A Very Safe 6.3% Yielding Utility Issue

Southern Co. (SO) is a large regional utilities provider in the Southeast US. The company is very profitable and grows book value every year, adding to its already impressive value creation. However, the most recent quarter has kept the stock anchored under $41 after touching $48+ earlier this year. As income investors, however, we needn't accept such volatility for our utility dividend investments. If you are looking to take advantage of SO's superior operating performance but don't want to own the common stock, there is hope. In this article, we'll take a look at the Alabama Power 6.5% Series Non-Cumulative Preference Stock (ALAWP, ticker may differ depending on your broker).

To begin, we'll define exactly what ALAWP is. ALAWP is a traditional preferred stock in that it has no stated maturity date and also has no debt security as its base, like a trust preferred security. Since there is no debt associated with this preferred stock it also has the distinction of being eligible for the preferential dividend tax treatment dividend investors enjoy. This can mean a large bump in the after-tax yield for an investor holding ALAWP in a taxable account over a similar issue whose distributions are taxed as ordinary income.

As I stated there is no maturity date associated with this preferred. However, beginning in October of 2017 SO can redeem ALAWP for the full issue price of $25. If SO chooses not to redeem ALAWP, however, it will persist until such time that SO ceases operations or it is ultimately redeemed.

At $25 and a 6.5% coupon rate, ALAWP pays annualized dividends of $1.625 in quarterly installments. However, shares are currently trading for a slight premium to the issue price, $25.80 as of this writing, so the current yield is actually a bit lower at 6.3%. I don't normally favor investing in preferred securities at a premium but given the rock solid strength of SO and the fact that premium is so small, the still-robust current yield is enough to make me still like ALAWP as an income investment.

Of course, there are risks to owning ALAWP. First and foremost is the risk that interest rates will spike and send income securities plummeting in price. This is unavoidable and something that you must make peace with before investing in any kind of preferred security, ALAWP or otherwise. A couple of factors make ALAWP less susceptible to this phenomenon, in my view. First, the payer is a very large, very profitable utilities provider, meaning this issue is going to be safer, and thus command a higher price all else equal, than a small bank preferred offering, for example.

Second, the call provision isn't that far away at less than four years, meaning that if it appears likely the issue will be redeemed as the call date approaches, investors will bid up the security towards the $25 mark if it has fallen below due to interest rates. Interest rate risk is very real and something you must consider before investing in ALAWP or any other preferred security but in my view, the risk is more muted with ALAWP given SO's strength.

In addition to that, a much smaller risk is that of the non-cumulative nature of ALAWP. Essentially, SO could miss dividend payments on ALAWP and have no financial penalties associated with it and also have no obligation to make up the missed payments. While this is never a desirable trait in an income investment, given the payer's strength and stability I don't see missed payments as a credible possibility. Missing dividend payments on preferreds is a PR nightmare with the investment community and SO would undoubtedly do everything in its power to make sure that didn't happen. However, in the event SO experiences tremendous financial strain and misses payments on ALAWP, keep in mind it needn't make them up to investors.

Overall, ALAWP is a great issue for those income investors seeking a stable, very safe source of strong income. Make no mistake; you can do better than a 6.3% yield if you are willing to look. However, higher yields often come with less desirable payers and stepping way out on the risk curve in order to reach for more yield. If you can look past the non-cumulative nature of ALAWP, you have a great income investment that pays quarterly dividends like clockwork and features the favorable dividend tax treatment to boot with less volatility than the stock market offers.

Source: A Very Safe 6.3% Yielding Utility Issue

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

Additional disclosure: I may initiate a position in ALAWP at any time.

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