Our March of 2011 article about adjusted earnings versus GAAP earnings discussed the topic in a broad sense. We are extending this topic to discuss one-time gains or losses for utilities, for which some accounting items may require special treatment. Although many companies (and sell-side analysts) exclude these items from their definition of “operating” earnings, we don’t necessarily follow suit.
As is the case for nonutility companies, if a one-time item is shown “below the (net income) line” as extraordinary or from discontinued operations, Value Line automatically excludes it from our earnings presentation. If the item is shown “above the line,” the analyst must decide whether or not to include it in earnings.
One of the most common themes that utilities face is ongoing mark-to-market unrealized accounting gains or losses that occur each quarter. These usually pertain to power or gas contracts that don’t qualify for hedge accounting, but can also arise from an interest-rate swap, as is the case for Black Hills Corporation (BKH). Many companies exclude them from their definition of operating earnings, but we include them. It’s true and unfortunate that they can skew quarterly and annual year-to-year earnings comparisons, but they even out over time. They are an ongoing aspect of a utility’s operations, and thus we can’t call them “nonrecurring” when they are recorded every quarter.
Sometimes, as part of a regulatory agreement, utilities refund previously collected revenues or provide temporary rate credits to their customers. In 2009, Dominion Resources (D) took a charge for a proposed settlement of its Virginia Power subsidiary’s rate case. The charge included the refund of previously collected revenues. Because these revenues were included as ordinary income when originally recorded, it would have been inconsistent to exclude the refund. In 2007, Exelon (EXC) and Ameren (AEE), the parent companies of utilities in Illinois, agreed to provide rate credits to their customers there over a period that ended in 2010. Even though each company excluded the costs of these credits from its “operating” earnings, we left them in our presentation because we consider such items a normal part of a utility’s operations.
On the other hand, utilities are sometimes forced to write down generating plants as part of the regulatory process. The companies treat these as one-time items, and we exclude them from our presentation, too.
Companies that own nuclear generation are required to have nuclear decommissioning trust funds to ensure that there will be adequate monies for the costly task of decommissioning a plant after it has completed its useful life. In a market downturn, the owners of regulated plants can eventually recoup the funds from ratepayers, but the owners of nonregulated plants record impairment charges when the value of their funds declines. Companies such as Public Service Enterprise Group (PEG), Constellation Energy (CEG), and Exelon have taken such charges in recent years. Although these companies exclude the losses from their definition of “operating” earnings, we include them as part of ongoing operations. Such charges can recur, so we don’t call them “nonrecurring."
Materiality also matters when deciding whether an item is included or excluded. In 2007, TECO Energy (TE) sold a nonutility business and recorded an aftertax gain of $149.4 million on the sale. The gain was not treated as income from discontinued operations (if it had, we would have automatically excluded it), so it was up to our discretion. Because the gain was large, we treated it as a nonrecurring item. If the gain had been small, we would have left it in our earnings presentation.
All Value Line reports list gains and losses from nonrecurring, extraordinary, and discontinued operations in the footnotes. Due partly to the regulatory process, utilities have more of these items than companies in many other industries. Where needed, the stock comments discuss the information about significant new one-time items.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.