Which Other Utilities Are In The Same Class As Southern Company?

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Includes: ARTNA, AVA, AWR, CTWS, ETR, FTS, MGEE, MSEX, NEE, PNY, SCG, SJI, SO, SWX, WEC
by: George Fisher

Summary

There are many different criteria to use to determine “class”, and I review just five.

Based on S&P Quality Ranking for 10-year consistency in earnings and dividend growth, there are only thirty utilities that equal or better Southern Company.

Based on Net ROIC, of this list, six best Southern Company, but only one offers a higher current yield.

Based on current valuation using the PE ratio, eleven stocks are trading at a lower discount to their historic PE than Southern Company.

Southern Company A few days ago, I wrote an article on the reasons why I am still buying utility Southern Company (NYSE:SO) and received an interesting comment. A reader asked what other utilities have the same quality attributes as SO: "Which other utilities are in the class of SO?" The most comprehensive answers is: It all depends.

It depends on what criteria is being used to classify SO. Is it by S&P Quality Rating for 10-yr consistency in earnings and dividend growth? Is it by level of credit support offer by the governmental regulatory bodies? Is it by earnings yield, dividend yield, PEG ratio, ROIC, or some other fundamental comparison? Is it a combination of all the above?

The criteria used should depend on the risk portfolio of the individual investor and on his/her goals and specific strategies to reach those goals.

Let's begin with arguably the easiest to research: S&P Equity Quality Rank. The Quality Rank groups companies based on their 10-yr consistency in earnings and dividend growth, with A+ being the highest and B+ considered average. Out of the 2,802 companies with equity ratings, only 2% fall into the top category and 10% are considered above average at A- and higher.

  • A+ Highest 2.2%; 38 companies
  • A High 2.9 %; 84
  • A- Above Avg. 5.6%; 159
  • B+ Average 16.8%; 473
  • B Below Avg 22.1%; 621
  • B- Lower 26.9%; 755
  • C Lowest 23.9%; 669

Most utilities are rated by S&P Capital IQ and their reports are readily available from most brokerage accounts. For example, I have access to a fidelity.com brokerage account offering a stock screener including the Quality Rankings as an option. Of the 137 utilities identified by S&P, 78 have an Equity Ranking; 3 are rated A+, 8 are rated A, and 19 are rated A-, with 48 rated B+ and lower. One of the criteria for a Ranking is a 10-yr trading history, and some utilities have recently restructured and have not achieved this minimum review period.

Southern Company is rated A-. Below is a listing of utilities whose Quality Ranking is A- or higher:


Sources: fidelity.com, S&P Capital IQ.

Another criteria could be Return on Invested Capital. ROIC is a tool used for comparing management effectiveness. While many will look at return on equity or return on assets, ROIC is a more encompassing matrix as it calculates shareholder returns generated by management utilizing all the capital at its disposal - debt and equity. Using the 30 companies above, comparison of 3-yr average ROIC would look like the table below. However, ROIC is only half the equation as it is best to also calculate the weighted average cost of capital WACC to determine the net return, also know as the "hurdle rate". While American Water Works (NYSE:AWR) has the largest 3-yr average ROIC at 9.0% and Entergy (NYSE:ETR) with the lowest at 5.1%, after deducting their WACC, AWR has a Net ROIC of 1.1% and ETR has a -0.2%. Of the above list, the best Net ROIC is generated by small-cap water utilities Artesian Resources (NASDAQ:ARTNA) and Connecticut Water Service (NASDAQ:CTWS) at 3.4% and 3.2% respectively. Southern Company at 2.2% outperforms most of its Electric and Multi-utility rivals except WEC Energy (NYSE:WEC) and SCANA Corp (NYSE:SCG).

Sources: Guiding Mast Investments, Morningstar.com, thatswacc.com.

It is important to note the average ROIC for the utility sector is between 4.0% and 4.5%, demonstrating the quality of the above list. Managers at the above listed companies outperformed the sector 3-year average on ROIC by between 20% and 100%.

Another method to review utilities is by the regulatory environment in which they operate. Even as an inexact science, the relationship between a utility and the regulatory body controlling its profitability is an important consideration. As the regulatory environment is essential to developing credit ratings for utilities, S&P Credit has a three-level assessment of the regulatory environment by state. Published in 2014, the latest US Utility Regulatory Assessment rates the following states as being "Strong", compared to "Strong/Adequate", and "Adequate": FERC, Wisconsin, Michigan, Iowa, Kentucky, Alabama, Florida, South Carolina, North Carolina, , and Colorado. Only Mississippi and Hawaii were listed as "Adequate" with the balance of the states falling in the middle. S&P believes these nine states and the Federal Energy Regulatory Commission offer improved support for the utilities under their jurisdiction. ITC Holdings (ITC), NextEra (NYSE:NEE), WEC Energy , MGE Energy (NASDAQ:MGEE), and SCANA have some of the same positive regulatory environments as Southern Company.

Some investors are focused on the income attributes of utility stocks, and the current yield is an important consideration. Various industries within the sector usually offer comparable yields, with Electric utilities historically paying a higher yield and Water utilities offering a bit lighter income. On this basis, the top yielding stocks by industry are Entergy and Southern Company, South Jersey Industries (NYSE:SJI) and Southwest Gas (NYSE:SWX) (GAS is being purchased by SO), Avista (NYSE:AVA) and SCANA , along with Artesian Resources and Middlesex Water (NASDAQ:MSEX). The table below lists the recent yield by company as offered on Morningstar.com


Source: Guiding Mast Investments, Morningstar.com, thatswacc.com.

Some investors are looking for stocks that are undervalued, and many investors have their own definition of "undervalued". One possible criterion could be the difference between the current PE ratio vs it historic PE ratio. Fastgraph.com offers their well-known above/below blue line visualization of this trend, with a black line representing current and a blue line representing a historic PE. The table below lists these stocks and their current relationship to historic PE ratios. For example, ITC is currently trading at a PE ratio of 18.8 when its historic PE is closer to 22.6, for a difference of -3.8. On the other end of the spectrum, the buyout is causing Piedmont Natural Gas (NYSE:PNY) to trade at a PE of 30.6 vs historic levels of 18.2 for a difference of +12.4. Southern Company is currently trading at its long-term historic PE valuation, and those stocks listed above it in the table has similar, or better, attributes.

While it is difficult to answer the original question of other utilities in the same "class" as Southern Company, the five attributes above should allow utility investors to begin their own comparison.

Personally, of the list above, I would chose four companies of similar "stature" as Southern Company: ITC Holdings, SCANA Corp, Connecticut Water, and Entergy/NextEra (tie).

Author's Note: Please review disclosure in author's profile.

Disclosure: I am/we are long SO, CTWS, ETR, ITC.

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.