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Southern Company: Invest While The Yield Is Still High

Summary Blue-chip utility Southern Company yields over 4.5%. Southern Company has healthy relations with regulators. The southeast region is one of the fastest-growing regions in the U.S. Bonus: Live fully functioning earnings and price-correlated graph on Southern Company. Introduction In consideration of today’s low interest rate environment, fixed income securities offer little in the way of return. Moreover, the safety characteristics normally associated with fixed income are also potentially upside down. Since early 1982, the interest rates available with fixed income have been in a continuous freefall. This has presented both good and bad news for the conservative investor desirous of a high and safe income stream on their portfolios. The good news is that bond prices move inversely with interest rates. Therefore, when interest rates drop, as they have done since 1982, the prices of previously issued bonds will rise. Therefore, fixed income investments, primarily bonds, have provided the opportunity for high yield and either capital appreciation or at least stable prices. This falling interest rate trend has gone on for more than three decades, and as a result, fixed income returns have been abnormally strong and even high. However, the first part of the bad news is that fixed income investors need to understand that previously issued bonds will move to a premium valuation as rates are dropping, but will eventually move back to par when they mature. Consequently, the only way to lock in capital appreciation in addition to your interest income would be to sell your bonds before they mature. Otherwise, temporary capital gains created by falling rates will inevitably dissipate to breakeven levels. As a result, investors that hold bonds to maturity will in effect suffer losses of purchasing power due to inflationary forces. On the other hand, the additional bad news is that falling interest rates result in the inability to reinvest in newly-issued fixed income instruments at rates that are attractive. But the worst bad news is that those investors purchasing fixed income at today’s extremely low rates are exposing their capital investments to potential losses in a rising interest rate environment. Investors need to understand that bond prices fluctuate just as stock prices fluctuate. If future interest rates move higher, and if that were to happen quickly, originally issued bond prices could drop just as much as stock prices did during the Great Recession. Bonds are considered safe because they mature at par; however, bonds are also liquid. Therefore, bond prices can, and do, fluctuate between their issue date and maturity. Fairly Valued Utility Stocks for Income and Safety Consequently, and as the result of the fixed income dynamic discussed above, I have been, temporarily at least, eschewing fixed income. In other words, I have been recently looking for viable alternative income-producing opportunities. Importantly, I am just not focused on finding higher income streams; I’m also concerned about finding income-producing alternatives with reasonable safety characteristics. I believe that carefully selected utility stocks can fit the bill, as long as they are purchased at sound or attractive valuations. Stocks and bonds are different investment types and therefore possess different investment merits and characteristics. In other words, I believe it would be a stretch to state that utility stocks are perfect fixed income alternatives. On the other hand, utility stocks, when purchased at sound valuation, do possess and/or share characteristics with bonds that are similar enough to consider them a reasonable alternative. When interest rates are at normal levels, bonds pay higher interest income than most blue-chip dividend paying stocks provide in dividend yield. Furthermore, since bonds provide an implicit guarantee of returning principle at maturity, they also provide a level of safety not normally associated with stocks. However, it is also true that all dividend paying common stocks are not the same. Utility stocks are generally regulated monopolies, and as such, have a history of producing reliable and consistent earnings growth and above-average levels of dividend income. Nevertheless, even though the earnings growth on utility stocks is generally consistent and reliable, earnings and dividends generally do not grow very fast. Regulation provides consistency and a level of reliability, but at the expense of higher or above-average growth potential. Southern Company High-Yield Sound Valuation Southern Company (NYSE: SO ) is a blue-chip utility stock that is considered one of the strongest among its peers. The two primary reasons supporting this view are the relatively