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Construction cost overruns will remain the headline grabbers that keeps share prices down, but as the saying goes, “This too shall pass”. Total returns will continue in the 9% to 11% range annually, and should be acceptable to most utility investors. AGL Resources acquisition will cement Southern Company as a premier electric and natural gas utility, with the prospects of future financial engineering. For long-term utility investors, there is a lot to like about Southern Company (NYSE: SO ). Southern Co is a worthy example of investor uncertainty creating opportunistic share prices. There is much to dislike about SO, but as the issues become resolved over the next few years, current investors will be amply rewarded. Starting with the negatives, investors have several issues working against the company. Over budget and behind schedule, the Kemper “clean coal” and Vogtle nuclear plants are viewed by some to be the firm’s twin albatrosses. Kemper is expected to be fully operational by mid-2016. Final rate decisions by the Mississippi Public Service Commission is expected in Dec of this year. As of this month, the plant has been producing power for a year. More information on what needs to be done for project completion can be found in SO’s latest investor presentation pages 12 to 16. As discussed in a previous SA article from last May, Moody’s downgraded Mississippi Power based on the financial stress of Kemper. In Aug, Mississippi Power senior unsecured rating was downgraded to Baa2 from Baa1 and its preferred stock rating to Ba1 from Baa3, and the outlook was termed “Negative”. These represent a bond rating still in the investment grade category but a preferred downgrade into non-investment grade. Southern Company’s credit rating remained unchanged and its outlook is “Stable”. Mississippi Power lost a 15% Kemper equity partner in May who requested their initial deposit back and was ordered to refund to customers a previously approved rate increase. Combined, these amount to a total of almost $650 million ($300 million and $350 million, respectively). To make up this shortfall, Mississippi Power has received a short-term loan from its mothership SO for $300 million and has received a $152 million rate increase approval in Aug. Vogtle construction will be a bit more drawn out as the project’s completion date is now 2019 and 2020, leaving several more years of headline-grabbing events. Some cost overruns are being challenged in court between SO and its contractors. Investors with sufficient grey hair to remember the 1970s and 1980s should also remember the cost overruns that plagued those years of the nuclear power plant buildout. From the publication , The Nuclear Energy Option, by Professor Emeritus Bernard L. Cohen, University of Pittsburgh: For example, Commonwealth Edison, the utility serving the Chicago area, completed its Dresden nuclear plants in 1970-71 for $146/kW, its Quad Cities plants in 1973 for $164/kW, and its Zion plants in 1973-74 for $280/kW. But its LaSalle nuclear plants completed in 1982-84 cost $1,160/kW, and its Byron and Braidwood plants completed in 1985-87 cost $1880/kW – a 13-fold increase over the 17-year period. Northeast Utilities completed its Millstone 1,2, and 3 nuclear plants, respectively, for $153/kW in 1971, $487/kW in 1975, and $3,326/kW in 1986, a 22-fold increase in 15 years. Duke Power, widely considered to be one of the most efficient utilities in the nation in handling nuclear technology, finished construction on its Oconee plants in 1973-74 for $181/kW, on its McGuire plants in 1981-84 for $848/kW, and on its Catauba plants in 1985-87 for $1,703/kW, a nearly 10-fold increase in 14 years. Current estimates are for reactors #3 and #4 to cost upwards of $15 billion with Georgia Power’s share at $7.5 billion. Investors should not believe this is both the final cost calculation and the final in-service date, as both will increase over the next four years. However, these projects will eventually pass and will contribute to higher cash flows over time, as did the previous construction overruns and delays of the 70s and 80s. On the positive side, SO dividend offers a nice yield of 4.75% and is expected to match earnings growth at around 4%. This current yield is on the higher end of its historic year-end yield as offered by fastgraph.com. In addition, SO return on invested capital ROIC has been one of the better in the utility sector. ROPIC was reduced in 2014 due to construction cost overruns charges against earnings. The graphs below outlines SO’s 20-yr history of stock performance and ROIC. (click to enlarge) (click to enlarge) Of interest to investors is the acquisition of AGL Resources (NYSE: GAS ). Since the deal was announced on Aug 24th, SO stock has been flat, with the day-prior to the announcement share prices of $45.80. The $12 bil deal will be financed through $9 bill of permanent financing and $3 billion of equity raises between now and 2019. With a market cap of $40 billion, this amounts to a dilution of around 8% but management believes will boost earnings growth from 3% – 4% annually to 4% – 5%. With the Clean Air Act applying added pressure on coal-fired power producers in favor of natural gas plants, this move not only leap frogs SO into the number 1 spot for utility size, but it also diversifies SO’s income stream to include more natural gas regulated assets, such as distribution, pipelines and processing. It seems Duke Energy (NYSE: DUK ) is not far behind with its acquisition agreement involving Piedmont Natural Gas (NYSE: PNY ). Over the long-term, the GAS acquisition will be a good move by management and may eventually offer the prospect for a financial re-engineering via a MLP spinoff similar to other gas utilities. Investors should factor in the advantages of SO operating in one of the most favorable regulatory environments and even setbacks with the Kemper plant cost recovery should not dampen its overall relationship with regulators. SO share prices hit a double bottom on June 25th at $41.61 and on Sept 4th at $41.98. Share prices have not broken below $40 since Aug 2011. Technically, the outlook is positive as long as share prices don’t break support at $42 and then $40. MACD has been rising since crossing its trend line on July 20 and is still above its trend, albeit with a skinnier spread. Income investors may want to analyze Mississippi Power’s various preferred stock offerings. The most liquid is their $30 million-issue 5.25% Cumulative Preferred Depositary Shares (MP-D), with each share representing one-quarter shares of the underlying $100 par value issue with the same dividend. This creates a trading par value for MP-D of $25 a share and a dividend of $1.32 a year, with a high/low for the year of $27.02/$24.92. At a current price of $25.46, the preferred shares offer a 5.15% yield, but its volume is quite low at just 1200 shares a day average for the past 90 days. Other Mississippi Power’s preferred include a $2.6 million-issue 4.4% Cumulative Preferred (MPRWL) with a current yield of 4.8% and a price of $90.60, a $1.7 million-issue 4.6% Cumulative Preferred (MPRWP) with a current yield of 4.9%, and a $3.4 million-issue 4.72% Cumulative Preferred (OTC: MSPWP ) with a current yield of 4.7%. However, the last three stocks trade very infrequently and should be considered as illiquid stock holdings. For example, according to OTCmarkets.com, MSPWP has only traded 12 days during past year. While naysayers are having a field day with cost overruns on its construction projects and these topics will still make headlines for the foreseeable future, the underlying moves by management reflect optimism concerning their business. I expect a 4% to 6% share price appreciation coupled with a 4.75% yield and a 4% dividend growth rate for a total return of 9% to 11% annually. This is why I am still a buyer of Southern Company stock. Author’s Note: Please review disclosure in Author’s profile. Scalper1 News
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