With a market cap of $77 billion, The Southern Company (SO -1.56%) is one of the largest regulated utilities in the United States. For a long time the company has had a problem hanging over it in the form of Vogtle 3 and 4, two nuclear power plants that it has been building. Vogtle 3 was attached to the U.S. electrical grid at the end of July, which could be the start of very good news for income investors.
A long and bumpy road
Building a large-scale nuclear power plant is complex and expensive. Southern's efforts have been anything but smooth, with the Vogtle project (which includes reactors 3 and 4) over budget and delayed. The electric and natural gas utility has even had to take multiple write-offs to account for the poor performance of the project.
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In fairness, some of the problems were outside of the company's control. For example, its original contractor, Westinghouse, declared bankruptcy. That resulted in Southern taking control of the project. Then there was the coronavirus pandemic, which resulted in delays to accommodate social distancing and increased difficulty in achieving full staffing levels. These examples aren't meant to let Southern off the hook, only to suggest that there was more going on with Vogtle than meets the eye.
But, after a very long time, Vogtle 3 has entered commercial operation. Now Wall Street will turn its gaze on Vogtle 4, which is scheduled to start up in late 2023 or early 2024. Southern has been using the lessons it has learned from Vogtle 3 to help smooth out the process of building Vogtle 4, so there's a reason to hope that Vogtle 4 will begin commercial operation without too much difficulty.
The next step
There are all sorts of positives here, including the fact that Vogtle 3 and 4 will provide non-fossil-fuel energy for decades into the future. But for income investors, the big news is that the Vogtle project will go from a cash drain to a cash generator. It's not complicated. Building power plants costs lots of money. Once they are built and start selling power, they bring in revenue.
The numbers are pretty sizable, given the scale of the two power plants. Vogtle 3, for example, can generate enough electricity to power 500,000 homes. That said, once Vogtle 4 is online, Southern expects the two nuclear power plants to add around $700 million to its cash provided by operating activities.
There are a lot of ways Southern can use that cash. Some will clearly go toward other capital spending needs, which will further enhance the company's long-term growth opportunities. Some will likely be used to strengthen the balance sheet. But it is also likely that some will get used to increase the dividend.
For many years now, Southern has hiked its dividend by $0.08 per share per year. That's left the average annual increase over the past decade at a modest 3% or so. In fact, the increase has been roughly 3% over the training one-, three-, five-, and 10-year periods. That's enough to roughly keep up with the long-term growth in inflation, which is good. But with Vogtle nearly complete, Wall Street will likely press Southern to do better, and it seems likely that the company will oblige.
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SO Dividend Per Share (Annual) data by YCharts
That said, investors probably shouldn't expect spectacular dividend growth from Southern. It is, after all, a utility. A dividend growth rate in the 5% range would be more in line with some of its large peers, and it would actually grow the buying power of the dividend over time. That won't happen this year, but there's a chance that 2024 could be the start of a new regime on the dividend growth front for Southern.
A decent time for a deep dive
Southern's nearly 3.9% dividend yield is noticeably higher than the average utility's yield of around 3.3%, using the Vanguard Utilities Index ETF as a proxy. That higher yield is at least partly related to the overhang of the Vogtle project. With that issue subsiding and the potential of higher dividend growth in the future, investors will probably start to revalue Southern Company's stock.
If you are worried about execution risk, you might want to wait until Vogtle 4 is online. Wall Street discounts the future, however, so that could mean missing some of the upside opportunity. For most income investors looking at the utility sector, Southern is a name you'll want to dig into now, because the story here is potentially just months away from changing in a very positive direction.
