Why FirstEnergy Is Replacing Edison as the Top Power Generation Stock

Merrill Lynch’s Brian Chin believes that the new place to go is now FirstEnergy Corp. (NYSE: FE). Chin added this electric generation and transmission player to the key US 1 List. In order to make room on the US 1 List, Edison International (NYSE: EIX) was removed from it.

The US 1 List represents a collection of Merrill Lynch’s best investment ideas that are drawn from the universe of its Buy ratings. Though Edison was removed from the US 1 List, the stock was maintained with an official Buy rating. Chin said:

In our view, FirstEnergy has a solid recipe for recovering and creating margin expansion. As noted in our upgrade note, FirstEnergy has three significant catalysts in the next 6 months that could induce long-term out performance: 1) the acceptance of an Ohio PPA by PUCO 2) execution of cost cuts 3) a likely constructive Capacity Performance auction.

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Chin effectively outlined that this is more or less the same story, just with a different company. FirstEnergy was talked up as follows:

The new FirstEnergy CEO, Chuck Jones, continues to shift the strategy to a back to basics approach. Peers such as Duke and Dominion have in years past implemented a refocus on the regulated business that helped lead to valuation uplifts. With PUCO already having accepted a similar Purchased Power Agreement in concept for peer AEP, (PUCO approves stabilization in concept, suggests a refile), FirstEnergy now has an instruction manual on how to approach Ohio regulators with its own purchased power proposal. In addition, new Commission Chairman Porter we regard as being more likely to execute decisions and remove uncertainty than his predecessor.

As we wrote in our FirstEnergy upgrade, we believe management will aim to reduce $2.6 billion in fuel/commodity purchases by roughly 5% to 10% over the next 1-2 years, with most of this from the competitive side. We conservatively estimate the impact on earnings per share in our forecast is between $0.10 and $0.15.

Merrill Lynch has an above-consensus point of view on the capacity auctions with a forecast. That megawatt per day view is at $200, rather than a consensus $150 to $170. The analyst’s call is based on a review of grid operator simulation model and scenario analysis. The auctions are also shown to be in the process of being delayed, but they are anticipated for August 2015.

Chin believes that Edison International still has a very solid outlook. Yet, he believes that the regulatory landscape has marginally declined, and this prompted the removal of Edison International from the key US 1 List.

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First Energy’s official price target was $40 at Merrill Lynch in an analyst upgrade from earlier in April. Its current share price, after a 2.8% gain on Monday, is $36.05, and it yields roughly 4%.

As noted above, Edison was maintained with an official Buy rating. At the end of 2014, Merrill Lynch had a $72 price target, which is roughly $10 higher than the $61.90 share price on Monday.