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Southern Company Q4 Earnings: The Damage Is Already Done

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Introduction

The Southern Company (NYSE:SO), nan regulated inferior that operates chiefly successful Georgia and Alabama, reported its 4th fourth and afloat twelvemonth 2022 results connected February 16, 2023. It's been immoderate clip since I last looked astatine nan institution - 15 months to beryllium nonstop - erstwhile I compared Southern Company to Duke Energy (DUK) and WEC Energy Group (WEC).

In this little update, I'll stock my sentiment connected Southern's capacity successful 2022 and update my finance thesis - aft all, nan scenery has changed significantly. The world, astatine slightest according to starring experts, is connected nan verge of a recession, ostentation is higher than it has been successful decades, and nan Federal Reserve has been raising liking rates astatine an unprecedented pace.

Southern Company 2022 Earnings Recap

For 2022, The Southern Company reported adjusted earnings of $3.9 cardinal connected a firm basis, up 7.1% from nan anterior year. On a reported basis, Southern earned $3.5 cardinal successful 2022. Once again, nan institution posted an estimated nonaccomplishment connected plants nether building (namely Vogtle Units 3 and 4), albeit a overmuch smaller 1 than successful 2021 - $199 cardinal versus $1.7 billion.

Finally, it appears that nan 2 caller units successful Georgia are nearing completion, and guidance expects Vogtle Unit 3 to beryllium successful work successful May aliases June 2023, pinch Unit 4 apt to travel successful nan first 4th of 2024. Other important adjustments included a $119 cardinal impairment of goodwill (PowerSecure Inc. write-down owed to deteriorating macroeconomic conditions) and charges of successful full $131 cardinal (pre-tax) attributable to nan waste of Southern Company Gas' earthy state retention assets. On an adjusted basis, Southern reported net per stock of $3.60 compared to $3.41 successful nan anterior year, an summation of 5.6% year-over-year (YoY), pointing to humble dilution (see below). For 2023, Southern expects net to beryllium astir level connected an adjusted per stock ground ($3.55 to $3.65).

Earnings maturation of 7% is beautiful beardown for a regulated inferior (excluding nan infamous Vogtle costs adjustments), but of people somewhat muted erstwhile compared to operating gross maturation of 26.7% YoY. Southern is emotion nan effect of importantly higher input costs and, arsenic a result, knowledgeable a gross separator contraction by astir 1,200 ground points (Figure 1), resulting successful gross profit maturation of 5.7% YoY. Adjusted EBITDA separator and adjusted operating separator were 33.5% and 19.6%, respectively, down 620 and 290 ground points YoY, but still an acceptable level fixed nan higher input costs and compared to semipermanent profitability (2017-2022 averages of 39.2% and 23.2%, respectively).

Southern Company's [SO] gross margin, calculated by taking into relationship substance costs, purchased power, costs of earthy gas, and costs of different sales

Figure 1: Southern Company's [SO] gross margin, calculated by taking into relationship substance costs, purchased power, costs of earthy gas, and costs of different income (own work, based connected nan company's 2017 to 2022 10-Ks)

Adjusted return connected equity (ROE) was very robust astatine 11.2% and successful statement pinch nan semipermanent average. The coagulated ROE is owed successful portion to nan affirmative regulatory ambiance successful nan states wherever Southern operates. While nan report is somewhat dated, it nevertheless shows that Georgia and Alabama are among nan astir favorable jurisdictions from a regulatory perspective, which puts Southern successful a bully position pinch respect to upcoming complaint negotiations. In fact, Alabama is nan only jurisdiction rated "Above Average/1" by Regulatory Research Associates (the champion rating).

While it's easy to spot nan solid half quiet successful times of precocious ostentation and customers who don't want to put up pinch complaint increases, I deliberation it's important to understand that regulators - particularly successful favorable jurisdictions - are perpetually trying to find a discuss betwixt nan interests of shareholders (reasonable ROE) and customers (tolerable value increases).

Southern Company's Customer Relationships

Southern Company operates successful Georgia, Alabama and, to a lesser extent, Mississippi, serving astir 9 cardinal residential, commercialized and business customers. The customer guidelines is mostly stable, pinch nan objection of 2018 and 2019 (YoY declines of 3.6% and 4.4%, respectively, Figure 2). These are owed to nan waste of Elizabethtown Gas, Elkton Gas, and Florida City Gas successful 2018 and nan waste of Gulf Power Company successful 2019. On a comparable basis, Southern would person added 77,000 and 73,000 customers successful those years, respectively. Customer maturation successful 2022 was besides acceptably beardown astatine astir 73,000 customers (+0.8% YoY). On a gross basis, Southern added 49,000 residential electrical customers and 31,000 residential state customers successful 2022.

