This Narrow-Moat Utility Is Undervalued

Charles Fishman: Over the past couple of years, the market has not been kind to unregulated power plants, or what is referred to in the industry as merchant generation. Weak electricity demand, falling natural gas prices, and tremendous growth in wind and solar energy have squeezed margins. FirstEnergy eliminated its merchant generation exposure by separating from its unregulated unit FirstEnergy Solutions, or FES, earlier this year.

Without the support of its parent, FES immediately filed for bankruptcy. To avoid years of litigation, FirstEnergy settled with FES creditors with guarantees and payments totaling roughly $2.7 billion. The market applauded the move, and the shares have been one of the best performing utilities in 2018, with a total return over 22%, double the S&P 500's total return.

Even after this year-to-date performance, we think the shares remain undervalued. We believe the market fails to fully appreciate the company's ability to invest over $2.5 billion per year in its wide-moat transmission businesses, which provides an almost guaranteed economic benefit to shareholders and narrow-moat utilities in constructive state regulatory environments, which together will account for 90% of earnings.

We believe solid earnings growth and a growing dividend will be the catalysts for the market valuing FirstEnergy shares more in line with its regulated-utility peers with economic moats.