Utility Investments Will Expand Electricity Capacity For Future Demand

Key Takeaways

• Southern Company expects steady earnings growth through economic development and increased electricity demand from expanding utility regions and data center needs.
  
• Significant capital investments in state-regulated utilities and natural gas capacity aim to enhance long-term earnings, revenue growth, and shareholder value.
  
• Execution risks, regulatory uncertainty, interest rate pressures, and resource competition could hinder Southern Company's capital projects, impacting revenue growth and shareholder value.

Catalysts

Through its subsidiaries, engages in the generation, transmission, and distribution of electricity.

• Southern Company is seeing significant economic development activity in its utility regions, with over 150 companies expanding or locating facilities there, supporting over 20,000 new jobs. This is expected to drive regular, predictable long-term earnings growth by boosting electricity demand.
  
• The demand for data centers is on the rise, representing a potential 50,000 megawatts of incremental load by the mid-2030s, which could substantially increase future electricity sales and revenue.
  
• Southern Power, a division of Southern Company, is well-positioned to capitalize on dispatchable natural gas capacity demand. This includes opportunities to renew contracts at higher prices, upgrade existing natural gas fleets, and explore new plant builds, enhancing long-term earnings growth potential.
  
• The company plans significant capital investments, with a projected $63 billion over the next five years mainly in state-regulated utilities, supporting an average annual rate base growth of 7%. This should enhance earnings and shareholder value.
  
• Southern's investment in infrastructure for future expansion, including substantial investments in transmission systems and potential new generation resources, is set to support long-term revenue growth and improve net margins by efficiently expanding its capacity to meet increasing electricity demands.

Southern Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Southern's revenue will grow by 3.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 16.5% today to 18.6% in 3 years time.
• Analysts expect earnings to reach $5.6 billion (and earnings per share of $4.85) by about March 2028, up from $4.4 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.8x on those 2028 earnings, down from 22.5x today. This future PE is greater than the current PE for the US Electric Utilities industry at 20.8x.
• Analysts expect the number of shares outstanding to grow by 0.31% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.21%, as per the Simply Wall St company report.

Southern Future Earnings Per Share Growth

Risks

• Regulatory processes for new capital investments are ongoing, and the timing and outcomes of these processes could lead to uncertainties in capital allocation, potentially impacting the projected revenue growth and long-term earnings.
  
• Higher interest rates, expected to prolong into the coming years, could offset some of the earnings growth as Southern Company refinances parent company debt at meaningfully higher rates, affecting net margins and earnings.
  
• The company's substantial capital investment plan, including transmission system expansions and other large infrastructure projects, carries execution risk and requires significant funding, which could dilute shareholder value through equity needs, impacting net margins and cash flow.
  
• The risk-adjusted outlook for sales growth is only a fraction of the economic development pipeline and relies heavily on commitments for incremental load from large projects like data centers, which may not materialize as expected, impacting forecasted revenue and earnings.
  
• Increasing competition for supply chain resources, particularly in the procurement of gas turbines and transmission equipment, could drive up costs and delay projects, affecting capital efficiency and net margins.

Valuation

• The analysts have a consensus price target of $91.516 for Southern based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $104.0, and the most bearish reporting a price target of just $72.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $29.8 billion, earnings will come to $5.6 billion, and it would be trading on a PE ratio of 21.8x, assuming you use a discount rate of 6.2%.
• Given the current share price of $90.23, the analyst price target of $91.52 is 1.4% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.