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Southern Company: Taking A Pass On This Quality Utility Name

Buffett’s words should be heeded concerning Southern Company: “Price is what you pay. Value is what you get”. Compared to 5-yr average fundamentals, Southern Company looks expensive. While not a seller, I would not be a buyer either. However, investors should evaluate their dividend reinvestment position. Many readers know I have been bullish on Southern Company (NYSE: SO ) for some time. Over the previous two years, I have written eight articles focused on SO. With the recent spike in price to the $53 range, SO is now overvalued. At its current price, while I would not be a seller, I would not be a buyer either. “Price is what you pay. Value is what you get,” says Warren Buffett. While SO is a strong utility with a bright future, the value investors are buying is not as attractive as a few months ago. Below is a comparison of current valuations vs SO 5-yr average. The corresponding price is the valuation of SO at each of these 5-yr averages. As shown, these fundamentals indicate SO is overvalued compared to its averages since 2009. Source: Morningstar, MyInvestmentNavigator.com Earnings have been reduced recently due to write-offs of cost overruns at their Kemper project. There are questions being raised as to first $900 million cost overruns on the Vogtle power plants as the resolution has now been passed to the courts. The consensus belief is SO will win these lawsuits based on the terms of their contract. However, delays from the planned fourth-quarter 2017 and fourth-quarter 2018 start dates seem inevitable, and could lead to future charges against earnings. Southern Company still has several very positive trends that should continue to reward shareholders. The regulatory environment is quite favorable in its service territory. Return on invested capital ROIC is one of the best in the business at a 5-yr average of 6.75%, even after a dismal 2013 at barely over 5%. Unlike many of its peers, SO’s ROIC is above its weighted average cost of capital WACC of 4.2%. Southern Company has earned an A- rating by S&P Capital IQ for 10-year consistency in earnings and dividend growth. The rating puts SO in the top 3.3% of all companies reviewed by S&P and in the top five management teams for the entire utility sector. These are very admirable qualities for long-term investors. Concerning distributed generation, CEO Fanning is on record as embracing this potentially disruptive power trend. In an interview last year, he is quoted, Fanning touts efforts by Southern subsidiary Georgia Power to promote both utility-scale solar as well as distributed generation. “If somebody wants to buy distributed generation, I want to sell it to ’em. I’m completely happy to do that.” To support that effort, rate structures will have to be redesigned, something Fanning thinks state regulators will be “constructive” about supporting. “You need to do it fairly. There are three components of that. One is revenue , which should be done at avoided cost. Second — it is not net metering; that is a flawed concept. Second is a fair charge for connection to the network, and third is a fair charge for the backup generation and the energy when the wind is not blowing and the sun does not shine. As long as you do that right, we’re 100 percent in,” Fanning said. “This is something where we’ve got to play offense.” Morningstar rates SO with only 2 Stars, not a very compelling value. Their unique Bulls and Bears comments from the latest update in early Dec are: Bulls Say: Southern operates in the business-friendly Southeast, where its traditionally low power prices and sterling reputation help to foster a constructive and stable regulatory atmosphere. As of mid-November, Southern’s dividend yield was 4.5%, well above its peers’ [Author’s note: with the recent run-up in prices, yield is 4.0%]. With a stronger business model and premium returns, the yield premium is appealing in an otherwise overvalued sector. Business investment continues to head to the Southeast, which bodes well for the region’s economy and Southern’s customer base even though residential demand has remained tepid. Bears Say: Southern burns a lot of coal, so complying with carbon emissions and coal ash regulations could require significant investments that would raise customer bills, discourage usage. We include $500 million of potential cost overruns at Vogtle that we project Southern will not be able to recoup in rates and $200 million in extra owners’ costs. These figures could go much higher in a worst-case scenario. Utilities suffer in times of inflation and rising interest rates. Inflation erodes the value of the rate base on which a utility’s allowed returns are calculated. This is where an automatic dividend reinvestment program becomes a bit dicey. Although I wrote a book on DRIPs in 2001 for McGraw Hill, All About DRIPs and DSPs , reinvesting dividends in SO at the current price seems a bit risky. Accumulating the dividend in a cash account for reinvestment in other income stocks may be preferred until SO’s fundamentals improve. While Southern Company is replacing its coal generating capacity with low-cost nuclear, has one of the best management teams in generating Net ROIC, is in a growing service territory with friendly regulators, and is embracing distributed solar generation, the current share valuation leaves much to be desired. Waiting for a better valuation would be prudent. Author’s Note: Please review disclosure in Author’s profile.

