FirstEnergy Is a Bargain

We are increasing our fair value estimate to $40 from $35 per share, as it has now been over one year since

However, returning to its regulated past will likely require a big move: Allowing FES to fall into bankruptcy. We estimate this could cost shareholders $1.7 billion for FES' unfunded liabilities and other cross-guarantees plus a potential $1 billion settlement with creditors to avoid yearslong litigation. We estimate the total cost to FirstEnergy shareholders could be $2.7 billion.

We recently changed our moat rating to narrow from none. Our analysis now assumes FirstEnergy is valued in our discounted cash flow analysis like the majority of regulated narrow-moat utilities using a cost of equity of 7.5% and a longer forecast period of returns on invested capital above weighted average costs of capital. Using these inputs, our discounted cash flow valuation is now $40 per share.

We think the stock is cheap as of early December, trading at a nearly 20% discount to our $40 fair value estimate and a 30% discount to fully regulated utilities. We think the market is too concerned about the pending FES bankruptcy. Even if FirstEnergy assumes all $3 billion of FES debt, our fair value estimate falls by only about $2 per share. Once FES worries subside and the market revalues FirstEnergy as the fully regulated and narrow-moat utility that it is set to become, investors should realize attractive upside.

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