friendly regulatory environment they operate in, and the better-than-average economic fundamentals associated with its region. Headquartered in Atlanta, Southern Company dominates the power business serving both regulated and competitive markets across the southeastern region. For example, Zacks considers Southern Company one of the largest and best managed electric utility holding companies in the United States. Operating in one of the fastest-growing and strongest regions of the country, Southern Company is a holding company for four regulated Southern electric utilities that serve about 4.4 million customers. Those utilities are Georgia Power, Alabama power, Gulf Power, and Mississippi power. Additionally, Zacks estimates that Southern Company’s impending acquisition of AGL Resources (NYSE: GAS ) could double its customer base and generate more revenues. However, this additional growth potential is slightly mitigated by what many consider the high valuation (approximately $28 billion) they paid for AGL. The following earnings and price correlated graph on AGL illustrates the premium valuation that Southern Company is paying. (click to enlarge) On the other hand, when looked at from the perspective of the 3- to 5-year trendline growth estimates for AGL Resources, the valuation that Southern Company might be paying appears more reasonable. These long-term growth estimates may in fact be reasonable, and more importantly, could provide a meaningful benefit to Southern Company. Considering that Southern Company currently generates approximately 40% of its power from coal-fired plants, the AGL acquisition could provide a breath of fresh air (pun intended). According to MorningStar: “If the AGL deal closes, Southern will operate 7 gas LDCs, including a core Georgia business and a large LDC in Illinois, while gaining stakes in two midstream gas projects with upside to more.” MorningStar also believes that: “Southern Company operates in the business friendly Southeast, where its relatively low power prices and sterling reputation help to foster a constructive and stable regulatory atmosphere.” The following Short business description courtesy of S&P Capital IQ provides further insight into Southern Company and its businesses: “The Southern Company, together with its subsidiaries, operates as a public electric utility company. It is involved in the generation, transmission, and distribution of electricity through coal, nuclear, oil and gas, and hydro resources in the states of Alabama, Georgia, Florida, and Mississippi.” “The company also constructs, acquires, owns, and manages generation assets, including renewable energy projects. As of December 31, 2014, it operated 33 hydroelectric generating stations, 33 fossil fuel generating stations, 3 nuclear generating stations, 13 combined cycle/cogeneration stations, 9 solar facilities, 1 biomass facility, and 1 landfill gas facility.” The company also provides digital wireless communications services with various communication options, including push to talk, cellular service, text messaging, wireless Internet access, and wireless data; and wholesale fiber optic solutions to telecommunication providers in the Southeast. The Southern Company was founded in 1945 and is headquartered in Atlanta, Georgia.” The biggest negative I see with Southern Company relates to issues within their nuclear power businesses. Cost overruns on their Georgia Power nuclear projects, principally Vogtle, do raise some concerns. However, I think those concerns are exaggerated given the diversity of Southern Company’s diverse electric generating businesses. Investing In Utility Stocks at Sound Valuation Is Critical When investing in low-growth companies like utility stocks, getting valuation right is even more critical. Just as it is with all companies, utility stocks can become overvalued from time to time. However, since utility stocks do not grow very fast, overpaying for future earnings can dramatically destroy the dividend income advantage that utility stocks typically offer. Paying too much for a low growth enterprise can easily result in long-term capital losses and future earnings will generally not be large enough to bail you out. You can test this statement by utilizing the following live earnings and price correlated Southern Company graph. Bonus: Live Fully-Functioning Historical F.A.S.T. Graphs on Southern Company In order to assist the reader in understanding Southern Company’s current valuation and historical operating achievements, I offer the following live fully functioning historical F.A.S.T. Graphs on the company. Furthermore, to get maximum benefit from this exercise, I offer the following tips on how to utilize and navigate the live graph. At the top of the graph, there are orange rectangles representing different historical time frames. For example, you