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Eric Apfel

SO AT A GLANCE

P/E ► 15.9 AVG EV/EBITDA ► 7.21 AVG ROA ► 4.9% AVG ROE ► 10.6% AVG Debt to Equity ► 2.35 AVG Current Ratio ► 1.14 AVG Interest Coverage Ratio ► 3.63 AVG

 

 

 

 

 

 

With over 42,000 Megawatts of generation capacity, Southern Company (NYSE: SO) is the second largest electric utility by market cap in the United States, supplying electricity to 4.4 million customers in the Southeast. The company had $15.35 Billion in revenues in 2007, with about 80% of its Kilowatt hour (KWH) sales to retail customers (customers that pay for electrical usage), and the other 20% of sales in wholesale electricity markets. ^[1] Southern's customer base is located primarily in Alabama, Georgia, Florida, Mississippi, and the Carolinas^[2].

Southern Company, like other electric utilities, benefits from being a natural monopoly in that community resistance and the huge cost of building new power plants provide significant barriers to entry for competitors. Additionally, customers have little choice when it comes to who they buy electricity from since their choices are limited by geographical proximity to power companies. However utilities' pricing power is limited as rate hikes are checked by government regulation, which makes Southern vulnerable to energy policy changes. Weather also plays an important role in Southern's business. Other risks to Southern are specific to its geographic region - extremely hot seasons can put strain on an already aging grid while severe weather like hurricanes can wreak havoc on generation facilities as well as transmission services.

Business Overview

Southern Company is responsible for $5.4 billion in transmission assets including more than 27,000 miles of transmission lines, 3,400 substations, and more than 300,000 acres of right of way. ^[3] This makes Southern Company one of the largest electric utilities in the United States and one the largest producers of electricity in the Southeast by generation capacity.^[4]

Southern Company's power generation facility allocations as of 2007^[5]

Through its partnerships and subsidiaries, Southern's energy portfolio includes coal, nuclear, and hydroelectric power generation. Southern Co. plans, designs, builds, operates, and maintains its systems to meet growing demand, and has budgeted $2.3 billion in transmission expenditures through 2008^[6]. Southern Co. also operates a wireless telecommunications service through their subsidiary, SouthernLINK Wireless.

Business and Financial Metrics

Southern Company supplies electricity to 4.4 Million customers in the Southeastern United States and has a generation capacity of 42,000 Megawatts. Since 2005, Southern Company has steadily increased revenues to $15.35 Billion in 2007, up 7.66% from 2006. Net income rose 8.07% to $1.714 Billion from 2006 to 2007. ^[8]

Business Segments

Traditional Operating Companies (93% Revenue, 92.7% Net Income)

This segment owns all generation and transmission facilities and supplies both wholesale and retail customers with electricity. It reported $ 14.851 billion, $13.920 billion, and $13.157 billion in revenue for Southern Co. in 2007, 2006, and 2005 respectively. ^[10]. Southern Company's Traditional power companies include Alabama Power Company, Georgia Power Company, Gulf Power Company and Mississippi Power Company. Retail sales accounted for 81.6% of traditional operating company revenues in the second quarter of 2008, with wholesale accounting for another 15.1% ^[11]

Southern Power (6.2% Revenue, 7.3% Net Income)

This segment's primary responsibility is the wholesale of surplus electricity (5,400 MW^[12])to other electric utilities in the region. Southern Power reported $972 million, $777 million, and $78 million in revenue for Southern Co. in 2007, 2006, and 2005 respectively. ^[13]

Key Trends and Forces

Government Regulation

Southern Co. spent $469 million on environmental compliance in 2007, up from $260 million in 2006. The company plans to spend an additional $1.389 billion through 2010 to continue to meet environmental standards alone.^[14] Both the Federal Government and local government play an enormous role in the heavily regulated energy industry. Especially for utility companies, rates are almost entirely set by regulatory boards, and Southern Company's rates are no exception. Under the Federal Power Act, utility companies' rates are subject to approval by state Public Service Commissions or PSC's. Southern Co.'s cost recovery limits (the amount of storm damage, environmental compliance, and fuel costs Southern Co. can pass on to its clients in addition to its base rate) are also set by PSCs. ^[15] New regulations in response to the threat of climate change are a threat to Southern's bottom line, especially with 70% of their electric generation coming from coal^[16].

