Time was when utility stocks were disparagingly called stocks for widows and orphans. Utility stocks were highly-regulated in their production and transmission of power to residential and commercial customers, Since this production and distribution is considered essential to the well-being of the country, the companies were run almost as quasi-governmental agencies. The regulations were such that utilities were strictly overseen by public utilities agencies, not only with regard to monitoring power transmission and supplies, but in their business practices like rate increases and other profit-making strategies. In return for this strict control, utilities had very little downside potential—they were not usually in danger of failing as a business in the same way as, say, the local sandwich shop on the corner. So they were a “safe” stock, a safe haven for investors who collected relatively high dividends which were the payoff as the stocks had little growth potential.
That was then. In the last twenty years, the regulatory climate has changed, with de-regulation being the watchword for public utility companies. This has changed the way they’ve had to do business, as the opportunity to compete was also the necessity to do so. Stronger utility companies which were better managed and had superior resources or strategic positioning ended up winning out and usually swallowed up the weaker ones. One such utility, FirstEnergy Corp. (FE) illustrates this perfectly.
First Energy was formed in 1996 and 1997 in its current version with the base of the company being Ohio Edison, an electric power company based in Akron, Ohio which served the surrounding area. Ohio Edison merged, as the dominant partner, with once-larger but weaker Centerior Energy, which had as its roots in the old Cleveland Electric Illuminating Co., or CEI. CEI had run into difficult competitive waters with de-regulation, as did its subsequent incarnation, Centerior. When First Energy was formed with Ohio Edison as the dominant partner over Centerior, the merging continued. First Energy , originally Ohio Edison, had taken over Centerior, which owned CEI and Toledo Edison, then added Penn Power in Western Pennsylvania, along with GPU, which was comprised of Med-Ed. in Reading, Pennsylvania, Pennelec, in Erie, PA., and Jersey Central Power and Light, in Morristown, New Jersey. The new First Energy now had 4.5 million customers and spanned northeastern Ohio, northwestern Ohio, parts of central Ohio, parts of western, northern, and southern Pennsylvania, and central and northern New Jersey. Thus First Energy became a regional powerhouse.
The company operates and transmits electric power through these seven wholly owned principal subsidiary power companies, and owns ATSI, American Transmission & Supply, which has transmission lines for power delivery. The power generation for the First Energy companies is currently approximately 53% fueled by coal, 28% by nuclear, 11% by natural gas, and 5% by hydro-electric, with 3% miscellaneous electric. With its geographical and operational range, First Energy is not subject to the effects of a narrow outage if, for example, one of its nuclear plants is offline. First Energy also resides in a rich coal region, with the Appalachian area and surrounding Pennsylvania and Ohio terrain abundant in this fossil fuel. This allows for the possibilities of relatively low-cost efficiencies of operation. The switch to low-sulfur coal with lower emissions has been an ongoing goal of the utility – a goal supported by regulators and environmental groups.
First Energy’s market cap stands at $22.5 billion, its 2007 revenue was $12.2 billion, with a net income of $1.3 billion, or $4.22 EPS. While earnings are expected to be flat for 2008, at about $4.27 a share, 2009 is expected to produce $5.15 per share, a tremendous acceleration in earnings. The stock traded recently at 74.50, and has been in a one-year range of 58.75-78.51. Its dividend of $2.20 annually currently yields 2.97%, and the stock has been trading at a PE of 17.5. The Dow Utilities average for the last twelve-months has been 457-557, with a recent close at 503. So although utilities have had some run-up, there is room for more with a market rebound.
Heightened demand for electric power, along with tight supply, is expected to contribute heavily to growth, as is a stabilization of costs in the coming years. First Energy is poised to be a regional low-cost producer, and although natural resources such as oil and gas may have peaked near term as commodities, investors can look at power itself as a commodity. Thus, you have many synergies at play here: electric utilities provide a commodity in power, they utilize natural resources in coal and gas, and while costs have grown, demand in the next few years for energy is expected to far outstrip costs and supply will remain tight. So utilities as a group have continuing potential for growth. Years ago that would have been inconceivable, but in business and investing, things change. You just have to watch.
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