Please ensure Javascript is enabled for purposes of website accessibility

Is This Utility Stock Worth Owning?

By Lior Cohen – Feb 11, 2014 at 12:22PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Will FirstEnergy recover from its recent tumble? Does its current valuation justify owning the stock?

As many had anticipated, FirstEnergy (FE 0.58%)recently cut its dividend payment by nearly 35%. This decision has steered investors away from the stock, which has declined 7% year to date. Following this dividend slash, are shares worth holding? How does the company's current dividend measure up to other utilities' dividend payments? 

The dividend cut
Following FirstEnergy's decision to reduce its dividend, its annual yield slipped to nearly 4.7%, bringing it closer to the industry average. For comparison, American Electric Power (AEP 1.96%) offers an annual yield of 4.2%, while Exelon (EXC 2.68%) pays a yearly yield of 4.3%. Thus, even though FirstEnergy reduced it dividend by 35%, its annual dividend yield is still higher than other leading utility companies.

One of the reasons FirstEnergy decided to reduce its dividend paycheck was the expected decline in its earnings in 2014. The company projects its basic earnings per share to reach $2.65; its operating earnings per share (excluding special provisions and one-time charges) are expected at $2.41 -- nearly 12% lower than in 2013. Assuming in 2014 there won't be many special provisions such as regulatory charges, deactivation costs, and debt-redemption costs, the company's payout ratio (the ratio between the dividend per share and basic EPS) will reach 59%, which is a reasonable ratio. In 2013, however, the company's payout ratio was very high, at 241%. This ratio was high even for the utility industry. The table below compares the payout ratios of several utility companies. 

Source: Google finance, American Electric Power's website, Exelon's website, and FirstEnergy's website

Other companies such as American Electric Power and Exelon had payout ratios of 64% and 90%, respectively. Keep in mind, however, that FirstEnergy had many "special one time charges" that reduced the company's EPS to such a low figure. For instance, back in July, FirstEnergy had to close two of its coal-generating power plants because they were responsible for $280 million out of the total $925 million in environmental fines the company had to pay.

Currently, the regulatory charges are expected to be very low in 2014 -- only $0.05 per share compared to $0.54 per share in 2013. Nonetheless, the company still expects its earnings to fall in 2014. In comparison, other utility companies expect a modest rise in their earnings during 2014; for example, American Electric Power's operating earnings per share are expected to be $3.30, which is 2% higher than what the company reported in 2013. Taking into account FirstEnergy's expected decline in earnings and the reduced dividend payment, does its current valuation make this stock a bargain?  

Let's examine FirstEnergy, American Electric Power, and Exelon's enterprise value-to-EBITDA ratios. One reason for using this metric is their different levels of debt. For example, FirstEnergy's debt-to-equity ratio is 1.6, while American Electric Power has a debt-to-equity ratio of 1.2, and Exelon's ratio is 0.9. Thus, FirstEnergy has the highest debt burden of the three. The enterprise value-to-EBITDA ratio takes this into account.   

Source of Data: Yahoo! Finance and Damodaran

As you can see, even after the decline in FirstEnergy's stock, its EV-to-EBITDA ratio is still much higher than the utility market average and other utility companies. These numbers suggest FirstEnergy's valuation is still high, even after considering the company's debt and cash on hand.  

Foolish bottom line
FirstEnergy isn't likely to increase its earnings in 2014. The company's dividend slash will free up some funds to augment its capital expenditures, allowing it to invest in newer power stations that will reduce emissions. These steps will also reduce the the cost of its environmental fines. But the company's current valuation is still high, and its dividend payment is only slightly higher than other utility companies. Since other utilities are expected to increase their sales in 2014 and are better priced, FirstEnergy seems to have little to offer investors.

Lior Cohen has no position in any stocks mentioned. The Motley Fool recommends Exelon. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

FirstEnergy Stock Quote
$41.57 (0.58%) $0.24
Exelon Stock Quote
$42.87 (2.68%) $1.12
American Electric Power Stock Quote
American Electric Power
$96.37 (1.96%) $1.85

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.