Southern Company Earnings – Beyond The Headlines
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Southern Company (NYSE: SO) is a well respected utility that many consider one of the safest and best buys today. The company operates in areas with growing populations, and is run conservatively. The fact that the stock has moved nearly straight up since the lows of 2009, doesn't hurt the company's popularity either. For income seekers, the stock's 4.26% current yield must look pretty good compared to other options like low rate CDs and bonds. Southern Company reported earnings not long ago, which gives us a chance to see how the company's doing. Many investors might just read the headlines and move on. I like to dig a little deeper into the numbers to see if there are trends that others might miss.
As a regulated utility, Southern Company operates in about as stable of a business as you could ask for. The company is essentially told how much it can charge for services, and then provides these services and collects the monthly bills. All utilities were hurt by this last winter's unusually warm weather and Southern Company was no exception. Revenues were down 10.2% and EPS was down 16% primarily due to the warmer than usual temperatures. The company owns 5 regulated utilities, and in all but two cases, net income for these units was down 17.1% or more. What some might have missed is, while the warmer weather did affect earnings, the company offset some of this impact with pricing. Southern Company specified they believe that they added about $0.05 to earnings through pricing, but lost about $0.08 through warmer weather effects, for a net loss of $0.03 per share. Since the company reported EPS down $0.08 from last year, where did the other $0.05 come from? One factor was the company had about 2.2% more shares outstanding versus last year. This accounted for the $0.01 EPS change. The company also reported higher depreciation which added another $0.02, and other one-time charges made up the remainder. This is important to understand because it wasn't just warmer weather that caused the drop in earnings. The company had some other challenges beyond that one factor.
There were some positives reported behind the headline numbers as well. First, the company saw strong residential growth with about 15,000 new customers. This was a big jump in new customers versus the 2,000 additions last year. Second, the company is seeing, “positive indications of economic growth in our service territory”. That has to be good news to hear, no matter if you are a Southern Company investor or not. Last, Southern Company has some diversification to their revenue stream that other utilities do not. Southern Company is nearly perfectly split between residential energy, commercial energy, and industrial energy sales. This helped the company tremendously since residential sales were down 13.7%, but commercial and industrial sales were down just 3.1% and 1.9% respectively.
Most investors buy utilities for their dividend, so it always makes sense to check on the health of the company's payout. Unfortunately, I found the same pattern here as with some other utilities I've studied. In the first quarter, the company generated about $568 million in operating cash flow, but spent $1.231 billion in capital expenditures. Anyone can tell you, when you spend more than twice what you brought in, there is going to be a need to borrow money. If this were a one time event, I would write this off to seasonal factors. The problem is, this isn't the first time the company has borrowed to cover the dividend. In the last three years, after the company's capital expenditures, the average year shows a slightly negative cash flow amount. Literally speaking, Southern Company has been paying its dividends by leveraging its balance sheet. You can see this from the fact that in that same three year timeframe, the company's total long-term liabilities have jumped by about $4 billion. This type of activity isn't limited to just Southern Company either. Duke Energy (NYSE: DUK) another popular dividend payer, has basically done the same thing. Duke shows negative free cash flow for the last three years plus, and has taken on over $2.5 billion in more debt to cover dividends and capital expenditures. While both Duke and Southern Company are stable enough to cover these additional debts, this is not a sustainable way to pay dividends. Both companies will face a choice at some point in the future to either curtail capital expenditures (which hurts future growth), or to lower or not increase their dividends.
In short, Southern Company operates in a growing part of the country, and they see positive signs of economic growth. However, the company needs to make some hard decisions when it comes to their dividend and how they can get back to paying the dividend out of free cash flow, rather than borrowing the funds to make these payments. Southern Company has a long history of increasing their dividend, but at some point, something has to give. Hopefully, the growth in the company's service area will increase earnings enough to make this cash flow problem a non-issue. I don't see Southern Company having a problem short-term, but longer-term I'm starting to get a little worried.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.