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Summary I recently published a follow- up article about Wisconsin Energy after the acquisition of Integrys. Several friends told me that I should prefer Southern Company over Wisconsin Energy. They claim that the superior yield is due to some short term hardships that will soon be over. I totally disagree, I believe Wisconsin Energy is by far a superior investment. I will now try to explain why. Introduction A week ago I wrote this article about Wisconsin Energy (NYSE: WEC ). In the article, I tried to analyze the company after the acquisition of Integrys (NYSE: TEG ). The article is really in favor of buying the shares of the company. Several friends told me after reading the article that I should prefer Southern Company (NYSE: SO ) over Wisconsin Energy. They claim that the superior dividend yield and the longer streak of dividend raises make it a superior investment for dividend growth investors. They believe that currently, the company suffers from short-term headwinds. I read a lot about Southern Company and I totally disagree. In this article, I will show the fundamentals and valuation of the company, and then show a comparison with Wisconsin Energy, that I believe will allow me to emphasize the superiority of Wisconsin Energy over Southern Company. Southern Company through its subsidiaries, Alabama Power Company, Georgia Power Company, Gulf Power Company and Mississippi Power Company, supplies electric service in the states of Alabama, Georgia, Florida, and Mississippi. Each of those subsidiaries is an operating public utility company. Additionally, Southern Company owns all of the common stock of Southern Power Company, which is also an operating public utility company, which constructs, acquires, owns, and manages generation assets and sells electricity at market-based rates in the wholesale market. Fundamentals Southern Company has terrible fundamentals, really, it is hard for me to describe it otherwise. The revenues for example grew from $13.554 in 2005 to $18.467 in 2014. This is CAGR of 3%, which might be reasonable if the income is growing at least at the same pace. Yes, it is a utility company which doesn’t show fast growth, but I still have higher expectations. SO Revenue (NYSE: TTM ) data by YCharts EPS growth is even worse, when thinking about the EPS growth together with inflation, well there is practically none. The EPS grew from $2.13 in 2005 to $2.18 in 2014. This is CAGR of 0.23%, which is practically no growth, and when taking inflation into consideration, it is practically declining. Let’s look now towards the future. The analysts’ estimates are for growth of 2.5%- 3% in EPS for the next 3- 5 years. Having said that, I am not happy with the EPS growth in the past and the future estimates. SO EPS Diluted (Annual) data by YCharts The dividend is another weak fundamental in my opinion. The annual payment grew from $1.49 in 2005 to $2.1 in 2014. That is CAGR of just 3.5%. As you read above, as EPS is flat, the dividend rose by expanding the payout ratio. This is not sustainable for the long run, and therefore it makes me worry about the ability of the company to show real growth. In 2014, the payout ratio was over 95%, and even for the estimate for 2015, the payout ratio will be over 75% which is high for utilities. Currently, the company yields just under 5%. I don’t think the yield is high enough to justify such slow growth. SO Dividend data by YCharts Usually I like it when companies reward shareholders by using big parts of the FCF for dividends and share repurchases. However, with such a high payout ratio, I didn’t expect Southern Company to buy its own shares. Yet, I figured out that not only that the number of shares didn’t decrease, it actually rose by over 22% over the past decade. I don’t mind being diluted when smart acquisitions are made like the acquisition of Integrys by Wisconsin, or by the purchases of new properties by Realty Income (NYSE: O ). In these cases the dilution is used to grow EPS and FFO. In this case, the dilution comes with low growth. Not my cup of tea. Valuation When I look at the valuation of Southern Company, I find a company that is valued cheaper than Wisconsin Energy. The difference in the valuation makes perfect sense as Wisconsin Energy is growing its EPS while Southern Company has stagnated. In my opinion, the difference isn’t big enough. I find Wisconsin Energy fairly valued for a company that will grow at around 6% every year. By looking at the forward P/E for this year and the year after, I can see that the gap is becoming smaller and smaller. As a long term investor, it is hard for me to justify purchasing Southern Company at the current valuation. SO PE Ratio ( TTM ) data by YCharts The lower valuation is not low enough for me to consider Southern Company at the moment. It might sound odd, but I find it overvalued when compared to other high yielding companies, with slower than average growth. Risks As I see Southern Company, there are two main risks to this investment. The first one is the lack of growth catalysts. The company is forecasted to grow its earnings by less than 3% annually over the next several years. This is very low even for a utility company, especially one that expanded its payout ratio so much. The company must find new ways to grow its income and revenues. The second risk is the still increasing expenses of the Kemper project in Mississippi. This project consumes more and more money, and it takes a big part of the cash flow as it increases the capex. In 2014 alone, the expenses on this project cost the company $0.83 per share. Southern Company will have to invest more money in order to finish it. Finishing it will indeed free some if its cash flow, but it will still not be able to serve as a real growth catalyst. Opportunities Southern Company still has several opportunities, but I find them pretty vague. Firstly, most major expenses on the Kemper project are behind us already. The necessary investment will now be much lower, and it will allow the company to use the money in a better way. Another opportunity is the fact that even when it suffers from headwinds, Southern Company still manages to show fair margins and fair return on equity. If the company will be able to find growth prospects, it will be able to utilize its efficient structure to create more income and more value to its shareholders. Comparison with Wisconsin Energy I will now sum the comparison between these companies. I believe that Wisconsin Energy has superior fundamentals when looking at the past decade and the next five years. Southern Company is valued cheaper, but not cheap enough to justify the lack of growth in the EPS. Wisconsin Energy, doesn’t suffer from huge expenses due to problematic projects such as Kemper in Mississippi. This kind of projects consume a lot of capital, and it will be hard for them to return the money invested. Wisconsin Energy has a lower debt burden. The debt to equity ratio is lower, and it gives Wisconsin Energy more flexibility. Southern company has more debt and a very high payout ratio. This is a combination that can be damaging to the company. It puts the dividend in an unpleasant place. Not only that, Wisconsin Energy is working on lowering its debt after the acquisition of Integrys. Southern Company on the other hand has higher margins and return on equity. This is a positive sign, which is not enough when the company can’t find growth prospects. Yet, to be fair, holding a more profitable company is always a plus. I am writing from my position as dividend growth investor, so it makes perfect sense that I will give Southern Company credit for the higher dividend yield. The dividend yield is much higher at almost 5% compared to the yield of over 3.5% that Wisconsin Energy has. If you look for income it is an important aspect. Conclusion I am certain that Wisconsin Energy can show superior returns for the near future. It has better fundamentals and growth opportunities, and I think that dividend growth investors should prefer it over Southern Company. In my opinion, it will also beat Southern Company in total returns even though the latter has higher dividend yield. I would only pick Southern Company if I were a retiree who is looking for income right here and right now. Scalper1 News
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