Why did reported earnings barely change in 1998 even though the core business grew?

Reported 1998 net income of $977 million ($1.40 per share) was held down by roughly $248 million, or $0.36 per share, of non-recurring charges. The largest was a $200 million after-tax write-down of Southern Energy's South American holdings, which the company decided to sell. A $21 million after-tax Rocky Mountain write-down and about $20 million of work force reduction costs also weighed on results. Excluding these items, earnings were $1.225 billion ($1.76 per share), up 8.4%. The prior year's reported figure also included a $111 million UK windfall profits tax, so the year-over-year comparison is distorted in both directions.

How much of Southern's earnings now come from non-traditional businesses, and how risky are they?

Southern Energy accounted for about 20% of 1998 net income excluding non-recurring items, up from about 10% in 1997. The company itself acknowledges that these activities carry a higher degree of risk than rate-regulated operations, and the Edelnor/Alicura write-down and the Mobile Energy bankruptcy illustrate that risk. The filing also states that the company expects to make substantial investments in these businesses during 1999-2001, so earnings from these ventures are likely to rise in absolute terms but are less predictable than regulated utility returns.

Is the dividend safe, and why did management change the payout policy?

The quarterly dividend was maintained at $0.335 per share ($1.34 annually) in January 1999, and the company paid $1.34 per share in 1998. However, management modified its policy from a targeted 75% payout ratio to a lower ratio over time. In 1998 the payout ratio was about 95.6% of reported earnings, so the lower-payout policy is meant to retain more cash for growth rather than signal a cut. Management says the change is intended to increase long-term shareholder value by reinvesting more internally generated funds.

What are the main regulatory and financial risks investors should monitor in 1999?

Key items include: the Georgia PSC's three-year rate order that cuts Georgia Power's retail rates by $262 million in 1999 and another $24 million in 2000; Florida PSC scrutiny of Gulf Power's authorized return on equity and possible write-off of regulatory assets; FERC proceedings that could lower wholesale equity returns (proposed from 13.75% to 12.5%); the Mobile Energy bankruptcy; expected additional equity issuance; and Year 2000 readiness, with critical systems targeted for June 1999 and Phase II Clean Air Act compliance due in 2000. The company also faces an unresolved SEC application for nearly $8 billion of non-traditional investment authority.

How strong is the balance sheet and how is the company funding its growth?

Common equity was 42.9% of total capitalization at year-end 1998, down from 43.5%, and long-term debt was 45.9%. Consolidated long-term debt was about $10.5 billion and total assets were $36.2 billion. The company had about $872 million of cash and $4.6 billion of unused bank credit at the start of 1999. The company raised $109 million from stock plans in 1998 and $350 million of trust preferred securities, and plans to raise additional equity in 1999 contingent on investment opportunities, with operating companies relying mainly on internal cash flow and unsecured debt.

SOUTHERN CO 10-K FY1998 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 26, 1999. Cited figures are marked; the original filing is the authoritative source.

Southern Company (SO) reported 1998 consolidated net income of $977 million^a, or $1.40 per share, down from $972 million ($1.42) in 1997.

Excluding non-recurring items totaling $248 million^b after tax (chiefly a $200 million after-tax write-down of its South American holdings in Chile and Argentina, plus a $21 million Rocky Mountain plant write-down), earnings were a record $1.2 billion ($1.76 per share), up 8.4% from $1,130 million. The traditional regulated utility business remained the core earnings engine, with retail revenues up 8.2% to $8.3 billion on customer growth and hotter weather, and retail kilowatt-hour sales up 6.2%, the strongest growth since 1986. Total operating revenues fell 9.6% to $11.4 billion because Southern Energy's energy trading operations were deconsolidated into the Vastar joint venture effective January 1, 1998.

The filing shows an aggressive push into non-traditional business. Southern Energy, which the company says accounted for roughly 20% of net income excluding non-recurring items in 1998, has SEC authority to invest up to about $8 billion^c in non-traditional domestic and international business, against $3.9 billion of current authority with $3.6 billion already invested. Management plans to acquire or build roughly 20,000 MW of North American capacity, has announced about $1.3 billion of U.S. generation acquisitions expected to close in 1999, and expects substantial investment in these businesses over 1999-2001.

Investors should weigh this growth against the higher risk the company itself acknowledges, as well as the January 1999 Chapter 11 filing by Mobile Energy Services (MESC), for which the parent paid about $36 million^d under guaranty agreements in March 1999. On the financial side, the company cut its dividend payout policy from a targeted 75% toward a lower ratio over time while keeping the quarterly dividend at 33.5 cents ($1.34 annually). Management says this lets more internally generated funds be reinvested.

