After last week’s widely-anticipated dividend cut, the question now facing FirstEnergy Corp. is whether its renewed focus on regulated operations will improve the beleaguered utility’s fortunes enough to regain Wall Street’s favor.

FirstEnergy announced on Tuesday it was reducing its quarterly dividend to 36 cents a share from 55 cents, a cut of more than one-third. The move followed a year in which the company’s stock fell 20%, making it the worst performer in the S&P 500 Utilities Index, according to Bloomberg.

Not a Surprise

The only surprise to some was that the cut — the first in the company’s 17-year history — wasn’t larger.

Although the company had resisted calls to cut the dividend, the move was widely anticipated by analysts as the company struggled to service its debt and fund capital spending.

Officials said last week that cheap natural gas and the lingering effects of the recession had undermined its competitive business at the same time its cash flow was pressured by about $1 billion in to-date unreimbursed storm damage.

“You have to take a look at reality,” CEO Anthony Alexander told an analysts’ call Wednesday. “The cost of equity became very, very expensive in a very short period of time. As we looked to a total repositioning of the company, this action seemed to be the most effective way to address what needs to get done.”

The company acknowledged that its focus on its unregulated business was a losing strategy at a time of flat demand growth, low energy prices and an unpredictable PJM capacity market. PJM’s real time load-weighted LMPs have dropped by more than 40% since 2008. RTO prices in the annual base capacity auction have fluctuated wildly over the same period, ranging from $16 to $174/MW-day, with a price of $59 last May.

“PJM’s capacity auctions, which are intended to provide support for competitive generators, do not and instead have delivered unpredictable and inadequate results,” Alexander said.

The company said it expects its regulated transmission and distribution businesses to account for more than 90% of its earnings going forward.

Cash Flow

FirstEnergy had negative cash flow of more than $1 billion in 2012 and 2013. Reducing the dividend will save the company $320 million in cash annually, reducing it to a level that can be supported by the more predictable regulated earnings, officials said. The competitive businesses should be self-supporting with potential “upside” if load growth and energy and capacity prices rebound.

Alexander said the moves will strengthen the balance sheet and credit metrics and “derisk the business overall.”

Response to Cut

The company’s shares fell 3% to $31.13 on trading of 14 million shares, three times the average volume, after the news Wednesday. It closed yesterday at $30.88.

The cut was in line with analysts’ consensus, according to Bloomberg, but less than some said was necessary. Analyst Paul Patterson, of Glenrock Associates, said the new dividend payout of 58% of regulated earnings “doesn’t sound particularly aggressive.” Kit Konolige, an analyst for BGC Partners LP said he had expected a 40% cut.

Moody’s Investors Service said although it welcomed the cut it was maintaining its negative outlook on the company’s credit.

Analysts on Wednesday’s call questioned whether the company was considering additional action, including more generation sales or closures, or the sale of the entire competitive operation.

“I’m not going to speculate on what’s out there” in potential sales opportunities, Alexander said in response to one question. “Right now we’re comfortable with the size of the fleet we have,” he added later.

Weak Earnings Forecast

While the dividend cut relieves pressure on the company’s cash flow, the earnings forecast officials outlined last week did little to inspire investor confidence.

The company said it expects to earn $2.45-$2.85 per share in 2014, down from a projected $2.95-$3.05 for last year.

“At the midpoint of guidance, FE has a forward multiple of 12x. For a company with earnings falling 10%, that is not a particularly attractive multiple,” analysts at Seeking Alpha wrote.

“Importantly, this guidance has to leave investors questioning whether FirstEnergy cut the dividend enough. The new dividend will still account for 58% of earnings from FirstEnergy’s main regulated business. Dividend payout ratios above 60% are often unsustainable, so if FirstEnergy’s business continued to erode, another dividend cut would not be out of the question.”

Others in Trouble?

FirstEnergy is hardly alone in its malaise.  Exelon Corp. cut its dividend by 41% last February, and officials said it may close unprofitable generating plants this year if capacity prices don’t increase. (See Exelon to Close Generating Plants if No Rebound Next Year.)

Hugh Wynne, analyst with Sanford C. Bernstein & Co. said last week that even distribution utilities insulated from competitive wholesale markets, including Pepco Holdings Inc., could be forced to cut their dividends. (See related story, Pepco CEO to Retire)

Generation Fleet Leaner

With the deactivation of 5,000 MW of generation within PJM since 2012, and pending sales of other generation, the company’s 13,000 MW generation fleet will be about the same as before its 2011 merger with Allegheny Energy but one that is “more environmentally sound and efficient,” Alexander said. “It’s a much stronger platform of units,” Alexander said.

The company expects annual retail sales of about 100 million MWh, about 25% more than produced by the fleet.

Once it completes spending to comply with the Environmental Protection Agency’s Mercury and Air Toxics Standard (MATS) and retrofits at the Davis Besse and Beaver Valley nuclear plants, 85% of FE’s capital expenses will be on regulated operations, officials said.

“I don’t see us having to make any cash injections into the competitive business,” said Chief Financial Officer James Pearson. “Their cash flow should be sufficient to fund the capex over the next three years.”

Officials said they were making “aggressive” operations and maintenance reductions with discretionary spending only if it’s justified by a “fundamental upside shift in market dynamics.” For now, any additional free cash from competitive operations will be directed to strengthening the balance sheet or investing in regulated operations.

Bright Spots?

Officials said they were seeing “early indications of a sustained [economic] recovery” in FE’s service territories, projecting a 0.6% load growth in 2014, most of it from industrial customers. Shale gas activity has led to 210 MW of new industrial demand with an additional 430 MW of planned expansion.

The brightest near term opportunities are in the transmission business, with a 20% earnings growth projected for American Transmission Systems Inc. (ATSI) and Trans-Allegheny Interstate Line Co. (TrAIL).

The company also vows to be “far more active in distribution rate filings” than it has been in the past, with rate requests planned this year for West Virginia and Pennsylvania. It expects a ruling shortly from the New Jersey Board of Public Utilities on Jersey Central Power and Light Co.’s request for reimbursement of storm recovery expenses.