Southern

Southern Co. subsidiary Nicor Gas announced it reached a multiparty settlement that would raise gas customer base rates $82 million if Illinois regulators sign off.

Why it matters: Although the agreed-upon rate increase is only about one-third of Nicor's initial request and the 9.48% allowed return on equity is below most utilities' allowed return on equity, the settlement maintains the status quo and avoids litigation in a state with a history of unfavorable rate regulation. Illinois' regulatory staff, attorney general, and major customer groups agreed to the settlement, making it highly likely that the Illinois Commerce Commission will approve it in the next few months and the rate increases will contribute to earnings growth in 2027. Southern's gas business represents less than 15% of consolidated earnings but offers diversification for investors if there is a slowdown in Southern's southeast electric business.

The bottom line: We are reaffirming our $83 per share fair value estimate and narrow Morningstar Economic Moat Rating for Southern. The stock trades at a 6% premium to our fair value estimate and at 19 times our 2026 earnings estimate as of Sept. 10, a slight premium to other regulated US utilities. Earnings through the first half of the year are on track to meet our full-year estimate and the high end of management's $4.50-$4.60 EPS guidance range.

Big picture: Our 7% annual earnings growth forecast is at the low end of management's 7%-8% range. Growth could top 8% beyond 2028 if current energy demand growth trends in the southeast continue. Management plans to invest $81 billion in 2026-30, primarily at Southern's regulated electric utilities. A large share of that is to support 31 contracted new data centers through June totaling 17 gigawatts. Electricity demand is growing this year at the fastest pace in decades in Southern's southeast service territories. Commercial customer growth, including data centers, is a key growth driver.

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Our fair value estimate is $83 per share after incorporating recent financial results, regulatory developments, and recent new data center announcements, such as the 3.2-gigawatt OpenAI project in Georgia.

We forecast 7% annual average earnings growth based on more than 2% annual electricity demand growth and $81 billion of capital investment in 2026-30. This is in line with the plan that management presented in February 2026.

The bulk of Southern's growth investment will be at its largest subsidiary, Georgia Power, to support energy demand growth that could reach 10% annually as large-load customers like data centers ramp up operations in 2028 and beyond.

New equity and debt to finance its growth investments will keep earnings growing slightly slower than Southern's rate base.

We forecast $3 billion of investment during 2026-30 at Southern's gas utilities, which represent less than 15% of Southern's total earnings.

We expect Southern to invest about $1 billion annually in energy infrastructure outside of its rate-regulated utilities during 2026-30. This primarily includes gas pipelines and renewable energy at Southern Power. We estimate earnings from these investments will remain about 10% of consolidated earnings.

Our 7% cost of equity is lower than the 9% we think investors should expect from a diversified equity portfolio. Our pretax cost of debt assumption is 5.4%, reflecting a normalized long-term real rate environment and normalized credit spreads. A 2.2% long-term inflation outlook underpins our capital cost assumptions. These assumptions result in a 5.9% weighted average cost of capital.

We believe Southern has a narrow moat supported by its state-regulated utilities, which represent approximately 90% of its earnings. Service territory monopolies and efficient scale advantages are the primary moat sources for Southern's regulated utilities.

State and federal regulators grant Southern exclusive rights to charge customers rates that allow it to earn a fair return on and return of the capital it invests to build, operate, and maintain their infrastructure.

In exchange for Southern's service territory monopolies, state and federal regulators set customer rates at levels that aim to minimize customer costs while offering fair returns for capital providers. We expect returns on invested capital to remain at a modest but consistent spread above Southern's cost of capital for the foreseeable future, supporting our narrow moat rating.

This implicit contract between regulators and capital providers should, on balance, allow Southern's utilities to achieve at least their costs of capital, though observable returns might vary in the short run based on demand trends, investment cycles, operating costs, and access to financing.

Southern benefits from operating in states with favorable regulatory jurisdictions and fastest-growing local economies. These factors and its constructive relationships with regulators contribute to the premium returns Southern has earned, the most critical component of a regulated utility's moat.

The investment opportunities and regulatory mechanisms that have allowed Southern to earn higher returns on equity than most of its peers are in large part because of the company's constructive relationships with state regulators in Alabama, Georgia, and Mississippi, in particular.

Southern has built constructive regulatory relationships in states with more challenging regulation such as Illinois following its acquisition of AGL.

The delays and cost overruns at the Kemper and Vogtle projects have weighed on earned returns for nearly a decade, but those headwinds are mostly gone.

Southern's competitive generation business benefits from long-term contracts for capacity and energy that lock in favorable returns on capital. Its average contract length is over 10 years and it takes little direct commodity risk.

Southern has excellent regulatory relationships in most of the states it serves, due in large part to low energy rates and solid operational performance.

Southern has paid a dividend that was the same as or higher than the previous year since 1947, including a 3% increase for 2026.

Business investment and customer growth remain strong in Southern's Southeast US service territory, supporting growing electricity demand.

Cost overruns and construction delays at Vogtle and Kemper demonstrated the risk of taking on large infrastructure projects.

A change in the constructive ratemaking structures in Georgia, Alabama, and Mississippi could slow earnings growth and reduce investment.

Rising interest rates can be headwinds for utilities like Southern as higher debt costs slow earnings growth and dividend yields are less attractive compared with fixed-income alternatives.