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Southern Company – Rising Infrastructure Assets But Look Out For Some Challenging Quarters

Summary Southern Company is one of the largest utilities in America. Will grow to #2 spot by customer count after the AGL Resources purchase. Southern announced its plan to acquire AGL Resources for $8B cash – fueled by debt and equity issuance. The company is a dividend contender having raised dividends for 15 consecutive years; 5-yr dividend CAGR is 3.7% and Chowder Rule is 8.56. The Southern Company (NYSE: SO ) is one of the largest utilities company in America. The company serves more than 4.4 million customers and has approximately 46,000 megawatts of generating capacity serving the Southeast through its subsidiaries. Subsidiaries include electric utilities in four states – Alabama Power, Georgia Power, Gulf Power, and Mississippi Power; a growing, competitive generation company – Southern Power; a licensed operator of three nuclear generating plants – Southern Nuclear; and fiber optics and wireless communications – Southern Telecom and SouthernLINC Wireless, respectively. (Source: September 2015 Southern Company Overview Presentation ) In August 2015, Southern Company announced that it will be acquiring AGL Resources Inc. (NYSE: GAS ) in an $8B cash deal. This combined company will shift Southern from being an electric-only utility company to an electric-and-gas utility company. The customer base is expected to double with this move and pushes Southern to become the second largest utility company in America (by customer count), if the deal is approved. Corporate Profile (from Yahoo Finance) The Southern Company, together with its subsidiaries, operates as a public electric utility company. It is involved in the generation, transmission, and distribution of electricity through coal, nuclear, oil and gas, and hydro resources in the states of Alabama, Georgia, Florida, and Mississippi. The company also constructs, acquires, owns, and manages generation assets, including renewable energy projects. As of December 31, 2014, it operated 33 hydroelectric generating stations, 33 fossil fuel generating stations, 3 nuclear generating stations, 13 combined cycle/cogeneration stations, 9 solar facilities, 1 biomass facility, and 1 landfill gas facility. The company also provides digital wireless communications services with various communication options, including push to talk, cellular service, text messaging, wireless Internet access, and wireless data; and wholesale fiber optic solutions to telecommunication providers in the Southeast. The Southern Company was founded in 1945 and is headquartered in Atlanta, Georgia. A Closer Look The Southern Company has remained focused as an electric utility company through the years. The company has remained a heavy user of dirty fuels such as coal (accounts up to 42%) for its power generation over the years, but has started transitioning to cleaner resources including natural gas, solar and wind. This move will also be welcomed as the company aligns itself with the US government mandate targeting power plants to cut carbon emissions by 32% (by 2030) on the 2005 levels. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) Acquisition of AGL Resources Inc. In August 2015, Southern Company announced a plan to acquire AGL Resources Inc. for about $8B in cash, fortifying SO’s assets with the natural gas infrastructure. AGL Resources distributes gas in Georgia, Illinois, Virginia, New Jersey, Florida, Tennessee and Maryland. Southern Co. owns utilities in Georgia, Alabama, Florida and Mississippi. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) This move lowers SO’s dependence on power generation and pushes SO to the #2 spot in the utility sector by customer count after Exelon Corp. (NYSE: EXC ). The combined company will operate 200,000 miles of electric lines and 80,000 miles of gas pipelines. The deal is expected to close in the second half of 2016. Southern Company will be issuing $3B in new stock and also tapping into the debt markets to finance the merger. (click to enlarge) (Source: September 2015 Southern Company Overview Presentation) The deal is expected to raise the long-term EPS growth rates by 4-5%. In addition, the dividend growth is expected to rise faster than current rates. Dividend Stock Analysis Financials Expected: A growing revenue, earnings per share and free cash flow year over year looking at a 10-year trend. A manageable amount of debt that can be serviced without affecting future operations. (click to enlarge) (Source: Created by author. Data from Morningstar) (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The utility industry is resilient and has seen a slow and steady rise over the years. Revenues and earnings are fairly constant with year-over-year growth ranging between -0.3% to +0.15%. The debt load is also stable and SO enjoys a ‘A-‘ credit rating from S&P. SO has a debt/equity of 1.36 and a current ratio of 0.80. Those numbers can be expected to change significantly over the course of next year or two as the AGL purchase moves closer to closing. Dividends and Payout Ratios Expected: A growing dividend outpacing inflation rates, with a dividend rate not too high (which might signal an upcoming cut). Low/Manageable payout ratio to indicate that the dividends can be raised comfortably in the future. