The electric utility industry has gone through some big changes over the years, as companies try to find the right balance between regulated distribution activities and deregulated power generation and wholesale-market sales. Utility giant Southern Company (NYSE:SO) has done a good job of finding ways to benefit from both segments, and coming into Wednesday morning's second-quarter financial report, Southern Company shareholders had hoped that the company would find a way to eke out at least marginal growth in both revenue and earnings. Southern was able to deliver on only half that task, with an unexpected drop in sales, but earnings actually topped most investors' expectations. Let's take a closer look at Southern Company to see how the utility did during the quarter.
A mixed spring for Southern
Southern Company's second-quarter results showed some of the crosswinds in the utility industry. Revenue of $4.34 billion fell nearly 3% from year-ago levels, falling short of expectations by about $300 million. Yet after excluding after-tax charges, adjusted net income of $647 million were up almost 6% from last year's second quarter, and adjusted earnings per share of $0.71 beat the consensus estimate by $0.02 per share.
Looking more closely at Southern Company's results provides a deeper understanding of the various forces working on the utility. Kilowatt-hour sales to retail customers in the company's service area rose by 2.2%, with strength coming across Southern's customer spectrum. Residential energy sales rose by the largest amount, with growth of 4.6%, but both commercial energy sales and industrial energy sales also posted smaller gains. Weather was a positive factor for Southern during the quarter, but even after adjusting for its impact, Southern saw adjusted energy sales rise in all three of its retail categories.
Meanwhile, the wholesale business was disappointing from a revenue standpoint. Sales from the segment fell 13% to $448 million, with pricing being the predominant factor in the drop. On a volume basis, kilowatt-hour wholesale electricity sales climbed by 1.3% to 7.8 billion kWh, reversing a big drop in electricity sales volume earlier in 2015.
Southern Company CEO Thomas Fanning was pleased with the utility's results, noting that this is the first time that weather-normalized results have grown in the residential, commercial, and industrial areas for two quarters in a row. "Our region continues to grow faster than the U.S. as a whole," Fanning said, and that accounts for much of the opportunity that Southern has to serve an increasing number of customers throughout its business.
What's next for Southern?
One concern that some investors have about Southern Company is its ability to control cost overruns. During the second quarter, Southern took an additional after-tax charge of $14 million to cover increased construction-cost estimates for the Kemper County integrated gasification combined-cycle project for its Mississippi Power unit. Similar overruns in the past have weighed on results, and while any construction project is subject to uncertainty, Southern needs to demonstrate that it can control such costs in the future and minimize their long-term impact.
Perhaps more importantly, Southern investors will need to keep an eye on how the stock fares in a future rising-interest-rate environment. So far, dividend investors have flocked to Southern Company stock, with a dividend yield that exceeds 5% remaining especially appealing to those seeking more income from their stock portfolios. As the Federal Reserve starts to raise rates, though, the relative appeal of fixed-income securities will rise, and that could put pressure on utility stocks like Southern.
Investors took Southern Company's latest results in stride, sending the stock down about 1% in the opening minutes of the regular trading session following the morning announcement. In the long run, Southern's second-quarter results will be far less important than the strategic path that the utility takes to take advantage of the growth in the Southeast and the opportunity to serve customers and meet their energy needs.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends 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.