Noting weak utility growth and debt at the parent level, Citi Research on Dec. 15 initiated coverage of Southern Co. with a "sell" rating and $44 price target.
Southern has been investing aggressively at its generation business, Southern Power Co., with $4.4 billion in capital expenditures in 2016 growing the unit's portfolio to more than 12,000 MW, about a quarter of which consists of wind and solar assets. But Citi analyst Praful Mehta questioned whether the asset acquisition spree represents an attempt on the part of Southern to "buy growth" that may not be creating long-lasting value at the company.
"It's no secret that returns for renewable projects are facing pressure from increased competition, and the company's high leverage and limited tax appetite create additional hurdles to achieving reasonable equity returns," Mehta wrote.
Meanwhile, Southern's traditional utility operating companies, which account for roughly 80% of earnings, have seen flat or declining retail sales due to energy efficiency, demand response and distributed generation. At Southern's analyst day presentation Oct. 31, management predicated its plan for 5% earnings growth on an expected energy sales growth rate of zero to 1%.
Major generation projects with costs and construction timelines that exceeded initial estimates, like two new nuclear reactors at the Vogtle plant in Georgia and Mississippi Power Co.'s integrated gasification combined-cycle Plant Ratcliffe in Kemper County, should help provide medium-term growth for Southern when they are added to rate base, according to Citi. But the risk of continued delays and the degree of cost overruns that may be disallowed from rate base remains. Southern plans to invest $22 billion at its utilities over the next five years, which should result in annual rate base growth of 3% to 4%.
To reach its $44 per share price target for Southern, Citi deducted $7 for the estimated $13 billion in parent company net debt as of June 30, 2017. Citi estimates Southern's parent net debt at 29% of total debt at the end of 2016, and that the company will slowly pay it down to a level of 24% by 2020. But if President-elect Donald Trump carries out his plan to cut corporate taxes to 20%, Citi noted Southern's parent-level debt would become more expensive on a post-tax basis.
Citi anticipates 8% annual earnings growth at Southern Co. Gas from 2017 to 2020, driven by an estimated $8 billion in rate base investments over the next five years, which should result in annual rate base growth of 10% to 12%.