FirstEnergy Corp. (10-Q) — Q2 2013
Business context and reporting period. This unaudited combined filing covers FirstEnergy Corp. (FE) and wholly owned FirstEnergy Solutions Corp. (FES) for the quarter and six months ended June 30, 2013. FE operates regulated distribution and transmission businesses and competitive energy and generation businesses; FES is its competitive energy and generation subsidiary. Unless noted otherwise, amounts below are FE consolidated and in millions of dollars.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $3,519 | $3,755 | $7,248 | $7,745 |
| Operating income | $54 | $557 | $708 | $1,303 |
| Net income (loss) | $(164) | $188 | $32 | $494 |
| FE earnings per share | $(0.39) | $0.45 | $0.08 | $1.18 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $493 | $62 |
- Revenue and earnings: Q2 revenue declined $236 million year over year; six-month revenue declined $497 million. Q2 operating income fell $503 million and FE recorded a net loss. For six months, net income was down $462 million.
- Primary earnings item: FE recorded a $473 million pre-tax impairment in Q2, including $13 million of excessive inventory, following the decision to deactivate Hatfield’s Ferry and Mitchell coal units. The filing attributes the decision to low power prices and environmental compliance costs.
- Segment mix: Q2 Regulated Distribution net income rose to $179 million from $158 million; Regulated Transmission was $51 million versus $54 million; Competitive Energy Services lost $339 million versus income of $25 million. For six months, those segments reported $389 million, $102 million and a $377 million loss, respectively.
- Cash flow and investment: Six-month operating cash flow was $493 million, versus $62 million in 2012. The increase chiefly reflects the absence of a $600 million pension contribution made in 2012; 2013 working-capital and other outflows were $194 million higher. Investing used $1,570 million, including $1,412 million of property additions; financing provided $976 million.
- Liquidity and debt: At June 30, FE had $71 million cash, $3,254 million short-term borrowings, $1,952 million currently payable long-term debt and $15,449 million long-term debt and other long-term obligations. Available liquidity at July 31 was reported as $2,986 million, including $189 million cash and $2,797 million available under facilities. FE’s debt-to-capitalization ratio was 62.0%, against a 65% covenant ceiling.
- Margins: The filing reports operating income but does not provide a single consolidated margin measure.
Material changes and management commentary
- FE attributed weaker competitive results to persistently low wholesale energy and capacity prices, excess regional generation supply, lower wholesale sales and lower capacity revenues. The May 2013 PJM capacity auction cleared at unexpectedly low prices; management said this could delay a meaningful price recovery.
- FE described competitive sales growth through governmental aggregation and mass-market channels, with those customer classes’ combined customer base increasing to 2.7 million from 2.0 million year over year. Estimated contracted competitive sales were 107 million MWh for 2013, above the original 104 million MWh target; 2014 contracted sales were more than 75 million MWh.
- Management said it was slowing forward sales to retain exposure to potential future price improvements and focusing on higher-margin customers as generation capacity declines. FE also planned additional cost controls, including reducing about 250 positions; approximately $3 million pre-tax severance expense was expected in Q3 2013.
- Distribution deliveries were down 0.9% in Q2 year over year, but up 0.9% for the first six months. Weather-supported residential usage was offset by weaker commercial and industrial deliveries and increasing customer switching to competitive suppliers.
- FE completed a $1.5 billion equity contribution to FES. It also redeemed or repurchased debt and completed $445 million of Ohio phase-in recovery bond financing, primarily refinancing higher-coupon debt. FE said it no longer expected to need a separate equity issuance for its 2013 financial plan; it planned to use authorized unissued shares for certain benefit-plan and dividend-reinvestment obligations.
Outlook, risks and contingencies
- Plant actions: FE expected Hatfield’s Ferry (1,710 MW) and Mitchell (370 MW) to deactivate by October 9, 2013, subject to PJM reliability review. Approximately 380 positions were expected to be affected; severance was estimated at $15 million pre-tax. The deactivations were expected to reduce estimated MATS compliance costs to approximately $650 million from $925 million.
- Financial plan: The plan included a proposed 1,476 MW generation transfer between AE Supply and Monongahela Power, a proposed sale of up to 1,240 MW of unregulated hydro assets, and further debt reduction. FE expected the generation transfer regulatory process to conclude in Q3 2013, but cautioned that approvals, asset sales and timing were not assured. The Ohio Companies had also issued notices to redeem an additional $660 million of debt, expected in Q3.
- Credit and collateral: Fitch downgraded FE, FES and AE Supply to BB+ from BBB- on July 31, 2013. The filing estimates up to $846 million of additional credit-contingent collateral obligations under the stated rating scenarios. Outstanding guarantees and other assurances totaled approximately $3.86 billion.
- Environmental and asset obligations: The proposed Little Blue Run impoundment closure plan was estimated at $234 million, including post-closure costs; the filing also reports a $151 million increase in FES asset retirement obligations, primarily reflecting higher closure estimates for Little Blue Run. Potential MATS, water-discharge and coal-ash rules may require substantial capital spending. Fort Martin permit compliance could require initial investment exceeding $150 million.
- Regulatory and legal uncertainty: JCP&L’s New Jersey rate case and storm-cost recovery remained contested, including review of Hurricane Sandy and other storm costs. FE warned that delayed or denied recovery could affect results and credit ratings. Other unresolved matters include PJM/MISO transmission-cost allocations, environmental proceedings, and coal transportation commitments; certain potential losses cannot be reasonably estimated in the filing.
- Other risks: Management cited weak demand, weather, competition, commodity and capacity prices, cost-recovery outcomes, plant availability, credit-market access, pension and nuclear trust values, and evolving environmental requirements. A 10% adverse commodity-price move was estimated to reduce net income by about $18 million over the next 12 months.
- FES separately: FES reported Q2 revenue of $1,459 million and a net loss of $71 million, versus revenue of $1,456 million and a $1 million loss a year earlier. Six-month revenue was $2,989 million versus $2,972 million, while its net loss was $69 million versus net income of $121 million. The filing shows the $1.5 billion parent equity contribution and debt repayments as significant support and financing activity.
Most important facts for investors to verify
- Whether PJM’s review permits the planned Hatfield’s Ferry and Mitchell deactivations on schedule, and whether associated severance, vendor and fuel-transportation costs remain within estimates.
- Whether competitive power and capacity prices, contracted sales, hedging and customer growth can stabilize Competitive Energy Services earnings after the impairment.
- Actual liquidity, short-term borrowing levels, credit ratings and collateral requirements following the Fitch downgrade; confirm headroom under FE’s and subsidiaries’ facility covenants.
- Whether the proposed generation transfer and hydro-asset sale proceed, and whether planned debt reduction is achieved without additional equity financing.
- Outcomes and timing of JCP&L rate and storm-cost recovery proceedings, and the eventual recoverability of other regulatory assets and transmission costs.
- Final costs and schedules for Little Blue Run closure, MATS and water-related compliance, and nuclear decommissioning funding.