The Southern Company
/ (SO-NYSE)/ Equity Research / SO | Page 7
Current Recommendation / NEUTRAL
Prior Recommendation / Outperform
Date of Last Change / 02/05/2015
Current Price (02/04/15) / $49.46
Target Price / $52.00
SUMMARY
We are downgrading our rating on Southern Company to Neutral from Outperform, as we see limited near term price upside. One of the largest and best-managed electric utility holding companies in the U.S., SO dominates the power business across the southeastern region. With good rate base growth and constructive regulation, we expect the firm to generate steady earnings and dividend growth in the coming years through its long-term power contracts. However, the challenging economic environment and increased spending levels may hamper SO’s results in the next few quarters. We are also concerned by its high level of Vogtle-related costs that may reduce forward returns. As such, we do not anticipate a significant upside in the near future and expect the stock to perform in line with the broader market./ Equity Research / SO | Page 7
SUMMARY DATA
52-Week High / $52.7952-Week Low / $40.82
One-Year Return (%) / 24.88
Beta / 0.14
Average Daily Volume (sh) / 5,221,332
Shares Outstanding (mil) / 900
Market Capitalization ($mil) / $44,505
Short Interest Ratio (days) / 6.38
Institutional Ownership (%) / 49
Insider Ownership (%) / 1
Annual Cash Dividend / $2.10
Dividend Yield (%) / 4.25
5-Yr. Historical Growth Rates
Sales (%) / 1.3
Earnings Per Share (%) / 4.2
Dividend (%) / 3.7
P/E using TTM EPS / 17.6
P/E using 2015 Estimate / 17.3
P/E using 2016 Estimate / 16.7
Zacks Rank *: Short Term
1 – 3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / Low,
Type of Stock / Large-Blend
Industry / Util-Elec Pwr
Zacks Industry Rank * / 84 out of 267
OVERVIEW
Headquartered in Atlanta, Georgia, Southern Company (SO) is one of the largest generators of electricity in the nation, serving both regulated and competitive markets across the southeastern U.S. It is a holding company for four regulated Southern electric utilities that serve about 4.4 million customers – Georgia Power, Alabama Power, Gulf Power, and Mississippi Power. The company participates in all phases of the electric utility business with more than 46,000 megawatts (MW) of electric generating capacity, and an extensive grid of transmission and distribution lines. The company also engages in the construction, acquisition, and management of generation assets, provision of digital wireless communications services, and the provision of fiber optic solutions to telecommunication providers.
The subsidiary units of Southern Company are responsible for the construction programs to accommodate existing and estimated future loads on their respective systems.
· Georgia Power: The largest of four electric utilities that make up Southern Company, Georgia Power is an investor-owned, tax-paying utility that serves 2.4 million customers in all but four of Georgia's 159 counties. It has been providing electricity to Georgia for more than a century at rates well below the national average.
· Alabama Power: Alabama Power, within the state of Alabama, is engaged in the generation and purchase of electricity and the transmission, distribution, and sale of such electricity to more than 1.4 million homes, businesses and industries across the state.
· Gulf Power: It is an investor-owned electric utility, 100% owned by Southern Company. Gulf Power is engaged, within the northwestern portion of Florida, in the generation and purchase of electricity and the transmission, distribution, and sale of such electricity to more than 430,000 customers in 10 counties.
· Mississippi Power: Mississippi Power is engaged in providing retail and wholesale electric service to approximately 186,000 customers in 23 counties from the Gulf Coast to Meridian. It owns or has major ownership interests in six generating facilities with net dependable generating capacity of 3,166 MW.
Additionally, Southern Company owns all of the common stock of Southern Power, which is also an operating public utility company. Southern Power builds, acquires, owns, and manages generation assets and sells electricity at market-based rates in the wholesale market. Southern Power owns and operates more than 7,500 megawatts-worth of energy plants across Alabama, Florida, George and North Carolina, with an additional 820 megawatts in development in North Carolina and Texas.
REASONS TO BUY
Ø Southern Company is one of the largest electric utility holding companies in the U.S., and the premier energy firm serving the attractive Southeast market. We consider the Southeast to be one of the better regions to operate an electric utility, due to the higher-than-average natural population growth, the strong and diverse regional economy, constructive regulation and comparatively tight power markets. These characteristics provide a solid basis for Southern’s regulated business, which is expected to make up roughly 90% of its consolidated earnings over the next few years.
Ø The company continues to earn returns that are among the highest in the industry, while at the same time maintaining its position as a low-cost provider of electricity with superior customer satisfaction levels. Additionally, Southern remains a leader in power plant productivity, cost control and new technology research.
