Southern Company (SO) is one of the largest electric utilities in the U.S. SO services 4.4 million customers through its regulated subsidiaries Georgia Power, Alabama Power, Mississippi Power, and Gulf Power. SO also operates merchant power producer Southern Power. SO generates 43,000 MW of electricity, of which Southern Power represents 7,000 MW. Breakdown of utility customers is in line with other large regulated electric utilities at 42% residential, 36% commercial, and 22% industrial. 93% of EBITDA is generated from regulated activities and 7% from unregulated merchant power, and is also in line with SO peers.
Fourth-quarter earnings were recently announced and were higher than anticipated at $0.44 a share vs. $0.40 consensus. The call transcript can be found here. Earnings benefited from a reduction in operating and maintenance expenses. These cost savings offset a slight reduction in electric usage growth, due to warmer weather along with higher depreciation and interest expenses. For the year 2012, SO earned $2.68 per share, up from $2.57 in 2011 and comparable with consensus estimates of $2.67. Fuel-sourced generation is 45% natural gas, 36% coal, 17% nuclear, and 2% hydro. Like many electric utilities, SO is cutting back its coal-fueled generation in favor of natural gas. Coal-fueled generation has been reduced from 50% for 2011 to 32% during the fourth quarter of 2012.
Due to higher expenses, however, earnings estimates have been coming down. Current 2013 consensus is for EPS of $2.76, down from $2.81 last November, and consensus for 2014 is $2.92, also down from $2.97 last November. Management has forecast 2013 EPS between $2.68 and $2.80, with a midpoint of $2.74. The midpoint forecast would represent EPS growth of 2.4%year over year. In addition, management has reduced its high-end long-term growth rate from 7% to 6% while maintaining its low end range of 4%. As the EPA has pulled in its horns concerning regulating coal pollution, capital expenditures and return on investment for environmental upgrades have come down, prompting the slight reduction in growth rates.
One of the largest uncertainties is the construction of new nuclear generation at Vogel 3 and Vogel 4 in Georgia. While construction expenses are currently below original approved budgets, completion is a long way off and cost spikes are still possible. SO anticipates capital expenditure budgets of between $5.1 and $5.5 billion a year going out to 2016. This aggressive capex program is well-supported by EBITDA in excess of $5.7 billion and operating cash flow in excess of $4.2 billion. There appears to be little need for excessive equity raises over the next few years, with share counts anticipated to grow from 874 million outstanding currently to 884 million by 2015.
Dividends are anticipated to grow by 4% a year, continuing their history of consistent shareholder payouts. Payout ratios will remain around 74% as EPS growth matches dividend growth. Below is a comparison of SO with other large regulated electric utilities: Duke Energy (DUK), Excel Energy (XEL), American Electric Power (AEP), and SCANA (SCG).
Am Electric Power
2013 EPS e
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LT Growth Rate
Below are charts comparing SO to those stocks mentioned above:
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Southern Company has historically traded at a premium to its peers due to excellent management and responsive regulatory environments. The premium has been upward of 15% based on P/E ratios.
SO has several drivers of future EPS growth. These include expanding merchant power Southern Power outside its current geographical area of the Southeast. Management has expressed its desire to grow into the Texas market driven by an expanding natural gas presence and a growing transmission network to bring more power from rural to urban areas. If Vogel comes online in 2015 at or below budget, the added regulated margins will lift earnings a bit higher as well. Continuing excellent relationships with the local regulators will allow SO to generate returns on the higher end of the scale.
Broker's consensus rating is for a Hold on Southern Company based on price targets in the $46 to $51 range. Investors looking to add a high quality, regulated electric utility should keep an eye on SO and nibble on dips at or below $42 for both adequate income and reasonable long-term capital gains.
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