We can also see that Southern Company’s reported earnings have remained remarkably stable over the last decade. The dip in recent years was caused by constructed-related charges. Otherwise, the steady earnings results look almost like interest payments coming in from a bond. Southern’s earnings growth isn’t exciting, but it’s dependable.
Source: Simply Safe Dividends
As a regulated utility company, Southern generates a moderate but predictable mid-single digit return on invested capital. The slight dip was due to write-offs on its capital projects, but the favorable regulatory environment in its key states has helped it earn somewhat higher returns than many other utility companies. We expect the company’s returns to improve as its large projects finally come on-line.
Source: Simply Safe Dividends
Utility companies maintain a lot of debt to maintain their capital-intensive businesses. Southern Company most recently reported $1.4 billion in cash compared to $27.4 billion in debt on its balance sheet. While this would be a concern for most companies, the stability of Southern’s earnings and strength of its moat alleviate much of this risk.
The company also has over $4 billion available in its credit facility and maintains investment grade credit ratings with the major agencies.
Source: Simply Safe Dividends
Despite the challenges Southern Company is facing with its major construction projects, the safety of its dividend still looks great. The company maintains a reasonable payout ratio for a utility company, earnings are predictable each year, and its key operating states have provided a historically favorable regulatory environment.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
The dependability of utility companies’ dividends comes at the price of growth. Southern Company’s dividend has grown at a 3.9% annualized rate over the past decade, and the business has a very low Dividend Growth Score of 9. The company most recently increased its dividend by about 2% in April 2015, marking its 14th consecutive raise.
Source: Simply Safe Dividends
While Southern Company is 11 years away from joining the dividend aristocrats list, we believe it has a good chance of getting there. The company’s dividend growth rate could even increase in coming years. Management believes the AGL Resources merger could increase Southern’s long-term earnings per share growth from 3% to 4-5%, which would allow for slightly greater dividend raises.
Valuation
Southern Co (NYSE:SO)’s stock trades at 17.4x forward earnings estimates and has a dividend yield of 4.36%, which is below its five-year average dividend yield of 4.46%.
If the AGL merger increases the company’s long-term earnings growth rate to 4-5% as management expects, the stock appears to offer total return potential of 8-9% per year.
We think the stock looks to be about fairly valued today, and it’s worth noting how the predictability of Southern’s business has resulted in very low stock price volatility. The chart below shows the volatility of each of the 20 utilities in the Philadelphia Electric Utility Index (UTY). Southern Company had the lowest level of volatility through the five-year period ending on 12/31/2014.
Source: Southern Company Annual Report
Conclusion
Southern Company is a blue chip dividend stock in the utilities sector. The last few years have been disappointing due to delays and cost overruns with some of the company’s major construction projects, but the long-term outlook appears to be intact.
Southern Company’s stock appears to be reasonably priced and offers a dependable income stream for those living off dividends in retirement. It’s hard not to like a business as sturdy and reliable as this one.
Disclosure: None
