Utility Dividend Promise Fades as Weak Prices Cut Profit

U.S. utilities’ promise of providing steady returns and plump dividends to investors is fading as growing competition erodes prices and profits.

FirstEnergy Corp., owner of electricity providers in six states, yesterday said it will cut its dividend by 35 percent. The Akron, Ohio-based company was the second large utility in the past 11 months to cut its payout as sales declined. Chicago-based Exelon Corp. chopped its dividend by 41 percent last February.

The moves echo cuts or lowered guidance in the past year from some of Europe’s biggest power companies, such as Germany’s RWE AG. For the two U.S. utilities, it was their first dividend reduction, and competitors may follow if power market conditions worsen or if regulators reduce cost recovery or limit earnings potential, according to Paul Patterson, a New York-based analyst at Glenrock Associates LLC.

“For companies with exposure to competitive markets, this is not your grandfather’s utility anymore,” Patterson said. The expansion of renewable energy, stiffer competition from regulated power generation and “anemic” sales growth are threatening their businesses, he said.

FirstEnergy fell 3.2 percent to $31.13 at the close in New York, its lowest price since September 2003.

Gas Prices

Owners of coal-fired and nuclear generators that sell electricity in competitive markets, such as FirstEnergy, have been hit hardest by the collapse in natural gas prices, which determine wholesale power rates. Utilities whose profits are set by state regulators are less exposed to the fluctuation in prices.

Even regulated utilities may feel the pinch as they seek to collect $2 trillion from customers in the next two decades to maintain their grids in a shrinking market. Pepco Holdings Inc., Ameren Corp. and Portland General Electric Co. are among the companies with the weakest ability to sustain their current dividend due to credit quality and growth potential below the industry average, Hugh Wynne, a New York-based analyst for Sanford C. Bernstein & Co., wrote yesterday in a research note.

“The stagnation in power demand is the real risk for regulated monopolies,” Wynne said in a telephone interview. “It makes it hard for companies to raise their revenues in tandem with their investments, which are still growing at about 5 percent a year. But your sales volume is growing between zero and one percent.”

Dividend Growth

Spokesmen for Pepco and Ameren weren’t available to comment on the report. Steven Corson, a spokesman for Portland General, said the company doesn’t comment on analysts’ projections. “We take our dividend seriously, and historically we’ve had a compounded annual growth rate of 3 percent since 2007,” Corson said in a phone interview.

In Europe, RWE, Germany’s second-largest utility, slashed its dividend in half in September after the country’s shift to renewable power curbed profit from gas- and coal-fired plants.

U.S. power sales have declined in four of the past five years in part because of energy conservation and increasing use of private rooftop solar panels, according to the U.S. Energy Information Administration. Electricity use is expected to be unchanged through 2015 and then grow at about 1 percent annually, according to a Dec. 16 report from the EIA.

Market Underperformer

FirstEnergy and Exelon were forced to cut their dividends to fund upgrades of their power-delivery systems. Exelon said it reduced its dividend to pay off debt over the next few years and invest in solar farms, gas plants and utility infrastructure.

FirstEnergy, the worst performer in the S&P’s 500 Utilities Index last year and so far this year, cut its dividend yesterday for the first time in the 17-year history of the company. Saving the funds will provide “additional financial flexibility to pursue regulated growth opportunities over the next several years,” FirstEnergy Chief Executive Officer Anthony Alexander said in the statement.

The quarterly payment decreased to 36 cents a share from 55 cents, and will be made March 1, according to the company statement. The previous dividend had been in place since 2008.

“The cut is not quite as large as I would have expected,” said Kit Konolige, a New York-based analyst for BGC Partners LP. Konolige, who rates FirstEnergy a hold and doesn’t own their shares, was anticipating a 40 percent reduction in the dividend.

Narrowed Forecast

The company said the new dividend is “fully supported” by profits and reflects a 58 percent payout of expected earnings from its regulated operations. The company narrowed its 2013 operating earnings forecast to $2.95 a share to $3.05 a share, from $2.90 to $3.10.

FirstEnergy has sold power plants and reduced spending by $1 billion as it refocuses on regulated assets, such as transmission networks, that offer a more reliable return than generation units that sell electricity into wholesale markets.

FirstEnergy intends to spend $4.2 billion on its high-voltage system through 2017, the low end of a range given in November, Alexander said today on a conference call with analysts.

“A dividend policy is better with a regulated model because it has a safe and secure earnings stream,” said Timothy Winter, a St. Louis-based analyst for Gabelli & Co. Regulated utilities that appear most attractive for dividend growth include Edison International, OGE Energy Corp. and Wisconsin Energy Corp., said Bernstein’s Wynne.

Power prices in mid-Atlantic markets dropped 45 percent to average $45.95 a megawatt-hour last year from $84.17 in 2008, driven down as the cost of natural gas has fallen. FirstEnergy’s electricity revenue declined 7.3 percent last year to $9.64 billion.

The company, which supplies power to 6 million customers in six states, was expected to reduce its dividend to 37 cents, according to data compiled by Bloomberg. FirstEnergy was formed by the merger of Ohio Edison Co. and Centerior Energy Corp. in 1997.

Before it's here, it's on the Bloomberg Terminal.