Southern Company (SO 1.38%) has basically sat out the market rally this year as investors constantly fret about rising interest rates eating into the company's profits. However, its results this year show that 2013 was essentially a business-as-usual year. What's more, future profits for Southern Company are much more reliant on its key strategic initiatives, specifically its ability to continue producing favorable rate outcomes, as well as the massive Kemper energy facility project.
That's why, while rising interest rates are a notable headwind as 2014 nears, there are more pressing issues for Southern Company and its shareholders to concern themselves with.
Are rising interest rates a major concern?
Judging by the market reaction, rising interest rates are a huge issue. Share prices of many utilities, including not just Southern but also Duke Energy (DUK 1.39%) and American Electric Power (AEP 0.79%), have lagged the broader market for all of 2013. This is due mostly to fears that rising interest rates will increase interest expenses for utilities, which are reliant on debt financing.
It's true that rising interest rates will make it more costly to refinance debt for these utilities, but at the same time, real underlying business conditions remain sound. Duke Energy points to the success it's having in its regulated businesses as reasons for confidence going forward. Favorable rate outcomes have kept its year-to-date earnings down just 1.5%, excluding one-time impairments and charges.
Meanwhile, American Electric Power has posted slightly higher revenue over the first nine months of the year. It's doing a good job at keeping costs under control as well, as its core operating earnings per share are up 1.5% year to date versus the same period last year. In addition, management recently increased its 2013 operating earnings guidance, which president and CEO Nicholas Akins stated after releasing third-quarter results. Management further demonstrated its confidence by increasing its dividend.
Southern's earnings, excluding one-time items, are flat over the first nine months of the year. On the surface, Southern's results look uglier than they actually are. The company took a $700 million impairment charge related to increased costs of its Kemper County project, but underlying business conditions are fairly steady.
Plus, Southern's debt load over the next few years isn't a huge cause for concern. Its long-term debt maturities through 2017 are manageable, meaning the company isn't likely to get caught off guard by burdensome debt coming due. The company has roughly $22 billion per year in maturities through 2015, which then drop to just $7.6 billion total for 2016 and 2017.
The Kemper facility: for 21st century coal
That's how Southern Company describes the massive Kemper facility in Mississippi, and it represents a key part of the company's future. It's a 582-megawatt electric power plant that features a high-efficiency technology capable of utilizing lignite, which accounts for more than half of the world's coal reserves. This technology converts lignite to gas at a much lower temperature than traditional coal conversion, resulting in significantly lower costs than what's possible with existing gasification technologies.
The simpler, more efficient technology used by the Kemper facility will allow for more power production at a lower capital cost, as well as lower operating and maintenance costs. It's also more environmentally friendly, as it reduces emissions of sulfur dioxide, nitrogen oxides, carbon dioxide, and mercury, as compared to the existing technology. The facility is expected to begin operation by the fourth quarter of next year, and represents a major project that is critical to Southern's future growth.
Don't get distracted by interest rates
It's understandable that investors would get caught up in the discussion of interest rates, given that utility stocks have been fairly volatile this year and badly underperformed the overall market. At the same time, it's probably wise to not get carried away with interest rates. Southern's debt maturities are manageable, and there are more important considerations for its investors to think about.
Specifically, Southern's level of progress on its huge Kemper coal-to-gas facility will be the primary drivers of future growth. That's why, heading into 2014, long-term investors should focus more intently on the core strategic initiatives that are critical to Southern's future than on interest rates.
