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Is a Southern Company (SO) Dividend Hike on the Horizon?

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Electric utility firm The Southern Company (SO - Free Report) traditionally makes an announcement to up its payout at this time of year.

Let’s evaluate whether Southern investors can expect a dividend increase this time around.

With their regulated business models and stability in earnings, utilities are among the most consistent dividend stocks in the market. Southern Company is one such blue-chip utility stock.

Based in Atlanta, GA, Southern Company is one of the largest power suppliers in the U.S. Offering an enticing dividend yield, the company remains an attractive option for investors seeking for a steady stream of income. Positioned in a niche industry with high barriers to entry, Southern's less-volatile, recession-proof business model presents a unique opportunity to earn high returns and steady payout hikes each year.

The Business & Financials

Following its merger with AGL Resources on July 1, 2016, Southern Company serves approximately nine million customers through its eleven electric and natural gas distribution units in nine states. It boasts of a generating capacity of 46,000 megawatts, around 200,000 miles of electric transmission and distribution lines, and more than 80,000 miles of natural gas pipelines. Southern Company’s operations include wholesale electricity generation and natural gas services, retail energy services and natural gas storage operations throughout the country.

A look at the company's 2017 financials suggest that Southern Company reported impressive business performance last year. The power supplier grew its revenues by 16%, while adjusted earnings per share was up by more than 4% despite an increase in operating expenses.

Strong Dividend History and Above-Average Yield

One of the premier domestic utilities, Southern Company pays an annual dividend of $2.32 per share, yielding an attractive return of 5.3% and above most other utilities. To put things in perspective, the utility offers current yield of 5.3. Meanwhile, the average yields for the utility sector and S&P 500 stands at 3.6% and 1.9%, respectively.

The firm hiked its dividend payout by 3.6% in April 2017, marking sixteen consecutive years of such increases. In particular, Southern Company boasts of an uninterrupted streak of paying dividends since 1948.

Room for Modest Hike Despite High Payout Ratio

Using Southern's 2017 adjusted EPS of $3.02, the utility pays out 76.8% of its earnings as a dividend, which is rather high compared to sector's average payout of 64.1%. Southern forecasts earnings to fall to $2.80–$2.95 per share in the current year. Considering the current annual dividend rate of $2.32 per share, this equates to a steep payout ratio of 79%-83% for 2018.

However, Southern also announced its long-term earnings per share growth outlook of 4–6%, commencing with this year's midpoint of $2.87 per share. We believe this should be sufficient for modest dividend increases.

Importantly, the utility is confident in its ability to sustain a payout ratio in the range of 80% for a few years, which it expects to eventually come back down in the 70s once construction of the Vogtle nuclear plant expansion project ends.

What Exactly to Expect?

As per Southern Company, its financial outlook allows for a dividend growth of 8 cents per year, or 2 cents on a quarterly basis. This seems quite doable, with a 2 cents hike taking the quarterly distribution to 60 cents per share ($2.40 per share annualized), which would represent a payout ratio of around 84% and in line with the firm’s expectations.

Therefore, going by Southern’s target, we see the quarterly dividend increase to 60 cents per share (or 3.4%) during the next few days.

Zacks Rank & Stock Picks

Despite being a top dividend-growth stock, Southern Company currently retains a Zacks Rank #4 (Sell), ostensibly due to continued timing and cost overrun issues over two large construction projects -- Vogtle and Kemper.

Georgia PSC's nod for the construction of the half-finished Vogtle nuclear plant expansion in Georgia notwithstanding, doubts remain about the $20 billion initiative that has gone well over budget and is years behind schedule. Southern is also facing challenges to place its Kemper, Mississippi project in service, which suffered yet another setback with the suspension of all coal gasification operations amid additional cost burden.

We believe the financial stress from these projects, together with Southern’s hefty expenses to comply with environmental controls/regulations will cause an underperformance in the utility's shares relative to the market as well as the sector in the coming quarters.

Not surprisingly, the stock has underperformed its industry in a year, having declined 7.4% versus the industry's 0.7% loss.

Meanwhile, one can look at better-ranked utilities like CenterPoint Energy, Inc. (CNP - Free Report) , The AES Corp. (AES - Free Report) and OGE Energy Corp. (OGE - Free Report) CenterPoint Energy is a Zacks Rank #1 (Strong Buy) stock, while both AES Corp. and OGE Energy hold Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

CenterPoint Energy Inc. is a domestic energy delivery company that provides electric transmission & distribution, natural gas distribution and competitive natural gas sales and services operations. The 2018 Zacks Consensus Estimate for this Houston, TX-based utility is $1.55, representing some 13.1% earnings per share growth over 2017. Next year’s average forecast is $1.64, pointing to another 6.2% growth.

AES Corp., based in Arlington, VA, is a global power company. The company’s businesses are spread across five continents in 18 countries. AES’s expected EPS growth rate for three to five years currently stands at 7.8%, comparing favorably with the industry's growth rate of 7%.

OGE Energy Corp. provides energy and offers physical delivery and related services for both electricity and natural gas primarily in the south central United States. The Oklahoma City, OK-based company has an enviable earnings surprise history. It surpassed estimates in three of the last four quarters.

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