Southern Company's Complete Commitment To Completing Plant Vogtle

Summary

• Despite losses incurred on its gasification project, Southern Company is fully committed to completing its nuclear construction project as demonstrated in their Fourth Quarter 2017 Earnings Report.
• The financial impact of the company's past and future big bets will drive the company’s direction for the next 5 years.
• Investors who do not share the company's faith in nuclear power should consider the costs and invest in utilities that are more aggressively pursuing renewable energy and grid modernization.

Southern Company’s (NYSE:SO) 2017 earnings results may not have surprised investors, but they did reinforce how deeply the company has had to pay for past failures and how committed they are to completing Plant Vogtle Units 3 & 4.

For the full year, the company’s 2017 earnings came in at $0.84 per share compared to $2.57 for 2016. Much of that drop reflects a $3.366 billion (-$2.33 per share) loss caused by the failure of the company’s Kemper gasification project in Mississippi. That represents just over half of the $6.4 billion that is the responsibility of shareholders according to an agreement between the Southern Company's Mississippi Power subsidiary and the Mississippi Public Service Commission.

Nevertheless, Kemper is in the past, and Southern Company’s latest financial report sends a very clear message to investors: just as the company once believed that the energy future was in gasification, it now believes that nuclear power is the future and the company is fully committed to completing its nuclear construction project at any cost.

Update on Plant Vogtle

After winning unanimous approval in December by the Georgia Public Service Commission to continue construction of Plant Vogtle Units 3 & 4, the company reports that it remains on track to complete Unit 3 in November 2021 and Unit 4 in November 2022.

Source: Southern Company, 4Q17 Earnings Presentation

The company believes that once Units 3 & 4 are in service, their costs will be deemed prudent and added to Georgia Power’s base rate ROE (currently 10.95%).

Considering the full impact of Plant Vogtle during construction

For investors, Southern Company’s $3.9 billion estimated cost-to-complete is only part of the price they will be paying for Plant Vogtle until the new units are in service. Meanwhile, the combination costs for Vogtle Units 3 & 4 along with the cost of the failure of the Kemper gasification project are putting a strain on Southern Company’s finances.

Southern Company CEO Tom Fanning acknowledged on the company’s Fourth Quarter Conference Call that the company needs to reduce its debt. Moody’s has already indicated that it has a Negative Outlook on Southern Company Stock, presently rated as Baa2.

At the end of 2017, the company’s long-term debt totals approximately $44.46 billion, an increase of $1.84 billion over the previous year with a total debt-to-equity ratio of over 200%. If possible, Southern would like to avoid a downrating to Baa3, Moody’s lowest level of investment grade rating. Such a downgrade would increase Southern Company’s borrowing expenses even more.

During the Fourth Quarter Conference Call, it became evident how Vogtle is driving Southern Company's future.

Southern Company's large bets, past and future, are molding the company's future

The company’s Fourth Quarter Conference Call demonstrates how the failure of Kemper and the ongoing nuclear project is impacting the rest of the company and shareholders until construction is completed.

Raise new equity

To shrink this $44 billion debt while still paying for the nuclear plant construction, the company is planning to sell $1.4 billion in new stock each year for the next 5 years, which may cause dilution of current shareholders’ holdings depending on how the company plans the new issuance.

While Southern Company emphasizes that the new equity will go to its regulated utilities, a significant portion of it will go to reduce debt, pay part of the cost of the Kemper project, and pay for Plant Vogtle construction activities.

Source: Southern Company, 4Q17 Earnings Presentation

This is a significant change from the company’s plan as outlined in their Third Quarter 2017 conference call (see slide below). At that time, Fanning indicated that the company projected a total of $1.4 billion in cumulative equity needs between 2017 and 2021.

Source: Southern Company, 3Q17 Earnings Presentation

It is unclear what has changed between the company's Third and Fourth Quarter Earnings Presentations but I suspect Kemper and Vogtle are weighing on the minds of bond rating agencies. Fanning was hesitant on the Fourth Quarter Conference Call to outline detailed plans for the sales or how it would impact existing shareholders.

Step back from unregulated businesses and renewables

An important message conveyed during the Fourth Quarter 2017 Conference Call was that Southern Company is refocusing on its regulated utilities business to the detriment of its unregulated Southern Power subsidiary.

