Southern Company Earnings: Will Coal Kill This Dividend Stock's Success Story?

Southern Company exceeded Q2 2014 earnings, but its sizable coal stake continues to make it a risky investment.

Aug 19, 2014 at 11:13AM

Southern Building

Source: Southern Company 

Southern Company (NYSE:SO) did it again. For the third straight quarter, the utility exceeded earnings expectations. But with a substantial investment in increasingly archaic coal, is Southern Company as solid as it seems? Here's what you need to know.

Number crunching
Southern surpassed predictions for both top and bottom line numbers. On the top, Q2 2014 sales clocked in at $4.47 billion, well above estimates of $4.27 billion and higher than Q2 2013's $4.25 billion.

Southern also succeeded in turning those top line sales into stronger earnings. The company reported adjusted earnings per share (EPS) of $0.68, two cents above expectations and four cents above 2013's second quarter.

This is the third consecutive quarter that Southern Company has exceeded earnings expectations, a welcome respite from three earnings misses in 2013.

Beyond the numbers
Q2 was a crux point in investors' opinions of utilities. An extremely cold winter pushed most utilities' Q1 earnings well beyond expectations, creating an untimely gap in interpretable and investable information. With second quarter results in, analysts have been keen to separate the economic winners from losers -- and Southern has made the cut for now. Southern Company Chairman, President, and CEO Thomas Fanning couldn't agree more:

Southern Company's second quarter industrial sales growth is an indicator of the potential for a broader economic recovery across the Southeast. Our commitment to provide clean, safe, reliable and affordable energy has enabled us to continue to meet the needs of a region that's growing faster than the U.S as a whole.

For Q2, industrial kilowatt-hour sales jumped a seasonally-adjusted 3%, with overall electricity sales up 2.1%. With over 90% of Southern's earnings originating from its four regulated subsidiaries, electricity usage growth like that is the envy of every utility.

Reg Map

Source: Southern Company; regulated subsidiaries 

Can Southern keep it up?
Q2 2014 was a stellar quarter for Southern Company -- but a good quarter doesn't dictate long-term success. Looking ahead, Southern expects to grow both its EPS and dividend at an annual rate of 3% to 4%. If Q2 is any evidence, growing customer sales won't be a major problem. But how Southern meets that demand growth presents another issue entirely.

The company is embarking on an expensive $17 billion capital expenditure program for the next three years, with projects ranging from maintenance jobs to environmental spending to power base load expansion. Unfortunately, around $2.6 billion of this is slotted to cover unexpectedly high costs for Southern's Kemper County, Mississippi, clean coal power plant.

So Cap Ex

Source: Southern Company Overview Presentation 

Coal currently accounts for around 38% of Southern's 45,500 MW of generation capacity, an unsustainably sizable portion for a fuel that has continually been targeted by new environmental policy. Southern is planning to drop around 7,500 MW of coal by 2015, but the move may not be enough. A new EPA Clean Power Plan proposal further tips the scales of cost competitiveness away from coal, and investors would do well to keep an eye on this controversial legislation.

Do it for the dividend?
Historically, utilities have been some of the safest dividend stocks around. Southern's 4.7% dividend yield is enough to make most income investors salivate -- but it's important to look beyond quarterly payouts.

Increasingly active energy policies, a domestic natural gas revolution, and a volatile recovering market may mean Southern Company's solid past is irreflective of its future success. Southern beat on Q2 earnings -- but its risk factors are all too real, and there may be better dividend bang for your buck.

Diversify your dividends
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term, but there are significantly safer stocks than Southern Company. Knowing how valuable such a dividend portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Justin Loiseau has no position in any stocks mentioned. The Motley Fool recommends Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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