How Safe Is Southern Company Stock?

Utility company The Southern Company (NYSE:SO) has largely moved in lock step with the market, up 24% for the year versus 26% for the S&P 500.

Over the past five years, the stock has gained 42%, while the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) gained 90.9% over the same period.

This longer term underperformance is largely attributed to the nature of the utility business, which is defensive in nature, meaning that these companies generally grow slowly over time while paying dividends to ensure shareholders receive a source of steady fixed income.

However, last year, utilities got pummeled, bringing their status as ‘safe-haven’ assets under question but this year they have largely bounced back. The Utilities Select Sector SPDR Fund (NYSEARCA:XLU) has gained 16.1% over the past six months, and it appears as if utilities more generally have regained their trusted status as steady income generators.

With Southern Company up substantially this year, what does the future hold for new buyers?

9 Million Customers Rely On The Southern Company

If you’re not too familiar with the utility provider, The Southern Company Gas operates three vertically integrated and state-regulated electric utilities, and the Gas segment alone serves 4.4 million customers.

The company’s clean energy portfolio ranges from nuclear energy to renewable energy to natural gas.

Under the company’s umbrella, lots of subsidiaries operate. Like its Alabama, Georgia, and Mississippi electric utilities and its Nicor, Atlanta, Virginia, and Chattanooga gas utilities.

Moreover, the company also operates Southern Power, providing solar, wind, natural gas, and other clean energy alternative technologies in 15 states. For example, PowerSecure offers infrastructure technologies while Southern Linc is a wireless communication service.

Combined, The Southern Company serves 9 million customers, with a whopping 44,000 MW of generating capacity. In terms of market valuation, it is the second-largest utility giant in the country, with a market capitalization hovering near $100 billion.

Monstrous Free Cash Flows Powering Dividend Hikes

For the first quarter of fiscal 2024, The Southern Company’s total operating revenues climbed by 2.6% from the prior year’s period to $6.65 billion.

Retail electric revenues led the charge, with the non-fuel segment, which is the largest contributor to the top line, grew by 14.9% year-over-year.

As utility revenues surged so too did the bottom line mushroom higher. Adjusted net income ballooned by 30.6% from the year-ago level to $1.13 billion.

It has also become a cash-generating behemoth generating $1.31 billion in net cash from operating activities in the most recent quarter, reflecting a growth of 55.3% year-over-year.

A hefty cash pile of $1.0 billion in addition to monstrous free cash flows has kept dividends flowing too. For a staggering 77 years, it has paid dividends equal to greater than the previous year. The company also has 23 consecutive years of dividend increases and that’s unlikely to change soon with a payout ratio of 63%.

In April, The Southern Company enacted an eight-cent dividend increase, taking the annualized dividend rate to $2.88 per share. This annual rate yields 3.27% on the prevailing price level.

How Safe Is Southern Company Stock?

With a 3.26% dividend yield, a 23 year streak of increasing dividends, and over $1.3 billion in free cash flows last quarter, Southern Company stock appears very safe.

The Southern Company trades at 20x price-to-earnings which is somewhat elevated but relative to forecast net income growth of 8.2% annually over the next 5 years it’s not especially concerning.

With that said, Southern Company’s price sits at a reasonable 20.64x its forward non-GAAP earnings and 8 analysts have revised their estimates lower for the upcoming quarter, so sentiment does appear to be dimming.

For conservative-minded investors there is lots to like, though, not least the fact that volatility tends to be quite limited. Also, the consensus among analysts is for the share price to hit $91 per share over the coming 12 months.

On the other hand, a discounted cash flow forecast reveals a less optimistic outlook with fair value sitting closer to $72 per share. 

Will Clean Energy Be a Growth Catalyst?

The Southern Company aims to reduce its greenhouse emissions by 50% by 2030, compared to the 2007 level, and reach net zero operations by 2050. The company is quite close to attaining the former goal because in 2023 emissions were already 49% below 2007 levels. It expects to continue reducing GHG emissions by more than 50% as early as 2025.

If we look at Southern Company’s energy mix, the company is actively trying to increase the leverage of renewables in that. As of year-end 2023, renewables made 14% of its total energy mix while by the end of Q1 the figure grew to 16%.

Nuclear energy in the mix increased from 17% to 19% over the same period. More favorably, the weightage of natural gas decreased, and coal remained the same.

The biggest tailwind that the company is currently facing in its aim to be more sustainable is the commercial operation in Plant Vogtle. The plant became the largest generator of clean energy in the U.S. after Unit 4 entered commercial operation in April this year. Unit 3 started commercial operations last year. So, with all four units active now, the nuclear energy portfolio is flying high for Southern Company now.

The bulls are clinging to the thesis that this pivot towards clean energy and nuclear gaining ever more attention thanks to heightened AI demand, The Southern Company may well ride on the coattails of higher clean energy demands over the coming decade and reward long-term shareholders.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.