Southern Earnings: Costs Could Kill This Dividend Stock

Southern Company (NYSE: SO  ) reported earnings Wednesday, matching revenue expectations but slightly underwhelming on earnings. With costs headed higher, let's take a look to see if this dividend stock is priced for perfection.

Number crunching
On top-line growth, Southern nailed it. The utility pulled in $3.9 billion in sales, 8.1% higher than Q1 2012 and a respectable 4% above analyst expectations.

On adjusted earnings, Southern managed just fine. Diluted EPS clocked in at $0.49, missing the market's $0.50 prediction by one cent.

But to make money, you have to spend money, and Southern spent more than Wall Street (or the company itself) expected. Unadjusted earnings added up to $0.09 EPS, compared with $0.42 for last year's first quarter.

The two main cost culprits: (1) a $16 million after-tax charge from restructuring a leveraged lease investment and (2) a $333 million after-tax charge for increased construction costs at a new Kemper County, Miss., power plant.

According to President and CEO Thomas Fanning:

In keeping with our commitment to customers, Southern Company will fully absorb the increased costs related to the Kemper project. This decision enables us to maintain our commitment to the Mississippi Public Service Commission under the settlement agreement, while retaining the benefits of 21st century coal for customers.

The most recent earnings report comes after a flurry of press releases earlier this week announced a newly increased dividend, purchase plans for 250 MW of wind, a 139 MW solar acquisition, and cost troubles at the Kemper plant.

Go with the flow
Southern's strategy isn't so different from other utilities. Its current 4.2% dividend yield puts Southern above most other utilities, but it's not a dividend stock standout. AEP also announced a 4.3% dividend increase this week, marking its 412th consecutive quarter of dividend distributions.

Southern's venture into renewables isn't a solo sojourn, either. Earth Day announcements shed green light on a variety of utilities' environmental efforts. Southern's teaming up with First Solar for its solar foray, while a partnership with Ted Turner's renewable energy company will wind up Southern's wind capacity .

While Southern's 1,250 MW of renewable generation capacity don't count for much of its 43,500 MW total generation, Atlantic Power is banking heavily on wind to pull its profits out of the red. The smaller utility acquired wind-heavy Ridgeline Energy last year and plans to focus on natural gas and renewables for future growth.

What does Q1 change?
Excluding one-time costs, there are no major movers for this dividend stock's new earnings report. Weather was the main reason for the utility's $0.07 year-over-year improvement, pushing retail sales up 2.3%. 

On the generation front, gas/oil took a larger piece of Southern's energy portfolio, up 2 percentage points to 47%. Coal remained steady at 32%, while nuclear dropped 3 percentage points to 16% and hydro headed up 1 point to 5%. 

Will Southern soar?
Southern shares fell 1.3% on its earnings announcement, signaling the market's disappointment with the utility's new costs. The Kemper plant will ultimately slice another $540 million off the utility's books, a price that doesn't match up with Southern's newly increased dividend. With natural gas prices headed higher, I'd rather see a steady diversification strategy than a bigger payout.

For Southern to deliver, the utility needs to:

  1. Control costs (Kemper keeps me unconvinced).
  2. Stay smart on its dividend distributions (the new increase is no good).
  3. Ramp up its renewables diversification (recent news has me optimistic here).

Until I can be sure that management is seriously strategizing to pull through on these three points, I'll leave this dividend stock on the sideline of my portfolio.

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