Why I Picked Southern Company

| About: Southern Company (SO)

Summary

Utility companies provide excellent portfolio defense through bear markets.

With so many utilities to choose from picking one to start with is difficult.

I plan to own several utilities as my portfolio grows over time but have chosen to start with Southern Company.

The construction of a portfolio can sometimes become difficult, especially in volatile markets. With so many quality companies selling off I had adjusted my plan to take advantage of the lower prices but am now refocusing on my portfolio construction. I have decided to add Southern Company (NYSE:SO) to my portfolio as my first utility company.

Southern Company sends over 46,000 megawatts of electricity to more than 4.4 million customers in four different states. The power comes from 73 plants that rely on coal, oil, gas, nuclear and hydro to keep the lights on. They're also working on solar, wind and "clean coal" (more on that later) to further diversify and clean up their energy footprint. Southern Company is simply the holding company for several subsidiaries which includes Alabama Power, Georgia Power, Mississippi Power and Gulf Power along with Southern Power which participates in the wholesale electricity market. In 2015 they paid out $2.17 in dividends and made $2.60 per share on an adjusted basis. The company brought in nearly $2.4B in net income for the year as well beating 2014 by 20%.

What I Like

What I like most is that it is a utility company, they have a virtual monopoly over the regions they serve. Southern Company is based in Atlanta and operates in Georgia, Alabama, Florida and Mississippi. From 2014-2015 SO added 37,000 residential customers to their customer base. According to the United States Census Bureau the South as a region has 37.7% of the US population and is growing year over year. In 2000 there were just over 100M people living in the South for 35.6% of the total population, in 2015 there were over 121M people for the 37.7% share. The only other region that grew in share of population over the same time was the West. With the South growing in popularity due to a lower cost of living and more temperate weather this trend will continue and add more customers to SO's base.

I also like the safe 4.5% dividend which is higher than the other major utilities like Duke Energy (NYSE:DUK) at 4.3% and Consolidated Edison (NYSE:ED) at 3.7%. They've increased the annual payout for 15 years now as well and their 5 year DGR is 3.6%, higher than ED at 1.8% and DUK at 2.2%. The payout is also safer than DUK who has a 93% POR compared to SO at 83%. Investors are expecting another dividend raise this year and should be around the 3.5% area.

Southern Power gives SO a growing business outside of their four subsidiary power companies. Southern Power buys power generating assets and sells the power on the wholesale market. They own a piece of 33 facilities in nine states and more on the way that gives them a wonderful growing business segment. They seek out "green" projects and have two wind farms, one biomass plant, nine gas plants, and 21 solar farms that generate over 10,400 MW of electricity. I like this approach to growth for the company and have high hopes that it continues to grow the bottom line.

What I Don't Like

Every investment has downside to it, SO is no different. Recently there has been plenty of news about the Kemper power plant. This plant is currently years behind schedule and has tripled in cost, now coming in at an estimated $6.6B. The plant is supposed to be a pseudo-savior of the coal industry, being one of the first "clean coal" power plants. Instead it has overran on costs and time and proven to be a drag on the companies bottom line; the costs of the project shaved off $.25 from the 2015 EPS. More optimistic investors can see the silver lining here that once this project is fully completed the bottom line should improve dramatically. With current estimates of a completion for late 2016 I am optimistic this can soon be put in the past.

Southern Company also has a large amount of debt coming to maturity in 2016, combined with cost overruns at Kemper this isn't ideal. In 2016 there is $2.6B coming due and in 2017 $2.4B. The company also plans to issue $1.2B in equity in 2016 to help fund the acquisition of AGL Resources and keep their current credit ratings intact. The equity issuance will lower EPS by about $.06 for 2016 with the total estimated to be about $2.76-$2.88, a 4-5% increase over 2015.

With the market swinging up and down and many investors concerned with a slowing global economy and lackluster numbers domestically many have been running to the safe harbor of utility companies. What this has done has driven share prices up and caused companies like SO to become slightly overvalued. Right now SO trades at a P/E of 16.6 and P/CFL of 7.6. Their 10 year averages are 16.3 and 7.8 respectively which makes SO just slightly overvalued when looking at EPS but undervalued looking at cash flows. I'd like to pick up SO at about 16x earnings and 7x cash flows but even with lackluster 2016 guidance and concerns with Kemper the stock price has held up relatively well, only falling off slightly. Compared to their peers of ED and DUK, SO is more attractively valued. Due to the current valuation the share price will likely be sideways through 2016 so I'm choosing to see this as more of a 4.5% yielding savings account.

Why I Picked SO

Every company has positives and negatives associated with it, right now I feel the positives easily outweigh the negatives for SO. They have a higher yield, larger dividend growth over five years, better ROE and more attractive valuation compared to ED and DUK right now. Kemper is nearing the completion and will cease to be a drag on the company and the Vogtle nuclear plant is also rapidly approaching completion. I like their Southern Power business a lot, not so much the green power assets they own but the increased regulation mandating lowered emissions and the public's concern with the environment make that a growing industry. The debt/equity isn't too bad at 44% and they also have an A- credit rating. The South is also a little more friendly to industry and it isn't a well-guarded secret that SO has a lot of sway in the region. Southern Company also holds 104 patents which will help protect their work on the Kemper and Vogtle projects keeping them the regional leaders.

Conclusion

With no end in sight to the market swings I'm okay with parking some cash in SO and waiting for the other utilities to drop a little bit. I've got my buy order placed at $47.25 and this will sit in my IRA and probably just be forgotten about and allowed to DRIP. This won't be my only utility, I'd like to "own the East Coast" eventually by adding DUK and ED but those will come as other companies are added. The 4.5% yield is nice and the ROE of 11.8% is also attractive for a younger investor with time on my side. I see plenty of opportunity for the company going forward with the completion of their Kemper and Vogtle plants and the growing portfolio of Southern Power. I appreciate you taking the time to read and I look forward to the discussion in the comments. As always I wish all of you the best of luck.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SO over 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.