Southern Company - Another Dividend Hike, But Is There Really Much Appeal Besides Dividends?

| About: Southern Company (SO)


Regulated utility company operating in the South of the US.

Investors have pushed up the stock in recent weeks as Treasury yield declines.

Combined with a recent dividend hike this has pushed up the differential between the dividend yield and risk-free rate.

Southern Company (NYSE:SO) is a holding company which owns four operating companies focusing on the delivery of electricity to SouthEastern American states.

The Atlanta-based company serves 4.4 million customers in the Southern states while having access to 46,000 megawatt of generating capacity.

It's All About The Dividends

Investors in utility companies tend to focus on dividends over spectacular capital gains. As a result, investors were very happy when the company announced a dividend hike for the 13th straight year on April the 21st.

Southern Company increased its quarterly dividend by 1.75 cents per share to $0.525 per quarter, providing investors with an annual dividend yield of 4.8%.

The dividend hike, once being paid out marks the 266th consecutive quarters in which the company has paid a dividend, marking an uninterrupted income stream to its investors since 1948.

First Quarter Results

On the final day of April, Southern Company reported its first-quarter results. The company reported earnings of $351 million, or $0.39 per share. Note that last year's earnings came in at just $0.09 per share.

Earnings were impacted by a $235 million charge related to the nightmare better known as the Mississippi Power's Kemper integrated gasification combined cycle project. Adjusted earnings of $586 million easily surpassed adjusted earnings of $430 million as reported last year.

Adjusted earnings of $0.66 per share came in comfortably ahead of adjusted earnings of $0.49 per share as reported last year. The major driver behind the earnings increase was the harsh weather which resulted in the second coldest first quarter in two decades. Increased electricity demand as a result of the weather added eight cents per share to earnings.

As an illustration, retail sales were up by 7.1% compared to last year but corrected for the harsh weather were up by only 1.3%. Growth was driven by the addition of roughly 10,000 new residential customers as well.

Winter Drives Earnings

During the first quarter harsh winter weather provided a challenge to the company as well as providing huge tailwinds. In total the technicians at the company were forced to repair electricity to nearly 800,000 customers. The harsh weather put a peak on electricity usage as well, peaking at 39,130 megawatt.

Cheaper cost of coal relative to oil & gas prompted the company to shift the generation mix significantly. Coal was used to produce 45% of all electricity provided which was up by 13 percent point in the mix compared to last year. The options provided by the diverse fleet allowed the company to save $100 million in costs.

Project Update

The major and ambitious Kemper IGCC project is now expected to be in service by May of 2015, one year later than originally anticipated. As noted above, the company took a $235 million charge related to this project over the past quarter on the back of increased costs. The charge is not the first, during the first quarter of last year the company took a $333 million charge related to this particular project.

The $5.5 billion coal-gasification plant in Mississippi was originally scheduled to cost only $2 billion. The project will create only one of the two integrated gasification combined cycle plants within the US. While Southern Company is able to offset some of the higher costs by increasing consumer rates, it does not come close to recovering all of these cost increases.


Trading at $44 per share, Southern Company's equity commands a valuation of around $39 billion.

As reported in its results, first-quarter revenues at $4.6 billion were up by an impressive 19%. Total Kilowatt hours sales of 47.8 billion, which rose by 9.7%, were a major driver behind this uptick in revenues. Based on historical trends and somewhat normal weather annual earnings of about $2-$2.5 billion should be attainable. This still gives the company a fairly high valuation at roughly 17 times earnings.

I have not seen a consolidated balance sheet with the latest quarterly report, yet the company ended the calendar year of 2013 with roughly $660 million in cash and equivalents. Total debt stood at $23.3 billion, resulting in a steep net debt position of about $22.6 billion.

Takeaway For Investors

The investment clientele for utilities is quite similar to that of bonds and Treasuries in general. Lower yields have pushed up the differential by the generous dividend yields which utilities like Southern Company offer and the yield provided on governmental bonds. As a result, investors have pushed up the valuation for utility company's based on earnings metrics in recent years as interest rates continued to decline.

For most of the past decade shares traded in a $30-$40 trading range after which shares rose to a $40-$50 range since 2011. I believe that investors take quite a big risk in their search for higher yields given the risks if the highly regulated industry might see more competition and given the leverage incurred by the company. Yet by far the biggest risk by investors would be rising interest rates.

While investors could still invest in the company for their generous dividend, the prospects for capital gains are not great and even risky in my opinion especially with rates at such low levels.

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.