Friday, September 23, 2011

Southern Company: Our Top Pick Among the Utilities

Here's a pop quiz for you:  What are the yields on 10-year and 30-year US Treasury bonds?  Unless you are an extremely keen observer of the bond markets, my guess is you will be shocked to learn that 10-year US Treasuries now yield only 1.80% and 30-year Treasuries are yielding a paltry 2.9%.

Just think of it, if you want a supposedly risk-free investment, the highest rate available is under 3%, and to get it you have to tie up your money for 30 years and pay taxes on the income.

Rates have fallen to these levels as a result of the Federal Reserve's attempts to stimulate the economy.  In driving rates to such low levels, the Fed is essentially trying to force investors to look away from Treasury bonds toward other investments that offer a better return.  We think it will work.

The chart above shows our 20 year Dividend Valuation Model for Southern Company (SO).  The chart clearly shows that SO's price (red line) and value (blue bars) have moved in close proximity over this time frame.  The statistical correlation is above 80% and suggests that SO is approximately 25% undervalued.

Southern is one of the country's biggest and best run utilities. You might call it the Sunbelt's power company because it serves most of the southern half of the United States east of the Mississippi River.  This is key to it long-term prospects.  It is well-know that the Sunbelt climate is popular with both people and businesses.  There has been a steady migration of both into the region for the last 30 years.

We believe one of the first places investors will look as they move away from bonds is at utilities.  Utilities offer high dividend yields, dividend growth, some governmental protection, and provide a service that is essential to our way of life.  Here's the bottom line on Southern Company.

  1. SO's current dividend yield is 4.5%, much more than the aforementioned Treasury bonds.
  2. They have paid a dividend since 1948
  3. They have increased their dividend for nine consecutive years, which means they did not cut their dividend during the recent recession.
  4. Dividends have grown at just over 4% per year over the last 5 years.
  5. They have a balanced electric power generating capacity with plants that use gas, coal, nuclear, and a small amount of alternative power production.
  6. Most importantly, they are well managed and serve a growing area.
Southern Company and many other high quality electric, gas, and telephone utilities offer good dividend yields, solid balance sheets, and modest growth prospects.  As investors come to grips with just how low interest rates are, we believe they will increasingly move to investments that offer higher yields.  We think the first place they will look is the utility sector and Southern is our top pick.

We own Southern Company and have no plans to sell it.