. According to Exelon’s third-quarter earning report , the company’s average margin rose by nearly 1%, year over year.
FirstEnergy‘s decline in profitability is due to several factors including: lower demand for electricity in its regulated distribution segment — this segment accounts for nearly 60% of its revenues ; increase in purchased power from other companies; changes in its amortization charges (non-cash provision). Moreover, the company’s revenues fell 6.4% during the quarter. FirstEnergy wasn’t the only one that recorded a decline in revenues: Exelon’s revenue fell by 1% during the third-quarter. One of the reasons for the drop in revenues is the lower demand: Exelon’s electric supply fell from 74,421 GWhs to 65,020 GWhs — a 13% fall. Conversely, during the first nine months of 2013, the company’s power generation operations grew in by more than 12.5%. In total, the company augmented its revenue by nearly 9% during the first three quarters of the year. Exelon’s merger with Constellation Energy back in 2011, which was completed during the first-quarter of 2012, has been the main driving force behind the company’s growth in sales.
During the third-quarter, Duke Energy’s revenue inched down by 0.2% mainly due to its electric supply drop of 1.6%.
Based on the above, it seems that FirstEnergy hasn’t done well compared to other utility companies. The company also faces ongoing regulatory problems in its attempts to comply with the Environmental Protection Agency’s Mercury and Air Toxics Standards. Because 60% of FirstEnergy’s power is generated with coal, high environmental costs are likely to keep this company’s capital expenditures and uncertainty high. After all, a few months back FirstEnergy shut down two of its coal based plants that were responsible for nearly $280 million in fines it had to pay. Duke Energy, much like FirstEnergy also heavily uses fossil fuel as it accounts for 70% of its power generation in the U.S. Therefore, Duke is also exposed the similar tax and fine burdens as FirstEnergy is. On the other hand, Exelon rely on nuclear power as more than 55% of the generated power is by nuclear.
The fourth-quarter isn’t likely to be much better for FirstEnergy as the company has already narrowed down its 2013 guidance to $2.9-$3.1 or an average of $3 basic earning per share (excluding special items such as regulatory provisions, merger costs etc), which is roughly 10% lower than 2012. Based on these numbers it implied that for the fourth-quarter the expected EPS will be around $0.7, which is also 12% lower than the same quarter last year. Besides lower earnings, the company’s potential dividend reduction could play a short term role in the demand for this stock.
With an annual dividend yield of nearly 7%, its high yield remains the main attraction for holding FirstEnergy or any other utility company. But will a sharp dividend cut could have long term effect on the company’s stock? Let’s try to tackle this issue by comparing the market’s reaction to another utility company that slashed its dividend — Exelon has cut down its dividend by 41% back in February 2013 . Exelon’s stock rallied in the following months after the announcement for a dividend slash was made — so it seems that investors didn’t react much to this new. Currently, the company continues to provide a dividend yield of 4.6%; this is close to several other utility companies’ yields such as Duke Energy that offers an annual pay of $3.12 — nearly a 4.6% yield. So even if FirstEnergy reduces its dividend, this may not have long term effect on the company’s stock; this could bring the yield closer to other utility companies’ current yield.
FirstEnergy is facing problems in increasing its revenue, and improving its profit margin. Even higher electricity prices aren’t enough to pull this company’s earning up. Moreover, the company’s reliance on coal will continue to be a “known unknown” that could adversely affect its bottom line. Therefore, even if the company doesn’t cut its dividend payment in the near future, the company’s fundamentals are still far from desirable.
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Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.