Should You Hit the "Off" Switch With Southern at a New High?
Jun 18th 2012 1:13PM
Updated Jun 18th 2012 1:20PM
Shares of Southern Co. (NYS: SO) hit a 52-week high today. Let's take a look at how it got there and see if clear skies are still in the forecast.
How it got here
One wonderful aspect about the stock market is that there will always be sectors bucking the trend and heading higher as the overall market ticks lower. One group that has fared moderately well despite global concerns of a slowdown has been electric utilities.
Southern, the second-largest generator of electricity in the United States behind only Exelon (NYS: EXC) , earns its keep in both regulated and competitive markets in the Southeast by turning coal, natural gas, hydro, and nuclear power into electricity for personal and industrial use. The reason it has done particularly well relates to it having an inelastic, necessity item: electricity. Unless you fancy living in candlelight, you need electricity! That demand provides steady and predictable cash flow that allows Southern to pay out a handsome dividend of 4.1%.
However, even companies with necessity products face headwinds that could derail their profitability -- or at least hinder it. Southern and SCANA (NYS: SCG) were both recently approved to build two new nuclear facilities (each) by the Nuclear Regulatory Commission. While that would normally be good news since nuclear is a cleaner form of energy than say coal, the costs of nuclear energy simply aren't very competitive relative to natural gas at the moment. In its latest quarter, Southern noted a 7.3% decline in overall electric usage (even with a moderate boost in industrial usage). Finally, Southern's business model is reliant on global growth to drive its industrial segment. May's weak jobs report didn't help that cause one iota.
How it stacks up
Let's see how Southern stacks up next to its peers.
Exelon's heavy reliance on nuclear and Entergy's (NYS: ETR) one-time losses have heavily weighed down these two utilities recently, allowing Southern and NextEra Energy (NYS: NEE) to run away from their peers.
Source: Morningstar, Yahoo! Finance.
We can also see the risks described above exhibited in these metrics. Entergy is the "cheapest" of the group, but it has also dealt with regulatory writedowns, non-fuel charges, and weather-related weakness in its latest quarter.
Similarly, Exelon has to deal with the prospect of being the largest provider of nuclear energy in the U.S. despite the fact that nuclear power is considerably more expensive than alternative forms of fuel at the moment. That is necessitating Exelon look at alternate forms of fuel or go natural gas heavy now rather than later.
NextEra Energy has done well because it's invested a considerable amount of its capital in green initiatives. It attributed an offset in lower energy prices (which all utilities are dealing with) to a rapid increase in wind generation. Those investments, however, have bumped its debt levels to worrisome levels relative to cash on hand.
Southern is actually the priciest of the group based on metrics despite suffering the same weather-related problems plaguing Exelon and Entergy and having considerably higher debt-to-equity ratio than Exelon.
Now for the $64,000 question: What's next for Southern? That question is going to depend on whether energy prices rebound, if Southern can reduce its costs by investing further in green initiatives, and if it can find a way to make its nuclear energy generation competitive.
Our very own CAPS community gives the company a highly coveted five-star rating, with 94.8% of members expecting it to outperform. Although I've yet to make a CAPScall on Southern, I'm ready now to enter a call of underperform.
You might be thinking, "Entering an underperform rating on an electric utility is suicide!" And you're probably right in almost every case. What I can't wrap my hands around is why Southern's stock is doing so well with electrical prices notably down and weather patterns clearly not in its favor. I also don't like the company's choice to build more nuclear facilities, which are currently not price competitive, or the fact that it's much heavier in debt relative to equity than larger peer Exelon. Southern's premium simply isn't warranted relative to this group, and I don't expect it to keep up this run much longer.
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At the time this article was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.Motley Fool newsletter services have recommended buying shares of Exelon and Southern Co., as well as creating a covered straddle position in Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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