Why Investors Should Continue Holding Southern Company For The Long Run

Sep. 4.14 | About: Southern Company (SO)

Summary

Southern Company has an attractive valuation, impressive growth estimates, and a strong dividend.

Southern Company's Plant Ratcliffe project can be a long-term catalyst.

Southern's focus on renewable energy is a move in the right direction considering the potential of the solar market.

Electric utility Southern Company (NYSE:SO) has marginally underperformed the broader market this year. Shares of the company have increased close to 7% so far this year, while the S&P 500 has gained around 8.5%. However, Southern is also a big dividend payer, with its yield standing at a handsome 4.90%, higher than its five-year average yield of 4.70%. As such, investors should not be paying much attention to Southern's underperformance this year, and instead focus on its long-term prospects as it seems to be in a strong position to continue getting better.

Moving ahead nicely

Southern's business is proceeding at a good pace. For instance, Southern turned in a robust performance during the second quarter, as its earnings doubled on account of strong electricity sales. Its revenue also rose year on year and was better than the Street's expectations. The company is seeing strong traction in its end markets despite the headwinds that it is facing at its Kemper County project, which has now become as the most expensive fossil-fuel power plant ever built in the U.S.

The company's second-quarter performance was in line with expectations, and things are expected to improve further going forward, driven by favorable weather conditions and a strengthening economy. Moreover, Southern's investments in infrastructure will also drive the company's performance going forward.

A key project

Southern is on track with the construction of its Plant Ratcliffe project at Kemper County. But, as mentioned above, this project has faced various challenges. In fact, its very design has been doubted by many scholars. The Kemper project is the first of its kind that will transform coal into gas, capture the carbon dioxide and pump it underground. Researchers say that this should increase the underground fossil fuel fortunes. But, whether this happen is the biggest question.

According to a Bloomberg report, "In 2011, carbon dioxide from a natural reservoir blew out of the oilfield where Kemper's gas is to be pumped, spewing for days." Thomas A. Blanton, an oil man from Hattiesburg, says, "There is no such thing as carbon-dioxide sequestration in an oil field." Consequently, there is uncertainty around this project, which will be cleared only when the plant starts working. In addition to all these uncertainties, the total cost of construction has now doubled from the $2 billion that was initially estimated to $5.24 billion currently. But, management is optimistic about the outcome.

Tailwinds to consider

Apart from this, there are various tailwinds that the company is betting on. For example, Southern continues to see recovery in the housing market. According to a survey, home sales have increased as compared to last year, and builders and brokers anticipate even increased activity in the southeast region during the coming months. According to management, "These trends are consistent with our internal measure of new housing activity, new connects, which were up 17% in the first six months of 2014, compared to the same period last year, with positive growth across all of our traditional operating company."

Going forward Southern Company has plans to build a strong position in the energy market. Southern LNG has entered in to a joint venture with Shell Oil at the Elba Island LNG Terminal. The electric utility company cites that once this is fully operational, the associated electrical load increase will be 180-megawatt, making it one of the largest customers in its service territory.

Focus on renewable energy

Moreover, apart from fossil fuels, Southern is also focusing on renewable energy. As a result, it has acquired the Macho Springs solar facility in partnership with Turner Renewable Energy. This is a 50 MW facility, which has the potential to provide power to more than 18,000 homes. This is a whole new opportunity for Southern Power. In fact, the company continues to seek more solar and natural gas facilities with a long-term contract.

Considering the potential of the solar market, Southern is doing the right thing by making a move in this area. Solar installations in the U.S. are growing at a good pace. According to a report:

"According to GTM Research and the Solar Energy Industries Association's Solar Market Insight Year in Review 2013, photovoltaic installations continued to proliferate, increasing 41 percent over 2012 to reach 4,751 megawatts. In addition, 410 megawatts of concentrating solar power came on-line.

Solar was the second-largest source of new electricity generating capacity in the U.S., exceeded only by natural gas. Additionally, the cost to install solar fell throughout the year, ending the year 15 percent below the mark set at the end of 2012."

Thus, the market is booming in the U.S., and since Southern is intent on capturing more opportunities in this space, it should see an increase in its addressable market.

Conclusion

From a valuation point of view, Southern Company has a trailing P/E of 20.24, which is quite expensive as compared to the industry P/E of 16.17. But, its forward P/E looks impressive at 15.28, reflecting an improvement in its earnings. Moreover, Southern is expected to outperform the overall industry in the next five years by delivering an annual earnings CAGR of 3.35%, well ahead of the 0.88% industry average.

Although the company is facing headwinds at one of its plants, it is nevertheless performing well financially. Also, management seems to be confident of its prospects going forward. The successful completion of the Kemper project will be a tailwind for Southern going forward, while its foray into the solar market is another opportunity. Moreover, the company is expected to grow at a greater pace than the broader industry, making it a worthy investment for the long run.

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.