Ø Southern pays an annual dividend of $2.10 per share, yielding an attractive 4.3%. The utility increased its dividend payout by 3.5% in Apr 2014, marking the 13th consecutive year of dividend increases. Southern has a long and consistent dividend paying record. The company has paid dividends in each of the last 269 quarters for more than 60 years. As such, we believe Southern’s dividend to be safe and reliable.
Ø Southern Company’s strong management team with decades of marketplace experience stands them in good stead, while its flexible capital structure and commitment to investment grade credit rating supports growth and dividend coverage.
REASONS TO SELL
Ø The operating results of Southern Company are affected by weather conditions and may vary on a seasonal and quarterly basis. Electric power supply is usually a seasonal business. In several regions of the country, demand for power peaks during the summer months, along with market prices. In other areas, power demand reaches its maximum during the winter. Consequently, the future operating results of Southern Company may fluctuate substantially on a seasonal basis.
Ø With approximately a third of the company’s total retail sales coming from industrial customers, a sluggish economy severely affects the fortunes of Southern, as compared to other utilities that are less dependent on the industrial component.
Ø Southern Company’s heavy reliance on coal-generated energy supply and a lack of meaningful contribution from renewable energy is a matter of concern. In the current age of growing emphasis on ‘environment friendly or green’ energy, the company may be forced to divert cash flows to ensure regulatory compliance, which can adversely impact profitability.
Ø We remain skeptical regarding Southern Company’s $14 billion investment for the construction of two new reactors at the company’s existing nuclear site in Vogtle, Georgia. With a fair chance of cost overruns and likely modifications – to fully address the safety risks exposed by the meltdown at Japan's Fukushima plant in 2011 following a devastating earthquake and tsunami – the project cost could easily end up around $20 billion. This will substantially increase Southern Company’s leverage and deteriorate its credit metrics. Additionally, the increasing capital intensity of its operations may result in reduced returns going forward.
RECENT NEWS
Fourth Quarter 2014 Results
On Feb 4, 2015, Southern Company reported fourth quarter 2014 earnings per share (excluding certain one-time items) of $0.38, $0.01 shy of the Zacks Consensus Estimate of $0.39. The slightly weaker-than-expected numbers could be attributed to spiraling expenses. However, Southern Company’s performance deteriorated from the year-ago adjusted profit of $0.48 per share amid lower residential and commercial sales.
The Atlanta, GA-based power supplier’s quarterly revenue – at $4,049 million – came 3.1% higher than the fourth quarter 2013 level of $3,927 million. Moreover, it surpassed the Zacks Consensus Estimate of $3,756 million.
Overall Sales Breakup
Closer-to-normal temperatures boosted Southern Company’s electricity demand. This brought about an upward movement in overall electricity sales and usage. Total electricity sales during the fourth quarter improved 1.8% from the same period last year.
Southern Company’s total retail sales inched up 0.5%. This reflects higher demand from industrial customers, which increased by 2.3%. But this was almost totally offset by lower residential and commercial sales that decreased 0.2% and 0.8% year over year, respectively.
Expenses Summary
Southern Company’s operations and maintenance cost jumped 33.4% to $1,330 million, while the company’s total operating expense for the period – at $3,457 million – was approximately 10.5% higher than the prior-year level.
VALUATION
The Southern Company is one of the largest electric utility holding companies in the U.S., and is the premier energy company serving the Southeast. It remains a leader in power plant productivity, cost control and new technology research. Southern Company is a quality utility that provides the security of regularly expanding dividend payments as well as the potential for moderate-to-high capital appreciation.
However, with approximately a third of the company’s total retail sales coming from industrial customers, a sluggish economy severely impacts the fortunes of Southern, as compared to other utilities that are less dependent on the industrial component. The challenging economic environment may hamper its results during the next few quarters, along with Southern shelling out hefty amounts to comply with environmental controls/regulations. Consequently, we see the stock performing in line with the broader market and now rate it as Neutral.
Southern Company’s trailing 12-month P/CF multiple is 9.4 compared to the 8.9 average for the peer group and 15.0 for the S&P 500. The company’s trailing 12-month EV/EBITDA multiple is 11.6, compared to the industry average of 9.8. Our $52 price objective is based on a multiple of 9.9X trailing twelve-month cash flow.
Key Indicators
Earnings Surprise and Estimate Revision History
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of SO. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1120 companies covered: Outperform - 15.6%, Neutral - 76.9%, Underperform – 6.8%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.
/ Equity Research / SO | Page 7