can click on the orange rectangle 10Y and the graph will automatically draw a graph over 10 calendar years. Therefore, you can quickly move from one time frame to the next and evaluate changes in earnings growth rates and historical normal P/E ratio valuations over each respective time frame. There is also a scrollbar at the bottom of the graph that allows you to focus on any historical time frame of your choosing. At the bottom of the graph, there is a long orange rectangle that allows you to take the graph apart or rebuild it by simply clicking on any of the words. For example, if you click on the word “Price,” monthly closing stock prices will be taken off of the graph and you can replace them by simply clicking on the word “Price” again. You can do this with all of the items located in the orange rectangle. But most importantly as it relates to the thesis of this article (valuation) the graph also has a built-in performance calculation feature. Simply point and click your mouse on any price point on the graph (the black line) until a red dot appears. Then simply move your mouse to any other price point on the graph and click it and a pop-up will appear with the calculation of the performance over the time frame you chose. To erase the calculation, simply point and click on your second red dot and you will be ready to perform another calculation. Note: all these calculations are based on purchasing and holding one share of the company’s stock. I suggest the reader utilize this calculation function feature in order to evaluate the effects that valuation has on long-term performance. You can measure periods of time from high valuation to low valuation (when price is above the orange valuation reference line), from low valuation (when price is below the orange valuation reference line) to high valuation, etc. As you perform these calculations, notice the effect that various levels of valuation have on long-term performance over time. I hope you have fun performing these various calculation exercises, and I hope they reveal and solidify the important effect that valuation has on long-term returns when investing in utility stocks. Southern Company’s Income Advantage The following detailed performance report on Southern Company since 1996 illustrates the significant income advantage it has provided shareholders compared to an equal investment in the S&P 500. Total cumulative dividend income from Southern Company would have been almost twice as high as the index would have provided. However, due to the low earnings growth rate that Southern Company (and utility stocks in general) has generated, higher yield came at the expense of capital appreciation. Nevertheless, in contrast to long-term bonds held to maturity, Southern Company did produce some capital appreciation in addition to its high dividend income generation. (click to enlarge) Reinvesting Dividends in High-Yield Southern Company Levels the Playing Field The above historical performance report on Southern Company validates the income advantage that a blue-chip utility stock investment can provide. However, for those investors focused more on total return, a low growth high yield utility stock like Southern Company can level the total return playing field – if you reinvest your dividends. As the following performance report on Southern Company with dividends reinvested each quarter illustrates, the high income advantage remains. On the other hand, the capital appreciation (total return) advantage that the index held without reinvesting dividends disappears. With dividends reinvested, the total return on Southern Company and the S&P 500 end up in a virtual dead heat. I believe this validates the power and protection that high-quality high-yield dividend paying stocks offer. This is especially true when a low growth high yielding utility stock like Southern Company is originally invested in when valuation is sound. On that note, I would like to add that both Southern Company and the S&P 500 were soundly valued at the beginning of 1996. Therefore, the return comparisons over this time frame are apples to apples from a valuation perspective. Additionally, the virtual tie in total return between Southern Company and the S&P 500 happened even though Southern Company only grew earnings at 2.5% while the S&P 500 grew earnings at 6.1% over the same time period. (click to enlarge) Additional supporting fundamental metrics on Southern Company Returns on invested capital (ROIC) is an important consideration when evaluating utility stocks. After hitting a low point in the last fiscal quarter of 2014, Southern Company has been steadily improving each quarter in 2015. I consider this a comforting accomplishment. (click to enlarge) In concert with an improving return on invested capital, Southern Company’s bottom line has also been steadily