A Southern Company facility.  Image Source: Southern Company

Southern Company (SO)

• Southeastern Power and Light was formed in 1924 as a holding company for a few small utilities in the southern United States.  It either created or merged with the following subsidiaries: Mississippi Power, Alabama Power, Gulf Power, and Georgia Power.
• Let’s take a quick detour in the story here to talk about another powerful utility of the day – the Middle West Power Utility company.  By the early 1930s, this company operated in 39 states and was one of the largest utilities in America.  It ended up going bankrupt, somewhat due to the Great Depression but also due to the shady dealings of a man named Samuel Insull (business magnate of the time who worked with Edison and built an empire of utility companies, including GE).
• Because of this disaster, many small investors lost money.  Even though Insull was found not guilty on multiple counts (the federal government wanted to make an example of him when really, the general economic environment was terrible even though Insull probably did have a lot of unethical practices) it set the precedent that large American companies (even utility companies) were not always safe investments.
• Meanwhile, Southern Company began to grow and merge with utilities in northern states but was quickly split up due to the Public Utility Holding Company Act of 1935.  This act was put into place partly due to the failure of Middle West Power – not to mention President FDR’s desire to reform the electricity industry.
• After this period in time, the electric/energy industry became a relatively sleepy industry.  As the population of the U.S. grew following WWII, demand for energy grew steadily, but not at an incredibly high rate.  New subsidiaries were started and spun off.
• One notable subsidiary was the creation of Southern Telecom, founded in 1997.  It’s purpose was to provide telecommunications services.
• In 2010, the U.S. Department of Energy awarded SO with $8.3 billion in loan guarantees to finance construction of two nuclear reactors, at Plant Vogtle, which is located near Augusta, GA.  This is significant because nuclear energy sources are very rare in the U.S. and a plant had not been built in decades.
• Also, in 2016, Southern Company purchased AGL Resources, which expanded its footprint and helped it diversify more into natural gas as opposed to other energy sources.

Business Overview

• Headquartered in Atlanta, SO is responsible for providing the majority of energy to residents of the southeast U.S.  This includes: Alabama, Georgia, Mississippi, Tennessee, Virginia, and even parts of Illinois.  With over 8.5 million customers, they’re the second largest utility company in the U.S.
• Half of their customers (4.27 million) are electricity consumers, and the other half consume natural gas.
• Of the electricity consumers, 75% of those are residential customers, and the rest are mostly commercial, but also industrial customers as well.  Even with these ratios, the actual energy usage between each customer type is split about equally (which makes sense because a single business entity would likely consume way more than an individual).
• 17% of the generating capacity now comes from renewable sources, and the company is moving away from coal (and trying to get more efficient with coal processing too).  It is also constructing two new nuclear units at Plant Vogtle, expected to be operational by the end of 2022.
• Reading through the company’s materials, it seems like this is a company that is always “shuffling around” assets – buying and selling subsidiaries here and there depending on its needs.
• Sales are splits between three segments: Electricity, Gas, and Other.  Electricity is about 70% of sales, Gas is about 12%, and the rest is Other.
• This is a highly seasonal business (but very predictably so).  Two thirds of the revenue but between 86-96% of the net income is generated during the Heating Season (five months of November through March).

Financials

Valuation and Closing Thoughts

• The tough thing about utility companies is that revenue growth is capped by regulatory bodies.  Public Service Commissions (state-run) and the Federal Energy Regulatory Commission, have caps in place to regulate how much people pay for power.
• On the flip side of this, massive infrastructure is required to produce, process, and deliver power in its various forms, and only a few companies can do this.  Southern Company is one of the few that has an established roster of assets that are capable of these needs.  Also, energy is a vital part of life, particularly in developed economies.  Consumption and other forms of production simply don’t happen when people don’t have electricity or gas to run their homes and businesses.
• That being said, buying stock in Southern Company is effectively an “equity bond” in the sense that I wouldn’t count much on its ability to produce capital gains.  It’s really all about the dividend.
• Management has stated for the next 3 years or so that in order to meet its obligations, it will have to continue to borrow more money in addition to using its operating cash flows.
• Long term debt is $42 billion but add in all of the other obligations (leases, retirement benefits, etc.) and you’re looking at $86 billion in liabilities.  Now, the assets are on the books as worth $118 billion, $83 billion of which are PPE, so the ratios are not that far off here.
• Current stock price is $54/share, which is around 26x earnings once you adjust for the Gulf Power sale.  The current dividend yield is 4.7% or so, so there is a large cash payout, but don’t expect much growth.  Also, I would expect some P/E compression in the future.
• Assets with a lot of debt like this that are heavily tied to regulatory restrictions and the credit markets are desirable right now because the Fed has vowed to keep interest rates low in the medium term.  That means stocks paying out hefty dividends can get bid up to higher levels as investors compete for assets with high yields.
• I might buy for the dividend but have no expectation of reasonable capital appreciation from here.
• This might be a good retirement stock because the company will likely be able to keep financing its debt at low rates, and infrastructure companies like this are vital for modern living.  But even with the enticing dividend, I am still a little leery of this stock at these levels.

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