Southern Company Will Be Teaming Up With The U.S. Navy And Air Force

Summary Southern Co. and HelioSage are teaming up with the U.S. Military to develop three solar facilities on military sites across the gulf coast. Southern Co. has taken added interest since the end of QE3 in October 2014, hitting new all-time highs in a fighting market. Southern Co. is a stable long-term stock with a respectable 4.02% dividend. Southern Co. is reporting earnings on February 4, 2015. Here we are, three weeks into the year, and we are working our way through earnings. If this is the first time you have read my articles, I am building a portfolio for 2015 that contains all original research. I am digging through SEC filings and considering the state of the economy. So far, I have written articles about seven stocks and my eighth pick is Southern Co. (NYSE: SO ). I am focusing on long-term growth, diversification, and I love dividend stocks. With the uncertainty of the market right now, I have begun each search with a few primary characteristics of each stock. Aside from the economic state, which is driving me towards oil and retail, I am also looking for stocks that popped around mid-October of last year, and that have weathered the January storm. The reason for this is because October was the end of QE and people reallocated their money, and stocks that gained interest in these time frames are a good indicator of where a lot of it went. I believe that some of the stocks that have done well since that time are likely to continue to rise for the time being. This article will take an objective approach to the company, and raise any potential issues. However, upon evaluation, I believe that the market risks are not of immediate concern, but should be considered when deciding whether to invest or not. A Brief Overview Southern Co. is seen as a secure investment because of its customer base. According to its website : Southern Co. is a leading U.S. producer of clean, safe, reliable and affordable electricity, Southern Company owns electric utilities in four states – Alabama Power , Georgia Power , Gulf Power , and Mississippi Power – and a growing competitive generation company – Southern Power – as well as a licensed operator of three nuclear generating plants – Southern Nuclear – and fiber optics and wireless communications – Southern Telecom and SouthernLINC Wireless , respectively. Their clientele is around 4.4 million and they have nearly 46,000 megawatts of generating capacity. Below is some info about the power subsidiaries. Gulf Power Company (Gulf Power) Gulf power has a variety of power generation sources, and has a focus on Carbon Conscious Energy. Specifically, gas-to-energy, wind and geothermal, and solar are highlighted focuses of the company. Any time a company pairs with the government, many opportunities of expansion are created because the military is seen as a reliable customer once commitments are made. Gulf Power just announced that it is partnering with the U.S. Navy and U.S. Air Force to build solar energy farms within its region. The planned implementation date is December 2016; however, in my experience with the military, it is highly likely that this date may be pushed back. If approved, it will still be a large revenue boost, and there will likely be a reduction in operating costs since solar requires less regulation than other options such as nuclear. It will not replace other forms of energy at the moment, but will supplement them. Georgia Power Company (Georgia Power) Georgia power services 2.3 million customers as of December 31, 2013. The majority of the customers are serviced in metro regions, with the fewest customers in Southern Georgia. Total Georgia Power kW Capacity Hydro 1,087,536 Fossil 8,791,427 Nuclear 1,959,852 Solar 705 Other (Diesel, Combined Cycle and Combustion Turbine) 5,746,409 Total 17,585,929 Although solar is the smallest of the generating capacity, Southern Co. has made it clear that solar is one of the focuses of the company as the country moves towards cleaner, safer forms of energy. Georgia power has an initiative called the “Georgia Power Advanced Solar Initiative (GPASI).” 2015 will begin the first year that four Power Purchase Agreements (PPA) will take effect totaling 50 MWs of utility scale solar generation to be purchased by the company. Southern Power Company (Southern Power) Southern Power recently announced plans to develop a 131MW PV solar project in Georgia. The electricity will power 21,000 homes and will be sold to three Georgia electric membership corporations. First Solar will be the engineer and contractor. Plans to begin this project are set for September, 2015. There will be approximately 1.6 million thin-film PV solar modules mounted on single-axis tracking tables. Alabama Power Company (Alabama Power) Alabama Power is the second largest subsidiary of Southern Company and its customer base is approximately 1.4 million homes, businesses and industries in the southern two-thirds of Alabama. There are 24 generating plants that range from Hydro, Coal/Gas, Gas, and Nuclear. The single nuclear plant has a total nameplate generating capacity of 1,720,000 KW. One concern is that with the major earthquake and tsunami that struck Japan, operating expenses may rise once reviews are complete of nuclear facilities in the US. This may result in higher capital requirements and increased costs associated with ensuring