What do you really know about Southern Company (NYSE: SO)? Maybe you think of it as a safe and boring utility stock to own -- no growth, but good dividends. Perhaps you even see a stock like Southern as a potential play on low natural gas prices, as it uses increasingly more of the plentiful fuel.
Are these preconceptions on target? Let's find out by answering three questions.
1. Is Southern a way for investors to capitalize on low natural gas prices?
Southern is likely to consume more natural gas than coal in 2012 for the first time in its history. Its not alone in the move toward natural gas.
American Electric Power (NYSE: AEP) now generates 24% of its power from natural gas and plans to increase these levels. Duke Energy (NYSE: DUK) is actively retiring coal-powered plants and replacing them with natural gas plants. Exelon (NYSE: EXC) plans to generate 67% of its fossil power generation from natural gas in the coming years.
Southern reported that its fuel costs per kilowatt hour for natural gas were 12% lower than coal in the first quarter this year. Fuel is by far the single biggest expense for the company. With lower costs in its largest expense item, the move to natural gas should certainly mean higher earnings, right? Nope.
The reason why is that Southern's rate structures include fuel cost recovery provisions. When fuel costs rise, the company can ask for approval to raise rates. On the other hand, when fuel costs go down, the company seeks to lower rates. For example, the company's Georgia Power operating entity filed a request in March to reduce fuel rates by 19% primarily because of lower natural gas prices.
Lower fuel costs might affect cash flow, but they don't significantly impact the bottom line. Investors must look elsewhere to take advantage of low natural gas prices.
2. Are there minimal growth prospects for the company?
Utilities like Southern don't fall in the growth stock category. However, that doesn't mean there aren't decent growth prospects for the company.
Southern's sales grew 68% over the last 10 years. Earnings per share grew nearly 38% during the same period. Those aren't numbers that impress growth-oriented investors, but they're not awful.
Two of the states that Southern serves -- Florida and Georgia -- rank among the fastest-growing in the U.S. Increasing populations will mean higher residential demand for electricity and corresponding growth for the company.
What about the other states in Southern's geographical area that aren't growing their populations as quickly? Boston Consulting Group released a report in 2011 that concluded that manufacturing costs in the U.S. could rival those of China's within five years. They noted that Alabama was one of three southern states that will "be among the least expensive production sites in the industrialized world." Mississippi was included as one of these states in an earlier version of the report.
Industrial customers account for 32% of Southern's retail energy sales' kilowatt hours. If the report's predictions are correct, the company could see solid growth in the next few years.
3. Are its dividends a sure thing?
The right answer, of course, is "no." There isn't a company that can honestly guarantee that its dividend will always be paid no matter what. If you answered "yes," though, you definitely have some ammunition to bolster your case.
Southern has paid a dividend for 64 years. It has gone 257 consecutive quarters paying a dividend equal to or higher than the prior quarter. Dividend increases over the last five years averaged 3.83% annually. The dividend yield currently stands at 4.1%. It's fair to say that Southern puts a high priority on dividend payments.
Are there any clouds on the horizon? There might be a few wisps in the skies, but there's nothing scary right now. Southern targets distribution of around 70% of net income back to shareholders via dividend payments. In 2011, the actual payout ratio was 73%.
Southern's payout ratio based on the trailing 12 months stands at 77%. That's a little higher than what the company prefers, but it's roughly in line with the ratio for Exelon. Outliers among its peers include AEP with a 46% payout ratio and Duke Energy with a high 89% ratio.
Boring but bright
Sure, Southern is somewhat of a boring stock. But boring isn't all that bad.
If you're looking for solid dividends with modest growth prospects and a solid moat, Southern is a good pick. You can count on it to keep the lights on for you.
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