SO - Southern Company: With Construction Delays Now Behind Stock Looks Ready To Go

2023-04-19 05:07:15 ET

Summary

• Southern Company has had issues in the construction of its two new nuclear power plant units.
• Major delays seem to be in the past, though, with both units scheduled to open this year.
• We believe this will position Southern to be a high-performer in the near future.

A Rock And A Hard Place

Utilities are unique among other industries. Typically they operate in something like a government-sanctioned monopoly status in the areas they serve. They must bear the cost of capital investments in equipment to generate power as communities grow, as well as invest in maintaining the reliability and safety of the infrastructure already in use. Importantly, however, they generally cannot unilaterally pass these costs on to customers--they must receive approval from the local government and/or the residents of the communities they serve in order to a that (which can be a hard sell).

Thus, utilities occupy a place at once enviable and tricky: they must make money for their shareholders while not being able to control the price of the vital service they provide.

Nonetheless, utility companies typically offer stable dividends, and that coupled with their generally subdued volatility makes them attractive to potential investors. Today, we'll examine a utility provider that is finally on the brink of completing a major addition to its system, and evaluate whether investors should consider it for their portfolios. That utility is Southern Company ( SO ).

Let's dive in.

New Units Coming Online

Southern Company is a holding company of several individual utilities that provide electricity across Georgia, Alabama, and Mississippi, and natural gas across a smattering of states in the Midwest. The company serves roughly 4.4 million customers throughout this service area. The company generates about 44% of its energy from gas, 20% from coal, and 16% from nuclear. Other sources or bought-in power make up the rest, but this is on the verge of a big change.

The biggest news that surrounding Southern, however, is the near completion of the country's first new nuclear power stations in over 30 years. These are Unit 3 and Unit 4 at Plant Vogtle outside of Waynesboro, Georgia. The two units have unfortunately run over budget and have been delayed for some time, but the company expects the delays to now behind them.

With Unit 3 expected to come online in April of 2023 and Unit 4 by the third or fourth quarter of the year, this represents a sea change for the company and its service areas. A diversification of power sources is not only vital for the region, which is especially prone to power disruptions from natural disasters such as hurricanes or tornadoes, but the low cost power generation of the new units should show themselves as a benefit to customers in the long run (the Units have an expected life of 60-80 years).

The company has been a strong earner overall in the last several years. While earnings per share may look a bit lumpy going back to 2018, these up-and-down figures also reflect the investments needed to get the nuclear plants up and running.

Revenues have grown steadily at the company as well as the region has generally had a net growth in population over the last several years.

Dividend & Valuation

Southern currently has an indicated dividend yield of 3.6%, which is better than average among utilities and far better than the SPDR Utilities ( XLU ) index's yield of 2.9%.

As the plants have been under construction and costs have risen, concern has been raised about the dividend (the Seeking Alpha dividend grade is currently a B-), but we believe that once both units are online and the need for cash outlays is no longer required, profitability metrics will improve substantially.

From a valuation perspective, SO stock is not particularly cheap nor expensive at the moment, although it has recently fallen from an elevated valuation.

Southern currently trades at 13.7x forward EV/EBITDA expectations. This is against the five year historical average of 13x--so, pretty much in line with the average.

Something interesting we found as well is that Southern, despite having a Beta of only .5, has kept up rather impressively with the wider market.

The top chart represents total return, while the bottom chart reflects only price appreciation. Remarkably, over the past five years, Southern has beaten the S&P 500 ( SPY ) in total return, delivering 99% against SPY's 68%.

While the total return metric may not be a complete surprise given Southern's strong dividend, the price appreciation alone took us by surprise. Excluding dividends, Southern's stock has effectively been neck-and-neck with SPY over the past five years, delivering 60% against SPY's 54%.

While we cannot predict future performance, we believe that Unit 3 and Unit 4 coming online will improve the company's overall profit profile and provide a further impetus for the stock to continue its move higher.

Management is committed to profit growth as well. In the latest earnings call , CFO Dan Tucker stated that "[w]e continue to see our long-term adjusted EPS growth rate in the 5% to 7% range, consistent with our updated 2024 adjusted EPS guidance range." If management can hit these targets, we believe bright days are indeed ahead for Southern's stock.

Risks to our thesis include major natural disasters which impact multiple Southern assets at once and effectively impair the company's ability to service its area, as well as any deterioration of relationship with local service area governments.

The Bottom Line

With new nuclear power generation facilities coming online and a broad geographic service base, we feel that there are a number of reasons that investors should consider Southern Company for a place in their portfolio. An above-industry average dividend combined with a reasonable valuation and history of solid price appreciation allow us to look past the construction stumbles the company has had in building the new units.

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