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Over the past month the Utility Sector (NYSEARCA:XLU) has been selling off. This has provided an excellent opportunity to investigate Utilities for investment purposes. Southern Company (NYSE:SO) is one company utility worth considering.

Southern Company 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. Southern Company brands are known for energy innovation, excellent customer service, high reliability and retail electric prices that are below the national average.

There are many advantages to adding Utilities to your portfolio. Two main advantages include Lower volatility and high dividends. So, if the market is getting unpredictable or "frothy", a well picked Utility can add some stability to your portfolio while paying a solid dividend. Currently, Southern Company has a beta of 0.25 and a yield of 4.49%.

Using the analysis below, I will analyze the past four years of Southern Companys performance. I will look at Southern Company's past profitability, debt and capital, and operating efficiency and free cash. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $2.040 billion
  • Net income 2011 = $2.268 billion
  • Net income 2012 = $2.415 billion.
  • Net income 2013 TTM = $2.128 billion.

Over the past co years Southern Company's net profits have increased from $2.040 billion in 2010 to $2.128 billion in 2012. This represents a 4.31% increase.

  • Operating income 2010 = $3.802 billion.
  • Operating income 2011 = $4.231 billion.
  • Operating income 2012 = $4.463 billion.
  • Operating income 2013 TTM = $4.022 billion.

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past four years, the company's operating income has increased from $3.802 billion to $4.022 billion. This represents an increase of 5.79%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $2.040 billion
    • Net income 2011 = $2.268 billion
    • Net income 2012 = $2.415 billion.
    • Net income 2013 TTM = $2.128 billion.
  • Total asset growth

    • Total assets 2010 = $55.032 billion.
    • Total assets 2011 = $59.267 billion.
    • Total assets 2012 = $63.149 billion.
    • Total assets 2013 TTM = $63.274 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 3.71%.
    • Return on assets 2011 = 3.83%
    • Return on assets 2012 = 3.82%.
    • Return on assets 2013 TTM = 3.36%.

Over the past four years, Southern Company's ROA has decreased from 3.71%% in 2009 to 3.36% in 2013 TTM. This indicates that the company is making slightly less on its assets than it did in 2010.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2009

  • Operating income 2010 = $3.802 million.
  • Net income 2010 = $2.040 billion

2010

  • Operating income 2011 = $4.231 million.
  • Net income 2011 = $2.268 billion

2011

  • Operating income 2012 = $4.463 million.
  • Net income 2012 = $2.415 billion.

2012

  • Operating income 2013 TTM = $4.022 million.
  • Net income 2013 TTM = $2.128 billion.

Over the past four years, the operating income has been higher than the net income in all years except 1. This indicates that Southern Company is not artificially creating profits by accounting anomalies such as inflation of inventory

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $55.032 billion.
    • Total assets 2011 = $59.267 billion.
    • Total assets 2012 = $63.149 billion.
    • Total assets 2013 TTM = $63.274 billion.
    • Equals and increase of $8.242 billion
  • Total liabilities

    • Total liabilities 2010 = $38.123 billion.
    • Total liabilities 2011 = $40.982 billion.
    • Total liabilities 2012 = $44.145 billion.
    • Total liabilities 2013 TTM = $45.237 billion.
    • Equals and increase of $7.114 billion

Over the past four years, the company's total assets increased by $8.242 billion, while the total liabilities have increased by $7.114 billion. This indicates that Southern Company is not financing debt to purchase its assets.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $5.883 billion.
    • Current assets 2011 = $6.272 billion.
    • Current assets 2012 = $6.162 billion.
    • Current assets 2013 TTM = $5.932 billion.
  • Current liabilities

    • Current liabilities 2010 = $6.472 billion.
    • Current liabilities 2011 = $6.577 billion
    • Current liabilities 2012 = $7.014 billion.
    • Current liabilities 2013 TTM = $6.439 billion.
  • Current ratio 2009 = 0.91
  • Current ratio 2010 = 0.95
  • Current ratio 2011 = 0.88.
  • Current ratio 2012 = 0.92.

Over the past four years, Southern Company's current ratio has remained relatively the same. As the ratio is about the same but is under 1, this indicates that the company would not be able to pay off its obligations if they came due at this point.

