Southern Company: No Dividend Cut Since 1948

A sub-theme that I occasionally stress is the difference between using the stock market as a vehicle to preserve wealth vs. using the stock market as a vehicle to build wealth.

When your goal is wealth preservation, you can keep your focus on companies that have very stable earnings no matter the economic conditions–your chief objective here is to protect what you’ve got.

If you’re trying to make investments that grow so fast they change your standard of living, you require earnings per share growth of at least 8% annually and probably in the neighborhood of 11% annually. Here, you are often taking on higher P/E ratios, more stock price volatility, and more variance in the earnings results during deep recessions. (Note: Another way to build significant wealth in the stock market is to practice a deep value strategy of purchasing stocks trading at $0.33 on the dollar and selling at fair value, but I find this strategy so difficult to practice in real life that I rarely cover it outside of a few blog posts per year.)

This distinction between whether you are pursuing wealth preservation or wealth accumulation is an antecedent condition to analyzing a stock like the utility company Southern Company (SO).

I saw the news release out of Atlanta today that said:

“Southern Company today announced a regular quarterly dividend of 56 cents per share on the company’s common stock, payable December 6, 2016, to shareholders of record as of November 21, 2016. This marks 276 consecutive quarters – dating back to 1948 – that Southern Company will have paid a dividend to its shareholders that is equal to or greater than the previous quarter.”

If you are someone who is already wealthy or near wealthy, this is great news! You get to collect another payout from a company that has raised its dividend every year since 2001 and has only frozen the annual payout five times since 1948. If you sold your business in 2007 and used the proceeds to buy 10,000 shares of Southern Company among other investments, you get to collect $16,000 in 2007; $16,600 in 2008; $17,300 in 2009; $18,000 in 2010; $18,700 in 2011; $19,400 in 2012; $20,100 in 2013; $20,800 in 2014; $21,500 in 2015; and $22,200 in 2016. You got your hands on an income stream that held its own with inflation, growing at a rate of 3.71%.

The reason why you would bother owning something like Southern Company instead of plain vanilla U.S. Treasuries if you entered wealth preservation mode is because ten year-treasuries would have only paid you about $8,000 per year and that figure wouldn’t have grown so you would be slowly losing the purchasing power of your income stream against inflation.

Over the past thirty years, the biggest earnings decline that Southern Company investors ever would have experienced came in 2000-2001 when the costs associated with an acquisition and failed regulatory requests for electric rate hikes resulted in a cash flow decline of 19% that year. It took 18 months for cash flow levels to recover and surpass the 2000 mark. And the dividend was frozen at that time, so you didn’t have to make any lifestyle sacrifices.

Meanwhile, this electric utility held strong when the storms of the recession arrived in 2008 and 2009. Southern Company’s earnings were $2.28 in 2007, $2.25 in 2008, and $2.32 in 2009. The per share Southern Company dividend went up from $1.60 to $1.66 to $1.73. If part of your asset allocation calls for things that are really stable cash generators during recessionary conditions so that you don’t break at the vulnerability points, this is an ideal stock holding. If you’re a retiree, or have money that can’t be comprised yet still must remain competitive with inflation, this is the profile of an investment you want to consider.

On the other hand, this is not the kind of stock you want to own if you have a small pile of capital that you hope will upgrade your lifestyle within a generation. Its P/E ratio is high, its growth is slow, and it has a lot of expenses related to the acquisition of AGL resources that are going to take some time digest.

For the past ten years, Southern Company has grown earnings at 3% annually. Over the past five years, earnings growth has been 3.5% annually. From 2016 to 2021, it looks like earnings are going to grow around 4%. Meanwhile, the stock trades at $50 compared to $2.75 per share in earnings for a P/E ratio of 18.1.

My guess is that, over the long haul, the P/E ratio for Southern Company stock will be around 15x earnings. This estimate is partially based on a historical valuation that has been between 12 and 16x earnings, partially based on reversion to the mean principles for when interest rates rise, and is partially based on a high debt.

To elaborate on that last point, Southern Company has taken on a lot of debt to fund its acquisitions in recent years. It has $30 billion in debt against $2.6 billion in profits. Because people are going to need their electricity no matter what, you can bet that the cash flows will be stable so the debt isn’t an issue from a bankruptcy perspective. However, when you have $30 billion in debt that isn’t even being paid down, the refinancings that occur in the next couple years may be brutal as 3% debt turns into 5.5% debt (when your profits are leveraged over ten to one, this is a big deal.)

You are probably looking at 3-4% long-term growth, 4.5% dividends, and -2% from P/E compression. That is 5.5% to 6.5% long-term returns. This is a great result if you’re already where you need to be and want to protect the fruits of your previous efforts, but that is not going to be enough if you are expecting 100 shares of Southern Company stock to turn into something in 2035 that will change your life.