Southern Company's [SO] customer numbers

Figure 2: Southern Company's [SO] customer numbers (own work, based connected nan company's 2017 to 2022 full-year net releases and packages)

Southern Company's Energy Sales

Against nan backdrop of higher power prices successful 2022, it is adjacent to opportunity that Southern Company has delivered coagulated results - 5.6% maturation successful energy depletion is nary mean feat (Figure 3). Interestingly, residential income grew nan astir (4.8% YoY), while commercialized and business income grew 3.5% and 1.5% YoY, respectively. This quality is mostly owed to warmer weather, but, of course, nan ongoing betterment from nan pandemic should besides beryllium taken into account. Going forward, depletion is apt to diminution against nan backdrop of a imaginable recession successful 2023 aliases later. At nan aforesaid time, a secular inclination toward power conservation among residential customers - and to a lesser grade among commercialized and business customers - should beryllium astatine slightest theorized, assuming power price-related ostentation remains precocious for nan foreseeable future.

The Southern Company's power operation did not alteration importantly from nan erstwhile year, pinch nan stock of earthy state successful full depletion rising from 48% to 50%, while nan stock of ember and atomic powerfulness each fell by 1% to 20% and 15%, respectively.

Southern Company's [SO] power income successful billions of kilowatt-hours (kWh)

Figure 3: Southern Company's [SO] power income successful billions of kilowatt-hours (kWh) (own work, based connected nan company's 2017 to 2022 full-year net releases and packages)

Development Of Debt, Shareholder Dilution, And Dividends At Southern Company

Regulated utilities are notoriously superior intensive. Not only do they require changeless maintenance, but modulation to fuels pinch much favorable biology effect (e.g., from ember to state and nuclear) aliases sustainable power sources (e.g., wind, solar) comes astatine a precocious cost. Those who travel Southern person go much aliases little accustomed to costs overruns and delays owed to operational challenges and setbacks astatine Vogtle Units 3 and 4. It is apt that nan problems astatine Vogtle contributed to CEO Fanning's status successful March 2023 - he will beryllium replaced internally by Chris Womack.

Unsurprisingly, The Southern Company's nett indebtedness has besides continued to emergence successful caller years, from $45.5 cardinal astatine nan extremity of 2017 to $55.6 cardinal astatine nan extremity of 2022, an summation of much than 22%. Shares outstanding accrued somewhat complete nan aforesaid period, from 1.01 cardinal to 1.08 billion, an summation of 7.2%. From a shareholder dilution perspective, location are decidedly worse utilities. Still, Southern's leverage is worrisome fixed its important indebtedness growth, only somewhat outpaced by adjusted net growth, and particularly fixed its stagnant operating rate flow. Figure 4 shows Southern's leverage successful position of adjusted EBITDA and operating rate flow. Readers accustomed to measuring leverage of utilities by nan ratio of operating rate travel to nett indebtedness are improbable to beryllium thrilled either, fixed that nan ratio declined from 14.1% successful 2017 to 11.3% successful 2022.

Of course, location are acold worse utilities retired there, and successful truth I still see Southern Company 1 of nan champion utilities, but nan inclination is discomforting - successful portion because superior expenditures will only proceed to emergence for nan reasons mentioned above.

Moody's past reaffirmed Southern's semipermanent Baa2 standing (S&P balanced of BBB) pinch a unchangeable outlook successful 2018, but is intimately watching nan latest building and testing milestones arsenic Vogtle Units 3 and 4 attack their in-service dates.

Southern Company's [SO] nett indebtedness to adjusted EBITDA and operating rate flow

Figure 4: Southern Company's [SO] nett indebtedness to adjusted EBITDA and operating rate travel (own work, based connected nan company's 2017 to 2022 10-Ks)

Due successful portion to rising liking rates and nan associated refinancing of maturing notes, liking disbursal accrued from $1.84 cardinal successful 2021 to $2.02 cardinal successful 2022, resulting successful a alteration successful Southern's liking sum ratio from 4.4 times to 4.1 times operating rate travel earlier interest. In 2017, nan ratio was 4.8 times.

Going forward, and assuming liking rates stay higher for a longer play of time, Southern Company's liking sum ratio will proceed to deteriorate. The institution has upcoming maturities of $4.7 cardinal successful 2023 and $11.4 cardinal by 2026, representing 7% and 21% of gross debt, respectively. However, while these numbers look somewhat concerning, I deliberation nan effect connected Southern's indebtedness work expertise will stay manageable fixed its finance people rating, favorable regulatory environment, and still very acceptable liking sum ratio. Also somewhat reassuring is nan truth that nan existent weighted mean maturity of Southern's semipermanent indebtedness is astir 18 years.

Against this backdrop, nan dividend seems safe to me, pinch a unchangeable payout ratio of astir 75% of adjusted earnings, aliases an mean payout ratio of 40% based connected operating rate flow. However, if rates enactment higher for longer, I tin ideate nan accustomed $0.08 dividend increases being reduced. Still, I uncertainty Southern's guidance will awesome a tightening of liquidity and rate travel anytime soon - fto unsocial trim nan dividend, pinch 21 years of uninterrupted maturation - and I afloat expect different $0.08 summation this April. Base connected today's stock price, this represents a guardant output of 4.25%, 40 ground points higher than nan current yield connected 30-year Treasuries

Concluding Remarks - Or Why I'm Not Buying SO Stock Despite Being 20% Off Its 52-Week High

Against nan inheritance of a presently alternatively difficult environment, The Southern Company has achieved coagulated results from a maturation constituent of view, ignoring nan well-known problems pinch nan building of Vogtle Units 3 and 4 and nan resulting costs overruns. The diminution successful profit margins was significant, but is still manageable and should beryllium considered temporary.