safety. Many of the capital expenditures include investments to comply with environmental regulations. Mississippi Power Company (Mississippi Power) Mississippi Power is another subsidiary of Southern Co. that operates utilizing multiple fuel sources. You will notice that the diversification of fuel sources is intentional, so that the distribution of each source can be modified to adjust to current price trends. Lignite, natural gas, and traditional coal are the primary sources of energy with 70% of the customers being fueled by natural gas. Mississippi Power is currently working on a $6.1 billion, 582-megawatt power plant in Kemper, Miss. This has contributed to increases in debt load and the costs have surpassed expectations. It has a coal gasification design called Transport Integrated Gasification. It will tap into lignite reserves, which will reduce shipping costs and stabilize prices in the long term. The progress of this project is important because of the sheer scope and cost. Another important factor will be the recapturing of CO2. The company will need to ensure that this new plant is able to capture the targeted amount (65%) because if there is any excess or does not comply with regulations, it could become a target, upping the cost even more. The projected completion date is mid-2016. The Commonality One common theme throughout all of these companies is the level of debt currently held by the company. The debt level has grown steadily over the past several years. The 2013 annual report reflects a total debt of $23.395 billion. In a low interest climate, this is OK, but this is something they will need to keep under control in a rising interest climate. An important point on their debt though is some of the forms of debt they hold. For example, Alabama Power established a wholly-owned trust to issue preferred securities. The investment in the trust is reflected as other investments, and the related loan from the trust is reflected as long-term debt. This total was $206 million as of December 31, 2013. A tactic used to maintain the control of debt in Alabama Power is through the conversion of long-term debt to short-term debt. While this is not generally a good practice, there are strategic reasons why this could be a good decision. From 2014-2016, the debt maturities are expected to exceed operating cash flows. The solution to this is for the company to take out short-term debts to cover longer-term debts. With the seasonality of the business, this is necessary and while interest rates are low, this tactic will benefit the business. Short-term cash needs are met through the paper program and through a SO subsidiary organized to issue and sell commercial paper at the request of the company. There are very specific actions being taken to ensure debts are taken care of and after their current projects are completed and implemented, the expectation is that some of the debts should decline. In the meantime, it is important to keep an eye on the allocation of their cash flows and how they control their debts. More items to consider are investments that are made to comply with imposed regulations. As mentioned previously, as CO2 emissions gain the attention of politicians, it will affect the operations of companies like SO. Swings in weather are generally good for power companies since colder days or hotter days require the use of either a heater or air conditioning. However, major disasters can have a drastic effect on SO (note the location of the nuclear power plant on the coast). Finally, I mentioned interest rates assisting or hurting their ability to pay off debts, this trickles down to the bottom line and expect EPS to be effected by the rise in interest rates that may come within the next year. Should I Buy It? (click to enlarge) The stock currently has an attractive dividend yield of 4.03% and a PE ratio of 21.4. Currently there are 2 analysts that rate Southern Co. as a buy, 4 analysts rate it a sell, and 8 rate it a hold. A look at the charts from 2014 makes it seem a bit rich for the typical growth of a utility company; however, expanding back to 2010 and before yields more information. A long, drawn out correction from 2012-2014 has given the stock room to grow in the near-term. Southern Co. has been reaching new all-time highs on a regular basis and is trading above both 50 and 200-day SMAs. The future growth will most likely not happen as quickly as the last year. In fact, the stock is due for a correction. While it is currently a bit pricey, the revenue growth has shown superior growth to the industry average of 5.8%. SO is sitting at 6.4%, and as a long-term growth strategy, this could be a promising company to hold for years. The future earnings potential are dependent upon a number of factors mentioned previously and since prices are regulated by the FERC, retail rates may be adjusted as necessary to accommodate the current economic climate. Earnings are due to be reported on February 4, 2015 and this should give a good indicator of where the company will go from here. Regardless of the earnings results, this stock is a wait and see in the short term, but I will buy it for the long term. In the event of negative earnings press, I will wait until after the stock has declined and shown support multiple times before purchasing it. In the event of an earnings beat, I may wait a bit longer until a reasonable correction has occurred.