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: Utility companies are slow and steady growers and are perfectly suited for long-term dividend investors. Southern Company is a Dividend Contender having raised dividends consecutively for 15 years. The 1-, 3-, 5-, and 10-year dividend CAGRs are 3.5%, 3.6%, 3.7%, and 39% respectively. Coupled with a current dividend yield of 4.86%, SO has a Chowder Rule number of 8.56. The current payout ratio is 89%. Outstanding Shares Expected: Either constant or decreasing number of outstanding shares. An increase in share count might signal that the company is diluting its ownership and running into financial trouble. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The number of shares have risen steadily over the years and are expected to rise more as the company intends to issue $3B of new equity to finance the AGL deal – approx 66M new shares based on current price, an increase in the number of outstanding shares by ~7%. Book Value and Book Value Growth Expected: Growing book value per share. (click to enlarge) (Source: Created by author. Data from Morningstar) Actual: The book value is a bright spot in the company’s financials. The book value has steadily increased over the years maintaining a nice upward trajectory, although we can expect this to stumble when more debt and shares are issued in the coming years. Valuation To determine the valuation, I use the Graham Number, average price-to-earnings, average yield, average price-to-sales, and discounted cash flow. For details on the methodology, click here . The Graham Number for SO with a book value per share of $22.22 and TTM EPS of $2.35 is $34.28. Based on the last closing price, the stock is currently 30% overvalued. SO’s 5-year average P/E is 18.92, and the 10-year average P/E is 17.80. Based on the analyst earnings estimate of $2.94, we get a fair value of $55.62 (based on the 5-year average) and $52.33 (based on the 10-year average). SO’s average yield over the past five years was 4.60% and over the past 10 years was 4.61%. Based on the current annual payout of $2.17, that gives us a fair value of $47.17 and $47.07 over the 5- and 10-year periods, respectively. The average 5-year P/S is 2.16 and average 10-year P/S is 2.0. Revenue estimates for next year stand at $21.18 per share, giving a fair value of $45.74 and $42.35 based on 5- and 10-year averages, respectively. The consensus from analysts is that earnings will rise at 3.58% per year over the next five years. If we take a more conservative number at 3%, running the three-stage DCF analysis with an 8% discount rate (expected rate of return), we get a fair price of $36.73. The following charts from F.A.S.T. Graphs provide a perspective on the valuation of SO. (click to enlarge) (Source: F.A.S.T. Graphs ) The chart above shows that SO is slightly undervalued. The Estimates section of F.A.S.T. Graphs predicts that at a P/E valuation of 15, the 1-year return would be 2.75%. (click to enlarge) (Source: F.A.S.T. Graphs ) Conclusion Electric utilities in general have seen slower sales industry-wide amid a combination of energy conservation, energy efficiency and shift towards independent power generation/natural gas usage. Coupled with the new regulations from the US government to reduce carbon emissions, electric utilities have started focusing a shift away from dirty fuels such as coal. Southern Company still relies heavily on coal, but has started focusing on cleaner energy alternatives to meet the target. In a move to diversify and fortify its assets, the company is moving to acquire AGL Resources Inc. in a deal financed by new share and debt issuance. While this is good for the overall company’s business, in the short term (over the course of next few quarters/years) some balance sheet damage can be expected as the company takes on more debt and investors see share dilution. An added risk for investors is the potential rise of interest rates by the US Fed. Bond substitutes such as utility stocks suffer the most in rising rate environments. Based on the metrics discussed above, if we give equal weight to all metrics, we get a fair value of $45.31. Full Disclosure: None. My full list of holdings is available here .

