SOJD - The Southern Company: The Edge Is No Longer There (Rating Downgrade)

Summary

• The Southern Company is currently in the process of bringing two new nuclear reactors online, which are expected to be operational within months.
• The Southern Company is a solid dividend payer and is currently down about 10% from its all-time high.
• The Southern Company has a strong balance sheet and a strong record of producing significant free cash flow, which it uses to invest in its business and return value to.
• The stock is now fairly priced after my entry in late 2021.

The Southern Company (SO) is a leading energy company that provides electric services to customers in the southeastern United States. The company has a long history of reliable operations and is one of the largest electric utility companies in the country, serving more than 9 million customers in four states.

The company is currently in the process of bringing two new nuclear reactors online, which are expected to be operational within months. Nuclear power is the most efficient form of energy in terms of peak production and is often less expensive to produce than other sources, such as coal. SO is a solid dividend payer that is currently down about 10% from its all-time high.

A Stable Utility Opportunity

The Southern Company is a true-to-form utility investment which makes it a bit different from your typical investment. For the uninitiated, dividend stocks provide value to investors a little differently than other types of stocks. The utility sector is made up of companies that provide essential services like electricity, natural gas, and water. These companies are considered to be defensive, meaning their performance is not affected by changes in the economy. As such, investors often view utility stocks as long-term holdings because of their low volatility and stable dividends. This is particularly true during times of economic turmoil when investors are looking for consistent and stable returns.

However, the utility sector is not without its challenges. The industry is heavily regulated, which can expose companies to certain risks. For example, regulations dictate how much utility companies can charge customers, which can limit their earnings potential. Additionally, utilities require a significant amount of expensive infrastructure, which can be costly to maintain and repair. For the most part, utility plays provide stable repayment schedules in the form of dividends and are often compared to bonds. As we discussed earlier, utilities still carry a layer of risk, so investors expected to be compensated for that risk premium to hold them over bonds. When rates rise to approach utility dividend rates, it is common for investors to prioritize bond purchases.

With that said, SO remains a solid name for long-term investors. The company has a strong balance sheet and a strong record of producing significant free cash flow, which it uses to invest in its business and return value to shareholders. The Southern Company has a history of consistently paying dividends and currently offers a dividend yield of 4%, which is attractive to income-seeking investors.

The Southern Company is well-positioned to benefit from the ongoing transition to a cleaner energy future. The company has a diverse mix of generation assets, including nuclear, natural gas, coal, and renewable energy sources. The Southern Company is committed to reducing its carbon emissions and has set a goal of achieving net-zero carbon emissions by 2050.

Earnings Download

Southern Company reported strong Q3 2022 earnings. Third-quarter net income totaled $1.3 billion or $1.14 per share, an increase of $0.06 per share compared to the third quarter of 2021. The company's third-quarter adjusted EBITDA was $3.5 billion, a 2% year-over-year increase. This was driven by higher retail electric margins and increased wholesale and other revenues. The company's CEO, Tom Fanning, stated that the economies in the company's service territories remain strong, including customer growth and economic activity that has exceeded expectations. As a result, the company expects full-year adjusted earnings per share near the top of its guidance range.

Vogtle

Fanning also provided an update on the progress of the company's Plant Vogtle Units 3 and 4. Investors will remember a few negative headlines due to cost overruns . The company is coming up on key milestones, with unit 4 expected to be in service by late 2023. The situation appears to be stabilizing.

The projected completion timeline and capital cost forecast for both units remain consistent with previous guidance. Unit 3 has achieved several significant milestones, including the successful transfer of all 157 fuel assemblies from its spent fuel pool to the reactor core. The next major milestone is initial criticality, which is projected for January. Unit 3 is expected to be placed in service by the end of Q1 2023.

Unit 4 has completed open vessel testing, and direct construction is now 97% complete. The focus is now on electrical production, with testing expected to become the critical path toward future milestones. The projected in-service date for Unit 4 is December 2023.

The Russia Conflict

The ongoing conflict between Russia and Ukraine has had a significant impact on the demand for nuclear energy and natural gas. The conflict, which really began in 2014 and continues to this day, has disrupted energy supplies and strained relations between the two countries. The Southern Company has a pretty diverse energy mix.

One of the main effects of the conflict on nuclear energy has been the disruption of uranium supplies from Ukraine. Ukraine is a major producer of uranium, which is a key component in the production of nuclear energy. The ongoing conflict has disrupted mining operations and caused a decline in production, leading to higher prices and reduced supplies of uranium.

The conflict has also had an impact on the demand for natural gas. Russia is one of the world's largest producers of natural gas, and Ukraine is a major transit country for Russian gas exports to Europe. The conflict has disrupted the flow of gas from Russia to Ukraine and Europe, leading to concerns about energy security and causing an increase in natural gas prices.

In addition to these direct effects on energy supplies, the conflict has also had a broader impact on the global energy market. The tensions between Russia and Ukraine have caused uncertainty and instability, leading to increased risk and volatility in the market. This has made it more difficult for companies to plan and invest in energy projects, potentially slowing the growth of the industry globally, but for The Southern Company, it may create opportunities as European demand lifts prices for alternative energy options for other companies. This is because the company services four states in North America which provide some stability.

Valuation and Forward-Looking Commentary

Moving on to valuation, Southern Company is currently trading right at multi-year averages based on PS and PE ratios.

If we consider the current macroeconomic tailwinds surrounding energy, it is easy to see room for multiple expansion in the future, but there are also plausible reasons to argue that prices may yet fall further. This implies the stock is fairly priced.

The company has a history of providing stable dividends to its shareholders and is known for its strong financial performance. However, its current ratio of 0.8 may be a cause for concern, as it indicates that the company may not have enough liquid assets to cover its short-term liabilities. This could put its ability to maintain its stable dividends at risk in the future.

Quarterly revenue performance is expected to cool over the next few quarters.

This also drills down to EPS figures. We can see that the company does a reasonably good job delivering to expectations but those expectations imply an EPS cooldown.

The Takeaway

The easy money has been made on the Southern Company. When I wrote this article , it was easy to see where the company could offer more upside in the short to medium term. Those gains have now materialized and the upside edge is not there. Bulls may yet enjoy another swing if the right headlines materialize, but there is no great need to buy at current levels. I rate the stock as a hold.

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