Common equity was 42.9% of total capitalization, the market-to-book ratio was 207%, and the year-end share price was $29 1/16. Key regulatory and competitive uncertainties include the Florida PSC's review of Gulf Power's return on equity, the Georgia Power 1998 rate order cutting retail rates by $262 million in 1999, FERC proceedings on wholesale equity returns, Year 2000 readiness (targeted June 1999), and Phase II Clean Air Act compliance in 2000.

02—Key points

Key Highlights

Record core earnings: excluding non-recurring items, 1998 net income rose 8.4% to $1.225 billion ($1.76 per share) versus $1.13 billion ($1.65) in 1997.
Reported EPS fell to $1.40 from $1.42, driven by a $200 million after-tax write-down of Southern Energy's Chilean (Edelnor) and Argentine (Alicura) investments, plus a $21 million after-tax Rocky Mountain plant charge.
Retail revenues rose 8.2% to $8.3 billion and retail kWh sales grew 6.2%, the fastest annual increase since 1986, driven by hot weather and customer growth (57,000 new residential customers).
Total operating revenues declined 9.6% to $11.4 billion after Southern Energy's energy trading business was deconsolidated into the Vastar joint venture on January 1, 1998.
Non-traditional expansion: SEC authority is $3.9 billion with $3.6 billion invested; a request to invest up to nearly $8 billion is pending, and about $1.3 billion of U.S. generation acquisitions are expected to close in 1999.
Dividend policy changed to lower the payout ratio over time from a 75% target, with the quarterly dividend held at $0.335 ($1.34 annually); the company plans additional equity issuance in 1999.
Risk items: Mobile Energy Chapter 11 filing (January 1999; $36 million paid under guaranties in March 1999), Georgia Power's rate cut effective 1999, and Florida PSC review of Gulf Power's authorized return.

03—Questions

Frequently Asked Questions

Why did reported earnings barely change in 1998 even though the core business grew?
Reported 1998 net income of $977 million ($1.40 per share) was held down by roughly $248 million, or $0.36 per share, of non-recurring charges. The largest was a $200 million after-tax write-down of Southern Energy's South American holdings, which the company decided to sell. A $21 million after-tax Rocky Mountain write-down and about $20 million of work force reduction costs also weighed on results. Excluding these items, earnings were $1.225 billion ($1.76 per share), up 8.4%. The prior year's reported figure also included a $111 million UK windfall profits tax, so the year-over-year comparison is distorted in both directions.
How much of Southern's earnings now come from non-traditional businesses, and how risky are they?
Southern Energy accounted for about 20% of 1998 net income excluding non-recurring items, up from about 10% in 1997. The company itself acknowledges that these activities carry a higher degree of risk than rate-regulated operations, and the Edelnor/Alicura write-down and the Mobile Energy bankruptcy illustrate that risk. The filing also states that the company expects to make substantial investments in these businesses during 1999-2001, so earnings from these ventures are likely to rise in absolute terms but are less predictable than regulated utility returns.
Is the dividend safe, and why did management change the payout policy?
The quarterly dividend was maintained at $0.335 per share ($1.34 annually) in January 1999, and the company paid $1.34 per share in 1998. However, management modified its policy from a targeted 75% payout ratio to a lower ratio over time. In 1998 the payout ratio was about 95.6% of reported earnings, so the lower-payout policy is meant to retain more cash for growth rather than signal a cut. Management says the change is intended to increase long-term shareholder value by reinvesting more internally generated funds.
What are the main regulatory and financial risks investors should monitor in 1999?
Key items include: the Georgia PSC's three-year rate order that cuts Georgia Power's retail rates by $262 million in 1999 and another $24 million in 2000; Florida PSC scrutiny of Gulf Power's authorized return on equity and possible write-off of regulatory assets; FERC proceedings that could lower wholesale equity returns (proposed from 13.75% to 12.5%); the Mobile Energy bankruptcy; expected additional equity issuance; and Year 2000 readiness, with critical systems targeted for June 1999 and Phase II Clean Air Act compliance due in 2000. The company also faces an unresolved SEC application for nearly $8 billion of non-traditional investment authority.
How strong is the balance sheet and how is the company funding its growth?
Common equity was 42.9% of total capitalization at year-end 1998, down from 43.5%, and long-term debt was 45.9%. Consolidated long-term debt was about $10.5 billion and total assets were $36.2 billion. The company had about $872 million of cash and $4.6 billion of unused bank credit at the start of 1999. The company raised $109 million from stock plans in 1998 and $350 million of trust preferred securities, and plans to raise additional equity in 1999 contingent on investment opportunities, with operating companies relying mainly on internal cash flow and unsecured debt.

04—Continue

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