The elephant successful nan room, of course, is nan monolithic superior spending and nan associated summation successful debt. While this is mostly normal for utilities, and nan 2 Vogtle units are apt to travel online later this twelvemonth and early adjacent year, nan continued important finance successful modern-era power sources, arsenic good arsenic nan costs associated pinch decommissioning ember plants and different older facilities, should not beryllium ignored. Considering that nan Federal Reserve has aggressively raised liking rates successful 2022, nan harm has already been done from a banal value position - Mr. Market has already factored successful nan radically changed environment, and Southern is presently trading 20% beneath its 52-week high. Interest disbursal will apt proceed to emergence arsenic indebtedness matures. Overall, investors should expect dividend maturation to diminution complete nan agelong term, but I americium rather assured that Southern will proceed to beryllium capable summation its dividend astatine its accustomed complaint of $0.08 per stock per twelvemonth successful nan adjacent term.

Although I don't for illustration to telephone stocks a "bond substitute" - aft all, stockholders person only a residual declare connected a company's assets - I really position my mini finance successful Southern Company arsenic conscionable that: it is simply a enslaved substitute pinch a output presently 40 ground points higher than semipermanent Treasuries, nan quality being that dividend maturation preserves nan dividend's purchasing powerfulness astatine slightest somewhat. Granted, Southern's 3.03% quarterly increase successful 2022 (3.05% annualized) has not kept gait pinch inflation, and moreover if yearly increases of $0.08 continue, Southern's dividend will diminution successful purchasing power. Personally, I expect ostentation to travel successful waves, but judge nan semipermanent mean ostentation complaint will settee successful nan mid-single digits.

With this successful mind, but besides owed to nan still reasonably noticeable overvaluation (Figure 5, Table 1), I americium not willing successful adding to my position astatine this time. The changeless request for investment, increasing debt, costs overruns astatine Vogtle, and perceived changes successful nan governmental scenery time off maine alternatively uninspired arsenic a inferior investor. At nan aforesaid time, I position value utilities operating successful a still favorable regulatory situation arsenic acceptable protect investments, truthful I americium not reasoning of trading my The Southern Company position astatine nan existent value either.

FAST Graphs floor plan of Southern Company banal [SO]

Figure 5: FAST Graphs floor plan of Southern Company banal [SO] (obtained pinch support from www.fastgraphs.com)

Various valuation metrics for Southern Company banal [SO]

Table 1: Various valuation metrics for Southern Company banal [SO] (obtained pinch support from seekingalpha.com/symbol/SO/valuation/metrics)

Thank you very overmuch for taking nan clip to publication my article. Do you work together aliases disagree pinch my conclusions? How did you for illustration it, my style of presentation, nan level of detail? Also, if location is thing you'd for illustration maine to amended aliases grow upon successful early articles, do fto maine cognize successful nan comments conception below.

This article was written by

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Tired of effortful investing strategies pinch uncertain prospects? As a erstwhile heavy worth investor, I learned to admit nan benefits of a dividend-focused worth strategy respective years ago. My strategy puts an accent connected superior preservation and steadily increasing income. I constitute chiefly astir stocks I clasp successful my diversified dividend banal portfolio, which emphasizes high-quality worth stocks that connection meaningful maturation and semipermanent safety. Feel free to scope retired to maine via nonstop messaging here, connected Twitter, aliases done nan comments conception of 1 of my articles. Hit nan “Follow” fastener if you'd for illustration to subordinate maine connected my travel to financial independence.

Disclosure: I/we person a beneficial agelong position successful nan shares of SO, DUK either done banal ownership, options, aliases different derivatives. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Additional disclosure: The contents of this article and my comments are for informational purposes only and whitethorn not beryllium considered finance and/or taxation advice. I americium neither a licensed finance advisor nor a licensed taxation advisor. Furthermore, I americium not an master connected taxes and related laws - neither successful narration to nan U.S. nor different geographies/jurisdictions. It is not my volition to springiness financial and/or taxation proposal and I americium successful nary measurement qualified to do so. I cannot beryllium held responsible and judge nary liability whatsoever for immoderate errors, omissions, aliases for consequences resulting from nan enclosed information. The penning reflects my individual sentiment astatine nan clip of writing. If you intend to put successful nan stocks aliases different finance vehicles mentioned successful this article – aliases successful immoderate shape of finance conveyance mostly – please consult your licensed finance advisor. If uncertain astir tax-related implications, please consult your licensed taxation advisor.

Editor: Naga



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