Southern Company: Debt Or Equity?

| About: Southern Company (SO)

Some income investors look to regulated electric utilities for dividend income and are willing to accept the risks to their principal that are associated with equity positions. Other income investors choose the debt issues of electric utilities for their stable interest payments and a high probability of principal repayment at maturity.

Southern Company (NYSE:SO) offers four different income opportunities: common equity in the holding company, preferred stock, publicly listed and exchange traded notes and traditional debt issues. A list of publicly traded preferred shares by subsidiary and exchange traded notes are in the table below:


Alabama Power Co., 4.20% Series Cumulative Preferred Stock


Alabama Power Co., 4.52% Series Cumulative Preferred Stock


Alabama Power Co., 4.60% Series Cumulative Preferred Stock


Alabama Power Co., 4.64% Series Cumulative Preferred Stock


Alabama Power Co., 4.72% Series Cumulative Preferred Stock


Alabama Power Co., 4.92% Series Cumulative Preferred Stock


Alabama Power Co., 5.20% Class A Cumulative Preferred Stock


Alabama Power Co., 5.30% Class A Cumulative Preferred Stock


Alabama Power Co., 5.625% Series Non-Cumulative Preference Stock


Alabama Power Co., 5.83% Class A Cumulative Preferred Stock


Alabama Power Co., 6.45% Series Non-cumulative Preference Stock


Alabama Power Co., 6.50% Series Non-Cumulative Preference Stock


Georgia Power Co., 6 1/8% Series Class A Preferred Stock, Non-Cumulative


Georgia Power Co., 6.50% Series 2007A Preference Stock, Non-Cumulative


Gulf Power Co. 5.60% Series 2013A Non-Cumulative Preference Stock


Gulf Power Co., 6.00% Series Non-Cumulative Preference Stock


Gulf Power Co., 6.45% Series 2007A Non-cumulative Preference Stock


Mississippi Power Co., 4.40% Series Cumul Preferred Stock


Mississippi Power Co., 4.60% Series Cumul Preferred Stock


Mississippi Power Co., 4.72% Series Cumul Preferred Stock


Mississippi Power Co., 5.25% Series Dep Shares Cumul Preferred Stock


Gulf Power Co., 5.25% Series H Senior Notes due 7/15/2033


Gulf Power Co., 5.75% Series 2011A Senior Notes due 6/1/2051


Georgia Power Co., 8.20% Series 2008C Senior Notes due 11/1/2048


Morningstar offers a list of outstanding traditional debt issues by relative size and due date through 2019, with yields to maturity. The table is below:


In Southern Company's 2012 Annual Report, the following tables list long-term debt maturities and interest rate ranges:

Source: Southern Company 2012 10-K

It becomes obvious that income investors have plenty of options concerning SO debt issues and preferred stocks.

The preferred stocks offer yields in the range of 5.11% (MP-D $25.69), 5.18% (ALP-N $25.15), 5.29% (ALP-P $25.05), 5.76% (ALP-O $25.30) to 5.96% (GPE-A $26.49). Most of these issues are currently in a callable mode and can be called away at a $25 par value at any time.

The ETNs offer yields of 7.9% for GAT and 5.6% for GUA. GAT is callable after November 2013. With these ETNs, it is important that potential investors review the callable features as a juicy 7.9% yield may not last in the reality of today's lower rates.

The importance of credit ratings reviews cannot be understated for utility companies. SO has one of the highest credit ratings in the sector, which translates to lower costs of financing. For example, S&P rates Southern Company debt as "A," five notches into the investment grade category. To review overall credit rating trends for the sector and a listing of EEI listed utility credit ratings, read this SA article.

Below are the most recent comments on SO from the three credit agencies: S&P, Fitch and Moody's. The full comments/press releases are available here, here and here.

S&P revises Southern Co. and subsidiaries rating outlook to negative:

On May 24, Standard & Poor's Ratings Services revised the rating outlook on Southern Co. and its operating subsidiaries to negative from stable. S&P stated, "At the same time, we affirmed the 'A' corporate credit rating on those entities and the 'BBB+' corporate credit rating on Southern Power Co. The rating outlook on Southern Power Co. is stable. The outlook revision on Southern Co. and its operating subsidiaries reflects our assessment of increased business risk as a result of a series of unfavorable regulatory, operational and risk management developments. Over the past 12 months, adverse regulatory and project developments at Mississippi Power's integrated gasification combined cycle generation facility have contributed to a significant increase to the company's business risk and by association to Southern Co.'s business risk.

