Utility stocks are preferred by conservative investors due to their higher yields. However, last year, investors unloaded utilities as treasuries offered attractive yields. Utility stocks, on average, dropped ~8% in 2015. Southern Company (SO) corrected by 6%, while peers Duke Energy (DUK) and Dominion Resources (D) fell by more than 10%.
The performance of utilities is gauged by the Utilities Select Sector SPDR ETF (XLU). XLU invests ~8% of its total holdings in Southern Company.
Currently, Southern Company is trading at an EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple of 10.3x. Its 5-year historical average EV-to-EBITDA multiple stands near 9.6x. The utility sector’s average ratio stands at 9.9x.
Southern Company’s forward EV-to-EBITDA, with an estimated EBITDA (earnings before interest, tax, depreciation, and amortization) for fiscal 2016, stands at 9.7x. This indicates expectations of a higher EBITDA in 2016. Southern Company’s EV-to-EBITDA multiple is higher than Duke Energy’s (DUK) 9.5x, NextEra Energy’s (NEE) 9.2x, and Exelon’s (EXC) 5.5x. EV-to-EBITDA is a valuation metric used to indicate whether a stock is overvalued or undervalued, irrespective of capital structure.
Utilities with higher proportions of regulated operations tend to have more stable earnings, which should translate into stable dividends. More than 90% of the total revenues Southern Company generates come from its regulated business. With AGL Resources’ (GAS) acquisition, Southern Company’s regulated revenues are expected to increase, as 80% of AGL’s total revenues come from its regulated operations. The AGL Resources acquisition is due to be completed in 2H16. Southern Company’s earnings should increase with the addition of AGL Resources’ operations. This may translate into higher dividends for its investors in the future.