FirstEnergy Corp

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

FirstEnergy Corp. is a major electric utility company, primarily operating in regulated distribution and transmission segments across several U.S. states.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

FirstEnergy Corp. (FE) is a diversified energy company operating within a regulated business model, where it provides electric power to a significant customer base. The company’s primary focus is on its distribution business, which comprises the delivery of electricity to residential, commercial, and industrial customers. It also includes a transmission business, which is the transmission of electricity over long distances. FirstEnergy’s geographic reach is concentrated in the Midwestern and Mid-Atlantic regions of the United States, serving diverse economies and customer bases. The majority of its revenue comes from distribution segment.

  • Regulated Distribution: This segment focuses on delivering electricity to customers through its local distribution lines. It represents a substantial part of FE’s revenues and is subject to regulatory oversight. The company needs to maintain and improve its infrastructure, while trying to keep their cost down.
  • Regulated Transmission: This segment focuses on delivering electricity over high-voltage transmission lines, which helps to transfer bulk power to other companies, other utilities, or end customers.

The company’s operations are heavily regulated, with tariffs and pricing models set by various state and federal agencies. The regulations ensure stability but can also put constraints on the company’s potential for growth and revenue generation. The company operates in states such as Ohio, Pennsylvania, West Virginia, Maryland, New Jersey, and New York. Each state has its own regulatory environment. A diverse regulatory framework adds additional operational complexity. FirstEnergy is exposed to changes in policy, new regulations, or delays in the regulatory approval process. These can have a significant financial implication for the company.

Financials

FirstEnergy’s financial performance is largely dictated by its regulated business model.

  • Revenue Trends:
  • Revenue increased by 5.8% to 1.27 billion in Q3 2023 compared with the same quarter of 2022. Revenue increased by 5.5% to $3.79 billion in 9M 2023 compared with 9M 2022. - Growth was mainly attributable to increased volumes from weather, rate increases, customer additions, and other factors.

  • A significant portion of revenue is generated from the Distribution segment.

  • Operating Expenses:
    • Operating expenses increased to 3.062 billion in 9M 2023 compared with 2.928 billion in 9M 2022. Operating expenses decreased slightly to 1.085 billion in Q3 2023 compared to 1.142 billion in Q3 2022.
    • The company reports increases in power generation costs, purchase power costs, as well as other expenses such as distribution, selling, general, and administrative (SG&A) expenses.
  • Net Income:
  • Net income attributable to FE was 420 million in Q3 2023, down from 731 million in Q3 2022.
  • Net income attributable to FE was 717 million in 9M 2023, down from 1.5 billion in 9M 2022.

  • This decline in net income in Q3 2023 is mainly attributable to a one time adjustment in their energy efficiency program of around 339 million. The decline in net income in 9M 2023 is mainly due to the recognition of some one time costs.

  • ROIC:
  • In 2023, the year-to-date adjusted return on invested capital was 6.5%. Company management is trying to improve that.

  • Over the long-term the company is targeting the upper end of the 8-10% range for return on invested capital.

  • Capital Structure:

  • The company is financed with both debt and equity. The debt-to-capitalization ratio is targeted at 55%-60%, implying a high reliance on debt financing.

  • Cash Flow:
    • The company has a large part of cash used in investing activities. This include investment in infrastructure upgrades and new projects.

Moat Analysis

FirstEnergy possesses a narrow moat that rates a 2/5.

While FirstEnergy operates in a regulated industry that has high barriers to entry and a stable demand base, which offers certain advantages, it doesn’t have strong economic moats. Here’s why:

  • Limited Pricing Power: As a regulated entity, the company’s rates are set by regulatory authorities, which limits its ability to increase prices beyond what is approved. Although it can be passed cost increases, price increases to customers is not always immediate. It doesn’t have full control over its pricing which limits its ability to take full advantage of its services.
  • Scale advantages: Being a large and established utility does provide the company with economies of scale. However, many other utilities operating in other regions have similar advantages and scale. In addition, economies of scale in distribution are not that valuable. Scale is not everything, because the more a company tries to control its operations the more the operations will deviate from its core and become less profitable.
  • Intangible Assets: FirstEnergy relies on government-issued operating licenses to operate in the region. They are not unique, are limited by the geographic area they are issued in, and can be renegotiated. These licenses don’t provide a substantial moat.

Risks to the Moat

  • Regulatory Changes: Changes in the regulatory environment, such as stricter rules or unfavorable rate decisions, could negatively impact the company’s earnings and returns. This could erode its pricing power.
  • Operational Disruptions: Natural disasters, equipment failures, or other operational disruptions may lead to significant costs and affect the company’s ability to serve its customers.
  • Competition from Alternative Energy: The rise of distributed generation such as solar and wind may limit growth in regulated distribution. It also presents a growing competition by distributed energy that can reduce the number of customers of the traditional utilities.
  • Financial Risks: High levels of debt can make the company vulnerable to interest rate changes or unexpected market turmoils. Poor liquidity would affect the ability to service its debt and invest in operations.

Business Resilience

  • Demand for electricity is stable: The company provides an essential service, meaning that it will always have a strong customer base, even during times of recession or difficulty.
  • Consistent business: The regulated nature of the utilities business model gives some predictability to its operations. Government oversight ensures a minimum level of stability in pricing.
  • Financial strategy: Company is committed to improving operating performance and cash flows.

Understandability Rating: 3/5

The business model of FirstEnergy is relatively easy to understand since it is based on the simple concept of delivering electricity to homes and businesses. However, its heavily regulated nature, makes this business more complex to fully understand, because its revenue streams, expenses, and capital allocation are strongly dependent on regulatory bodies. As such, its understandability rate is a 3/5.

Balance Sheet Health Rating: 3/5

FirstEnergy’s balance sheet is mixed and rates 3/5. While the company has a solid base of assets, it also carries significant debt that may be problematic in times of rising interest rates and market volatility.

  • The company’s debt-to-capitalization ratio target at 55%-60% is relatively high.
  • High Debt to equity ratio.
  • However, the company reports having $2.7 billion in cash and cash equivalents as of September 30, 2023.
  • The company’s liquidity position is expected to remain strong. The company has access to sufficient cash and credit lines, and intends to use that liquidity responsibly, but is susceptible to market volatility and economic downturn.

Recent Concerns / Controversies / Problems

  • In July, the Board of Directors initiated a leadership transition. John Somerhalder II was named as new interim president and CEO in a move that seems like they’re working towards putting up a strong governance structure after previous problems.
  • The company has incurred many costs to settle different lawsuits and regulatory issues that have been occurring in the past few years. In the last year alone, they’ve incurred hundreds of millions of dollars of one time adjustments, including for pension, legal, and environmental issues.
  • FirstEnergy is currently operating in a highly volatile and uncertain environment of regulations, interest rates and market volatility. This is making forecasting revenue and profits very hard for the company to estimate and has made the business seem a bit riskier.
  • The company is trying to reduce its debt to a targeted debt-to-equity ratio of 55% to 60%. However, this would be influenced by the market. Rising interest rates could also make this task more difficult.
  • Company continues to face various legal and regulatory investigations and has to face increased financial burden as a result.