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Southern Company: 4.8% Yield And Decades Of Dividends

Summary Investors can expect 7.8% to 8.8% total returns from Southern Company. The company has an exceptionally long dividend history. Is Southern Company over indebted? Southern Company (NYSE: SO ) is a large cap utility that supplies electricity to 4.5 million customers in Georgia, Alabama, Mississippi, and Florida. What stands out about Southern Company is its stability and consistency. The company has paid dividends every quarter since 1948 . In addition, the company has not reduced its dividend as far back as I can find. My records stopped in 1982 – it’s been at least that long since the company has been forced to reduce its dividend payments. The image below shows its more recent dividend history: (click to enlarge) These are not small dividends either. Southern Company currently has a dividend yield of 4.8%. The company’s long history of dividend payments makes it a member of the Dividend Achievers Index. Click here to download a list of all 238 members of the Dividend Achievers Index . It’s not just Southern Company’s dividends that are stable. The company’s stock price exhibits low volatility as well. Southern Company’s 10-year average stock price standard deviation is just 16.9%. For comparison, the only other large cap stocks I’ve found with lower standard deviations over the last decade are Johnson & Johnson (NYSE: JNJ ) and Consolidated Edison (NYSE: ED ). If you are interested in high yields and stability with inflation-beating growth, then Southern Company makes a compelling investment to consider further. Business Overview Southern Company generates over 90% of its earnings from the heavily regulated utilities industry. The remaining income comes from competitive wholesale electricity sales. The image below shows the company’s current and “under-construction” portfolio of power assets. The company’s entire portfolio is spread across the Southern half of the United States – hence the name “Southern Company.” (click to enlarge) Growth Prospects Let’s be very clear: Southern Company is not a fast grower . The company has compounded earnings per share at 3.0% a year over the last decade. Dividends per share have grown slightly faster at 3.9% a year. The company currently has a payout ratio of 80%. As a result of Southern Company’s high payout ratio, investors should expect dividend growth in line with earnings per share growth going forward. One way that businesses with stable cash flows boost growth is through share repurchases. Reducing the number of shares increases earnings on a per share basis. Unfortunately, Southern Company regularly raises capital through share issuances . This dilutes current shareholder ownership and reduces earnings per share (all other things being equal). Over the last decade, Southern Company has increased its share count at 2.3% a year. Had Southern Company been able to finance its growth without increasing share count, its earnings per share growth rate would have been a more respectable 5.3% a year over the last decade. Fortunately, management does not plan to fund its current growth plans with more share issuances. The company’s financing plan ( in the image below ) aims to rely exclusively on debt through 2017. Simply halting share issuances will go a long way toward improving Southern Company’s growth. (click to enlarge) Southern Company showed earnings per share growth of 1.5% in its most recent quarter . Southern Company is expecting earnings per share growth of between 3% and 4% in fiscal 2015. This is also in line with management’s long-term earnings per share growth goals. Given the company’s history, growth of 3% to 4% a year seems likely. This earnings per per share growth, combined with the company’s current 4.8% dividend yield, gives investors in Southern Company expected returns of 7.8% to 8.8% a year. Current Troubling Issues Southern Company has experienced 2 recent setbacks , which have hurt earnings in the short-run. First, the company is building a coal gasification plant in Mississippi. The plant was originally expected to go online in May of 2014 but has been stalled due to ongoing construction delays. The plant is now expected to go online during the first half of 2016. This 2-year delay has already cost Southern Company over $1 billion. Secondly, Southern Company is also experiencing delays for the construction of its Vogtle nuclear plants. The completion date has already been delayed 18 months . Every month of delay will cost Southern Company an extra $40 million. The full 18-month delay is expected to cost over $700 million While troubling, these delays to not reflect long-term threats to Southern Company’s dominant position in the electric utility markets which it serves. Utilities form natural monopolies. They are highly regulated as well. These two factors make utility businesses in general – and Southern Company in particular – highly stable. Balance Sheet and Recessions Southern Company is heavily indebted, as most utilities are. The company has around $25 billion in debt. In addition, the company has another $1.2 billion in unfunded pension liabilities. On top of that, Southern Company has $1.3 billion in preferred stock as well. The company has $220 million in cash. The company has annual interest expenses and preferred dividends of around $870 million a year. Annual operating income is around $4 billion. While Southern Company has a large debt load, the company is not at risk of defaulting thanks to its large, stable cash flows. The company’s performance over the Great Recession of 2007 to 2009 gives an example of consistency of Southern Company’s earnings: 2007 earnings per share of $2.28 2008 earnings per share of $2.25 2009 earnings per share of $2.32 2010 earnings per share of $2.36 Final Thoughts It is very unlikely that Southern Company generates double-digit returns for investors going forward. Still, total returns of 7.8% to 8.8% a year, coupled with low risk and low volatility, make Southern Company an interesting choice for investors needing both safety and current income. The company’s high 4.8% dividend yield and extremely low stock price deviation give it an above-average rank among dividend stocks with long histories using The 8 Rules of Dividend Investing. Southern Company has a price-to-earnings ratio of 16.8 using adjusted earnings. The company is likely trading around fair value at this time given its decent total return prospects and high scores for stability. 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. I have no business relationship with any company whose stock is mentioned in this article.

