We are going to look at two utilities today. The first one is Southern Company (NYSE:SO), and the second one is Exelon Corp (NYSE:EXC). Without a doubt, Southern Company is the stronger of the two. However, from a contrarian perspective they could make for good long-term investments. Exelon is now the largest electric and gas utility provider in the US as a result of its completed merger with Constellation Energy. The company will service roughly 100,000 businesses and about 1 million residential customers. Synergies in operation and maintenance should help them save between $100 million to $170 million in 2012. The merger will provide it with the opportunity to work on fuel innovation to improve operational efficiency. Exelon also appears to be in the process of putting in a bottom and this should eventually lead to higher prices. As long as it does not close below $34.54, the outlook will remain bullish. Southern Company's rate of return is among the highest in the industry. It is one of the top energy firms servicing the Southeast market, and it is a leader in power plant productivity, cost control and technology research. It has also consecutively increased its dividend for 11 years in a row.
Reasons to be bullish on Southern Company:
- Management expects to invest $14 billion between 2012 and 2014. The bulk of this capital will be invested in transmission, distribution and generation facilities and this is expected to boost earnings growth through an increase in efficiency and production.
- A respectable yield of 4.3%.
- It is a low cost provider of electricity and continues to generate returns that are among the highest in the industry.
- A good operating margin of 24% and a decent profit margin of roughly 13%.
- A good five year dividend average of 4.6%.
- A healthy five year dividend growth rate of 3.74%.
- It is one of the top energy firms servicing the Southeast market.
- Five-year sales growth rate of 2.61%.
- Annual EPS before NRI rose from $2.24 in 2007 to $2.57 in 2011.
- A manageable payout ratio of 77%.
- Cash flow increased from $4.62 in 2009 to $5.01 in 2011.
- Net income rose from $1.7 billion to $2.2 billion in 2011.
- A 3-5 year estimated EPS growth rate of 5.04%.
- It has consecutively increased its dividend for 11 years in a row.
- Projected year-over-year growth rate of 3.00% and 6.25% in 2012 and 2013 respectively, according to dailyfinance.com.
- A good interest coverage rate of 4.50.
- $100K invested 10 years ago would have grown to $199K. If the dividend were invested the rate of return would be higher. The results below are based on 1K, we simply multiplied these result by 100.
A stock tends to perform much better when it is trading above the EPS Line. This is clearly demonstrated in the above chart. The outlook for Southern Company is positive as the stock is still in a strong uptrend.
The stock has been consolidating after it put in a double top formation towards the end of July. It is now in the process of putting in a bottom, and ideally, it would test the 444.70-445.50 ranges before trending higher. The most bullish setup would be for it to trade down to $44.70 and then end the day on a positive note. A weekly close above $47.60 will signal higher prices, and it could test the $49-$50 ranges before running into resistance. Consider waiting for a test of the $44.70-$45.50 ranges before jumping into this stock.
Additional Reasons to consider on Exelon Corp.
- A good yield of 5.8%.
- A quarterly revenue growth rate of 32.4%.
- A five-year dividend average of 4.00%.
- An operating cash flow of $6.5 billion.
- Even though net income has dropped slightly from $2.5 billion in 2010 to $2.49 billion in 2011, it still generates a huge amount of cash flow, which is more than enough to cover the dividend payments.
- Annual EPS before NRI has increased from $4.12 in 2009 to $4.16 in 2011.
- A good operating margin of 18.6%.
- A 5 year cash flow average of $7.72.
- It sports a current ratio of 1.5. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing future earnings. As the ratio is above 1.00, it should have no problem making its debt payments.
- It has an excellent interest coverage ratio of 24. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. With an interest ratio of 24, it means that Exelon can cover interest expenses 24 times with operating profits, so there is no danger of it running into any problems in the near future.
- A five dividend growth rate of 3.9%.
- A very good free cash flow yield of 5.4%.
- An incredible long dividend history - it has been paying dividends since 1902.
- $100K invested 10 years ago would have grown to $158 as indicated by the table below. Fast graphs bases the data on $1k. We simply multiplied the result by 100.
When the stock is trading above the EPS line, it tends to perform better. The stock is still trading below the consensus EPS line, but the stock is showing signs of putting in a bottom and could trade above the EPS line in the near future. Note also that the EPS line is flattening out, and this can also be taken as a sign that the worst news could be already be priced in the stock.
The stock has given the first confirmation that a bottom has taken hold or could take hold soon. It traded higher after dipping down to a new 52-week low on the 12th of September. A retest of the lows and the ability to end the day on a positive note would be a strong confirmation that a bottom was fully in place. It could trade below the current 52-week low of $34.54, but as long as it ended the day on a higher note, it would be a strong signal that the stock had put in a bottom. On the other hand, a weekly close above $37 should be viewed as a bullish development, and it would signal that the stock was ready to test the $40-$41 ranges. It is generally better to wait for a confirmed bottom before jumping into a stock. A confirmation that a bottom was in place would entail the stock retesting its lows and then trending higher from there. Investors should consider waiting for a test of the 34.50 ranges before jumping into this play.
Alternatively, you could sell puts at strikes you would not mind owning the stock at. For example, if you thought $35 would be a good place to open a position you could sell puts at this strike. The benefit of this is that your final price will be a lot lower when the premium is factored in. If the shares are assigned to your account, your final price could be below $34 a share. It would all depend on how much time the puts you sold had on them. Puts with more time would fetch higher premiums and vice versa. The disadvantage is that there is no guarantee that the shares will be assigned to your account. In this event, your reward will be the premium you received when you sold the puts.
While they differ strongly in terms of growth and performance, both companies could make for good long term plays. It is easy to side with Southern Company as it is the clear leader in terms of growth and performance, but Exelon appears to be putting in a bottom, and its merger with constellation allows it to work on fuel innovation, thereby improving operational efficiency, which will help lower production costs going forward. Current synergies are expected to produce a net saving of $100-$170 million in 2012. Exelon is continuing with its program to upgrade its plants, and this is expected to help the company produce an additional 420 million watts of carbon-free power over the next five years. Consider waiting for both stocks to trade to the stated ranges before committing new funds to either play.
EPS charts and some of the research data used in the article were obtained from zacks.com.
It is imperative that you do your due diligence and then determine if the above plays meets with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was prepared for Tactical Investor by one of our analysts. We have not received any compensation for expressing the recommendations in this article. We have no business relationships with any of the companies mentioned in this article.