Southern Company: Project Cost, Completion Timing Issues Continue To Take Toll On The Stock

Oct.26.13 | About: Southern Company (SO)

I reiterate my stance that investors should stay on the sidelines with regards to Southern Company (NYSE:SO), as uncertainties regarding costs and the timings of ongoing construction projects prevail. SO has been delivering a healthy financial performance in the past, and has remained an attractive investment option for income-seeking investors; SO offers a strong dividend yield of 4.8%. However, lately, the company has been involved in several construction projects aimed at upgrading its power generational fleet, which have faced delays, and there has been an increase in he estimated construction costs attached to the projects. Also, the rising Treasury yields do not portent for the stock price, as the stock price might experience a pullback to keep the dividend yield attractive in comparison to rising Treasury yields; the 10-year Treasury yield has increased by 52% in the last six months. The following graph shows the 10-year Treasury yield in the last six months.
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Source: Yahoo Finance

Uncertainties Related to Ongoing Construction Projects
SO has been building two nuclear units, Unit 3 and 4, at Plant Vogtle, to upgrade and strengthen its power generation fleet. However, due to delays and unexpected costs, the total estimated cost of the project has increased by $1.5 billion to $15.5 billion. Also, as the construction of the two units at Plant Vogtle is under process, risk prevails that the construction cost might increase even further. The ongoing construction of Plant Vogtle has increased the company's operating and business risk profile.

As the completion time and costs associated with construction remain uncertain, SO has signed an agreement with Georgia Power, under which the company cannot request to increase the certified costs of the project recoverable from customers until the completion of Vogtle Unit 3, does not portend well for the company. Vogtle Unit 3 is scheduled to be completed by the fourth quarter of 2017. If the construction costs of Plant Vogtle increased considerably in the future, the company may have difficulty in convincing regulators to allow an increase in the rate base to recover the cost increase. Moody's also sees the agreement between SO and Georgia Power as a negative development and as a risk to the company's financial performance. Recently, on October 21, Moody's published a report in which it stated the uncertainties related to the construction project and the agreement between SO and Georgia Power as 'credit negative'.

In addition, a delay and an increase in costs for Plant Ratcliffe remain an important overhang on the stock. The plant continues to face operational delays. SO has already pushed the operational timeline beyond May 2014, forfeiting approximately $130 million in investment tax credits. The company has yet to provide details on the new expected completion date and costs. A delay in the Plant startup is expected to cost $15-$20 million each month. Plant Ratcliffe has already hit its cost cap limit that was bargained with the Public Service Commission, which means that every additional spending on the construction of Plant Ratcliffe will result in equity dilution.

Dividend Declared
SO currently offers an attractive dividend yield of 4.8%. The company has a solid dividend history as it has never missed its regular quarterly dividend in the last 264 quarters. Recently, on October 21, the company declared a regular quarterly dividend of $0.5075 per share, translating into an annualized dividend rate of $2.03 per share. The dividend is payable to shareholders of record of November 4 on December 6.

Earnings Preview 3Q2013
SO is scheduled to report its 3Q2013 financial performance on October 30. Analysts are expecting the company to report an EPS of $1.13 for the quarter. Also, the company' management provided 3Q earnings guidance of $1.13 during the 2Q2013 earnings conference call. Recently, Jefferies trimmed its 3Q EPS estimate for SO by $0.05 to $1.10, due to unfavorable weather conditions and lower retail sales.
In the last four quarters, SO has registered three earnings misses. The following table shows the comparison between consensus EPS estimates and the actual EPS reported by the company.
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Source: Yahoo Finance

An important takeaway from the upcoming earnings release will be an update on the ongoing construction projects. The company is likely to provide an update on the estimated costs and the completion timing of Plant Ratciffe, and the status of its construction of Plant Vogtle.

An increase in estimated construction costs and delays in startup dates of the ongoing construction projects pose a risk to the company's future earnings potential. In the near future, investors should look for any increase in the estimated construction costs or delays of the ongoing construction projects, which could have an adverse impact on the stock price.

Due to the abovementioned uncertainties, I believe the stock should trade at a discount to its peers. Due to the uncertainties surrounding the stock, I applied a 10% discount to the utility sector forward P/E of 15.75x to calculate a price target for SO. I calculated a price target of $40 for the stock, using a discounted forward P/E 14.15x and the 2014 EPS estimate of $2.83 for SO.

Forward P/E


2014 EPS est.


Price Target


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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.