My Favorite Ratios – Part 1

When the dog bites, when the bee stings, when I’m feeling sad, I simply remember my favorite things, and then I don’t feel so bad!” -The Sound of Music When Julie Andrews sings about bright copper kettles and whiskers on kittens, she’s trying to calm her charges during a violent thunderstorm. When the market gets turbulent and frightening, I turn to my favorite indicators of financial performance. I’ve noted before how – sooner or later – stock market performance has to come back to fundamentals. There has to be a way to evaluate how well a company is performing, whether it’s providing insurance or selling tractors. Most analysts use financial ratios. But there are literally hundreds of these, evaluating credit quality, efficiency, growth, even management’s language in their quarterly conference calls. Which ratios should we choose? I like to look at financial disclosures as a tripod, the three legs being the income statement, the balance sheet, and the statement of cash flows. The most basic analysis looks at earnings per share and (perhaps) sales as an indicator of how a firm is doing. But management sometimes manages those numbers. An investor once told of visiting a corporate loading dock on September 30th at lunch time. He asked the shipping manager how the quarter had gone. The manager looked at his watch and said he couldn’t tell, the quarter was only half over. Principal Financial Statements. Source: Douglas Tengdin But it’s hard to manipulate the entire financial picture. So I look at ratios that evaluate how these three principal disclosures interact. The most basic relationship is that between income and the balance sheet. This indicates how efficiently management is utilizing the assets that are under its control – how effective they are at turning an investor’s cash into earnings. So I use Return on Invested Capital – net earnings divided by the book value of equity and the market value of debt. I like to include debt in this analysis, because that doesn’t incent management to borrow money just to boost their return on equity. Second, I evaluate the ratio of cash from operations – part of the Statement of Cash Flows – to net income. This gives me, in broad terms, an indication of how much of the corporation’s earnings are based on cash receipts, versus accruals of one sort or another. Warren Buffett has said that cash is to a business as oxygen is to an individual. This relationship can give us a sense whether a company might need CPR soon. Finally, I examine the ratio of cash delivered to shareholders – both through dividends and net share buybacks – to the market value of equity. This ratio is the Shareholder Yield . This gives analysts a sense of how committed management is to returning cash to the company’s owners. We may be uncertain about many things that companies may disclose, but one thing we can be sure of is how much they pay us to hold their stock. And stock buybacks are important, as they can be a more tax-efficient way to return money to shareholders. Each of these numbers is independent of a company’s size. A mega-cap like GE (NYSE: GE ) with billions in capital is on the same footing as a 1000-person firm like Box. But taken together, they measure how efficiently a company is at generating cash from their businesses and how willing they are to send some of it to their investors. These indicators aren’t perfect. They are biased towards established companies that are in the process of paying shareholders – rather than taking in money and using it to grow, or even just redeploying their own internally-generated resources. And it’s important to look at footnotes as well, especially when accounting standards are changing. But when things go wrong, it’s comforting to know that a company’s management team is committed to distributing cash to me quarter after quarter. When a firm can do this from its own efficient operations, this can become an anchor of value in a storm of market turbulence. So, to paraphrase Maria (from The Sound of Music ), when the economy slows, when interest rates rise, when investors are feeling sad, I simply remember my favorite ratios, and – hopefully – my investments won’t do so bad.