Surf’s Up With Hawaiian Electric Industries

Summary Hawaii Electric Industries has 95% of Hawaiian electricity market. Hawaii population and building projects are trending up. Hawaiian Electric is poised to expand into this growing market while aligning with other macro trends. Hawaii has been known as one of the most coveted tourism destinations in the United States, but has recently started to become a hot area for residency and permanent living. As mainlanders flock to the beautiful beaches and island lifestyle offered by the most recently inducted U.S. State, opportunity for investors becomes more and more apparent in a variety of different ways. A company that is fully equipped and already capitalizing on Hawaii’s growth is Hawaiian Electric Industries (NYSE: HE ). A leading electricity provider for the Hawaiian Islands, Hawaiian Electric is a strong pick in an expanding economy, especially where residencies and buildings are being built and filled at a high rate. The Opportunity Hawaiian Electric Industries is the leading electricity provider, supplying almost 95%, roughly 450,000 customers, of the Hawaiian population with electricity through its various subsidiaries, including Hawaiian Electric Light Co., and Maui Electric Co. With obvious domination of the market, HE is poised to grow with the economic and population growth of Hawaii. As population trends towards higher numbers, more projects and residencies will continue to be built, and power will need to be supplied to these new homes. Hawaiian Electric can expect to get that call based off of their dominant market share and well known reliability. A steady flow of new customers in the foreseeable future as migration to Hawaii grows, coupled with a company that already has a strong grip on the market could lead to attractive profits and growth. (click to enlarge) As one can see from the chart, after soaring housing numbers pre-recession there was an obvious lull in authorized projects. Since, there has been growth, that, while not at pre-recession numbers, is trending up. This opens the door of opportunity for a company that provides electricity to almost all new housing projects in Hawaii. If this growth continues, look to see HE increase customers and ultimately profit from the construction of new housing. Expansion is looking to be a promising opportunity in the near future as a merger between HE and NextEra Energy, Inc. (NYSE: NEE ) is in the works, currently clearing obstacles in the process of joining forces. NextEra is a clean energy company stationed in Juno Beach, Florida, with almost $17 billion in latest reported annual revenues. As one of the top ten in Fortune’s 2015 list of “World’s Most Admired Companies,” NEE will offer a variety of services and assistance for HE to reach it’s goal of an entirely renewable energy portfolio by 2045, matching Hawaiian Electric Ind. with a leading trend in the utilities macroenvironment. The Company HE is a mid-cap stock with a strong financial base. Revenues have remained steady over the past 3 years, leading many to believe a stall of sorts has occurred, but as macro conditions improve and the company expands its portfolio these numbers could see growth. Forward thinking management strategies such as the renewable energy plan set forth by HE President Connie Lau will propel the company into the future of energy, aligning with not only consumer trends, but natural trends as well. Recognition of the fruits of these plans may not be seen for a number of years, but strong strategy and pursuit of that strategy is paramount in any business, but vital to the energy and utilities sectors in particular. Dividends have remained strong at $1.24 (4.37%) per common share, a respectable number for a mid-cap stock. One thing to consider when analyzing HE as a company is the strong growth in operating income this company has experienced over the past few years, from $284 million in 2012 to $329 million in their most recent 2014 annual report. This shows internal strength in its ability to generate larger profit margins while revenues remain steady, a competency necessary to success in an industry where squeezing higher profits from sales is so integral to growth and financial health. Share prices have seen a recent decline, from around $34 in January, down to about $28 in the recent days. Expect to see a rebound in these prices if the eminent merger with NextEra is completed, as this would lead to expansion and increased internal company strength in the market. Analysts predict company growth of 19% next quarter, along with 6% for the next year. Conclusion All investment decisions should warrant caution, and HE is no different. That said, a strong company with a large market share in a growing market are good finds. HE is exactly that, a strong, financially healthy, company that owns 95% of a market that expects steady growth in the coming years. Couple that with strong expansion strategy to meet changing macro trends towards cleaner, renewable energy and HE could be a strong investment.

Principal Solar – A Silk Purse Or A Sow’s Ear?