Fitch maintains credit ratings:


Southern Company's ratings recognize the relatively stable and predictable cash generation of its operating subsidiaries and the financial support it gets from them in the form of dividends for the payment of corporate expenses, debt-service, dividends to common stockholders and for other business matters. Southern Company's regulated utility subsidiaries enjoy a relatively favorable regulatory framework in their service territories and exhibit limited commodity price risks due to the ability to recover fuel and purchased power through separate cost trackers.

Its non-regulated generation subsidiary, Southern Power, follows a conservative business model by signing long-term sale contracts with creditworthy counterpanes and minimal commodity exposure through recovery of fuel costs through its power supply contracts. Southern Company provides equity funding to its subsidiaries for their long-term growth and to optimize their capital mix within a target range. The Stable Outlook for Southern Company reflects adequate liquidity, financial flexibility and easy access to capital markets during a period of high capital investment.

Regulatory risk has increased for Southern Company's utility subsidiaries given the ongoing rate proceedings at Georgia Power and Gulf Power, return on equity (ROE) review proceedings at Alabama Power and higher regulatory scrutiny of Mississippi Power's cost overruns associated with the 580 MW.

Integrated Gasification and Combined Cycle (IGCC) plant at Kemper. Favorable outcomes for Georgia Power and Alabama Power's regulatory proceedings will be key to sustaining Southern Company's current ratings given that the two subsidiaries account for approximately 84% of consolidated operating income.

Moody's maintains credit ratings:


Southern's Baa1 senior unsecured rating reflects its position as the parent company of four regulated utility subsidiaries rated at low to mid-A rating levels and a highly contracted Baa1 rated wholesale generating company. Three of its four regulated utilities operate in consistently supportive regulatory environments, with the Florida regulatory environment stabilizing and potentially improving after a period of substantial uncertainty. Southern's traditionally low risk profile has increased modestly in recent years as a result of new nuclear and IGCC construction, substantial environmental compliance costs, and a thus far limited expansion into unregulated generation outside of its historical Southeast region, including biomass generation in Texas and solar generation in New Mexico. The company also has a renewable energy partnership with Ted Turner, the largest landowner in the U.S., to develop solar power.

Rating Outlook

The stable rating outlook reflects Moody's expectation that Southern Company's utility regulatory environments will remain credit supportive; that there will be no substantial delays or cost overruns at either the Vogtle nuclear or Kemper IGCC construction projects; that costs resulting from new environmental regulations will be manageable and recovered in rates without significant regulatory lag or substantial deferrals; and that growth of its renewable energy business outside of its region will remain modest.

According to the website, SO has a weighted average cost of capital WACC of 2.88% as of the end of 2011. The calculations are explained on the site and through the link. This means the average cost for SO to issue debt or equity is 2.88% and a return on invested capital ROIC of greater than this amount is a positive financial strength for investors. SO has a trailing twelve month ROIC of 4.71% and a 5-year historical ROIC of 6.28%. The lower TTM ROIC is caused by short-term reductions in profitability from plant construction cost overruns and subsequent write-downs.

Compare the above preferred yields and yields to maturity for the debt/ETNs to the current common stock dividend yield of 4.94% and a 5-year average dividend growth of 4.04%.

I believe the best risk to reward for income investors in SO lies in the common equity. With the uncertainty concerning the two large construction projects of the "clean" coal/gasification in Kemper Mississippi and the added nuclear reactors at the Vogle facility in Georgia, common share prices have declined about 16% from their all-time high reached in April of this year. In the $41 range and below, SO common shares offer long-term investors adequate income in this low rate environment.

Plus, common shareholders get the added benefit of owning the highest rated electric utility by the three credit agencies.

Author's Note: Please review important disclaimer in author's profile.

Disclosure: I am long SO. 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.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Tagged: , , , Electric Utilities
Problem with this article? Please tell us. Disagree with this article? .