Baby Boomers: Cash Is NOT Trash

Summary Record low cash allocations exist in the market. Investors should use this as a contrary indicator and raise cash. Think safety first in a market this extended. With persistent, historically low interest rates, it’s no wonder people think ‘cash is trash’. Cash equivalents (Money market, U.S. government T-Bills, etc.) essentially yield nothing so it seems like a very logical place to avoid as one approaches, or has recently entered, retirement. But that’s exactly where we think you should be overweighting. It runs so contrary to most investors, which is precisely why it’s so actionable. Little thought exists to what happens if the stock market sells off and remains low for a long period of time. The only fear evident in the current environment is being underinvested and missing out on further gains (evident last week when the VIX hit 10.88, the third lowest reading since before the financial crisis). The nest egg many baby boomers have toiled for and nurtured is very vulnerable if positioned too aggressively, whether in a reach for yield scenario (junk-rated debt, MLPs, REITs, BDCs) or simply being fully invested, possibly even on margin, to buy solid ‘blue chips’. There is no shortage of scary commercials by asset managers insinuating that you’ll run out of money in retirement unless you’re fully invested (with them). Prudential’s (NYSE: PRU ) commercials come to mind (“How old is the oldest person you’ve ever known?)”. But a scarier one might feature someone trying to re-enter the work force in a few years whose portfolio’s value has been cut in half. Contrary to popular opinion, the stock market’s function is not to provide you with an income stream to live off of . Cash is not Trash But first, is there really an aversion to holding cash? Unequivocally, yes. Here’s two data points that bear out the aversion to cash: 1) The data we’ve seen in mutual funds corroborates this. There have been record lows in cash on a sustained basis with another new all-time low in the mutual fund cash ratio of 3.2% for June. This low demand for cash is remarkable and is one of several factors we believe portends a steep market selloff in the not too distant future. While it’s true that cash levels have been low for years now, we think a turn is imminent. A worrisome chart we came across from Acting Man illustrates the sentiment very well: (click to enlarge) In the chart above (we tweaked it a bit – we added the orange line, the yellow and pink shaded zones and the boxed labels with red arrows and try and put into context the severity of the current complacency) that for the entire period of the 1980s and most of the 90s (until the dotcom boom kicked in), cash levels were dramatically higher, ranging between 7%-12% versus today’s 3.2%. In fact, the ratio during the entire yellow-shaded range was also markedly higher than the 6% we saw during the panic at the March 2009 lows . To put things into perspective, the U.S. market capitalization was around $2 trillion near the beginning of the yellow shaded area and is now almost $25 trillion, according to Bloomberg . If cash levels even begin to return to these former (one might say ‘responsible’) levels, given the amount of money currently invested in our stock markets, there will be a severe shock to our economy and way of life. 2) We also see this by looking at retail accounts, where the money market ratio (assets in money market funds and not invested in the stock market) is a measly 2.47%, which is just off the all-time low of 2.45% earlier this year. Again, people are fully invested and probably reaching for yield. There has been an intensifying decline in the money market ratio over the last 4 years built on the dual pillars of extreme complacency and continued optimism. Many boomer retail accounts have been heavily invested in three sectors that have, unfortunately, probably all peaked – REITs (NYSEARCA: VNQ ), utilities (NYSEARCA: XLU ) and energy MLPs (NYSEARCA: AMLP ). We’ve been amazed at the amount of follow-on equity offerings (often overnight or ‘spot secondaries’) for energy stocks, often MLPs, over the last few years. This is a key source of financing for MLPs. We’ve already witnessed the carnage for high-yield bonds of the energy sector with the Shale collapse – when the appetite on the institutional side really disappears for their junk debt, these companies will be scrambling for capital even more than they are now. On the retail side, the retail investor’s powder is running dry, as it appears to be now given the above ratios, and the selling pressure should persist, especially as natural gas and crude oil should continue their slides. We see WTI getting back to the low $30s. Back to the Future Below is a great chart of the Dow Jones Industrial Average going back to 1900 (we added some data to try and give some perspective). In the early 1980s, everyone was in cash (and avoiding the stock market) when 3-month T-Bill rates were over 16%. The stock market had essentially gone sideways for about 17 years (1965-1982), investors were exhausted from the whipsaws and economic conditions (inflation) were terrible. People just wanted to be in cash. “Why risk it in a stock market going nowhere when we can get these high Treasury yields”? Eyeballing the chart above, mutual fund cash levels then were roughly 11% (versus 3% today). Completely logical thinking but also completely wrong. The market ascended around 14-fold over the next 17 years. (click to enlarge) Below is some monthly data from the St. Louis Fed on 3-month U.S. Treasury bill yields: A logical investor in 1982, seeing this data set above