Berko: Taking a look at whether Southern Co. is a good buy

Dear Mr. Berko: We have a $17,000 certificate of deposit coming due and are thinking of buying 300 shares of Southern Co. because of the 5.3 percent yield. We found that the stock has fallen by 9 points in the past three months. What do you think?

— L.W., Kankakee, Ill.

Dear L.W.: Southern Co. (SO-$43.82) dominates the power business across the Southeast, with 4.6 million electricity customers in Georgia, Alabama, Florida and Mississippi plus 4.5 million gas customers in Georgia, Florida, New Jersey, Illinois, Virginia and Tennessee. Gas and oil account for 42 percent of SO’s power generation. Coal accounts for 31 percent, and nuclear produces 15 percent, while the remaining 12 percent is purchased power.

In the past five years, SO’s shares have traded at an average high price of $52.25 a share, while its low price has been $42.88 on average. And given today’s price of $43.82 and a dividend that has been raised for 25 consecutive years, SO’s 5.3 percent yield is very comforting. But I was gabberflasted to discover that in 2017, several executive vice presidents, the comptroller, the CFO, the general counsel and el presidente sold over 500,000 shares for between $49 and $53. What’s more, in 2016, the same officers and directors sold 1.2 million SO shares for between $48.40 and $54.10.

Today’s price appears to be a good level at which to buy 300 shares. SO’s dividend yield is among the highest in the utility industry. The company earned $3 a share in 2017 on $22.6 billion in revenues and expects to earn $3.08 a share this year on expected revenues of $23.5 billion. Meanwhile, the dividend should be raised to $2.38 this year, up from $2.30 last year. However, SO has underperformed most utility issues in the past four years because of construction difficulties related to unexpected cost increases for the company’s two major construction projects. These projects were planned and designed to eliminate SO’s need to purchase 12 percent of its power from other utilities. I think that the construction risks are minor inconveniences and that revenues, earnings and dividends will continue to improve modestly.

Crimp in its growth

That said, this has crimped SO’s non-organic growth. As a result, SO’s price has fallen by 9 points, causing the company to take a $9 billion hit to its capital this year. SO will need about $1 billion a year in various forms of additional equity to meet its ongoing expenses and complete its power construction projects by 2022. This additional equity could hurt the current shareholders’ equity, which has averaged a good 12.2 percent during the past few years. And the issuance of additional shares to pay for this cost could dilute earnings by a few pennies a share, going out to 2022. Some watchers of SO note that the utility has, like a number of its peers during the past 10 years, cobbled together a strong network of natural gas midstream assets. And these assets could be merged into an independently managed corporate structure with good earnings. If this happens, SO could spin them off as a master limited partnership or even issue a tracking stock. This could easily raise the $4 billion that SO needs to complete its construction projects. And the sale of two gas utilities, Elizabethtown Gas and Elkton Gas, which should close late this year, will offset a good portion of SO’s equity needs and take some of the pressure off management.

Though SO, rated A- by Standard & Poor’s, has woefully underperformed most utilities, I believe that it can be safely bought for the stability of its dividends and the near certainty of its annual dividend growth. The dividend yield is certainly better than any CD’s, and I suspect that if you were to buy SO shares and hold them for five years, you would see the price of your shares run up to the low $50s. But if you’re uncomfortable with buying 300 shares, consider buying just 100. Meanwhile, most of the analysts on Wall Street have “hold” recommendations on SO, while S&P, Deutsche Bank and SunTrust have “buy” recommendations.

Malcolm Berko addresses questions about stocks. Reach him at P.O. Box 8303, Largo, FL 33775 or mjberko@yahoo.com.