In 2017, Southern Power contributed $1.07 billion towards the company’s reported earnings of $1.12 billion, so refocusing away from the competitive power business is a significant change in the company’s outlook. Granted, the loss on Kemper IGCC played a significant factor in the company’s 2017 reported income totals, but choosing to return to a focus on its regulated utilities is a change of direction for the company.

Southern Company plans to remain in the competitive power business, but no longer will seek growth in that sector and instead return to its roots in the regulated utility sector.

As you can see from the slide below, their capital investment will shift away from the competitive unregulated markets to its regulated markets.

Source: Southern Company, 4Q17 Earnings Presentation

There was already a hint of this policy in the Third Quarter 2017 Conference Call when the company announced that it was seeking to sell part of its stake in its Southern Power solar portfolio. No announcement of a buyer has come yet, but the plan remains the same.

For shareholders, the implication of this shift is twofold.

1. Southern Power is home to most of the company’s renewable energy projects. By choosing not to expand its business while other companies such as NextEra (NEE) pursue new opportunities in renewable energy, the company is slowing its transition to renewables and depending on older and potentially higher-cost forms of power generation. This bet is contrary to other utilities that are increasing their reliance on renewable energy projects.

Source: Southern Power

2. The second implication is that Southern Company believes that its regulated utilities with their older generation plants and their slow but reliable earnings, will provide higher profits than the competitive, unregulated market.

The competitive market can be lucrative but it is also riskier. An example of failure in the competitive market is FirstEnergy’s merchant business. Much of the failure of its competitive subsidiary FES's failure is due to having generation based on coal and nuclear plants. FES appears headed for bankruptcy as it has struggled to compete against cheap natural gas and renewables, according to Utility Dive.

While FirstEnergy moves away from older types of generation, Southern Company is embracing them while choosing to partially withdraw from the risks inherent in competitive markets.

Slow Modernization Plans

On the Third Quarter 2017 Conference Call, CEO Tom Fanning emphasized a Modernization plan. While not providing details, he said that more information would be forthcoming in February 2018.

On the Fourth Quarter 2017 Conference Call, modernization was barely mentioned, with the implication that those earlier plans have been shelved.

Grid modernization is the number one topic for most electric utilities in 2018. Electric utilities are focusing on the future for improvements in such areas as battery storage, smart meters, and hardening the power grid.

As the Southeast has experienced more violent hurricanes and other weather events, hardening the electric power grid is becoming an important part of long-term utility planning.

In its Fourth Quarter 2017 Earnings Call, Duke Energy (DUK) outlined their investments in grid modernization over the next five years. Its plans include $16 billion for its North and South Carolina operations and another $1.1 billion in Florida.

Source: Duke Energy, 4Q17 Earnings Presentation

In contrast, Southern Company is committing to a total of $1.6 billion between 2017 and 2021 to grid modernization for all of its operations.

By allowing grid modernization to take a back seat to other priorities, namely Plant Vogtle, Southern Company will fall behind its peers over the next 5 years and lower its reliability to the long-term detriment of ratepayers and shareholders.

Even if Plant Vogtle Units 3 & 4 begin producing power, without a robust transmission network, getting that power to customers will become riskier in an era of more violent and extreme weather.

Conclusion

Southern Company is making sacrifices in the rest of its businesses and remolding its business to accommodate the financial resources needed to complete Plant Vogtle Units 3 & 4.

For shareholders this represents a gamble on their future dividends. While the company currently offers a $2.32 dividend with a better-than-average yield of 5.27%, a portion of that yield can be attributed to the stock’s poor performance over the past 3 months.

Looking ahead, the company plans to increase dividends by $0.08 per year for the foreseeable future, and there is a core set of investors who will hold onto the stock for its yield alone and take it on faith that dividends will continue to grow.

Source: Southern Company, 4Q17 Earnings Presentation

Taking a longer view beyond the dividend, investors should consider that Southern Company is betting its future that nuclear power will be cheaper and more reliable than other forms of electricity generation, including renewables, and that grid modernization can wait. Stockholders who share that view should stick with the company and wait for the nuclear construction to be completed.

Those who see a brighter future for electric utilities through the increased use of renewables and a smarter, modernized grid should consider what Southern Company's commitment to nuclear power is costing the rest of its businesses and shift their investments towards utilities pursuing a more progressive view of the future.

Disclosure: I am/we are long DUK. 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.