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09 Mar 2015
New York, March 09, 2015 -- Moody's Investors Service today said that FirstEnergy Corp.'s
(FE, Baa3 stable) lower earnings guidance announced on Feb 17,
2015, has no impact on FE's ratings or outlook for now.
FE provided full-year 2015 earnings guidance which lowered their
Cash from Operations pre-WC by about $350 million which
was significantly below expectations. The key factors that drove
the reduction included lower earnings from the competitive business as
well as at Jersey Central Power & Light (Baa2 negative) on account
of the pending rate case, offset partially by higher earnings at
the Pennsylvania utilities and FirstEnergy Transmission (FET, Baa3
stable). Our stable rating outlook incorporated expectations that
FE would maintain consolidated financial ratios appropriate for an investment
grade hybrid utility holding company. This includes a ratio of
cash from operations pre-WC to debt of 13-15%,
CFO-pre WC interest coverage of about 3.5x, and retained
cash flow to debt of about 10-11%.
Under the company's new guidance, CFO pre-WC coverage
of debt is expected to fall to between 11-13% for the next
few years, a material credit negative. However, we
are retaining our stable outlook for now given the many significant moving
parts in FE's credit profile, including a very important change
in management's strategic direction that includes a reduction in
merchant risks and an improvement in leverage, both credit positives.
The rating drivers that could affect FE's credit rating and/or outlook
include the following:
LOWER MERCHANT RISK APPETITE
FE's new publicized strategic direction emphasizes a reduced appetite
for merchant risk. Although management indicated a belief that
it may not make economic sense to sell the merchant business right now,
it is seeking to operate the competitive business more conservatively,
thus making it more predictable. This includes substantially reducing
retail business volumes, keeping a long generating position to reduce
operating/weather risks, curtailing production at less economic
units, if necessary, implementing greater operating cost controls
while seeking PPAs for two of its Ohio power plants (plus its ownership
in OVEC). Moody's believes that there are additional opportunities
for further PPAs should FE be successful in Ohio. Although the
Ohio Public Utilities Commission recently rejected AEP's request
for a PPA, it is noteworthy that they did not reject the concept
of a PPA in a de-regulated state. Instead, they created
a "zero price" rider and implied that it was more a question
of the proposed PPA's price. Nevertheless, we consider
the likelihood of a PPA now to be somewhat remote, any success here
would significantly reduce FE's risk profile.
MANAGEMENT'S BROAD OBJECTIVE
FE management reiterated that they expect the competitive business,
at current market prices, to be cash flow positive each year for
the 2015-18 period. Importantly, they also announced
an intent to utilize this positive cash flow to retire holding company
debt associated with the merchant business. We estimate that under
current market prices, the competitive business may generate free
cash flow of about $200-250 million over 2015-16.
While the use of cash to pay down debt is a positive step and demonstrative
of management's intent to deleverage, the amount that can
be paid down this way will be by itself insufficient to materially improve
FE's financial profile. Management has also indicated that
it is targeting stronger investment grade metrics and will assess its
progress as greater clarity emerges on the Ohio PPA, PJM Capacity
reforms, etc. Additional credit enhancement options management
has articulated include further O&M and capital reductions,
sale of non-core assets, and additional equity issuances
to finance capital expenditures should that become necessary. However,
it is important that any such plan should demonstrate the ability to achieve
the required financial metrics in a credible and time bound manner.
MERCHANT MARKET CONDITIONS
Gas and power prices have weakened significantly over the past several
months. The drop is less steep from Moody's perspective because
we used pre-polar vortex price curves when we revised FE's
outlook to stable in July 2014. Nevertheless, current "round
the clock" prices for the AD Hub are in the range $31-34/MWh,
about $3-5/MWh lower than pre-polar vortex prices.
The outcome of the PJM capacity auction in May and its new capacity performance
product will provide an important indicator of longer term earnings potential
of the merchant business. While the auction expectations are positive
for FE, there is considerable uncertainty over exactly how much
improvement there will be in capacity prices.
BOTH FE AND FES' RATINGS COULD BE AFFECTED
Ultimately, the critical question is what management will do in
the event that the PPA request is rejected, PJM capacity prices
don't improve significantly and energy prices remain as weak as
they are at present. We are likely to reassess FE's credit
quality when there is more clarity on these variables and the new management
has an opportunity to prepare a revised business plan. Management's
willingness to issue equityto finance growth is a positive but will have
to be executed in a reasonable timeframe to be incorporated into Moody's
analysis. Given management's preference for regulated businesses,
and in the event that there is no PPA in Ohio, we will also evaluate
if another possible response could be the spin-off of the merchant
business to shareholders similar to what PPL has done, an action
that would preserve any future upside value for shareholders. Thus,
our assessment would evaluate not only the rating and outlook on FE but
also if the ratings of FE and First Energy Solutions (Baa3 stable)/Allegheny
Energy Supply Company (Baa3 stable) ought to be differentiated.
This publication does not announce a credit rating action. For
any credit ratings referenced in this publication, please see the
ratings tab on the issuer/entity page on www.moodys.com
for the most updated credit rating action information and rating history.
Swami Venkataraman, CFA
VP - Senior Credit Officer
Infrastructure Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
William L. Hess
MD - Utilities
Infrastructure Finance Group
Moody's: FirstEnergy Corp.'s weaker financial guidance will not affect ratings, for now
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
No Related Data.
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