When FirstEnergy Corp. used the words “right-sizing” to describe to the investment community an important change in how the electric utility will operate in the future, it did not come as a surprise to Paul Fremont, an analyst with Jefferies & Co. in New York.
Elaborating on its plan, FirstEnergy said it was shifting its assets away from competitive markets toward making money from its utilities that operate under rate regulation.
The move indicated that Akron-based FirstEnergy — and other utilities that had focused in recent years on competitive markets after deregulation came to the industry — was acknowledging it has not fared as well as peers who have focused on regulated environments.
A 10-year look at the Dow Jones Utility Index shows that FirstEnergy, its peers and its nearby competitor, AEP of Columbus, started out evenly.
In 2008 in the middle of the Great Recession of 2007-09, FirstEnergy’s stock price rose above its peers and AEP.
But beginning in 2010, the stock price sagged — and trails the utility index today.
FirstEnergy ended the opening day of trading in January 2007 with a per-share price of $60.46. Prices peaked at $83.21 on July 11, 2008. On Friday, FirstEnergy shares closed at a multiyear low of $32.44.
Fremont attributes the stock price swing to the market’s view of two different types of companies — utilities that were mostly regulated and fared well and those that underperformed and participate in competitive markets.
“It’s fair to state the index breaks into these subgroups. One has performed very well and AEP could be the poster child for that group and FirstEnergy could be the poster child for the other,” said Fremont.
FirstEnergy President and Chief Executive Officer Tony Alexander, in a recent interview with the Beacon Journal, offered this explanation: the competitive markets were impacted and depressed by the economic conditions of the first decade of the 21st century, and also the “constant change of the rules that have made competitive markets very challenging.”
AEP chose better strategy
Alexander said while FirstEnergy watched closely the changes that deregulation brought, it became more exposed to a market downturn. Meanwhile, AEP chose a different strategy and “they ended up in the end, better.”
FirstEnergy also made a major decision during the period of economic ups and downs to acquire Western Pennsylvania-based Allegheny Energy in 2011.
The move made FirstEnergy one of the nation’s largest investor-owned electric systems.
Yet greater size did not help the company’s stock get better appreciated by the investment community.
Asked in retrospect if the merger has hurt or helped, Alexander said he believes it has helped. FirstEnergy purchased Allegheny for $4.3 billion in stock and the assumption of $3.8 billion in debt.
The purchase provides more stable revenues for the company than it would otherwise have, Alexander said, and after some facility closures, he added that the company believes it has ended up with more efficient plants.
“We’d be a smaller company without the resources available to otherwise sustain a challenging market now,” he said.
The recession played a major factor in how the company fared in the competitive electricity segment, said Alexander. Though the competitive market is still an important and successful part of FirstEnergy’s business with 2.7 million customers, Alexander said, there has been virtually no significant economic growth in customers in its six-state footprint for almost seven years.
In Ohio alone, there are 24,000 fewer regulated customers for FirstEnergy because of the 2007-09 recession, he said.
While there have been pockets of increased activity, such as increased shale-related businesses and auto plants running strong, industries such as autos didn’t replace what was previously shut down, he said. In Twinsburg in northern Summit County, for example, Chrysler closed an auto parts stamping plant.
Another factor cited by the company is the decline in natural gas prices, which affect energy prices, including electricity.
Taken together, these conditions have played a role in FirstEnergy’s decision to focus back on its opportunities in regulated markets.
The company announced a plan last month to invest $2.8 billion in the next four years at Ohio Edison and three other operating companies to upgrade transmission power lines and substations. The improvements will be paid for after each phase is completed, so the earliest increases in customer bills would be 2015, the company said.
In 2009, FirstEnergy’s portfolio consisted of 55 percent unregulated and 45 percent regulated operations. In 2013, the balance has changed to about 20 percent unregulated and 80 percent regulated, the company said.
By law, utilities are allowed to recoup a percentage of any investments made, in addition to the actual investment, from ratepayers.
The Federal Energy Regulatory Commission’s approved return on investment is allowed at 12.4 percent. That would calculate to more than $347 million the company can expect to take in, in addition to the $2.8 billion in spending planned. The project begins in Northeast Ohio and will continue to the company’s other states to replace aging infrastructure, said Alexander.
FirstEnergy has operations in Ohio, West Virginia, Pennsylvania, Maryland and New Jersey.
Growth potential seen
Alexander said the company is shifting its capital expenditures from an area where it does not see as much growth potential to one where it can grow.
“The company’s always had a view towards when we would be moving more of our investment into other parts of our operations, whether it be transmission, distribution or generation,” he said.
“But since the markets simply don’t support any investment in generation, as you look to grow your business, then it’s important to look at the other aspects of it and determine whether we should be reallocating resources to other pieces of the business.”
The $2.8 million in improvements will be made on the what are called 69 kilovolt (kV) transmission lines in Ohio Edison, Cleveland Illuminating Co., Toledo Edison and Penn Power areas. The company described them as attached to high wooden poles but said they are not lines running through neighborhoods and cities and substations.
The transmission business is much more stable than the competitive business with its guaranteed rate of return and pure profit, said Bob Whalen, president of the Utility Workers of America System Local 102.
Local 102 is part of another local called 180 and represents FirstEnergy workers in Central Pennsylvania. The workers are in the midst of a lockout by the company over an expired labor contract.
While investment in transmission is a good investment, Whalen lamented the business decisions FirstEnergy has been making when it comes to personnel.
Whalen’s unions are relatively new to FirstEnergy’s culture after the company purchased the former Allegheny Energy.
Whalen said he believes a trend he saw with Allegheny has continued under FirstEnergy.
He said the company has “gotten away from listening to the employees who actually do the work as to what are the best practices.
“Akron is dictating to everybody how they are doing it. We are going back 20 to 30 years in time with antiquated work practices since joining the company and we just can’t believe it.”
Alexander declined to comment on Whalen’s allegations.
Market hasn’t responded
Since FirstEnergy’s announcement at an industry conference in mid-November that it would shift its focus back to its regulated business, the investment market has not responded with a rising stock price.
Fremont, the financial analyst, does not attribute the market’s performance to the company’s announcement of “right-sizing.” Instead, he pointed to the company and its peers lowering their earnings guidance for next year.
“There’s a lot of uncertainty right now in terms of how the company is going to fund growth opportunities it has on the transmission side and right now, I think the market is trying to sort through exactly what that means,” said Fremont.
The company has said it will use dividend reinvestment and employee stock programs to fund the program and between 2015 and 2017, Alexander said there might be a need to sell what the company considers “noncore assets,” such as its partial ownership in the Signal Peak coal mine in Montana.
“We will continue to work on the issues we have internally to make sure we provide strong and adequate service to our customers,” he said. “We will accelerate some of the investment we’d otherwise make, quite frankly, in a more efficient way to address the aging infrastructure.”