SO - Southern Company: 22nd Consecutive Annual Dividend Increase

2023-04-17 18:52:49 ET

Summary

• The Southern Company is a reliable dividend player, as evidenced by it declaring the 22nd annual dividend increase.
• But the current macro environment makes investing in utility stocks highly questionable.
• The Southern Company stock's own valuation is too rich for my taste as well.

Not many things can be boring in the exciting world of investing. But there are always exceptions. Investing in and tracking utility companies might be one such exception. There are no charismatic CEOs or flash alerts or constant "next big things." But, boy are they effective. The Southern Company ( SO ) is living proof of being "boringly effective," as the company has just announced its 22nd annual dividend increase, as reported here by Seeking Alpha.

Since this article focuses on The Southern Company's dividend strength, I am using Seeking Alpha's dividend grades and evaluating each of these major sections in increasing order of importance. Let us get into the details.

• Yield: With the latest dividend increase, The Southern Company's annual dividend of $2.80/share gives it a forward yield of nearly 3.90%. This is not too far from the 5-year average yield of 4.10%. The average yield matters for well-known dividend-paying stocks since investors tend to bid up the stock price based on dividend increases. Frequent readers of my articles will be well aware that I don't chase high yields, so let's get a bit deeper.
• Consistency and Growth: Southern Company has a respectable history of 22 annual dividend increases, and in a clear sign of its maturity as a reliable dividend payer, the company has now stuck to its pattern of announcing a dividend increase in the second quarter of each calendar year at least since 2005, as shown below. In this 15-year time period, the dividend has gone up from 42 cents a share to 70 cents a share. So, consistency and dividend growth both get a pass.

• Safety: Let's move onto dividend safety evaluation. Readers know that I prefer using Free Cash Flow over Earnings Per Share.
  • Current outstanding share count is at 1.089 Billion.
  • The new quarterly dividend is 70 cents per share.
  • That would represent a commitment of $0.7623 Billion/quarter towards dividends (1.089 Billion shares times 70 cents).
  • The Southern Company's average quarterly free cash flow ("FCF") over the last 5 years was -$333.74 Million . Ouch! And to make matters worse, the best quarterly FCF over the last 5 years was $435 Million, which is significantly less than the $762 Million needed to cover dividends alone. Double Ouch! So, how is this company not just paying dividends but increasing it for more than 2 decades now? Let's park that question for a minute and look at other things that impact dividend coverage.
  • Using a forward EPS estimate of $3.61, The Southern Company has a relatively comfortable payout ratio of 77 %. Earnings are expected to grow by 7%/yr over the next 5 years, and the company does have about $2 Billion in Cash and Short-term investments and an agreeable debt-equity ratio of 1.40.

Now, back to the elephant in the room. In short, the answer is the industry. The long-drawn answer is that utility companies tend to and need to invest in a lot of physical assets to maintain/grow the business over time. This trend is the same with almost any utility company, as can be seen here with Dominion Energy, Inc. ( D ) and here with Duke Energy Corp ( DUK ). I highly recommend this article if you are skeptical about investing in utility stocks because of FCF concerns.

Outlook and Conclusion

The Southern Company has stuck onto the pattern of increasing quarterly dividend by 2 cents every year since 2017. This means, the dividend growth rate has fallen each year and I expect this trend to continue in the future.

From a technical perspective , SO stock is showing reasonable strength. The stock is trading above its 100-Day and 200-Day moving averages but is lower than the 5-, 20-, and 50-Day moving averages. Lastly, utility stocks are highly susceptible to interest rates for two reasons: (1) they tend to carry high debt; and (2) investors look up to utility stocks primarily for their yield.

When the much safer savings accounts yield more, there is little reason to touch these stocks unless they offer a huge bargain, which The Southern Company isn't at this moment. The stock is trading at a multiple of nearly 20, and at the expected earnings growth of 7%, a Price-Earnings/Growth ("PEG") ratio of 3 is too rich in the current macro environment.

I was invested in The Southern Company in the past but took sizeable gains around 2016/2017 when dividend-paying stocks got excessively overvalued. When I got back into utilities, I decided to invest in Vanguard Utilities Index Fund ETF Shares ( VPU ), as it had a comparable yield and is less risky than a single stock by definition. However, should I get back into individual utility stocks, there is no doubt in my mind that The Southern Company will be at the top of the list as the company marches towards the coveted 25 year mark in dividend growth.

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