In June, I warned that Southern Company’s (NYSE: SO) dividend safety rating was a D. As I explained in the article, utilities have very low free cash flow thanks to their massive spending on capital expenditures.
The business of running a utility is profitable… until you account for the cost of maintaining and building new facilities. After those capital expenditures, many utilities don’t generate free cash flow.
They may be profitable according to earnings, which have all sorts of noncash items in the calculation. But when you factor in the money that’s coming in and going out, many of these companies are bleeding cash.
Utilities take on a lot of debt to pay for these expenditures. When interest rates go higher, the debt rises and it becomes more difficult to pay the dividend.
That hasn’t been an issue for Southern Company in the recent past. It actually has raised the dividend every year for the past 17 years. What is an issue is free cash flow…
It doesn’t have any.
In 2018, Bloomberg expects its free cash flow total to improve, though it will still be negative. Wall Street estimates an outflow of $4.5 billion more than what the company takes in.
In fact, the company hasn’t had positive cash flow since 2013. Southern Company hasn’t reported full-year 2017 results yet, but when it does, free cash flow is projected by Bloomberg to come in at negative $5.9 billion.
If a company’s free cash flow is negative, it has to pay the dividend with either cash on hand or borrowed funds.
And Southern Company has been on quite the borrowing spree.
The power company’s debt has more than tripled over the past decade…
So we have a company that doesn’t generate any cash to pay its dividend and has a huge debt burden. That isn’t a recipe for a safe dividend*.
Southern Company isn’t alone in this predicament. Many utilities have low or no free cash flow and a large amount of debt.
In fact, out of 41 utilities rated by SafetyNet Pro, only four are rated A or B. CenterPoint Energy (NYSE: CNP) and AES Corp. (NYSE: AES) get the top rating while National Fuel Gas Co. (NYSE: NFG) and Oneok (NYSE: OKE) are rated B.
Southern Company doesn’t make that list… not even close.
Unless it changes its free cash flow situation, it will continue to deserve a low rating for dividend safety.
Dividend Safety Rating: D
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*according to Marc Lichtenfeld’s proprietary SafetyNet Pro database