Federal Energy Regulatory Commission (FERC) Proceedings

• In 2005, the Federal Energy Regulatory Commission began proceedings against Southern Company for showing preferential treatment to one of its subsidiaries in wholesale energy contract bidding. Southern Company has agreed to pay a fine and is distancing itself from its wholesale business by restricting information related to marketing activities conducted on behalf of Southern Power. ^[17][18]
• In December 2004, FERC began assessing a Market Dominance Test to determine if Southern Co. was capable of moving wholesale market prices unfairly. Should Southern Co. fail the test, the Traditional Operating Companies would be required to charge cost-based rates for certain wholesale sales and to pay $19.7 million in refunds to customers. According to Southern Co. these rates are likely to be lower than market rates, and would put pressure on margins. ^[19],^[20]

GDP Growth

One of the most important factors driving Southern's revenue is GDP growth. As the economy expands, electricity demands increase as manufacturing, business, and consumption expands. Although Southern's revenues are closely tied to GDP growth, electric utilities are considered counter-cyclical since electricity is a necessity. In the face of a major recession, the main risk to long-term cash flows is in Southern Co.'s ability to finance its acquisitions.

Population Growth

Southern Co.'s customer base is mostly driven by population growth, particularly in Alabama and Georgia. As local populations expand, Southern Co. gains new retail customers, which drives revenues. The company serves retail customers outside of Alabama and Georgia, but most of its operations outside these two states involve wholesale power.

Weather

In 2005, Southern Co. spent twelve days repairing and replacing 322 transmission towers, 2,500 miles of power lines, 10,376 power poles, and 65 percent of local transmission facilities that were destroyed by hurricane Katrina^[21]. Southern Co. estimated the total recovery cost of Hurricane Katrina to be $302.4 million. As of June 1, 2007, has secured approval from regulators permitting them to fully recover these costs. ^[22] Hurricanes and other severe weather can be huge setbacks for large utilities, especially Southern Co. with its 120,000 acres of serviced territory in the Southeast, an area at high risk of hurricane damage. More frequently, however, hot weather and the accompanying spike in consumption from mass air conditioning can be a problem for some electric utilities.

Competition

Southern Company is one of the largest electric utilities in the United States, and the largest in the Southeast. Due to its sheer size in its territory, Southern is well protected from competitors for its retail clients. Southern produces such high levels of excess capacity that they rarely have to purchase any power from competitors. In 2007, Southern Co. sold 204.4 billion KWHs of which only 8 billion had been purchased^[23]. Still it faces fierce competition in its wholesale business, particularly in areas where competitors are expanding capacity. Its top local competitors are as follows:

• Duke Energy Corporation (DUK): Generating 28,000 MW and supplying over 3.9 Million customers with electricity, Duke and Southern compete for wholesale in their common regions, particularly in the Carolinas^[24].
• Florida Light & Power Group: FPL generates 37,500 MW and serves over 8.7 million customers along the east coast of Florida^[25].
• Entergy (ETR): Entergy generates approximately 30,000 MW of electricity and serves 2.7 million people from Texas to Arkansas^[26].

References

1. ↑ Southern Co. Annual Report 2007 pg. 30
2. ↑ Southern Co. Megawatt Profile
3. ↑ Southern Co. Company Megawatt Profile
4. ↑ Southern Co. Megawatt profile
5. ↑ Southern Co. climate change presentation pg. 6
6. ↑ Southern Co. Company Megawatt Profile
7. ↑ Southern Company Annual Report 2007
8. ↑ Southern Company Dividend Distributions
9. ↑ Southern Co. 10-K 2007
10. ↑ Southern Co. 10-K 2007
11. ↑ Southern Company 10-Q Q2-2008
12. ↑ Southern Co. Generation Capacity
13. ↑ Southern Co. 10-K 2007
14. ↑ Southern Co. 10-K 2007 pg. II-109
15. ↑ Southern Co. 10-K 2007 pg. I-10
16. ↑ Southern Co. climate change presentation pg. 6
17. ↑ Southern Co. Annual Report 2007 pg. 40
18. ↑ Southern Co. 10-K 2007 pg. II-75
19. ↑ Southern Co. Annual Report 2007 pg. 40
20. ↑ FERC Order Establishing Hearing Procedures
21. ↑ Hurricane Katrina Damage
22. ↑ Southern Co. 10-K 2007 pg. II-79
23. ↑ Southern Co. 10-K pg. II-15
24. ↑ Duke Energy Business Segments
25. ↑ FPL Group Profile
26. ↑ Entergy Profile