FAST Graphs At-A-Glance

Articles which show the principles for reading and analyzing FAST Graphs At-A-Glance.

Southern Company: The Wait For Fair Valuation Is Over

Tim Loudin - Friday, September 13, 2013

Thesis For Growth

To be perfectly blunt, there really isn’t much of a growth thesis for the Southern Company (SO). Founded in 1945, Southern Company is an electric utility company that serves over 4.4 million customers in Alabama, Georgia, Florida and Mississippi. As a regulated utility, the company is better known for its high payout ratio rather than exceptional growth.

Yet that doesn’t mean an investment in this slow-grower can’t still be worthwhile. For one thing - like most utilities - Southern Company is effectively a monopoly that is allowed to give its shareholders “reasonable” returns. So immediately an investor is less worried about whether or not the company will remain in business – after-all, you can’t just shut off the lights for millions of people overnight. Instead, an investor is probably more concerned with whether or not the current market price allows for a reasonable chance at tracking the company’s business results.

In our view, considering today’s low interest-rate environment, we believe that it would be prudent to consider Southern Company as a bond alternative rather than an equity replacement. In this way, the prospective risks and opportunities of the company are important, but they are likely to be less extreme than their equity counterpart as well.

Aside from the monopoly-like benefits of the business, Southern Company has also received awards such as being named the “No. 1 Electric Utility in North America”, the “2012 Energy Company of the Year” and was recently named as one of the “World’s Most Admired Electric and Gas Utilities.” As we will see in the return results below, the company has been nothing if not consistent.

Moving to the risk side of the table, Southern Company faces anything from regulation and ligation concerns to economic risks and unexpected construction delays. In turn, many of these factors – much like any other company – are out of management’s hands. For example, Morningstar analyst Mark Barnett lists nuclear cost overruns and emissions legislation as two uncertain cost areas; while further indicating that the deterioration of Southern Company’s positive regulatory relationships would be the most devastating risk factor. However, it should again be noted that while these risks exist, they are likely to be “watered down” in a regulated and essential utility business.

Finally, while we have thus far been describing Southern Company as a slow but steady monopoly, the company also likes to tout the fact that shareholders received greater total returns than the S&P 500 index for the last 5, 10 and 30 years. F.A.S.T. Graphs™ wrote about Southern Company a little over a year ago, indicating that it was “A Solid Dividend Choice Worth Waiting For.” At the time, Southern Company had a P/E ratio around 17.6 and a current dividend yield of 4.3%. Today, the P/E is closer to 15 and the current yield is just shy of 5%; in other words, we believe the wait might be over.

15 Years of Results

The Southern Company has grown earnings (orange line) at a compound rate of 3.2% since 1999, resulting in a $35+ billion dollar market cap. In addition, the Southern Company’s earnings have risen from $1.90 per share in 1999, to today’s forecasted earnings per share of approximately $2.74 for 2013. Further, Southern Company has paid a dividend for 263 consecutive quarters and has been able to increase this payout for the last 12 years. For a look at how the market has historically valued Southern, see the relationship between the price (black line) and earnings of the company as depicted on the Earnings and Price Correlated F.A.S.T. Graph below.

Here we see that the Southern Company’s market price has mostly paralleled its justified earnings growth; with the exception of starting to become undervalued during the most recent recession and being slightly overvalued in the last year or two. Today, Southern Company appears fairly valued in relation to both its historical earnings and relative valuation.

In tandem with the consistent earnings growth, Southern Company’s shareholders have enjoyed a compound annual return of 5.5% which correlates closely with the 3.2% growth rate in earnings per share. A hypothetical $10,000 investment in Southern on 12/31/1998 would have grown to a total value of $21,866.87, without reinvesting dividends. Said differently, Southern Company’s shareholders have enjoyed total returns that were roughly 1.5 times the value that would have been achieved by investing in the S&P 500 over the same time period. It’s also interesting to note that an investor would have received about 3.5 times the amount of dividend income compared to the index as well. 

Looking to the Future

But of course – as the saying goes – past performance does not guarantee future results. Thus while a strong operating history provides a fundamental platform for evaluating a company, it does not by itself indicate a buy or sell decision. Instead an investor must have an understanding of the past while simultaneously thinking the investment through to its logical, if not understated, conclusion.

