Shares of Akron, Ohio, utility FirstEnergy (FE - Get Report) fell 10% on new federal regulatory orders that will prevent it from having customers help subsidize uneconomic coal and nuclear plants hurt by low priced natural gas in the Marcellus and Utica shale regions.
After the markets closed Wednesday, the Federal Energy Regulatory Commission, or FERC, sent orders to FirstEnergy and American Electric Power (AEP - Get Report) that rescind affiliate waivers and reject implementing power purchase agreements, known as PPA's, with their generation businesses.
Analysts at bond research firm CreditSights wrote in a report that FERC's rejection of FirstEnergy's PPA's has serious implications for its credit profile, bond spreads and only remaining investment grade rating from Moody's Investors Service.
A solution to preempt rating action would be to issue a sizeable amount of equity, CreditSights said. "We may even hear the conversation shift to how can FE exit the merchant generation business," the analysts wrote.
Jefferies & Co. analyst Anthony Crowdell cut his rating on the stock to hold from buy and his price target to $35 from $40.50, citing the news. "Our buy rating was predicated on our belief the stock was a free option on FERC approving the PPA and without it we now believe FE is fair value," he said in a report.
Crowdell also lowered his earnings estimates to reflect the loss of PPA profits and included $2 billion worth of equity issuances to support the company's balance sheet, which he thinks could mean 32 cents to 40 cents in total dilution for shareholders.
RBC Capital Markets also downgraded the stock to sector perform and his price target to $33 per share, citing the regulatory pressure and having to likely sell $2 billion in new equity.
Crowdell said FirstEnergy has the option to submit its PPA to FERC for review and approval, which could possibly take 18 months, but he thinks it would be unsuccessful. It could also look for Ohio to re-regulate, which he thinks could take two to three years.
The analyst said FERC's issue with the PPA was that retail ratepayers, despite having the right to choose an electricity provider, were "captive," meaning that they didn't have a choice as to payment of the non-bypassable charges.
John Moore, senior attorney at the National Resources Defense Council's Sustainable FERC Project, said in a statement that FERC's order is great news for consumers and cleaner energy. "FERC is simply enforcing its longstanding restrictions on deals among affiliated companies - especially sweetheart deals like the AEP and FirstEnergy bailouts that shoulder utility customers with high costs and dirty energy," he said.
FirstEnergy, which is led by CEO Charles Jones Jr., reported first quarter operating earnings after the markets closed Tuesday of 80 cents per share, up 29% over the same period last year and 6.6% higher than what analysts generally expected. The earnings improvement was driven by improved performance at its Competitive Energy Services segment primarily due to higher capacity prices and lower fuel/purchased power expense.
American Electric Power reported results Thursday morning.