Southern Company (SO 0.62%) is one of the largest utilities in the United States. With a largely regulated and fee-based business spanning electric, natural gas, and renewable power, it has a sizable and locked-in customer base. Add in a generous 4%-or-so dividend yield, roughly twice what the S&P 500 Index is offering today, and dividend investors should be interested in this high-yield name. But don't jump in just yet -- there's a lot more to know before you decide whether or not Southern Company is a great dividend stock to add to your portfolio.
Definitely some greatness here
There is no question that Southern Company has some serious dividend bonafides. The biggest one by far is its 19-year streak of annual dividend increases. That's a pretty impressive number that places this utility in rare company, but it isn't the only one to look at. Southern Company also hasn't cut its dividend in over 70 years. That's seven decades of dividends, at equal or higher levels, that income-focused investors were able to count on. And Southern has no intention of violating this streak now; its goal is to continue making modest increases over the next few years (more on this in a second.)
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That dividend has been so regular and secure because Southern's business is largely regulated and fee-based. It has a monopoly in the regions its electric and natural gas utilities serve. These are vital energy sources that customers buy in good and bad times. Demand will vary, of course, but there's an underlying need that makes the business robust to downturns. In exchange for this monopoly, Southern is regulated by the government and must get the rates it charges approved. While that limits upside profitability, it creates a fairly steady upward trend for growth over time. In the operations that aren't regulated (such as the company's large renewable power business), Southern tends to sign long-term fee-based contracts. That creates another stable income stream.
Diversification is another positive. As hinted at above, Southern operates in multiple lines of business, but it also operates in a number of different states as well. When one segment is facing headwinds, another can pick up the slack. If one area isn't growing much, another can carry the load. These are subtle benefits that often get lost in the mix, but that make Southern's dividend all the more reliable. When you add it all up, there's a lot to like about Southern as a dividend stock.
Some other facts to consider
But don't stop there. Being regulated requires Southern to get its rates approved. That basically means it has to prove a need for rate hikes, which it generally does by spending money to improve its business in some way -- fortifying its distribution assets or building power plants, for example. That means that Southern can have some big, and even high-risk, projects in the works. Right now it is building a pair of nuclear power plants, a project that is behind schedule and over budget. Southern has this project back on track at this point, but progress needs to be watched closely. It's also worth noting that a clean coal plant the company had in the works didn't pan out, and ended up being a high-cost natural gas power plant. Put simply, Southern's capital spending has been a sore point lately -- and with the nuclear build not scheduled to be done for a few more years, it will remain one.
That's notable, because this spending is very costly and Southern has been using leverage and asset sales to help cover the cost. For example, the utility's financial debt to equity ratio is roughly 0.66 times, not a crazy number but high relative to those of more conservative peers like NextEra Energy, which sits at 0.35 times. In addition, Southern's payout ratio has been 80% and higher in recent years -- last year it approached 100%. The average for large utilities in closer to 70%. Material leverage and a high payout ratio are warning signs of a strained dividend. These concerns are offset somewhat by the regulated nature of the company's operations, but Southern's balance sheet strength and payout ratio need to be monitored along with its progress on the nuclear front.
And one last piece here is dividend growth. Right now Southern is in a construction cycle, so investors might rightly expect dividend growth to be muted -- it simply has other places that it needs to put cash to work. But even when it wasn't dealing with the big nuclear project, Southern wasn't making huge dividend increases. You should expect something close to the level of inflation over time, maybe just a tad higher. That means that the dividend's buying power will be maintained, or grown slightly, but you shouldn't buy Southern thinking the dividend will double in a few years. That's just not the type of investment it is.
Great or not, it's your call...
With those big pros and cons, it's up to you to make the final decision on whether or not Southern is a great dividend stock. However, there's one more factor to look at before making a buy call. Southern stock is up nearly 40% in 2019, and sitting near all-time highs. Its dividend, meanwhile, is the lowest it has been in decades.
That suggests that Southern is pretty expensive today. Interested investors would probably be better off putting it on the watch list than the buy list right now, a fact that remains true even if you decide it is a great dividend stock. To paraphrase value investing legend Benjamin Graham, even a great dividend company can be a bad investment if you pay too much for it.
