Utilities such as Southern Company (NYSE:SO) are often looked at as widow-and-orphan stocks. In other words, they're so safe that even the most risk-averse investors could buy them and sleep well at night. While on the whole that might be true, there's a lot of variation when you bring it down to an individual company. Is Southern a relatively safe company? Yes. Is it risk-free? No. Here are some of the risks you need to think about here.
Safe at its core
To put things in perspective, Southern Company is a pretty safe utility. It has around 4.5 million customers, largely in the Southeastern United States. The vast majority of its business is in regulated markets, which means it gets a set return on its investments. Even better, it has generally positive relationships with its regulators, and the regions in which it operates have been growing, albeit slowly. This all helps explain why Southern has paid a dividend every year for over 60 years, with the past 15 including annual distribution increases.
Compare that with a company such as AES Corp. (NYSE:AES), which is largely an independent power producer. That means it sells power to utilities and is exposed to fluctuating power prices. Why is this relevant? Because low natural gas prices in the U.S. market have led to falling revenues for power producers such as AES. To offset regional risk, the company is widely diversified geographically, operating power plants literally around the world. But that, too, poses risks. For example, AES recently had to lower guidance because of slowing economic growth in key markets such as Brazil and currency headwinds from the strong U.S. dollar.
So on a relative basis, Southern looks lower-risk than some alternative utility options. But that doesn't mean it has no risk.
Construction and more
One area that's been a major sore spot for Southern in recent years is construction. The utility has two big projects that have hit cost and timing snags -- a clean-coal plant with carbon-capture technology, and a nuclear plant. Both are massive projects, with the clean coal a first-of-its-kind project. In other words, it's probably unfair to expect smooth sailing. However, it's been pretty rough for Southern, which has taken write-offs because of troubles at both projects.
In fact, it recently chose to rejigger its construction team on the nuclear side in the hopes of getting that project back on track. And while both projects are inching toward completion, there's still the risk that they don't work out as planned and that investors wind up bearing the brunt of the cost for more delays and overruns.
Then there's the not-so-subtle issue that Southern is in the process of acquiring natural gas-focused AGL Resources (NYSE:GAS). The two companies operate in similar regions and would be pretty complimentary to each other. So in many ways, the $8 billion deal looks like a good call. But it's a big deal that would roughly double Southern's customer base. And just like every merger, there's a chance that it might not get done. But as a utility, there's even more risk on that score, because regulators from every region in which the two companies operate have to approve the deal.
It shouldn't be too big a problem to clear that hurdle, except for the construction issues that Southern has had. That might cause regulators some concern. And don't think that regulatory issues are a non-event, either. As an example of how difficult it can be to get a utility deal done, look at Exelon's (NYSE:EXC) ongoing efforts to close a $6.8 billion acquisition of Pepco Holdings (NYSE: POM). Essentially, regulators in Maryland and Washington, D.C., are opposing the deal because they believe it will harm the competitive landscape, including investment in renewable power. And while Exelon has made concessions, so far it hasn't been enough to get regulators to approve the deal.
There's no reason to believe that Southern's purchase of AGL will go down the same path. But there's always the risk that it could. So until the deal closes, hopefully in the second half of the year, this is another issue that makes Southern look less like a widow-and-orphan stock than you might expect from a boring regulated utility.
There's one other major issue that investors need to keep in mind, and that's the changing face of electricity. Once power came mostly from coal, and now it's shifted toward natural gas in recent years, but the long term appears to be renewable power. Southern is working to change its portfolio, but carbon-based fuels still account for most of what it produces. It should have plenty of time to work with its regulators to adjust to a changing power market, but investors still need to keep this big-picture shift in mind when examining Southern. It's an industry-wide risk, but it shouldn't be forgotten.
None of these issues, even taken together, should stop you from owning Southern Company stock. It's a good company with a long track record of success. However, each of these issues proves that Southern isn't a risk-free investment. If you own this utility or are looking at it for its 4.5% or so yield, just be aware that you need to watch more than your dividend checks if you want to understand the real risks of owning Southern Company.