and the long-term Dow Jones chart, probably followed the Flock of Seagulls hit from that year and ‘Ran so far away…’ from the stock market. It is really amazing to see these numbers from the early 1980s, especially when compared to today’s yields: A logical investor in 2015, looking at the last two years of T-Bill rate data above, might say, “why would I put my money into this instrument that pays [essentially] nothing, when I can put it into the stock market that has been on fire for 6 straight years. There’s plenty of individual securities paying high single-digit returns, and the overall market yield is about 2% (which is 2% more than nothing) – I need the yield to live off of.” Sounds perfectly logical, but we think many investors are ignoring the risk side of the equation and only looking at the return side. A measly 2% market yield is unacceptable for a tremendous amount of market risk, in our opinion. We think these miniscule T-bill (or money market) rates are exactly where investors should be going at this point . From page 445 of Robert Prechter’s book , Conquer the Crash, from October 1998 through March 2008, the S&P 500 returned 3.84% while investments in U.S. T-Bills returned 30.22%. Today’s investors should be listening to ‘Timber’ by Pitbull and the message it portends. Safety with Benefits Here are three benefits for raising cash – 1) your capital will be preserved (at a time when markets look very frothy), 2) you have the potential for an increase in purchasing power if the deflation we’re seeing around the world hits here, which seems more likely than not and 3) you’ll reap the benefit of higher rates by rolling over whatever ultra-short term investments you’re in (T-Bills, money market funds, etc) and especially any floating rate securities the money market fund has. We want ‘cash’ in a money market fund that will hold up through a crisis or a sustained interest rate rise. Don’t forget, money market funds are portfolios of debt (shorter term and safer types, but debt nonetheless). You may even want to avoid a more traditional money market fund and opt for a lower yielding one that’s tilted towards very short-term Treasuries. But the government shutdown debacle in 2013 showed that there is risk involved in even that. ( Recall the yield on one-month T-Bills shot up from two basis points to sixteen in a week when there were very real worries of a default on short-dated T-bills). The dysfunction in Congress was serious enough that firms like BlackRock (NYSE: BLK ), JPMorgan (NYSE: JPM ) and Fidelity were scrambling to sell or reshuffle their securities (T-bills in the money market funds) that were most likely to be impacted by a default. So it might pay to ‘diversify’ with a couple different money market funds (preferably held at different brokerage accounts) if you have that option. There’s even some ETFs that try to achieve similar safety. Charles Schwab (NYSE: SCHW ) has the Short-Term U.S. Treasury ETF (NYSEARCA: SCHO ) which we prefer to Vanguard’s Short-Term Bond fund (NYSEARCA: BSV ) which is slightly longer in maturity and has commercial paper. Summing it Up Again, we like the idea of raising cash. Cash in a bank, referred to as ‘free cash’ at some institutions. Now if your assets are in a deferred retirement account, taking the money out would probably incur a tax liability (and possible penalties). So if you want to avoid that, liquidating perhaps one of the funds you have but keep the sale proceeds in the sweep account (presumably some type of money market fund). As long as it stays in the account, there won’t be any distribution so you’ll avoid tax or penalty as a result of that. If you have a defined contribution plan like a 401(k), you should have a few choices and look closely at the ones with the lowest yield. Lower yield money markets will probably have more of a short-term treasury component and less repurchase agreements, commercial paper and ‘asset’-backed securities which could become problematic in a crisis and certainly aren’t worth the risk for potentially another fraction of a percent in interest. By taking a portion of your money, if interest rates rise, you will benefit by rolling into higher and higher rates (given the short duration). We like the idea of putting at least a quarter of your portfolio into cash (or an equivalent) given these market levels. If you are adamant about not selling anything outright, one option could be simply taking the dividends you are getting in your funds and not reinvesting them – instead take them as cash and they’ll automatically go into the sweep vehicle or money market. If interest rates rise, you’ll benefit if you own ultra-short investments such as T-Bills since you’ll have the flexibility to roll over the investments as rates go higher. It appears more than likely that rates in the U.S. have bottomed and is being confirmed by the 3-month LIBOR. This should usher in a new era of rate increases worldwide. Raising cash on one-quarter of your portfolio plus hedging another quarter of your portfolio with the long-dated put option (an idea we highlighted in last week’s article ) could effectively cut your portfolio’s risk by half for the next almost 2 ½ years. As we’ve said before, we think now is a time to think independently and play defense with your portfolio and we look forward to the future when we can ‘back up the truck’ when things really go on sale. But that time doesn’t appear to be any time soon. 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. Additional disclosure: I/we are not registered investment advisors and these ideas are not recommendations to buy or sell any specific security.