Southern Company Retains Appeal For Long-Term Investors

Summary Southern Company’s near-term may remain overshadowed due to ongoing construction projects. Ongoing capital expenditures will fuel rate base and long-term earnings growth. Attractive dividend yield of 4.1% makes SO a good investment for dividend-seeking investors. Southern Company (NYSE: SO ) is one of the leading energy companies in the U.S. utility sector. The company’s solid fundamental outlook is supported by its accelerated capital expenditures for several energy projects. In the near term, the company’s stock price can come under pressure due to its risk in delay and cost overruns for its ongoing projects, Kemper and Vogtle. But in the long run, once these projects are completed, they will help the company grow its rate base and fuel earnings growth. Also, as the company’s capital expenditures have been fueling its EPS growth, it will also fuel dividend growth for the company in the future. Currently, the stock has a dividend yield of 4.1%, which makes it attractive for dividend investors. Also, the low treasury yield environment will support the utility sector and SO’s performance in 2015. The following graph shows the low U.S. 10-year treasury yield. (click to enlarge) Source: Yahoo Finance Investors Have a Secure Long-Term with SO The company has been making capital expenditures to strengthen its electricity generation portfolio. Capital expenditures, which the company is making, are focused towards regulated operations, which will provide stability to its cash flows and earnings. The capital expenditures will also fuel long-term earnings growth for the company. As far as SO’s 582MW Kemper project is concerned, the project has been subjected to ongoing cost revisions and delays, and the issues of delays and cost overruns still prevail. As per the revised estimates, the project’s total cost will now reach $6.1 billion, an increase of $330 million as compared to previous estimates. However, the project is near completion and is expected to be completed by the end of 1H’15. In addition, the company is in the process of building two new nuclear power plants, Vogtle 3 and 4, with a power generation capacity of 2,200MW . These nuclear projects were previously estimated to be in running condition by the end of 2017 or 2018, but as per recent revisions, these projects are also expected to face operational delays. The Vogtle project is expected to experience a one-year delay and cost an additional $730 million to the company. Owing to these ongoing delays and expected cost increases, I believe the project will remain an overhang on its stock price performance in the near term. But in the long run, these projects will uplift SO’s production capacity and optimize its generational portfolio, which will help grow its rate base and earnings. In addition to these power generation projects, the company is bidding on the growth potentials of solar energy projects. SO is building a 131MW solar farm in Georgia, which is expected to be operational in 2016. The value of building this farm lies in generating healthy earnings growth for the company, by selling generated electricity to corporations through long-term power purchase contracts. Moreover, the company’s subsidiary Southern Power has accelerated acquisitions to improve the overall power generation capacity and to fuel its long-term earnings base growth. Southern Power won a bid for 100MW of solar projects in Georgia, and the subsidiary acquired the 150MW Solar Gen2 and 50MW Macho Spring solar facility. The company’s robust capital expenditures for future years will add to its rate base and long-term earnings growth. The company has plans to make capital expenditures of $17.4 billion from 2014-2016. The following chart shows the company’s expected capital expenditures for future. (click to enlarge) Source: Company’s Quarterly Earnings Report The company’s efforts to expand and strengthen its electricity generation portfolio will portend well for its long-term operational performance, and the capital expenditures will fuel its long-term earnings growth. Analysts are expecting a decent next five-year earnings growth rate of 3.63% for the company. Rewarding Investors SO has a strong history of rewarding its shareholders through healthy dividend payments. The company has a solid cash flow base to support its ongoing dividend increases. SO has recently announced a quarterly dividend payment of 52.50 cents . Currently, SO offers a high dividend yield of 4.10% , which is well covered by its cash flows, as indicated by the company’s strong dividend coverage ratio (Operating cash flows/ Annual Dividends) below. Based on the growth potentials of ongoing capital expenditures and large scale dependence on regulated operations, SO’s cash flow base will continue to grow at a decent pace. And owing to the company’s secure cash flow base, I believe SO’s dividends are secure and sustainable in the long run. The following table shows the company’s healthy dividend per share, dividend coverage and dividend payout ratio in the past three years, and for 2014 and 2015, based on estimates. Dividend Per Share Dividend Payout Ratio Dividend Coverage 2011 $1.87 73% 1.4x 2012 $1.94 73% 1.4x 2013 $2.01 75% 1.3x 2014(NYSE: E ) $2.10 74% 1.3x 2015( E ) $2.17 74% 1.3x Source: Company’s Annual Reports and Equity Watch Estimates Risks The company’s earnings growth faces risks of regulatory restrictions at the federal or state level, and an increase in environmental expenditure as directed by the EPA. Also, an increase in interest rates poses a risk to the stock price. Moreover, economic weaknesses in SO’s service territory are causing lower demand growth. Significant cost increases and delays due to the construction of Kemper and Vogtle plants, and unfavorable weather are key risks to the company’s future stock price performance. Conclusion The company’s near-term may remain overshadowed due to ongoing construction projects, but in the long run, as the construction projects will be completed and its generational portfolio will improve, its operational performance and stock price will be positively affected. The ongoing capital expenditures will fuel its rate base and long-term earnings growth. And as the company has significant regulated operations, it will portend well for its earnings and cash flows stability. Also, an attractive dividend yield of 4.1% makes it a good investment for dividend-seeking investors. Due to the aforementioned factors, I remain bullish on this stock.