Southern Company: Making Correct Moves To Secure Long-Term Growth

| About: Southern Company (SO)

Summary

The company is correctly strengthening and diversifying its asset base by targeting high-growth assets, which will fuel its long-term earnings growth.

Shift into gas infrastructure will position it well to take advantage of growth opportunities in the gas infrastructure business.

Stock is trading at an attractive forward P/E of 17.5x, in comparison to its industry average forward P/E of 19.5x.

In the current low interest rate environment, utility stocks are a popular investment option for income-hunting investors. Southern Company (NYSE:SO), the second largest utility company in the U.S., is an attractive investment prospect for long-term income investors; the stock offers a solid dividend yield of 4.3%. The company has a robust capital expenditure (CAPEX) profile, which will fuel its rate base, revenue and earnings growth. Moreover, the company's aggressive efforts to shift into the gas infrastructure business and waning risk from ongoing construction project will positively affect its business risk and growth profile. Moreover, the company's efforts to develop its solar and wind generation assets will allow it to alter its generation assets consistent with regulatory requirements, therefore, reducing its regulatory risk. As the company is making efforts to diversify and strengthen its product portfolio, by targeting high growth potential assets, its stock valuations will expand.

Financial Performance and Growth Catalysts

The company registered healthy financial performance for 2Q16. It reported adjusted EPS of $0.74, beating the consensus estimate of $0.69, and up from $0.71 in 2Q15. The earnings for the quarter were positively affected by retail revenues and lower non-fuel operating and maintenance expenses. Also, operating revenues for the quarter increased to $4.45 billion in 2Q16, from $4.34 billion in the corresponding period last year. SO expects its 2016 earnings to be in a range of $2.76-$2.88, and targets long-term earnings growth of 4%-5%. I believe the company's long-term growth will be above that of the company's target, as it is aggressively diversifying and expanding its assets. The company has been strengthening its asset base through robust CAPEX and acquisitions. The company updated its capital investment plans and now expects capital investments to be $20.1 billion for 2016, as shown below in the chart.

Source: Investors Presentation

The company has been focusing on adding assets to its portfolio which offers attractive growth and will position it well according to the changing regulatory environment. Recently, the company completed the acquisition of AGL Resource for $12 billion and acquired 50% interest in Kinder Morgan's (NYSE:KMI) natural gas pipeline for $1.47 billion to develop and strengthen its gas infrastructure. As environmental regulations for coal usage are becoming stricter, natural gas will continue to become the fuel of choice and demand for natural gas will increase, which will require pipeline infrastructure to support growing gas demand. Therefore, SO is correctly positioning itself by developing its gas infrastructure through strategic acquisitions and partnerships. As regulated utilities are a slow growth business, SO's diversification into the fast-growing natural gas business will augur well for its long-term earnings growth profile.

The acquisition of Kinder Morgan's natural gas pipeline will allow the company to expand its operations in Alabama, South Carolina and Georgia. These regions are among the fast growing areas and are experiencing fastest natural gas demand growth in the U.S.; the deal will have a positive impact of $0.03-$0.09 on the company's 2017 EPS. Also, the gas pipelines revenue streams are very predictable and are fully subscribed which will provide certainty to SO's revenue stream. I believe utility companies, including SO, will continue to expand their gas infrastructure assets to take advantage of the growth opportunities. Also, SO is aggressively working to strengthen its solar and wind generation assets, consistent with regulatory requirements. The company increased its capital expenditure forecast for renewable energy portfolio to $4.5 billion for 2016 from the prior target of $2.4 billion.

As the company is diversifying its asset base by targeting high-growth assets, its stock valuation will expand. Also, SO's construction risk is reducing which will positively affect the stock price. The company's Kemper project is likely to start commercial operations by the end of the ongoing third quarter, which will augur well for the stock valuation. The stock is currently trading at relatively cheap valuations; it is trading at a forward P/E of 17.5x, versus its industry average forward P/E of 19.5x.

Summation

The company is correctly strengthening and diversifying its asset base by targeting high-growth assets, which will fuel its long-term earnings growth. Also, the company's shift into gas infrastructure will position it well to take advantage of growth opportunities in the gas infrastructure business which offers a secure revenue stream and will augur well for its business risk profile. Moreover, the stock is currently trading at an attractive forward P/E of 17.5x, in comparison to its industry average forward P/E of 19.5x. The company's initiatives to strengthen its asset base will result in stock valuation expansion. Also, SO offers a solid dividend yield of 4.3%.

Disclosure: I/we 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.