Utilities are supposed to be the penultimate widow-and-orphan stocks — People use electricity, investors get dividends. That’s how it works. So when mega-utility Southern Company (SO) made a $12 billion deal (including debt) for AGL Resources (GAS), participants in the sector took notice in a big way.
The deal vaults Southern Company into second place for largest utility company in America. All in all, Southern Company will serve 9 million customers across nine states, and have 11 regulated electric and natural gas distribution companies. Assuming the deal gets past regulators, the buyout should close in the second half of next year.
But investors, or potential investors, in SO stock should not jump for joy just yet. Southern Company does have a few warts. And some of those blemishes are pretty unsightly and worrisome.
So should you buy shares in one of America’s largest publicly traded utilities given the mega-merger? Let’s take a look at some of the pros and cons of SO stock and see whether the utility is worthy of your hard-earned coin.
Southern Company Stock Pros
Dividend Machine: The reason why people are attracted to utilities in the first place comes down to dividends. And Southern Company is no different. Its core business of providing electricity to residential and industrial customers continues to be strong and consistent, which has helped on the cash flow front. Since 1972, SO stock has increased its dividend every year, save a three year stretch in the early 1990s. All in all, Southern Co. has managed to increase its annual payout a whopping 233% since 1972. That trend should continue. Today, SO stock yields a healthy 5%.
MLP Potential: AGL’s bailiwick is natural gas and everything that comes with it. This includes a hefty dose of midstream muscle — from pipelines to salt cavern storage facilities. Heck, AGL even has liquefied natural gas liquefaction facilities under its umbrella. The beauty for Southern Company is that all of these things can be placed inside a master limited partnership. By placing assets such as AGL’s Atlantic Coast pipeline — which transports natural gas from the Marcellus shale — into a MLP, Southern Co. will be able to realize huge tax savings on its newly acquired midstream portfolio. Meaning more dividends for shareholders.
Size Does Matter: As I said in the opening, the deal will make Southern Co. one of the largest utilities in the United States. This sheer size and customer base is going do wonders for SO’s earnings and growth potential. Southern expects the deal will increase its earnings per share in the first full year after the deal closes, and drive long-term annual EPS growth of 4% to 5%. Additionally, Southern is one of the largest consumers of natural gas, via its portfolio of gas-generation assets. By owning some of the distribution infrastructure, it should be able to save on costs as well. Again, all of this will result in higher dividends down the road for shareholders.
Southern Company Stock Cons
Interest Rate Risk: That sound you hear are the gears turning in Janet Yellen’s head on when the Fed will raise interest rates. Since the recession, the Fed has kept rates at virtually zero to stimulate the economy. With things grinding forward, the Fed should begin to raise those key interest rates. That’s a bad thing for high yielding sectors such as utilities or strong dividend paying firms like Southern Company. That’s because investors looking for yield can now move into the safety of Treasury bonds to get the same payout as “riskier” asset class. And as they shift away, shares of Southern Co. stock should, and will, fall. Investors looking to buy SO stock today could be setting themselves up for some heavy losses when Yellen and crew finally raise rates.
Obama’s Clean Power Plan: Already President Obama and the Environmental Protection Agency have dealt coal a harsh blow by restricting emissions and the building of new plants. Now Obama’s new Clean Power Plan is aiming to reduce carbon emissions further — that’s a huge problem for Southern Company. SO is one of the largest coal-centric electricity generators in the nation. More than 40% of its generation capacity comes from coal, and hardly any comes from renewable sources. And Southern Co. faces hefty fines and penalties if it doesn’t comply with the pending rules. Also worrisome is SO’s foray into green technology, such as carbon capture and clean coal, which were met with major setbacks and cost overruns.
Falling Revenues: For its latest quarter, Southern Company managed to see some pretty decent profits. But those profits actually masked a serious problem for the utility — decreasing revenues. Part of the reason why comes down to energy efficiency. Everything device in your home — from light bulbs to your toaster — is designed to use less and less energy with each iteration. That trend of energy efficiency is only going to continue with smart homes, as consumer seek out products that leave less of an environmental footprint. That’s kind of a big deal when your main business is selling energy.
Given the pros and cons on SO stock, I’m inclined to believe that Southern Co. is a pretty decent buy at these levels.
SO stock is pretty cheap, and the AGL buy only makes Southern Co. that much stronger of a utility, with a new avenue for growth to fuel its juicy dividend. That’s exactly what a long-term investor should be looking for in a blue-chip utility stock like SO.
Just keep in mind that some of the headwinds facing Southern Company — rising interest rates and Obama’s Clean Power Plan — are kind of big deals, which could lead to lower SO stock prices in the near-term. However, forward-thinking investors could use those dips to snag SO stock at an even cheaper price.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.