FirstEnergy Is Not Cheap Enough To Compensate For Problems
Summary
- FE has some serious political and credit issues.
- The stock has a 4.55% forward yield and forward P/E of 13.6.
- The Wall Street consensus is bullish, with 6.5%-8% expected 12-month price appreciation.
- The market-implied outlook (derived from options prices) is bearish.
- My final rating is neutral.
First Energy (NYSE:FE) is a challenge for investors. The stock price had started to recover from its COVID-driven fall when the company was rocked by revelations of a bribery scandal in July 2020. The stock fell from a close of $42.14 on July 18th to a close of $27.09 on July 22nd. Since this event, the stock price has gradually increased, reaching $34.31 at the most recent close. Between COVID and the scandal, the stock is down 34% from its pre-COVID 2020 high close of $52.15 on 2/19.
While the P/E is low compared to the utilities sector, and the forward dividend yield is 4.55%, it is not clear that the stock is a bargain. Expected earnings growth is anemic. There are larger utilities that are not in distress, with similar P/E ratios, and which have forward yields greater than 4% (SO, DUK, and ED, for example).
Price history and basic statistics for FE (Source: Seeking Alpha)
The company's credit rating was cut to junk levels by the three largest ratings agencies in November 2020. Investing in companies in the throes of this level of distress is challenging.
In this post, I am not going to offer my own analysis and opinions on FE. Instead, I examine two types of consensus outlooks for the stock. The first is the Wall Street analyst consensus rating and price target. The second is the market-implied outlook derived from the prices at which call and put options are trading. The market-implied outlook represents the consensus view on the relative odds of gains vs. losses of various magnitudes.
Wall Street Analyst Outlook
I was quite surprised to find that the consensus rating from Wall Street analysts is bullish. Among the cohort of 9 ranked analysts that contribute to eTrade's consensus, the 12-month price target is $36.56, 6.56% above the most recent close. It is also notable that the consensus rating for FE has been bullish since before the bribery news and never changed.
Wall Street analyst consensus rating and 12-month price target for FE (Source: eTrade)
The consensus rating from the 17 ranked Wall Street analysts included in Seeking Alpha's calculation is also bullish and only one of these is bearish (although that analysis is very bearish). The consensus price target for FE is $37.07, 8% above the most recent close.
Wall Street analyst consensus rating and price target for FE (Source: Seeking Alpha)
The consensus price target for FE has been declining since early 2020, with an abrupt drop following the bribery news, but the overall rating has remained consistently bullish through it all.
Wall Street consensus price target history for FE (Source: Seeking Alpha)
Market-Implied Outlook
The market-implied outlook is calculated from the prices of call and put options at various strike prices and the same expiration date. The market price for a $30 strike price put option expiring on January 21, 2022, reflects the market's assessment of the probability that the price will fall to $30 or below between now and that date, for example. It is possible to infer the probabilities of all possible future prices such that these probabilities reconcile the observed options prices.
This approach is widely applied in quantitative finance but is less well-known among individual investors. For those who are not familiar with market-implied outlooks (aka option-implied outlooks), I have written an overview post that includes examples and links to the finance literature and an implementation by the Federal Reserve Bank.
For this post, I have analyzed call and put options expiring on January 21. 2022, thereby generating a market implied outlook for the next 9.57 months (between now and that date). As outlined in my overview post, the market implied outlook is in the form of a probability distribution, charted with probability on the vertical axis and return on the horizontal axis, going from most negative returns on the left side to most positive on the right.
When I chart this distribution, I rotate the negative return side about the vertical axis, to make it easier to compare the relative probabilities of positive and negative returns of the same magnitude. A 5% return on Negative Return line corresponds to a return of -5%, etc.
Market-implied price return probabilities for FE between now and January 21, 2022 (Source: author's calculations using options quotes from eTrade)
The market-implied outlook for FE for the next 9.57 months (between now and January 21, 2022) is modestly bearish, with elevated probabilities of negative returns vs. positive returns of the same magnitude (the red dashed line is above the solid blue line). The median price return for this period is -2.5%.
The annualized volatility derived from this distribution is 28%, which is higher than my estimate for DUK (20%) but close to those for SO (26%) and ED (27%).
Summary
While FE has rallied since its declines due to COVID and the breaking news of the bribery scandal, the question is whether it is worth taking a risk on the stock. The valuation is low, but not especially cheap given the low expectations for EPS growth. The dividend is maybe 0.5% per year above those of a range of other well-known utilities.
In other words, the stock is not trading at deep value levels (relative to peers) that might entice investors to look past the poor credit ratings and the company's political troubles. Against this backdrop, however, the consensus opinion of Wall Street analysts is bullish, with 12-month expected price appreciation of 6.5% to 8%.
Along with the 4.55% dividend yield, the consensus price targets imply a total return of 11% to 12.5%. The market-implied outlook to early 2022 is moderately bearish, with elevated probabilities of declines relative to similar-magnitude positive returns. Balancing the bullish Wall Street view and the bearish market-implied outlook, along with a valuation that is not substantially lower than peers that are not in distress, my final rating is neutral.
This article was written by
Analyst’s Disclosure: I am/we are long DUK, SO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (5)
This guy plays in the billions and has the best
analysts in the industry working for him...
This should tell you something regarding the
longer term prospects of FE.
This is all I have to say...
