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I am bullish on The Southern Company (NYSE:SO) as it has a strong dividend yield of 4.5%, lowest payout ratio of 75% amongst its peers, high ROE of 12% and high expected growth rate of 5% per year for the next five years. Also, the company has delivered strong financial results in the past and experienced margins expansion in the most recent quarter.

SO is among the leading utility companies of the U.S. with 4.4 million customers and is a major source of energy in southeastern U.S. The company has approximately 35,000 MW of regulated and more than 8,000 MW of wholesale generation capacity. SO operates four utilities and its two largest subsidiaries; Georgia and Alabama Power account for 80% of total earnings.

The company has been delivering healthy financial results over the years. In the last five years SO has been able to grow its sales and earnings by approximately 4% per annum. In 3Q'12 SO reported quarterly revenue of $5.05 billion. SO registered third-quarter EPS of $1.11, compared with $1.07 in 3Q 2011. The increase in quarterly earnings was mainly driven by rate relief, which had a positive impact of $0.09 on the EPS. Also, the company experienced margins expansion in 3Q'12.

3Q'11

3Q'12

Gross Margin

61%

66%

Operating Margin

30.5%

34.5%

Net Margin

17.2%

19.6%

Source: Quarterly Report (pdf)

SO reaffirmed 2012 earnings guidance of $2.58-$2.70, which is in accordance to its earnings growth target of 5%-7%. Analysts are expecting 2012 EPS of $2.63. Also, analysts are expecting a healthy growth rate of 5% per year for the next five years.

The company has been increasing its dividends over the years and currently offers a healthy dividend yield of 4.5%. The payout ratio for SO has remained in range of 70% - 76% in the last five years. I believe dividends offered by the company are sustainable given its strong dividend history (258 consecutive quarterly dividends) and healthy CFO and dividend relationship over the years.

2008

2009

2010

2011

Dividend (Annual)

$1.66

$1.73

$1.80

$1.87

Payout Ratio

70.5%

75.5%

76%

73%

Source: Annual Reports
(click to enlarge)


Source: Annual Reports

SO has a debt-to-equity ratio of 110% and interest coverage of 4.8x. Debt to equity seems to be on the lower side as compared with its peer's average of 150%. Also, SO holds an 'A' credit rating by Fitch.

Coal to Gas Switch
(click to enlarge)
Source: Investors Presentation (pdf)

Natural gas prices remained low in 2012 and bottomed in April 2012. To take advantage of lower natural gas prices the company increased power generation from gas whereas coal-based power generation was reduced significantly as displayed in the table above. Current natural gas price is $3.28 mmBtu. It is expected that as natural gas prices decline, U.S. utilities will burn more natural gas for power generation.

Conclusion
SO is a great company with a strong past financial performance. I believe SO offers an attractive investment opportunity for the dividend-seeking investors. The company has a high dividend yield of 4.5% and the lowest payout ratio of 75%. Also, the company has the highest ROE of 12% among its peers as shown below in the table. Analysts are expecting a growth rate of 5% per year for the next five years, which is on the higher end compared with its competitors.

SO

CenterPoint Energy, Inc. (NYSE:CNP)

Duke Energy Corporation (NYSE:DUK)

Edison International (NYSE:EIX)

Forward P/E

15.6x

15.5x

14.8x

14.3x

PEG

3.3

2.9

5

15

Five years growth rate

5%

5.5%

3%

1%

P/B

2x

2x

1.1x

1.5x

ROE

12%

9%

5%

-2.8%

D/E

110%

230%

95%

125%

Dividend Yield

4.5%

4.1%

4.7%

2.9%

Payout Ratio

75%

87%

95%

-

Source: Yahoofinance.com

Risks
SO is exposed to changes in regulations, unfavorable weather conditions and economic slowdown.

Source: Why You Should Buy The Southern Company: A Utility Stalwart