Eventually the Kemper plant will start adding to the bottom line, not weighing on it. Image source: Southern Co.

Southern Co. (NYSE:SO) reported second-quarter financial and operating results on July 27, delivering steady profits that met investor expectations, on a small decrease in the amount of power the utility generated and sold. The company also announced (another) cost increase in its ongoing Kemper plant project, raising estimates for the plant's completion, while taking an estimated $38 million loss in the quarter on costs related to the plant's construction. 

Southern also announced that it will spend more money on capital investments for the full year than previously anticipated, both on capital construction and acquisitions, even as some of those existing projects take longer and cost more to complete than initially promised. So what does all this new spending mean for Southern Co. now and in the future? Let's take a closer look at the utility giant's quarterly results. 

The numbers

MetricQ2 2016Q2 2015 Change
Revenue  $4,453  $4,337 2.7%
Net income  $638  $629 1.4%
Earnings per share  $0.68  $0.69 (1.4%)
Adjusted earnings per share  $0.74  $0.71 4.2%

Data source: Southern Co. Revenue and net income in millions.

Southern Co. saw its GAAP net income rise in the quarter, though earnings per share declined slightly because of the issuance of approximately 34 million new shares -- a 3.7% increase -- over the past year to raise capital. But at the same time, one of the big projects Southern has been raising capital for, its Kemper plant in Mississippi, weighed on earnings again in the quarter, as the company continues to spend more than expected to finish the project and bring the plant online. 

Adjusting for the non-recurring losses related to the Kemper plant, as well as $44 million in acquisition costs in the quarter, earnings per share increased slightly. And while GAAP earnings are important -- since many companies regularly have "non-recurring" items for which they report adjusted earnings to reflect -- breaking things out helps investors see both the impact of items such as capital projects and acquisitions on the bottom line each reporting period. It also helps better measure a company's operating performance. 

Key happenings in the quarter

The company said there were two key drivers behind its earnings growth in the quarter:

  • Lower expenses, particularly lower non-fuel operations and maintenance expenses across its regulated utility businesses. 
  • Strong results from Southern Power -- its electricity wholesaler -- which reported 4.4% growth in wholesale Kilowatt-hour sales, helping absorb the decline in KwH sales at its utilities. 

Southern also said it's accelerating its investments in new projects, as well as increasing its spending on acquisitions. Back in February, management said the company would spend $7.3 million in capital expenditures in 2016, and $8 billion on acquisitions. In its updated forecast, the company said it will spend $10.2 billion on capex and $9.9 billion in acquisitions this year, a 31% increase. Southern will use both debt and share issuance to pay for much of this capital spending, but management says the new capacity in its utility business, along with its expanded natural gas infrastructure, would lead to better per-share earnings over time. 

One particular area of its business where Southern bumped up its planned spending was its Southern Power wholesale subsidiary. In February, the company had planned to spend $2.4 billion there, but that amount was increased 88% to $4.5 billion, largely aimed at renewables:

Image source: Southern Co. earnings presentation..

The vast majority of these investments will be in renewables, particularly solar and wind, which make up a very small percentage of Southern Co.'s total mix currently. 

Southern Co. also announced at the end of the second quarter that all relevant regulators had approved its pending merger with AGL Resources, and on July 1, the merger was completed. On July 11, AGL Resources was renamed Southern Company Gas, and the company intends to spend $800 million on capital projects at the subsidiary this year. 

On July 10, Southern Co. also announced a new joint venture with natural gas infrastructure giant Kinder Morgan (NYSE:KMI), acquiring a 50% equity interest in the Southern Natural Gas pipeline system from the company. Southern Co. will pay $1.47 billion for its interest in the pipeline, while Kinder Morgan will continue to operate it.

Notably, Kinder Morgan plans to use the proceeds it receives from Southern Co. to reduce its debt, which was over $43 billion at last report, while Southern Co. said it will finance the purchase, which both companies expect will close before the end of 2016. 

On the earnings call, management also talked about the acquisition of PowerSecure, which it made early in the second quarter. While the $400 million acquisition was relatively small for a behemoth like Southern Co., CEO Tom Fanning highlighted the importance of how it will help the company address how distributed power, such as the growth of rooftop residential solar, is expected to affect utilities in the coming years. Fanning said that "this business is a way to play offense in the energy efficiency/distributed infrastructure sector, extending our customer-focused business model beyond the meter."

Looking ahead

Even while the Kemper project continues to cost more than anticipated and take longer to bring online, Southern Co. hasn't been shy about investing in capital expansion, as the big increase in capex and acquisitions guidance showed.

And while at least part of it -- particularly in the wind and solar spending -- was a unique product of timing because of some big changes with tax credits and renewables, it's evident that management also sees the benefit to diversifying its business away from being solely a power producer and seller. This is where big investments into the natural gas infrastructure and utility businesses come into play, though it will take some time for those investments to add to the bottom line. 

Company guidance is for third-quarter earnings per share of $1.16, and full-year EPS between $2.76 and $2.88. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.