improving throughout 2015. Southern Company’s net profit margin per quarter (npmq) in 2015 has increased from 7.04% to 17.6% in their most recent quarter ending in September 2015. (click to enlarge) Southern Company’s revenues for quarter (revq) have also been improving throughout 2015. Importantly, revenues had recovered to 20-year highs in 2014, and 2015 is on track to be even higher. (click to enlarge) But perhaps most importantly, since I’m attracted to Southern Company for its dividend yield, cash flow per quarter (cflq) strongly support dividends for quarter (dvq). Southern Company is a Dividend Challenger on fellow Seeking Alpha author David Fish’s CCC lists that has raised its dividend for 15 consecutive years. Moreover, southern company has paid a dividend every quarter since 1948. (click to enlarge) Summary and Conclusions I consider Southern Company a strong and healthy utility stock that can currently be purchased at a sound and attractive valuation. At current levels, its dividend yield is approaching 5%, and I believe this represents an opportunity for investors in need of current income. Consequently, I would recommend purchasing Southern Company as long as its yield remains above the 4.5% level or better. In today’s low interest rate environment, a current yield above 4% with the potential for modest capital appreciation to fight inflation looks attractive. Southern Company, like most utilities, is not offered as a high total return opportunity. Instead, I suggest that is most suitable for those investors, including retired investors, that are looking for high current income and reasonable safety. Disclosure: Long GAS Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Why I Am Still Buying Southern Company

Construction cost overruns will remain the headline grabbers that keeps share prices down, but as the saying goes, “This too shall pass”. Total returns will continue in the 9% to 11% range annually, and should be acceptable to most utility investors. AGL Resources acquisition will cement Southern Company as a premier electric and natural gas utility, with the prospects of future financial engineering. For long-term utility investors, there is a lot to like about Southern Company (NYSE: SO ). Southern Co is a worthy example of investor uncertainty creating opportunistic share prices. There is much to dislike about SO, but as the issues become resolved over the next few years, current investors will be amply rewarded. Starting with the negatives, investors have several issues working against the company. Over budget and behind schedule, the Kemper “clean coal” and Vogtle nuclear plants are viewed by some to be the firm’s twin albatrosses. Kemper is expected to be fully operational by mid-2016. Final rate decisions by the Mississippi Public Service Commission is expected in Dec of this year. As of this month, the plant has been producing power for a year. More information on what needs to be done for project completion can be found in SO’s latest investor presentation pages 12 to 16. As discussed in a previous SA article from last May, Moody’s downgraded Mississippi Power based on the financial stress of Kemper. In Aug, Mississippi Power senior unsecured rating was downgraded to Baa2 from Baa1 and its preferred stock rating to Ba1 from Baa3, and the outlook was termed “Negative”. These represent a bond rating still in the investment grade category but a preferred downgrade into non-investment grade. Southern Company’s credit rating remained unchanged and its outlook is “Stable”. Mississippi Power lost a 15% Kemper equity partner in May who requested their initial deposit back and was ordered to refund to customers a previously approved rate increase. Combined, these amount to a total of almost $650 million ($300 million and $350 million, respectively). To make up this shortfall, Mississippi Power has received a short-term loan from its mothership SO for $300 million and has received a $152 million rate increase approval in Aug. Vogtle construction will be a bit more drawn out as the project’s completion date is now 2019 and 2020, leaving several more years of headline-grabbing events. Some cost overruns are being challenged in court between SO and its contractors. Investors with sufficient grey hair to remember the 1970s and 1980s should also remember the cost overruns that plagued those years of the nuclear power plant buildout. From the publication , The Nuclear Energy Option, by Professor Emeritus Bernard L. Cohen, University of Pittsburgh: For example, Commonwealth Edison, the utility serving the Chicago area, completed its Dresden nuclear plants in 1970-71 for $146/kW, its Quad Cities plants in 1973 for $164/kW, and its Zion plants in 1973-74 for $280/kW. But its LaSalle nuclear plants completed in 1982-84 cost $1,160/kW, and its Byron and Braidwood plants