Principal Solar is on schedule to build the largest solar farm east of the Rockies. Principal Solar has tremendous potential in terms of expanding its solar utility distribution because of backing by wealthy investors. Principal Solar’s stock has significantly underperformed its competition. On June 1, I wrote an article on Principal Solar’s ( OTCPK:PSWW ) business strategy as the “world’s first distributed solar utility.” The company had issued a series of press releases announcing its plans. Starting on Feb. 4, 2015, it announced that it was building the largest solar project east of the Rockies, which was followed on March 9, 2015, by news that a second, equally large plant would be built in North Carolina. (See company press releases at principalsolar.com for more details.) PSWW then attempted to attract investors when a proposed IPO was announced on May 20, 2015, and an S-1 was filed with the SEC seeking to raise $27.5 million. On June 5, 2015, management announced a reverse 1:4 stock split. When these tactics didn’t work, management lowered the IPO to $12 million. When that proved unsuccessful in generating finds, management withdrew the IPO. One of the interesting notations in this article was that “The Dallas energy company [Principal Solar], backed by oil billionaire Ray Hunt.” Interestingly, a separate article on Bizjournals.com notes the following: A Nov. 3 date has been set for a hearing on whether to confirm a plan that could eject Energy Future Holdings from bankruptcy by allowing the Dallas-based energy giant to sell its transmission utility Oncor to a consortium led by Hunt Consolidated Energy. Ray Hunt’s son, Hunter, is CEO of Hunt Consolidated Energy. In a deal valued at about $19 billion, Energy Future’s revised plan calls for selling Oncor to a consortium that includes its junior creditors, Hunt Consolidated, the Teacher Retirement System of Texas and investment firms Anchorage Capital Group, Arrowgrass Capital Partners, Avenue Capital Group, BlackRock and Centerbridge Partners. As I mentioned in my June article: Texas has plenty of rich investors. With 93 billionaires with a combined net worth of $493.5 billion, California has the highest number of Forbes 400 members. New York claims the second spot with 65 members, followed by Texas (39), Florida (31), and Illinois (17). So a silk purse is PSWW’s relationship with Hunt, which in turn seems to have the connections to attract additional high-worth investors. On Aug. 26, Principal Solar issued its latest press release, which states: PSWW has agreed to terms to co-develop its first major solar asset with affiliates of Entropy Investment Management, LLC (‘Entropy’). The 100MW facility, located in Cumberland County, North Carolina, will produce enough electricity to power approximately 20,000 average American homes. Construction began the week of Aug. 17, 2015, and the project is expected to begin generating power before the end of 2015. In the transaction, PSI will continue to play an important role in completing the project’s development phase and sold its interest in the project to affiliates of Entropy. PSWW seems to be changing its contractors. A company press release from May 11, 2015, stated that Alpha Energy would be its contractor to build the Cumberland solar farm. Initially, PSWW announced that Spanish firm Isolux Corsan as its engineering, procurement and construction contractor. Additional confusion comes from a Feb. 5, 2015, article in CleanTechnica.com : Principal Solar acquired the right to develop the project from Innovative Solar Systems, LLC of Asheville, North Carolina. The acquisition of the project is expected to close no later than June 3, 2015, with construction to be completed in early 2016. In July, I phoned John Green, managing partner of Innovation Solar Solutions, and he told me that all contracts have been signed and the project was on schedule. So here are my big questions: Why did the company announce that it expected to close the deal on June 3 and never make the announcement, even though a month later John Green said the project was proceeding and on schedule? Why did management wait until Aug. 26, nine days after construction began and two months after the failed IPO and plummeting stock? Why is PSWW down from a high of $35.60 in April to close at $1 on Tuesday? I don’t want to speculate, but I thought executives of companies did everything they could to prop up the price of stock for investors. I would like to understand these questions, but emails to PSWW’s CEO, CFO, and VP went unanswered. Principal Solar is competing against some heavyweights in the solar power utility market — Solar City (NASDAQ: SCTY ), TerraForm Power (NASDAQ: TERP ), Canadian Solar, and First Solar ( OTCQB:FLSR ). However, TERP is down from about $40 per share in July to close at $21.63 on Tuesday. SCTY is down from $60 per share in August to $50.10 on Tuesday, and FLSR is down from $53 in June to $49 on Tuesday. Yet PSWW is down from $35.60 to $1. Principal Solar is a silk purse when it comes to investor potential, primarily through Hunt. If Hunt acquires Oncor, there are significant opportunities for PSWW. Hunt Consolidated would own Oncor and Ray Hunt, who is the father of Hunter Hunt, CEO of Hunt Consolidated, is a backer of PSWW. According to the Oncor website: Oncor is a regulated electric distribution and transmission business that uses superior asset management skills to provide reliable electricity delivery to consumers. Oncor operates the largest distribution and transmission system in Texas, providing power to 3 million electric delivery points over more than 103,000 miles of distribution and 15,000 miles of transmission lines. From an investor standpoint, PSWW certainly looks like a sow’s ear at this time. But the deep pockets and strategy of the company executives could turn the stock into a silk purse. The man question is whether stock investors will buy the incongruous events and look to the future. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.