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Edited By Marianna Avilkina

Southern Company (NYSE:SO) is one of the largest utility companies in the U.S. The company generates electricity and serves both regulated and competitive markets across the southeastern United States. Based in Atlanta, Southern Company has 42,000 megawatts of generation capacity, 43,000 km of distribution lines, and 4.4 million customers. SO operates in wide range of energy fields, including nuclear energy, coal gasification, natural gas, solar energy, and biomass. The company provides exemplary customer service as well as retail electric prices that are below the national average. That is why Southern fairly looks like a kingfish among electric service providers, largely influencing prices in U.S. Its stock has been a slow, but steady upside mover. Its shareholders enjoyed double-digit annualized returns in the last 15 years.

As of September 21, 2012, SO stock was trading at approximately $45, with a 52-week range of $41.00 - $48.59. It has a market cap of about $40 billion. The trailing twelve-month P/E ratio is 18.2, whereas the forward P/E ratio is 16.0. P/B, P/S, and P/CF ratios stand at 2.2, 2.3, and 7.5, respectively. The operating margin is 24.5% while the net profit margin is 12.8%. A debt/equity ratio of 1.1 indicates that SO has some debt issues.

Southern Company pays solid dividends; moreover, the trailing yield of 4.26% is higher than the forward one. Upcoming dividends are expected to be about $.49 per share in Q4 2012. Over the last five years, the company has been following a reasonable dividend philosophy resulting in gradual dividend upturn. The five-year dividend history suggests that Southern is a solid and reliable dividend payer.

SO has a 2-star rating from Morningstar. Out of four analysts covering the company, three have a "hold" rating, whereas one has a "underperform" rating. This is good reason to suppose that Wall Street holds fairly neutral opinions about the company's future. The average five-year annualized growth forecast estimate is 5.5%. What is the fair value of Southern given the forecast estimates? We can determine SO's fair value using the discounted earnings plus equity model, as follows.

Discounted Earnings Plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.

E0 = EPS = ($2.48 + $2.82) / 2 = $2.65

Wall Street holds diverse opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 5.5%. Book value per share is $20.72. The rest is as follows:

Fair Value Estimator

V (t=0)

E0

$2.65

V (t=1)

E0 (1+g)/(1+r)

$2.52

V (t=2)

E0((1+g)/(1+r))2

$2.39

V (t=3)

E0((1+g)/(1+r))3

$2.28

V (t=4)

E0((1+g)/(1+r))4

$2.16

V (t=5)

E0((1+g)/(1+r))5

$2.06

Disposal Value

E0(1+g)5/[r(1+r)5]

$18.69

Book Value

BV

$20.72

Fair Value Range

Lower Boundary

$32.74

Upper Boundary

$53.46

Minimum Potential

-27.50%

Maximum Potential

18.38%

(You can download FED+ Fair Value Estimator, here.)

I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for SO is between $33 and $53 per share. At a price of about $45, Southern is trading at a fair price. The stock has about 18% upside potential to reach its fair value maximum.

Peer Performance

While there are many companies in the market segments SO operates in, American Electric Power Co Inc (NYSE:AEP) is probably the closest competitor of Southern Company. My FED+ valuation suggests that AEP stock is trading within a fair price range. In contrast to SO, American Electric Power has a relatively low ttm P/E ratio, while it has debt issues similar to SO. While both companies offer strong dividends, AEP currently does have a slightly better outlook in terms of profitability.

Southern Limited

American Electric Power Co Inc

Duke Energy Corporation

Trailing P/E

18.21

13.16

19.03

Forward P/E

16.02

13.96

14.43

Yield

4.26

4.28

4.72

Debt/Equity

1.1

1.0

0.8

Return on Equity

12.4

13.7

6.7

Another competitor, the largest multistate holding company among regulated electric and gas utilities - Duke Energy Corporation (NYSE:DUK) - is also trading at a fair stock price. In contrast to SO, DUK's ttm P/E of 19.03 is far above the forward one. However, the ttm ROE of Southern is twice as high as Duke's. Duke Energy has also been offering a rather solid dividend yield over the last five years. In the current volatile business environment, Duke's stock seems more preferable in terms of both profitability and dividend stability.

Economic Outlook

Southern has been one of the best dividend-growth companies in the last 11 years in a row. Moreover, it has been evaluated as the company with the highest rate of return on investment in the industry. From almost its inception in 1945, the company has been paying dividends every year. A critical period that the company faced was in 2007, when transmission demand reached its peak at 48,008 megawatts. However, there was no alert issued. Customer satisfaction was even at its highest level (81/100) that year. Since then, the company has focused on investing in new technologies in order to reduce costs and raise efficiency.

Southern has very ambitious plans for the future. After extensive research, management of the company decided to invest $14 billion in transmission, distribution and generation facilities in the next two years. This should raise productivity and fulfill customer requirements. SO also participates in the regulatory process through industry groups and committees. The goal of these activities is to establish and advance the company's position in the market.

Summary

The above-mentioned facts prove that Southern Company has satisfactory economic performance and takes its corporate responsibility seriously. Investing in this company should offer investors a positive outcome due to a strong dividend history as well as reasonable business strategies. This is a good reason to suggest that SO will certainly meet the expectations of its investors in the coming years. Based on historical valuation metrics, SO stock currently has fairly reasonable price.

Disclosure: I 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.

Source: How Much Is Southern Company Worth?