Local utility South Jersey Industries (NYSE:SJI) isn't all that unusual a company in the utility sector, serving a relatively small part of the country, and focusing on serving its core customer base. Coming into Friday's first-quarter financial report, South Jersey investors expected that the company would see its earnings fall somewhat from year-ago levels.
South Jersey's results confirmed that expectation, but the utility thinks that, by shifting away from the solar market and concentrating more on its regulated utility unit, it can maximize its potential. Let's take a closer look at South Jersey Industries, and why investors aren't buying the bullish argument that the utility is trying to sell.
South Jersey Industries bridges the GAAP
Understanding South Jersey Industries' first-quarter results requires a closer look at how the utility accounts for its business. On a GAAP basis, income from continuing operations jumped by more than a quarter, to $68.2 million, and that produced a solid gain on earnings per share. However, using the company's preferred economic earnings metric, the level of economic net income fell about 3%, to $57 million. That produced economic earnings of $0.80 per share, exactly matching the consensus forecast among investors, but falling from last year's $0.86 per share figure.
The key to the drop in economic earnings lies in the way that South Jersey handles derivatives. Economic earnings is an important concept because, under GAAP accounting rules, a company has to claim the gain or loss on a derivative contract during the period. However, the rise or fall in the value of a derivative now is offset by the changes in the future costs that the transaction was designed to hedge in the first place.
For instance, if you enter into a futures contract to buy natural gas to generate electricity at $2 per million BTUs, and the price rises to $3, you'll have an immediate profit from the contract. However, you'll suffer the higher cost in the future of potentially paying $3 for the natural gas when you need it. The concept of economic earnings offsets that element, and that explains most of the difference between GAAP and economic earnings for South Jersey this quarter.
Looking more closely at South Jersey's numbers, the regulated South Jersey Gas unit enjoyed a 4% rise in net income, with strong customer growth helping to add to contributions from various program investments. Nearly 6,600 new customers have come onboard in the past year, bringing its total to above 375,000. South Jersey also believes that the warmer winter will reduce its uncollectible account balances this year compared to previous periods, which should help in the future.
South Jersey's other businesses enjoyed success, as well. In the South Jersey Energy Group, efforts to use storage and transportation assets as efficiently as possible helped send economic earnings upward by more than half from year-ago levels, and the company has several contracts coming online both this year and in the future to produce ongoing growth. Meanwhile, the South Jersey Energy Services unit saw economic earnings also disappear, with the company saying that the phase out of investment tax credits from solar development weighed on its overall results.
CEO Michael Renna summed up the results nicely. "Robust performance in our utility," Renna said, "complemented by a 56% year-over-year increase in earnings from our commodity business and improved operations from our energy production business, nearly offset an $8.5 million year-over-year planned reduction in investment tax credits."
What's ahead for South Jersey Industries?
Looking forward, South Jersey remains excited about its utility business. The gas utility unit should amount to 67% to 70% of overall earnings. That will likely come at the expense of SJ Energy Services and its solar development exposure. Core business growth should offset the shrinking solar revenue, and South Jersey expects to spend more than $600 million on investments in 2016 and 2017.
In the long run, that strategy could pay off well. As a five-year goal, South Jersey wants to post $150 million in economic earnings by the year 2020. That's ambitious, but not unattainable, especially if overall conditions change for the better.
South Jersey investors didn't respond well to the news, as the stock fell 3% by late in the trading day following the announcement. Longer term, though, South Jersey Industries has the potential to ride the strength of its regulated utility unit to more successful growth for years to come.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends South Jersey Industries. 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.