Why Exelon and FirstEnergy Are Sliding

Shares of FirstEnergy  (NYSE: FE  ) and Exelon  (NYSE: EXC  ) have declined in the past month by more than 6% and 9%, respectively. If you're chalking it up to the U.S.'s plan to reduce carbon emissions by using less coal, which could lead to higher operating costs for utilities, then this reasoning doesn't hold up for Exelon. This company mostly uses nuclear power to generate electricity. So, let's consider the following factors that could be behind these companies' recent falls. 

Bullish market
As stated by a Foolish colleague, the recovery of the financial markets, including the S&P 500, is driving investors toward higher-risk assets and away from less risky assets such as utilities. If the bullish trend continues, investors are likely to look for growth companies and less for stocks offering high dividend yields and little to no growth in value. This also brings up another point: Will utilities' dividend yields remain high? 

Rise in debt and borrowing costs
The main draw of utilities is the high dividend yields they pay to their investors. But these companies aren't making enough to sustain the high dividend paychecks. In the first quarter, FirstEnergy's earnings per share reached $0.29, while its dividend per share was $0.36. Exelon's EPS reached only $0.1, while its dividend was $0.31 per share. 

Even these companies' operating cash flows don't cover the dividend payments. As a result, Exelon and FirstEnergy's debt levels increased in the past year by $0.5 billion and $1 billion, respectively. 

If their earnings don't pick up in the coming quarters, they are likely to slash their dividend payments again. Late last year, FirstEnergy reduced its dividend by 35%. Exelon also slashed its dividend payment by nearly 41% in early 2013. In such a case, these stocks will lose their appeal even further. 

The current market expectations are that the Federal Reserve may raise its interest rates by mid-2105. Such a change in policy is likely to lead to a slow rise in borrowing cost for companies, which will make borrowing cash less desirable for Exelon and FirstEnergy. 

Lower profit margins
Both companies use natural gas as one of their energy sources to generate electricity. For Exelon, natural gas accounts for 22% of its input; for FirstEnergy, natural gas is roughly 8% of its total fuel mix. During the first half of this year, the price of natural gas spiked to hover over the $4.5 mark. Further, during the second quarter of 2014, coal prices also rose by almost 5%, year over year. Coal accounts for 57% of FirstEnergy's fuel mix.  

The rise in energy prices could partly explain the drop in profitability of these companies, as indicated in the chart below.  

Source: Google Finance.

If natural gas and coal prices remain high, they could further cut the profit margins of these companies and make them less attractive as investments. 

The bottom line
FirstEnergy and Exelon haven't done well in the past several weeks, and as long as they don't show any significant improvement in their profit margins, and the bullish run in the equities market continues, these companies' stocks will keep losing their appeal, and investors will likely steer away. 

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Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 19, 2014, at 5:32 PM, Paulson545 wrote:

    NGas is the clean energy fuel of the future. Better to look at Rice Energy ( rice ) who recently had an upgrade and $51.00 price target placed on it....Coal stock will break your heart....jmho

  • Report this Comment On July 19, 2014, at 10:26 PM, vireoman wrote:

    "If natural gas and coal prices remain high, they could further cut the profit margins of these companies and make them less attractive as investments."

    Both natural gas and coal prices are as low as they've been in a long while. Meanwhile, EXC did poorly in 2013 due to natural gas prices that were too low, thus negating the advantage of their low-cost nuclear power. According to your thesis, EXC has no opportunity at all to make money.

  • Report this Comment On July 20, 2014, at 7:48 PM, fool1953 wrote:

    I think FE & EXC will be able to sustain their current dividends. FE this year looks like it will only pay out dividends of about $.6 billion year. This year and next analyst's are projecting over $15 billion in revenues. Their depreciation is like $1.2 billion. Analysts are projecting earning of about $2.49 per share this year which should be more then enough to support the dividend. High yields are tough to get and it appears it will be that way for awhile even with the bond buyback program ending. I think FE is a buy once it bases out from this current drop. I am basing this on the yield fluctuation between 4-4.5% sometime over the next three months. It is at a 4.5% yield now. If it goes to a 4.1% yield it will be sitting at about $35 which it hit not so long ago. So you could get about a 10% gain if you buy now and hold for a couple months. IMHO EXC I am not so sure about because of their recent acquisition. The good thing about both these stocks is that if the market tanks the dividend supports them As always the market over reacts so FE & EXC may continue to go down but watch for them to base out because their next intermediate move should be up.

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