Southern Company (SO) is a large regional utility based in the southeast United States. The company has over four million customers and sports a $36 billion market cap as of this writing. The common stock also pays a very nice dividend but in this article, we'll take a look at another way to take advantage of SO's strength and stability, the Alabama Power 6.45% Series Non-Cumulative Preference Stock (ALBMP), and to see if it is right for your income portfolio.
ALBMP is a traditional preferred stock which means it has no stated maturity date and pays regular, quarterly dividends. The stock was issued at $25 per share and pays an annualized dividend of $1.6125, good for a 6.45% coupon yield. As shares are trading at a small premium to that price, $25.95 as of this writing, the current yield is actually a bit lower at 6.2%. However, that is still a very strong yield and particularly from a stable cash machine like SO.
Beginning in 2017 ALBMP is callable by SO for the $25 issue price plus any declared but unpaid dividends. This means that if you were to initiate a position today and shares were subsequently called, you'd be subject to a capital loss of 95 cents per share 3.5 years from now. While that is undesirable it is also a very small potential capital loss. While I don't normally recommend buying preferreds at a premium, this particular issue still warrants a look because of its strong yield in relation to the safety of the payer. SO is about as safe as it gets in terms of repayment risk so you aren't going to see its preferreds in the 8%+ range unless interest rates spike out of control.
ALBMP is also eligible for the preferential dividend tax treatment, meaning that holders of ALBMP in a taxable account will see an appreciable increase in the after-tax yield of this security in relation to a comparable issue that is ineligible for the preferential tax treatment. This is a sizable positive as it means holders in a taxable account would have an after-tax yield of 5.3% versus 4.3%, assuming 15% and 30% tax rates, respectively. That is a huge difference and thus, the preferential tax treatment makes ALBMP all the more attractive.
ALBMP, like any other security, has risks associated with owning it. Principal among them is interest rate risk. If we see interest rates spike, ALBMP will trade down, all else equal. This means that holders will be subject to capital losses. Unfortunately this is a hazard of owning any income producing security and ALBMP is no exception. However, I believe ALBMP will stand up to interest rate spikes somewhat better than less favorable issues from companies with higher repayment risks. The reason is because the dividend on ALBMP is about as safe as you can get given SO's financial strength and proven ability to produce cash. However, ALBMP is not immune to interest rates and as such, will likely move down in price if interest rates spike.
Additionally, ALBMP is non-cumulative, meaning that if SO were to miss dividend payments, it is under no obligation to make them up to holders of ALBMP. Thus, SO could potentially stop paying dividends on ALBMP and never restart if it so chose. Of course, reality is more complicated than that as SO is a seasoned security issuer and if it suddenly chose to stop paying on its existing obligations, new security issues would undoubtedly carry much higher coupons in the future. As SO relies on the capital markets for funding that seems a very distant possibility to me. However, just be aware the risk exists due to ALBMP being a non-cumulative issue.
Overall, while ALBMP doesn't have the highest yield in the preferred security universe, it does offer stability and safety from a very high quality payer with stable cash flows. If you can look past the non-cumulative nature of the issue, the preferential dividend tax treatment combined with the nice yield of more than 6% could be a decent addition to your income portfolio. Keep in mind that buying a preferred at a premium brings with it risk of capital losses should the issue be called but given the other positives of ALBMP, the premium is a small price to pay.