Southern Comfort, Utility Style
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For years, electric utility companies have been converting their coal fired generators to natural gas. The reason is simple: The price of converting to natural gas is cheaper than installing "clean coal" technology on existing coal burning plants. Further, the price of coal has increased while natural gas has decreased. In some respects, this is paying off for all Americans. The US Energy Information Administration recently announced the US is producing significantly fewer CO2 and other emissions primarily due to the increased use of natural gas by electric utilities. But what does this switch do for the financial health of such a utility?
Southern Company (NYSE: SO) is a great example of an electric utility converting to natural gas from coal. According to their Q2 2012 conference call, SO has shifted its electrical power generation from 27% natural gas last year to 46% this year. Coal went from 53% to 35%. Plans to are continue this trend. Parenthetically, SO is also increasing its electricity generation from solar and biomass sources. The stock is trading at the middle of its 52 week high/low prices and tends to trade at a high PE ratio, likely because of its track record of strong earnings and rising dividends. In fact, the dividend has risen from $0.28/sh in 1992 to $0.49/sh in 2012. Currently, SO has one of the highest operating profit margins in the industry. Debt is under control and cash flow improved in 2011. The company is doing some things right.
So what has the conversion to natural gas done for SO earnings? They won't say. If rival Xcel Energy's experience is any indication, SO will save $235 million on every power plant it converts to natural gas over clean coal tech. The US Energy Information Administration has studied this question and estimates that in 2017, a new coal burning generating plant with carbon control and sequestration will have a levelized cost of $138 per megawatt hour. The cost for a comparable plant using natural gas: $90.1. The USEIA also notes that the price utilities paid for coal, on national average, has risen from $46.54 to $47.85 over the past year. Natural gas has dropped from $5.25 to $4.07. I'd bet that helped earnings.
American Energy Power Company (NYSE: AEP) is making a similar coal to natural gas switch, but not to the same degree as SO. AEP owns coal mines and coal transportation networks. The cost advantage for natural gas is likely not as great for AEP as for SO. From an investment perspective, AEP pays a 4.3% dividend and has a similar debt load. However, return of equity and return on investment isn't as good as SO. Profit margins aren't as strong as SO, either. This is not to say AEP is in trouble, just that SO has better numbers. That said, there is no getting around the fact that the stock price for AEP has steadily increased while SO has had a roller coaster ride of late.
NextEra Energy (NYSE: NEE) is a different natural gas utility play. This company operates primarily in Florida and already produces almost 60% of its electricity from natural gas. Thus, as gas prices go down, AEP's earnings improve. NEE is heavily invested and investing in renewable and other clean energy. Currently, wind and nuclear power are the number two and three sources of electricity. While declining natural gas prices help, the current dividend is 3.5%, less than SO or AEP. The dividend has increased every year since 1995. The stock slid in August, perhaps due to the impact of significant investments in alternative energy. However, as the economy slowly recovers and Florida's population growth continues, NEE's investments in its power portfolio should combine to produce better than average returns relative to other utilities.
In 2010, the NY Times ran an article that, in part, warned of possible rising natural gas prices as more power companies shifted away from coal to natural gas. So much for that. Simply stated, natural gas production has outpaced consumption despite the expanding demand of electric utilities. SO looks like a strong utility paying a good dividend that will likely become even stronger as it continues its conversion to natural gas. While this is good for shareholders, the reduced pollution from the shift to natural gas is a dividend everyone can enjoy.
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