completed in 1985-87 cost $1880/kW – a 13-fold increase over the 17-year period. Northeast Utilities completed its Millstone 1,2, and 3 nuclear plants, respectively, for $153/kW in 1971, $487/kW in 1975, and $3,326/kW in 1986, a 22-fold increase in 15 years. Duke Power, widely considered to be one of the most efficient utilities in the nation in handling nuclear technology, finished construction on its Oconee plants in 1973-74 for $181/kW, on its McGuire plants in 1981-84 for $848/kW, and on its Catauba plants in 1985-87 for $1,703/kW, a nearly 10-fold increase in 14 years. Current estimates are for reactors #3 and #4 to cost upwards of $15 billion with Georgia Power’s share at $7.5 billion. Investors should not believe this is both the final cost calculation and the final in-service date, as both will increase over the next four years. However, these projects will eventually pass and will contribute to higher cash flows over time, as did the previous construction overruns and delays of the 70s and 80s. On the positive side, SO dividend offers a nice yield of 4.75% and is expected to match earnings growth at around 4%. This current yield is on the higher end of its historic year-end yield as offered by fastgraph.com. In addition, SO return on invested capital ROIC has been one of the better in the utility sector. ROPIC was reduced in 2014 due to construction cost overruns charges against earnings. The graphs below outlines SO’s 20-yr history of stock performance and ROIC. (click to enlarge) (click to enlarge) Of interest to investors is the acquisition of AGL Resources (NYSE: GAS ). Since the deal was announced on Aug 24th, SO stock has been flat, with the day-prior to the announcement share prices of $45.80. The $12 bil deal will be financed through $9 bill of permanent financing and $3 billion of equity raises between now and 2019. With a market cap of $40 billion, this amounts to a dilution of around 8% but management believes will boost earnings growth from 3% – 4% annually to 4% – 5%. With the Clean Air Act applying added pressure on coal-fired power producers in favor of natural gas plants, this move not only leap frogs SO into the number 1 spot for utility size, but it also diversifies SO’s income stream to include more natural gas regulated assets, such as distribution, pipelines and processing. It seems Duke Energy (NYSE: DUK ) is not far behind with its acquisition agreement involving Piedmont Natural Gas (NYSE: PNY ). Over the long-term, the GAS acquisition will be a good move by management and may eventually offer the prospect for a financial re-engineering via a MLP spinoff similar to other gas utilities. Investors should factor in the advantages of SO operating in one of the most favorable regulatory environments and even setbacks with the Kemper plant cost recovery should not dampen its overall relationship with regulators. SO share prices hit a double bottom on June 25th at $41.61 and on Sept 4th at $41.98. Share prices have not broken below $40 since Aug 2011. Technically, the outlook is positive as long as share prices don’t break support at $42 and then $40. MACD has been rising since crossing its trend line on July 20 and is still above its trend, albeit with a skinnier spread. Income investors may want to analyze Mississippi Power’s various preferred stock offerings. The most liquid is their $30 million-issue 5.25% Cumulative Preferred Depositary Shares (MP-D), with each share representing one-quarter shares of the underlying $100 par value issue with the same dividend. This creates a trading par value for MP-D of $25 a share and a dividend of $1.32 a year, with a high/low for the year of $27.02/$24.92. At a current price of $25.46, the preferred shares offer a 5.15% yield, but its volume is quite low at just 1200 shares a day average for the past 90 days. Other Mississippi Power’s preferred include a $2.6 million-issue 4.4% Cumulative Preferred (MPRWL) with a current yield of 4.8% and a price of $90.60, a $1.7 million-issue 4.6% Cumulative Preferred (MPRWP) with a current yield of 4.9%, and a $3.4 million-issue 4.72% Cumulative Preferred (OTC: MSPWP ) with a current yield of 4.7%. However, the last three stocks trade very infrequently and should be considered as illiquid stock holdings. For example, according to OTCmarkets.com, MSPWP has only traded 12 days during past year. While naysayers are having a field day with cost overruns on its construction projects and these topics will still make headlines for the foreseeable future, the underlying moves by management reflect optimism concerning their business. I expect a 4% to 6% share price appreciation coupled with a 4.75% yield and a 4% dividend growth rate for a total return of 9% to 11% annually. This is why I am still a buyer of Southern Company stock. Author’s Note: Please review disclosure in Author’s profile.

