Description
First Energy (FE) is a utility trading at 11x 2021EPS of $2.65 (midpoint of guidance) in comparison to large-cap regulated utility comps that trade at 19x 2021 EPS.
The reason for the discount is due to an FBI investigation announced in July 2020 surrounding $61 million of bribery payments from former subsidiary Energy Harbor and First Energy (split roughly 75%/25% respectively) into a PAC (known as a 501c4) controlled by Ohio House Speaker Larry Householder.
Householder used these funds to make campaign finance donations to various members of the Ohio state legislature in order to ensure the passage of House Bill 6 (HB6). The FBI affidavit which can be found at the following link: https://assets.documentcloud.org/documents/6999130/Ohio-House-complaint.pdf
Consumer advocates note that HB6 is a bill that increased customer’s utility bills. There are a number of articles written in local papers that summarize this argument. Lobbyists, First Energy, and the Ohio governor argue that HB6 lowered rates, ensured zero-carbon power generation in Ohio, and ensured good tax paying jobs in Ohio. Ultimately, the Ohio legislature passed HB6 and made it into law.
No one from First Energy has yet been implicated—though subpoenas have been issued as the investigation is ongoing. FE is not a beneficiary of HB6 because the HB6 rate premiums pass through to the power generating company Energy Harbor. A repeal of HB6 would likely not have a material effect on FE.
The announcement of the investigation caused the stock to sell-off by $6 billion. I believe the discount as overdone.
In July, after the announcement of the investigation, the company reiterated 2020 EPS guidance of 2.40-2.60 and 5-7% growth for 2021.
Morgan Stanley (MS) estimates that there is over $2 in EPS excluding all of Ohio distribution, and points out Ohio distribution is just 26% of the distribution rate base. MS notes that if the bribery investigation ultimately results in a new rate case and a reset to a 10% ROE—which is just speculating on a potential penalty—then the company stands to lose approximately $0.22 per share in earnings. Goldman Sachs calculates $0.23-0.28 in EPS at risk if Ohio decides to change the way it calculates FE’s rates under SEET (Significantly Excessive Earnings Test). RBC expects "RBC's earnings earnings power [to be] fundamentally unfazed."
A clean bill of health, and $2.65 2021 EPS less $0.25 in earnings power results in $2.40.
In the past couple of years, FE has traded at a 4-23% discount to peers, largely because First Energy Solutions or FES was spun off, filed Chapter 11, and this created an overhang on FE.
Large cap utility peers trade for 18.5x 2021 estimates. Applying a 20% discount to this, FE would trade for 14.8x 2021 earnings which I'm using as my target price for fair value based on what we know now.
2021 earnings are $2.65 assuming no reduction in earnings power, or $2.40 assuming a $0.25 haircut due to a fine or rate change. At 14.8x earnings, this results in $35-39 per share. Inclusive of the 5% dividend yield, this offers upside of 26-39%.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
As for the catalyst, I think the primary driver will be a resolution to the bribery case and repeal of HB6 and any regulatory concerns, which will I estimate will take 12 months.