Southern Company: What 'Chugging Along' Looks Like

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About: Southern Company (SO)
by: Eli Inkrot
Summary

The Southern Company has been a quintessential example of slow growing, stodgy but safe utility.

This article looks at the past returns of the security along with future possibilities.

You’re probably not going to be “wowed,” but there is something to be said for an above average and consistent cash flow component.

When I think of a stodgy, slow-growing but consistent utility, a company like Georgia-based Southern Company (NYSE:SO) fits the bill. Let's look at some history to see what I mean.

Here's a look at the year-over-year growth in Southern Company's dividends, earnings and share price:

Even more so than your typical dividend growth company, this business has been especially stable. Take a look at the dividend per share column; that's consistency. In no period during the last decade and a half was the dividend reduced. Instead, it's been growing by 3% or 4% annually for some time now. Given a solid starting yield and where we have been with inflation, this has represented a solid income stream. Over the entire period, the dividend grew by an average compound rate of roughly 3.4% per annum.

When you look at earnings, you see similar consistency, but a bit more volatility. The numbers range from a 2% reduction in adjusted per share earnings all the way up to a 13% increase in one year. However, the trend is largely positive and slow moving. Earnings per share have compounded by about 3.9% per annum dating back to 2001.

Finally, you have the share price. Despite the exceptional consistency in the operating and payout performance, Southern Company's share price has still jumped around a bit - posting one-year movements as low as negative 10% and as high as 21%. Still, despite the increased volatility in this factor, this is still a whole lot more stable pricing-wise than your typical firm. When you think of utility returns, this is the thing that comes to mind.

The share price grew by about 4.5% per annum over this period, which offers a few insights. For one thing, the total return of the Southern Company from 2001 through 2016 was about 7.5% per annum. Roughly, half of the gain was attributable to dividends and the other half to capital appreciation. You're not going to see spectacular advances (at least not over multi-year periods) but there is a high cash flow and stability advantage.

The other thing to note is how the growth rate of dividends, earnings and share price interact. Earnings per share grew faster than dividends per share, so we know that the payout ratio decreased over this period. Dividend per share growth also trailed the share price growth, so we also know that the dividend yield decreased. And finally, with share price performance outpacing earnings growth, we know that the P/E ratio must have increased well.

Here's what that looks like over time:

You can see that the payout ratio has been fairly stable and actually declined a bit over the period. In the last half decade or so it has ticked up, but something in the mid-70% range has certainly been typical.

Based on a $0.56 quarterly dividend and a share price near $49, the "current" dividend yield sits near 4.5%. This too is more or less where it has been. Occasionally, you might see something above 5% and it's been rare to find a yield under 4%.

Finally, we have the earnings multiple, which has averaged just over 16 times adjusted earnings during the last 15 years. As we sit today, shares are a bit above this mark. Notably, the valuation swings haven't been all that dramatic. You have a low of 14.4 during the recession (that's at year-end, it did get closer to 12 times earnings during the depths) and a high of just over 18. I think you'd be hard pressed to make an argument that shares ought to trade outside of that 14 to 18 range. It's conceivable sure, but you'd need an unlikely circumstance to support that notion.

Reviewing the history can give you a feel for whether or not today's value proposition might be attractive. Obviously, history does not dictate the future, but it can give you clues. You know that a mid-70% payout ratio, 4.5% dividend (and above) and a valuation near 16 times earnings are a pretty good baseline - especially with the growth prospects you're dealing with.

Here's a look at what Southern Company recently told investors to anticipate for the intermediate term:

Looking at the midpoints, that's $2.82 in earnings per share for 2016 and $2.96 in 2017. Thereafter, 5% growth is anticipated. Given the industry and the company's past record, ~3.9% annual growth dating back to 2001, let's scale that back slightly and call it 4% yearly growth.

At that rate, you might anticipate Southern Company earning $3.45 or so per share by 2021. Should shares trade at 16 times earnings, this equates to a price of $55.40 - you're going to get precise numbers, but the point is to think about it as a baseline with a wide margin for error.

Should the dividend increase in line with earnings, you might expect to collect $12.60 or so in cash payouts. That's a total anticipated value of ~$68 per share after five years (prior to thinking about reinvestment) or a total gain of 6.8% per annum. Not spectacular, but still quite reasonable.

And naturally, things could go better or worse. For instance, 3% growth coupled with an ending P/E ratio of 15 equals anticipated average compound gains of "just" 4.9% per annum. Or on the higher side, a 5% growth rate and a 17 earnings multiple equates to total gains of 8.6% per annum. It's a wider set of possibilities, but as a baseline, something in the 5% to 9% range as a beginning expectation seems to make a lot of sense.

In short, Southern Company has been a classic example of a security continuing to "chug along." The dividend inches up year after year, earnings follow suit albeit slightly more erratically and the share price also gets there. This last part is a bit bumpier, but there is certainly a predefined range and structure for the share price to eventually follow business results.

At present, shares are trading perhaps just a touch above normal, but the anticipated growth is a bit higher as well. Reasonable business expectations turn into reasonable potential returns - perhaps the definition of a "fair" price. You're not going to be "wowed" by the return possibility - it'd be exceptionally hard to make a "two-bagger" case over the next five years - but the business continues to offer a solid and stodgy cash flow that could supplement a lot of portfolios.

Disclosure: I am/we are long SO. 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.