A Narrow Beat for Southern Company

Electric utility firm Southern Company (SO - Analyst Report) reported marginally better-than-expected second quarter 2012 earnings on the back of solid industrial demand and lower costs. The company reported earnings per share (excluding the impact of an insurance claim) of 69 cents, a penny ahead of the Zacks Consensus Estimate.

However, the Atlanta, Georgia-based power supplier’s per share profits came slightly lower than the second quarter 2011 level of 71 cents amid a drop in the demand for electricity in mild spring weather.

Quarterly revenue at $4,181 million was down 7.5% year over year, below the Zacks Consensus Estimate of $4,745 million.

Near-normal weather across most of the country curbed electricity demand for air conditioning. This brought about a downward movement in overall electricity sales and usage. Total electricity sales during the second quarter were down 3.0% from the same period last year.

Total retail sales fell by 1.9%, reflecting lower demand from residential customers, which deteriorated by 4.3%. Commercial sales registered a year-over-year decline of 1.4%.

In an encouraging sign though, Industrial sales remained essentially flat. With approximately a third of the company’s total retail sales coming from industrial customers, direction of the economy significantly affects the fortunes of Southern, as compared to other utilities that are less dependent on the industrial component.

Expenses Summary

The company’s operations and maintenance expense increased 3.7% year over year, the second consecutive quarterly rise following three successive declines. However, Southern’s total operating expense for the period, at $3,038.0 million, was approximately 10.3% lower than the prior-year level.

Outlook

Management indicated that it continues to see positive indications of economic growth, especially in Southern’s core Southeast market. The company remains particularly upbeat about the addition of 20,000 new residential customers in the first six months of 2012, which exceeded its projections for the entire year.

Rating & Recommendation

Even though Southern Company has a Zacks #2 Rank (Buy rating) in the short run, we are Neutral on the shares in the longer term.

Southern Company – one of the largest generators of electricity in the nation along with the likes of Exelon Corporation (EXC - Analyst Report) and Duke Energy Corporation (DUK - Analyst Report) – serves both regulated and competitive markets across the Southeastern U.S. It is a holding company for four regulated Southern electric utilities that serve about 4.4 million customers: Georgia Power, Alabama Power, Gulf Power and Mississippi Power.

One of the largest and best-managed electric utility holding entities in the U.S., Southern Company dominates the power business across the southeastern region. With a good rate base growth and constructive regulation, we expect the firm to generate steady earnings and dividend growth in the coming years through its long-term power contracts.

However, the challenging economic environment and increased spending levels to ensure regulatory compliance may hamper Southern Company’s results in the next few quarters. We are also concerned by its high level of Vogtle-related spending, which may result in reduced returns going forward.

Consequently, we do not anticipate a significant upside in the near future and expect the stock to perform in line with the broader market.