$100,000 Investment Into Yearly Income: The Southern Company Example

Summary A dividend strategy is essentially turning investment into a yearly income stream. Boring utilities stocks can help you generate great levels of wealth. Here is the way it can work for you. In the article “Can A $100K Investment Produce A $50K Yearly Income? Walking The Model Step By Step” I introduced a model to generate an ongoing income steam through initial investment of $100,000 and by reinventing the net dividend flow. There were many comments and feedbacks to this model and I thank all commentators for their good inputs. One key concern that was raised was that achieving a $100,000 worth of savings is almost an impossible challenge these days. Well, I will fool you not. Getting to a significant amount of wealth is not an easy task. It requires both discipline and setting straight the priorities. There is no magic here. In order to achieve significant amount of savings one must put aside a portion of his income. These amounts can be either fixed or it can change from week to week or month to month. Nevertheless there should be constant contribution. In order to achieve something there must be a goal. A goal should be set realistically based on the ability to routinely contribute to the accumulated wealth. In the next example I will continue to use the $100,000 as the goal. After we set our mindset straight and agreed to take responsibility over our spending and savings, and after we set up a goal that is reasonable to achieve, how can we generate wealth using dividend investing strategy? The example of The Southern Company I decided to use The Southern Company (NYSE: SO ) as an example as it is conceived as a boring type of investment. It is less exciting from the growth machines out there but it can definitely fit to our purpose of generating wealth. SO is a holding company that operates in the South East counties of the U.S. It owns Alabama Power Company, Georgia Power Company, Gulf Power Company, and Mississippi Power Company, each of which operates as a public utility company. SO is the 16th largest utility company in the world, and the fourth largest in the U.S. It serves more than 4.5 million customers in Alabama, Georgia, Florida, and Mississippi. The company was founded back in 1945 and began paying quarterly dividends in 1972. SO never had a dividend cut and has been steadily increasing its dividend since the year 2002. An investor who decided back in November 2005 (ten years ago) to regularly invest in SO, to routinely invest $450 per month and buy more shares. And alongside during this period, each quarter he reinvested the dividends after tax to buy more of SO’s shares he could have reached the $100,000 goal by the end of 2014. Even after the 2015 correction in the Utilities’ stock prices he would have reached the goal again by the month of September 2015. It means that based on these particular assumptions the goal was achieve after nine years. Let’s see how it worked in more details. The investment Since SO paid a quarterly dividend through the assumed period, the investment is built out of two elements: the first one is the monthly contributions of a fixed $450. That means yearly contributions of $5,400 each year. The second element is the dividends net of 25% tax rate which have constantly grew from year to year. The higher dividends together with the higher number of accumulated shares delivered an everlasting growing purchasing power to buy more shares. As we can see in the next graph, during the recent years the dividend became a significant portion of the yearly investment and by 2014 it was about 40% of the $8,568 yearly investment. The shares accumulation The monthly contributions allowed to constantly increase the amount of shares but the accumulation was highly dependent on the share price. The next graph shows the yearly stock price average during the recent ten years alongside the accumulated number of shares during each period. At times of high stock price the accumulation power was lower. The situation of the zero interest rate brought the stock price to recent highs and by that reduced the buying power of the routine contributions. In a scenario of a hiking interest rate we might see SO’s stock price going down and by that a fix accumulation will allow to purchase more shares. The total investment value: The dividend yield went down from the levels of 6-7% in the years 2005-2009 to the levels of 5% in the recent years due to the stock price hike. But this exact hike also drove the holding value to higher levels and led the total value to exceed $100,000 by December 2014. If indeed the interest rate hike will arrive soon (and it depends how high it would reach in the next couple of years) the value of the portfolio will be highly volatile and might go down in value. The income: Which brings us to the last piece. The accumulated holding at the value of $100,000 generates in 2015 a yearly net income of $3,566. As this machine will continue to work it would grow its income power even higher. Even if the stock price will go down due to a FED’s action the power of time and reinvestment will allow to accelerate the income machine even faster (as lower stock price allows to accumulate more shares). If you are interested in the excel model behind this example you can find it here . Conclusions: Even a boring type of investment like SO can serve well the patient investor to generate wealth using a sound dividend investment strategy. Dividend strategy cannot depend on a sole stock and should be based on a diversified portfolio. The monthly contributions should be aimed towards high quality stocks that face temporary headwinds but have long and proven history. Nowadays this list may include companies like Chevron (NYSE: CVX ), ConocoPhillips (NYSE: COP ), Deere & Company (NYSE: DE ), Eaton (NYSE: ETN ), Johnson & Johnson (NYSE: JNJ ), HCP (NYSE: HCP ) and other names from the Industrial sector. A consistent strategy of constant contributions and dividends reinvestment will allow to obtain sound results overtime. There would be those who would criticize the length of the time required to achieve the goal at it was shown in this example. As mentioned earlier: there is no magic here. In order to accelerate the accumulation and reduce the length of time the monthly contributions should be higher. For example, a monthly contribution of a $1,000 would have reduce the time by ~40% allowing the goal to be achieved in early 2011 or after six and a half years. There are highly subjective decisions to be made and it will vary from one person to the other, but if the mindset should be set to take responsibility over your financials, a sound goal should be set and the only thing left is to execute the strategy. Happy investing.