Utilities are capital-intensive businesses. They need to invest a lot of capital to maintain and expand their power plants and energy distribution assets. That means they tend to borrow a lot of money to support their operations.
While all utilities issue debt, Southern Company (SO -1.56%) has been very wise in how it uses the debt market. It brilliantly capitalized on the low-interest-rate environment in recent years to lock in relatively low-cost, long-term debt. As a result, it has largely insulated its business from the impact of higher rates, which will act as a headwind for some peers as more of their debt matures and rolls over to higher rates in the coming years. That puts Southern in an even better position to continue growing its extremely durable dividend.
Locked in for the long term
Because it's typically cheaper to borrow money for a shorter term, many companies issued short-term debt when interest rates were low to save money. That strategy has turned out to be shortsighted now that rates have surged in the past year. As that debt matures, they'll pay a much higher interest rate to refinance.
Higher interest rates are much less of a headwind for Southern Company. Its financing strategy centered around issuing long-term debt. While it's currently paying a higher interest rate (coupon) on that debt compared to peers who opted for shorter terms, it has locked in a relatively low rate for a very long time:
Image source: Southern Company.
As that slide showcases, Southern Company has the second longest average time to maturity among its peers at 16 years. It locked in that debt at a relatively low coupon of 4%. The company's decision to lock in long-term, fixed-rate debt when rates were lower is becoming a competitive advantage in a rising rate environment. It doesn't have as much debt maturing in the near term, leaving it less exposed to higher interest rates:
Image source: Southern Company.
As that slide shows, the utility has well-laddered debt maturities, with a very manageable amount of debt coming due over the next few years. Meanwhile, over 10% of its debt won't mature for more than three decades.
While Southern Company will have to pay a higher rate to refinance debt as it matures, it can still borrow at relatively low rates thanks to its strong investment-grade bond rating. For example, the company issued two tranches of debt in May to redeem $1.5 billion in notes due in July. It issued $750 million in notes yielding 4.85% due in 2028 and $750 million in notes due in 2033 yielding 5.2%.
The power to continue growing its dividend
With most of its debt locked in at low rates over the long term, higher interest expenses won't be much of a drag on Southern Company's earnings in the coming years. It will experience more of the benefits of its expansion-related investments, which are sizable. The company is currently finishing construction on the second of two new nuclear power generating units, with the latter one expected to enter commercial service in the first quarter of next year. It invested over $10 billion in the project, which should generate $700 million in operating cash flow for the company. It's also investing capital to expand its utilities and renewable energy business.
Those capital investments will grow Southern's earnings, giving it more cash to pay dividends. Southern Company has been a durable dividend payer over the years. For over 70 years, the utility has paid a dividend equal to or greater than its payment in the previous quarter. It has increased its payment in each of the last 22 straight years. That steady upward trend seems likely to continue, thanks largely to Southern's smart financing strategy.
A wise decision
Southern Company was smart to focus on securing long-term fixed-rate debt rather than issuing shorter-term borrowings. That strategy has helped insulate it from the impact of higher rates, and it will capture more of the growth from its expansion-related investments, which should give it the fuel to continue increasing its dividend. That makes it an ideal stock to buy for those seeking a steadily rising payout.
