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FirstEnergy Looking Past Dark Days

The utility widely blamed for August's blackout continues to surge despite an earnings setback.

FirstEnergy

(FE) - Get FirstEnergy Corp. Report

, the utility blamed for America's largest blackout, has offered a dim forecast for the coming year.

Even after factoring in positive developments -- some of them viewed as too sunny -- the company expects to fall short of Wall Street expectations in 2004. The company cited increased costs in its home state of Ohio, together with an unfavorable rate case and equity dilution, for the earnings shortfall. It now expects to deliver full-year profits of $2.70 to $2.85 a share, or at least a nickel shy of the $2.90 consensus estimate.

Yet the market ignored the bad tidings, pushing shares of FirstEnergy up 32 cents to $35.12 in late-morning trading. Buoyed by a surging stock market, the company's stock has now recovered all the ground it lost in the wake of Aug. 14's massive power outage.

At least one Wall Street analyst shrugged off the warning as well. Daniel Ford of Lehman Brothers determined that FirstEnergy's guidance was "roughly in-line with expectations," although he dropped his own earnings forecast by a dime to $2.80 a share to reflect "shortfalls in performance initiatives and cost savings." He also predicted that FirstEnergy's Davis-Besse nuclear plant -- long idled over serious health threats -- will not restart until January. The company itself assumed the plant would restart this month when calculating its 2004 forecast.

Asking Questions

But FirstEnergy last month fielded a federal subpoena that could complicate the situation. Following a long investigation by the Nuclear Regulatory Commission -- whose findings were apparently turned over to the Department of Justice -- federal prosecutors have begun asking FirstEnergy for additional information about a faulty reactor vessel head at the Davis-Besse plant. Reactor coolant, meant to protect against a devastating leak, had eaten nearly all the way through the vessel lid before FirstEnergy detected a problem. The plant has been shut down for nearly two years.

Merrill Lynch analyst Steven Fleishman questions whether the long-awaited restart date is now feasible.

"Given the heightened nature of this review, it is not clear whether restart could occur prior to resolving this legal process," wrote Fleishman, who nevertheless has a buy rating on the stock.

FirstEnergy will formally ask to restart the nuclear power plant later this week. But even if the company gains approval, it could face future risks associated with the criminal probe.

"What is not yet clear is whether the legal action will be taken against the company, or employees of the company that may have provided false information, or both," Fleishman wrote. "The greatest potential penalty, we believe, would be risk to

FirstEnergy's nuclear operating license."

Fleishman did, however, downplay this possibility since FirstEnergy has been allowed to operate its other nuclear plants throughout the two-year probe.

Tree-Trimming

But FirstEnergy faces other hurdles. A damaging report, issued last month by a U.S./Canadian task force, singled out the company as the primary culprit of a huge blackout last summer. Even Ford, who has an overweight rating on the stock, was disturbed by the findings.

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"Troubling to us was FirstEnergy's violation of four

Federal Energy Regulatory Commission standards out of six identified in total," Ford wrote last month. "The personnel and, in particular, procedural shortfalls were also disappointing."

According to the findings -- which FirstEnergy is contesting -- the company did not respond promptly to a power line outage, notify other systems of an impending emergency, use proper tools to assess the situation or adequately train its operators. It was also cited for poor tree-trimming, blamed for the first outage that led to the cascading blackout.

Even so, FirstEnergy could escape both government fines and civil penalties.

Ford noted that "the response from various agencies might have been critical, but not putative." He also pointed out that plaintiffs would have to prove that FirstEnergy was guilty of "willful, gross negligence" -- a tough hurdle -- to recover any damages.

He did, however, acknowledge that FirstEnergy may need to spend considerable amounts of cash to upgrade its system. But he downplayed the potential impact on the company's credit rating.

Standard & Poor's

was less kind. Four days after Ford's report, S&P warned that FirstEnergy's senior unsecured debt -- rated just one notch above junk -- would remain on CreditWatch with negative implications due to the task force findings.

"Standard & Poor's is concerned that the negative findings could affect FirstEnergy's relations with state and federal regulatory agencies, adversely affecting Standard & Poor's assessment of the company's business profile, resulting in lower ratings," S&P analyst Aneesh Prabhu wrote.

S&P cited the Davis-Besse subpoena as yet another concern.

"It is Standard & Poor's understanding that the request is independent to the restart process and the unit can restart without the investigation's completion," the rating agency wrote. "However, from a practical standpoint, if the investigation delays the restart, it could result in a Standard & Poor's rating action."

FirstEnergy is counting on lower financing costs -- which could disappear with a credit downgrade -- to help it meet current 2004 targets.

Fleishman acknowledges that FirstEnergy faces "serious problems." But he still sees them as manageable.

"The Davis-Besse outage and Aug. 14th blackout keep pointing to the same main weakness at FirstEnergy -- operational management," Fleishman wrote. "While these are serious problems, we believe this is a very fixable issue, either through renewed operational focus or through a change in management."