Business context and reporting period
FirstEnergy Corp. filed this unaudited combined Form 10-Q for the quarter and nine months ended September 30, 2012. The filing also covers wholly owned FirstEnergy Solutions Corp. (FES), Ohio Edison Company (OE), and Jersey Central Power & Light Company (JCP&L). FirstEnergy operates regulated distribution and transmission businesses and competitive energy and generation businesses, serving approximately 6 million customers.
Comparisons require care: FirstEnergy’s 2011 nine-month results include only seven months of Allegheny Energy, which merged with FirstEnergy in February 2011. In 2012, reporting segments were also reorganized to reflect management’s view of regulated transmission operations.
Financial performance and condition
| FirstEnergy consolidated | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $4.311 billion | $4.719 billion | $12.258 billion | $12.355 billion |
| Operating income | $907 million | $1.057 billion | $2.210 billion | $1.928 billion |
| Earnings available to FirstEnergy | $425 million | $532 million | $918 million | $787 million |
| Diluted EPS | $1.01 | $1.27 | $2.19 | $2.00 |
| Operating margin | 21.0% | 22.4% | 18.0% | 15.6% |
Third-quarter revenue fell 8.6% and earnings available fell 20.1% year over year; operating income declined $150 million. For the first nine months, revenue was nearly flat while earnings available rose $131 million. Operating margin is calculated as operating income divided by revenue.
For the first nine months, operating cash flow was $1.276 billion, down from $2.229 billion. Cash used for investing was $1.990 billion, including $1.686 billion of property additions and $207 million for nuclear fuel. Financing provided $662 million, including $1.604 billion of net short-term borrowings; FirstEnergy paid $690 million in common dividends. Cash and cash equivalents were $150 million at September 30, versus $202 million at year-end 2011.
At September 30, total assets were $48.738 billion and equity was $13.449 billion. Balance-sheet debt and other obligations included $1.473 billion currently payable long-term debt, $1.604 billion short-term borrowings, and $15.627 billion long-term debt and other long-term obligations. The filing reports approximately $3.993 billion of available liquidity, including cash; management described liquidity as approximately $4 billion. Current liabilities exceeded current assets, largely because of debt classified as currently payable. Credit facilities require debt-to-capitalization ratios of no more than 65% for most borrowers and 70% for FET; reported ratios ranged from 30.9% to 63.4% for the listed borrowers.
FirstEnergy contributed $600 million to its qualified pension plan during the nine-month period and expected no further 2012 contributions. Management estimated a fourth-quarter 2012 pre-tax pension and OPEB mark-to-market charge of approximately $300–$400 million, net of amounts capitalized.
Material changes and business drivers
- Third-quarter regulated distribution earnings increased $6 million to $286 million, while competitive energy services earnings fell $113 million to $129 million. Regulated transmission earnings increased $3 million to $59 million.
- Distribution deliveries declined 4.1% in the quarter, reflecting milder weather and lower industrial deliveries. Customer shopping continued to reduce utility generation sales: alternative suppliers served 80% of Ohio Companies’ deliveries, 62% in Pennsylvania Companies’ service areas, and 47% for JCP&L.
- Competitive energy services faced lower power and capacity prices and higher purchased-power needs. Direct and governmental aggregation customer count rose to 2.5 million from 1.7 million a year earlier; sales volume grew, but lower unit prices and reduced wholesale and capacity revenues weighed on quarterly earnings.
- FirstEnergy deactivated several older coal-fired units by September 1, 2012, citing environmental requirements and market conditions. The company reported $14 million of pre-tax severance expense for the nine months. Beginning in August, the 2,200 MW W.H. Sammis plant was placed in cold storage and was not expected to resume full operation until market conditions improve.
- FirstEnergy’s 2012 commodity hedges covered 99% of expected physical sales; 2013 coverage was 78%, according to management.
Outlook, risks, contingencies, and unusual items
FirstEnergy did not provide a specific 2013 EPS or revenue forecast in the supplied filing text. Management cited expected 2013 earnings support from higher distribution throughput, Ohio distribution capital recovery rider revenues, lower operating costs, and reduced costs following 2012 sale-leaseback interest repurchases. Expected headwinds included weaker competitive energy margins and lower capacity prices, reduced transmission revenues, and higher depreciation.
Hurricane Sandy occurred after quarter-end. FirstEnergy reported outages affecting approximately 2.3 million customers; as of November 7, more than 95% of affected customers in Pennsylvania, Ohio, West Virginia, and Maryland had been restored, compared with 85% in New Jersey. Storm costs were expected to exceed $500 million, approximately 95% of which management expected to capitalize or defer for future customer recovery; final costs were still to be determined.
Key regulatory and environmental exposures include an estimated $975 million of future MATS compliance costs; potential additional costs from water and coal-combustion-residual rules; and pending proceedings over transmission cost allocation and the canceled PATH project. PATH companies sought recovery of approximately $121 million of project costs, with a proposed 10.9% return, subject to FERC review. FirstEnergy had accrued approximately $123 million for environmental remediation liabilities. The filing also describes unresolved air, water, nuclear, and other legal proceedings for which some possible losses could not be estimated.
Credit and market risks include collateral requirements and potential rating triggers. FirstEnergy disclosed up to $819 million of additional credit-contingent collateral obligations under the stated rating scenarios. FES had posted $73 million of collateral and the regulated distribution segment $21 million. An adverse 10% commodity-price change was estimated to reduce net income by approximately $18 million over the next 12 months. Other material items include pending JCP&L base-rate proceedings, a potential Pennsylvania energy-efficiency penalty of up to $20 million for WP, and the possible non-recovery of approximately $254 million in disputed historical transmission-loss costs sought by ME and PN.
Most important facts for investors to verify
- Whether Sandy-related costs exceed the estimate and whether regulators permit the expected recovery or deferral.
- Whether competitive power and capacity prices, customer shopping, and generation availability further pressure margins and cash generation.
- The actual fourth-quarter pension and OPEB mark-to-market charge versus management’s $300–$400 million estimate.
- Liquidity and refinancing needs, including the $1.604 billion short-term borrowing balance, debt maturities, and collateral exposure if credit ratings weaken.
- Regulatory outcomes affecting PATH cost recovery, JCP&L rates, environmental compliance spending, and potential disallowances or penalties.
- How deactivated and cold-storage units, reliability-must-run arrangements, and planned generation transfers affect operating costs and customer supply.