For Southern Company (NYSE:SO), one of the leading regulated utilities in the U.S., regulated earnings accounted for almost 90% of the company's total earnings per share. The company has delivered healthy and consistent financial performance in the past. Also, it has remained a popular choice among income-seeking investors, as it offers a solid dividend yield of 5%.
The stock price has experienced a pullback, as the stock is down 15% since May this year. Among the reasons for the pullback are the rising Treasury yields and unexpected increases in the construction costs of ongoing projects. As a dividend-paying utility, SO's shares remain vulnerable to rising Treasury yields. The 10-year Treasury yield has increased by more than 56% YTD. If Treasury yields continue to increase in the near future, dividend-paying utility stocks could face pressure on stock prices. However, I believe that the 10-year yield will stay around 3% in the ongoing year (2013), and SO's stock price has bottomed out on the concerns of rising Treasury yields. The following graph shows the 10-year Treasury yields since January 2013.
(click to enlarge)
Source: Yahoo Finance
An unexpected increase in the costs of ongoing construction projects also had an adverse impact on the stock price. One of SO's ongoing projects includes the construction of the Plant Ratcliffe. The projected cost of the plant has increased by almost $1 billion YTD. The projected costs of the plant were increased to make sure that the project is completed on time; the plant is expected to be in service by May 2014. Timely completion of the project will allow the company to get approximately $130 million in tax credits over a 30-year time period. On August 30, the company filed a status report [pdf] of the project with the Mississippi Public Service Commission, according to which the construction of the plant is 81% complete and its total cost is estimated to be $3.868 billion. As the Plant Ratcliffe becomes operational next year (2014), it will strengthen SO's power-generational fleet, and have a positive impact on its future earnings potential.
Currently, the stock offers an attractive dividend yield of 5%, which is backed by its healthy operating cash flow yield of 14%. I believe that dividends offered by the company are sustainable, as it has never missed a regular quarterly dividend since the last 263 quarters. The company has increased its dividends by 4% on average in the last 5 years. The table below shows annual dividends and the corresponding payout ratios from 2008-2013:
(click to enlarge)
Source: Financial Reports
Recently, the company completed its senior unsecured debt offering of $500 million with a maturity date of September 1, 2018. The unsecured senior notes have a spread of 93bps above that of the benchmark Treasury. The proceeds of the transaction are likely to be used to pay part of its short-term outstanding debt of $740 million. Credit rating agencies, S&P and Fitch Ratings, have assigned A- and A credit ratings, respectively, to the recent debt issue.
Timely completion of the ongoing projects within the estimated costs will boost investor confidence and bode well for the company. In the near term, the stock price might remain volatile due to changes in Treasury yields and uncertainty regarding the completion time and costs of the Plant Ratcliffe. However, I believe for the long term, the company remains on track to deliver a healthy performance, as it has done over past years. Also, the stock is trading at attractive valuations after the recent pullback. SO is currently trading at an attractive forward P/E of 14.45x, in comparison to the Dow Utility forward P/E of 15.45x. I believe that the current valuation represents an attractive entry point for income-seeking investors.