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Summary

  • Capital investment initiatives to optimize generating fleets will strengthen business operations in long term.
  • Risk of project delays and cost overruns remain concerns for investors in short run.
  • Planned investments will help utility companies further increase regulated operations.

Utility companies in the U.S. have been undertaking initiatives to increase their regulated business exposure and incurring capital investments to optimize their power generating fleets. Ongoing construction projects of utility companies will strengthen the power generating fleets, which will augur well for companies' performance in the long term; however, in the near term, construction projects add to the risk profiles of a few utility companies.

Southern Company (NYSE:SO) is a leading utility company and remains a favored stock among income-seeking investors, as it offers a dividend yield of 4.7%. The company has been making capital investments to optimize its generating fleet and deploy generating assets that produce cleaner electricity. The company's Kemper IGCC project has inflated the companies' risk profiles and pressurized their valuations in recent quarters because of delays and cost overruns. FirstEnergy (NYSE:FE) and Duke Energy (NYSE:DUK) are two other utility companies that have been making capital investments. Capital investments undertaken by utility companies to optimize their generating fleet will result in rate base and earnings growth in upcoming years.

Southern Company has been making capital investments to build new efficient power generation plants and optimize its existing fleet in a bid to construct a power generating portfolio that leads to less pollution and cleaner electricity generation. The company has planned capital investments of $17 billion from 2014-2016, including $6.9 billion in 2014, $5.6 billion in 2015, and $4.5 billion in 2016. As a significant proportion of the planned capital investment will be directed toward regulated operations, it will result in rate base and earnings growth. Also, the planned investment will increase the company's exposure to regulated operations, which will provide further stability to revenues and earnings; currently, almost 90% of the earnings are generated from regulated operations. Also, the company anticipates EPS growth of 3%-4% in the next three years, which is slightly less than Duke's rate base growth of 4%-6% in the second half of the decade.

Currently, the company has been working on two major power projects, including the Vogtle (units 3 and 4) nuclear project and the Kemper County Integrated Gasification Combined Cycle (IGCC) project in Mississippi. The Vogtle units 3 and 4 have a total generating capacity of 2,200MW and will cost the company almost $6.8 billion. The construction of the ongoing Vogtle project is rolling on well, with units 3 and 4 anticipated to be operational and placed in service in the fourth quarters of 2017 and 2018, respectively.

Another important ongoing construction project for Southern Company is the Kemper County IGCC power plant in Mississippi. The plant has a power generating capacity of 582MW. The project will be a zero liquid ejection facility, and water used in power production will not be dumped into rivers or streams. Once it's completed, the project will strengthen the company's generating portfolio; however, delays and cost increases related to the project remain a concern for investors. The construction costs of the plant have increased to $4.44 billion net of DOE grants, up from an initial estimated cost of $2.4 billion. Because of the delays and cost increases, the company registered an after-tax charge of $729 million and $235 million in 2013 and in the first quarter of 2014. Now the project is expected to be in service by May 2015. Delays and an increase in estimated costs for the Kemper County project have remained concerns for investors, which will weigh on the stock valuation in the short term; however, they will strengthen the company's generating fleet and augur well for the company's performance in the long term.

FirstEnergy and Duke Energy are among the other utility companies that have been undertaking capital investments to strengthen their power generating fleet. FirstEnergy has been consistently making investments to optimize its generating fleet and increase its regulated business operations, which will provide earnings and cash flow stability, and reduce overall business risk. FirstEnergy's business profile has been consistently changing, which is evident from the fact that its exposure to the regulated business increased from 65% in 2009 to 85% in 2013, whereas unregulated business exposure dropped from 35% in 2009 to 15% in 2013. As the company intends to achieve stability, it has planned to incur planned investments of $4.2 billion in its transmission business over the next four years.

Duke stays focused on its regulated operations and plans to accelerate capital investment, beginning from 2015 through 2018. The capital investment undertaken by Duke will be recovered through rate increases, which will result in rate base and earnings growth in the long term; the company projects its rate base to increase from 4% to 6% in the second half of the decade. Duke recently announced a plan to build a new combined-cycle natural-gas plant in Florida with a generating capacity of 1,640MW. The project is expected to cost $1.5 billion and will be in service by 2018. Also, Duke will be incurring capital investment of almost $4 billion through 2018 in Carolinas, including a recently announced natural-gas-fired combined-cycle plant with a capacity of 750MW.

Final Words
Utility companies' capital investment initiatives to optimize their generating fleets will strengthen their business operations in the long term; however, in the short term, risk of project delays and cost overruns remain concerns for investors. Also, the planned investments will help utility companies further increase their regulated operations, which will enhance revenues, earnings and cash flow stability.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Southern Company: A Defensive Utility Stock