Top regulated utility Southern Company (SO) stock gained again last week. The stock has surged more than 40% and has notably outperformed the broader utilities. The Utilities Select Sector SPDR ETF (XLU) is up 22% while the broad market index S&P 500 has surged 18% so far this year.
Amid recession fears and trade war tensions, Southern Company looks strong primarily due to its dividends. It currently offers a dividend yield above 4% and has increased its dividends for the past 18 consecutive years. However, its inflated valuation makes it a relatively risky bet compared to its utility stock peers.
Subdued earnings and dividend growth
Southern Company stock has shown an unusual rally this year despite subdued earnings and dividend growth. In the first half of 2019, Southern Company’s EPS fell more than 10% compared to the first half of 2018.
For 2019, Wall Street analysts expect flat to negative earnings growth from the utility. However, a utility’s subdued earnings growth might not concern investors much. Southern Company increased its per-share dividend by 3% in April, lower than the industry average. Southern Company has increased its dividends by more than 12% this year. Utilities at large increase their dividends by 4%–6% per year.
Decreased uncertainty at Southern Company’s Vogtle power plant and lower interest rates fueled Southern Company’s rally. Lower interest rates make the utilities’ dividends more attractive. Also, lower debt servicing costs led by lower interest rates boost the company’s profitability.
Southern Company stock continues to trade at a record valuation. It is trading 20x its estimated earnings against its five-year average valuation of 17x. Based on estimates, Southern Company could return -1% in 2019 and 4% in 2020 YoY. In our view, a 20x multiple for such a slow-growing company looks unjustifiable.
NextEra Energy stock also looks to be trading at a significant premium to its historical valuation average. It is currently trading 26x its forward earnings while its five-year average valuation is near 20x.
Based on its technical indicators, Southern Company stock look strong. It is currently trading at $61.80, almost 6% and 16% above its 50-day and 200-day moving average levels, respectively. The strength in the stock is underlined by the huge premium to both support levels. Its 50-day level of $58.40 could act as a support for the stock in the short term.
SO is trading at an RSI (relative strength index) of 73, indicating that the stock is trading in the overbought zone. An RSI above 70 suggests that the stock is overbought, and an RSI below 30 suggests that the stock is oversold, both of which imply an impending reversal. Peer NextEra Energy is also trading in the overbought zone with an RSI of 78.
Analysts’ price targets
Analysts expect a downside of almost 6% from Southern Company stock in the next year. They gave it a price target of $58.10 against its current market price of $61.80.
Among 19 analysts tracking SO, 12 analysts recommended it as a “hold,” two recommended it as a “buy,” four recommended it as a “sell,” and one recommended it as a “strong sell.”
Based on analysts’ estimates, NextEra Energy has a mean price target of $225.00, which implies a downside of 3% for the next year. It closed at $231.30 last week.
Among the 16 analysts covering NextEra Energy, nine analysts recommended it as a “buy,” five recommended it as a “strong buy,” and two recommended it as a “hold.” None of the analysts recommended it as a “sell” on September 30.