Common Shares Outstanding

  • 2010 shares outstanding = 837 million.
  • 2011 shares outstanding = 864 million.
  • 2012 shares outstanding = 879 million.
  • 2013 TTM shares outstanding = 875 million.

Over the past four years, the number of company shares has slightly increased. The amount of common shares has increased from 837 million in 2009 to 875 million in 2013 TTM. This signifies a 4.54% increase in the past 4 years.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $10.194 billion / $17.456 billion = 58.40%.
  • Gross margin 2011 = $10.787 billion / $17.657 billion = 61.09%.
  • Gross margin 2012 = $10.936 billion / $16.537 billion = 66.13%.
  • Gross margin 2013 TTM = $11.077 billion / $16.830 billion = 65.82%.

Over the past four years, Southern Company's gross margin has increased. The ratio has increased from 58.40% in 2009 to 65.82% in 2013 TTM. As the margin has increased, this indicates that Southern Company overall has been more efficient.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $17.456 billion.
    • Revenue 2011 = $17.657 billion.
    • Revenue 2012 = $16.537 billion.
    • Revenue 2013 TTM = $16.830 billion.
    • Equals an decrease of 3.59%.
  • Total Asset growth

    • Total assets 2010 = $55.032 billion.
    • Total assets 2011 = $59.267 billion.
    • Total assets 2012 = $63.149 billion.
    • Total assets 2013 TTM = $63.274 billion.
    • Equals an increase of 14.98%.

As the revenue growth has decreased by 3.59% while the assets have decreased by 14.98%, this indicates that the company has been generating less money with more assets, effectively becoming less efficient at creating revenues.

Free Cash Flow = Operating Cash Flow - Capital Expenditure

Over the past four years we can see that Southern Company has posted positive free cash each year except 2009. In a business that is looking to spend a lot of cash in upgrades to increase efficiency and keep up with increasing environmental standards this is a positive. This indicates that Southern Company is growing at a pace that it can support, without adding additional risk to the company and ultimately the shareholder.

  • 2010 - $3.991 billion - $4.086 billion = $(95) million
  • 2011 - $5.903 billion - $4.525 billion = $1.378 billion
  • 2012 - $4.898 billion - $4.809 billion = $89 million
  • 2013 TTM - $5.067 billion - $4.775 billion = $292 million

Based on the fundamentals above, Southern Company is showing very good results. Over the past four years, the company is showing strength in all areas except for the TL&A ratio and the ROA. The TL&A ratio indicates that the company's revenues have decreased over the past four years (on a yearly basis) while the assets have increased. The ROA indicates that Southern Company's net income is not rising as fast as the company's assets. These are two key points to watch moving forward. Based on the above criteria, Southern Company is showing that it is a solid company from a fundamental point of view.

Analysts' Estimates

Analysts at MSN Money are estimating an EPS for FY 2013 at $2.75 while moderate growth is expected to continue into 2014 as EPS estimates increase to $2.88. Bloomberg Businessweek supports this idea as they expect the company's revenues to be around $17.3 billion for FY 2013 and increase to $17.8 billion for FY 2014.

Price Targets

  • Finviz has a price target for Southern Company at $47.96.
  • Recently, Barclays gave the company an "Equal Weight" rating. They increased their target to $51.00.

Over the past five of years, the average P/E ratio for Southern Company has been 15.80. As the company has averaged a P/E of 15.80 and is expected to have an EPS in 2014 of approximately $2.88, this would give the stock a price target of around $45.50.

Over the past month or so the utility sector has been showing weakness compared to the market. The above analysis reveals that Southern Company is a fundamentally sound utility. Analysts at MSN Money and Bloomberg predict growth for the company over the next couple of years. Analysts predict a stock target price between $47.96 and $51.00 over next year. Currently, Southern Company has a very attractive yield of 4.49%. Even though the stock price has declined over the past month, Southern Company proven itself to be fundamentally sound. If patience is used and price begins to form a bottom and ultimately break to the upside, it could prove to be an excellent opportunity.

Source: Southern Company: 4.49% Yield With Growth Potential