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Factors That Could Aid or Spoil Southern Company’s Rally

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There’s been a lot of talk about defensive stocks amid broader markets’ volatility this year. Southern Company (SO) stock, the top-gainer among utilities, has rallied almost 40% year-to-date. In comparison, the Utilities Select Sector SPDR ETF (XLU) is up about 20%. Although Southern Company stock has stayed strong, some fundamental factors might obstruct its rally ahead.

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Concerning valuation

Southern Company stock’s valuation is much higher than its historical average. It’s currently trading at close to 19.5 times its estimated earnings for the next year, while its five-year average multiple is around 18x.

Overall, most utility stocks’ valuation is higher than their average of around 19x. Although that valuation isn’t much higher than broader markets’, it seems unjustified for a sector growing 3%–4% per year.

The biggest utility stocks by market cap, NextEra Energy (NEE) and Duke Energy (DUK), are trading at 25 times and 18 times their estimated earnings, respectively. The stocks have risen about 25% and 10% this year.

Technical indicators

Southern Company stock reached an all-time high of $60.90 yesterday, and it is currently trading 5% and 15% above its 50-day and 200-day moving averages. That premium highlights the stock’s strength. Its 50-day average of around $57.60 could act as short-term support for the stock.

However, Southern Company stock could reverse soon, as it has recently entered “overbought” territory. Its 14-day RSI (relative strength index) score was 72 yesterday. An RSI score above 70 indicates a stock is overbought, while a score below 30 suggests it’s oversold.

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Southern Company’s earnings

Despite Southern Company’s poor quarterly results, its stock has risen this year. In this year’s first half, the company’s revenue and earnings fell about 10% year-ver-year. In the third quarter, analysts expect its earnings and revenue to be almost flat.

However, that flattish growth may not bother investors much, as utilities tend to grow slowly. However, investors will likely pay close attention to the company’s Plant Vogtle developments.

Southern Company stock has underperformed for the last couple of years because of the company’s power plant issues. This year was different, though, thanks to Plant Vogtle, the country’s only nuclear power plant under construction. Southern Company has maintained its service schedule and budget.

However, Georgia regulators expect delays, which could ultimately increase costs for the project, Greentech Media reported last month. Such developments could significantly pressure Southern Company stock.

Dividend yield and rate cut

Southern Company is one of the top-yielding utilities, with a yield of 4.1%. It has a long dividend payment history, having increased dividends for the last 18 years. In comparison, NextEra Energy yields 2.4%, and Duke Energy yields 4.0%. With increased tensions in broader markets, investors could continue to take shelter in high-yield stocks.

Also, the utility sector is one of the most rate-sensitive among broader markets. Utility stocks are often seen as bond substitutes due to their stable dividend payments. Lower interest rates could make utilities more attractive than bonds. Recently, the Fed has trimmed interest rates by a half a percentage point.

Analysts’ views and price target for Southern Company

Wall Street has long been cautious on SO stock. Of the 19 analysts tracking SO, 12 suggest “hold,” two suggest “buy,” four suggest “sell,” and one suggests “strong sell.”

Their mean price target of $57.60 for the stock implies a downside of more than 5% from its current price of $60.80.

Whereas some factors may support Southern Company ahead, its inflated valuation is a concern. Its Plant Vogtle is also a weak spot, as the plant’s in-service dates are still a couple of years away. Although dividend-seeking investors are continuing to switch to defensives such as Southern Company, the upside might be limited.

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