In the opening paragraphs a variety of potential risks were described. It follows that the probabilities of these outcomes should be the guide for one’s investment focus.  Yet it is still useful to determine whether or not your predictions seem reasonable. 

Twenty-two leading analysts reporting to Standard & Poor’s Capital IQ come to a consensus 5-year annual estimated return growth rate for Southern Company of 4.7%. In addition, Southern is currently trading at a P/E of 15, which is inside the “value corridor” (defined by the orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Southern’s valuation would be $51.37 at the end of 2018, which would be a 9.2% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator below.

Now, it’s paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for the two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company. However, a F.A.S.T. Graphs’ subscriber is also able to change these estimates to fit their own thesis or scenario analysis.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk Treasury bonds. Comparing an investment in the Southern Company to an equal investment in a 10-year Treasury bond, illustrates that Southern Company’s expected earnings would be 2.8 times that of the 10-year T-Bond Interest. This comparison can be seen in the 10-year Earnings Yield Estimate table below.

Finally, it’s important to underscore the idea that all companies derive their underlying value from the cash flows (earnings) that they are capable of generating for their owners. Therefore, it should be the expectation of a prudent investor that – in the long-run – the likely future earnings of a company justify the price you pay. Fundamentally, this means appropriately addressing these two questions: “in what should I invest?” and “at what time?” In viewing the past history and future prospects of Southern Company we have learned that Southern Company appears to be a consistent company with reasonable upcoming opportunities. However, as always, we recommend that the reader conduct his or her own thorough due diligence.

Disclosure: No position at the time of writing.

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.

 

 


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    Testimonials


    “I appreciate your work, Chuck. As a subscriber to FAST Graphs™, I use the tool to decide on whether to purchase additional shares of what I currently hold or to add a new holding. Your articles help me make full use of the tool and give other readers valuable information, if they take the time to learn. One of the biggest enhancements that I use is the FFO data added for MLPs and REITs.”


    “When FAST Graphs™ were unavailable because of Hurricane Sandy, I realized how much I need them in order to make investment decisions.

    (Wish I could be) Long FAST Graphs!!!”


    “One more vote for the value of FAST Graphs™; just started a subscription to Chuck's great service (premium), and am having a ball analyzing so many stocks quickly.”


    “I feel very ill-equipped to make investment decisions without Fast Graphs. :-)”


    “Yesterday, I signed up for your F.A.S.T. Graphs™. It's a really amazing, valuable tool for checking over/undervaluation of stocks. Wish I had it years and years ago!!”


    “Love the F.A.S.T. Graphs™: One glance and you know a whole lot.”


    “About Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


    "Chuck -- Your proprietary F.A.S.T. Graphs™ are a VERY impressive tool!"


    “If there were an Investor Hall of Fame for people who have helped others with their investing, and sharing valuable information, you and your F.A.S.T. Graphs™ would get one of my selections.”


    “I love Chuck's F.A.S.T. Graphs™! Well worth the price of admission for what he gives you.”


    "Chuck - Thank you for your well thought out articles. I tend to be a visual type of person so I really appreciate the F.A.S.T. Graphs™ approach."


    "Great article, as always! I always look forward to your articles, and am especially eagerly awaiting your next in this series. I find the F.A.S.T. Graphs™ extremely helpful."


    “Your F.A.S.T. Graphs™ put all of this in a single artful picture and the accompanying spreadsheets hammer home the point.”


    “I use the F.A.S.T. Graphs™ method to evaluate all of my ideas. I recommend it for individual investors, since it helps them focus on data and get past the many emotional arguments.”


    “I recently subscribed to the F.A.S.T. Graphs™, and these articles are helping me learn how to better use them. They really do give you a good quick look at the valuations picture. A much needed tool!”


    “I also always appreciate the clear-cut information provided through your F.A.S.T. Graphs™ and articles.”


    “Thanks, Chuck, for your F.A.S.T. Graphs™. Each of these graphs is worth 1,000 words in describing a company's growth, consistency and valuation. Thanks for sharing your graphs.”


    “Thanks, Chuck. Love the F.A.S.T. Graphs™! It makes investing so much more clear.”


    “Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


    ”I am amazed at the usefulness of your F.A.S.T. Graphs™ and I plan on using them for a long time to come.”


    “Chuck's F.A.S.T. Graphs™ will give you a tool to find those well chosen stocks...”


    “Thanks for the F.A.S.T. Graphs™, Chuck. They are the best tool I've used.”