Is Southern's Dividend Growth About to Tick Up?

Southern Company (NYSE: SO), one of the largest utilities in the United States, has undertaken a massive construction project that no other utility in the country has been able to get over the finish line. However, the two nuclear power plants it is building are long delayed and wildly over budget. And yet they are also very close to being brought online. When that happens, this dividend stock could see important changes in its dividend policy.

A balancing act

Southern is a regulated utility, which means it has been granted a monopoly in the regions it serves but it must ask regulators for permission with regard to price hikes and capital spending plans. It has to walk a fine line between doing what is right for its customers and providing its shareholders a desirable return.

An electrical engineer working near high voltage utility towers.

Image source: Getty Images.

Getting to the proper balance is a negotiation and the real world doesn't always work out as planned. That's been a big headwind for Southern since it started to build two new nuclear power plants, collectively known as the Vogtle project. The effort began with the project's approval in 2009, with an expected cost of $14 billion and in-service targets of 2016 and 2017.

The project has experienced huge delays, including the bankruptcy of Southern's primary contractor. Based on current projections, the two nuclear power plants will both come online by the end of 2023 and cost well more than twice the original estimate. Investors have not been particularly pleased with the history here and for good reason, noting that several "one-time" charges have been taken because of the cost overruns.

The dividend

Another side effect of the project has been the board's conservative approach to Southern's dividend. Over the past decade, it has increased at just 3% annually. That figure is the same over the trailing one-, three-, and five-year periods. In fact, the annual per-share dividend increase has been capped at $0.08 since 2017. With the uncertainty surrounding the Vogtle project and what it might ultimately cost, there really wasn't a viable option to increase the pace even if it could have been higher.

However, once that uncertainty is over, the board might have a freer hand on the dividend front. Specifically, management projects that having both of the nuclear power plants up and running will add $700 million to the company's cash flow. CEO Dan Tucker explained during the third-quarter 2022earnings conference callthat there are three places where that extra cash might get used: improving the company's balance sheet, future capital investment plans, and the dividend.

As the drag of the Vogtle project subsides, the board may very well look to raise the dividend at a pace that more closely aligns with Southern's earnings growth. To put some numbers on this, the 2022 dividend increased 3% but adjusted earnings are projected to rise by nearly 10%. It wouldn't be realistic to expect Southern's dividend to start growing at 10% a year, given that dividends are just one of the options for the additional cash flow expected. However, it seems reasonable to expect dividend growth to increase, perhaps into the mid-single digits. And that would make Southern a far more attractive dividend stock.

Not just yet

At the end of the day, the dividend discussion is really about 2024 and beyond, since the Vogtle project isn't set to be completed until the end of 2023. However, even after a rise in the stock price, lowering the dividend yield to 3.8%, Southern is still offering an above-average yield relative to the market and the average utility stock, using Vanguard Utilities Index ETF as a proxy. If you are a dividend investor looking for a utility, the combination of a high yield and the nearly complete Vogtle project might make Southern worth a close look today -- before the dividend grows at a more rapid clip.

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Reuben Gregg Brewer has positions in Southern. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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