My last review of Dominion Energy (D) was just as the coronavirus pandemic was unfolding in the U.S., so rereading it shows how much has changed. Indeed, Dominion’s electricity demand was less affected by the pandemic than many other utilities. Nonetheless, some of the changes at the company since February are not pandemic-related.
After lengthy legal and regulatory battles, and despite a Supreme Court win, Dominion Energy has canceled the $8 billion Atlantic Coast gas pipeline project which it had undertaken with Duke Energy (DUK). Note that the pipeline was meeting demand: its capacity was over 90% subscribed for 15 years. As in the Northeast, and due in part to the decisions against the Keystone XL Pipeline, the Dakota Access Pipeline, and the Tesoro High Plains Pipeline, this suggests a hostile regulatory and judicial environment, exacerbated locally by Virginia’s Executive Order 43, which targets zero hydrocarbon use for Virginia’s electricity by 2050. At present, Dominion’s generation mix – primarily for electricity sales in Virginia, North Carolina, and South Carolina – includes 12% coal and 42% natural gas.
Moreover, Dominion is selling some of its natural gas storage and transmission assets to Warren Buffett’s Berkshire Hathaway (BRK.A) for $4.0 billion in cash and $5.7 billion of debt assumption. Gas storage and transmission as a sector is separately notable, since Berkshire Hathaway has a reputation for buying undervalued assets.
The asset sale will reduce operating earnings, and so, the company expects to reduce its dividend from $3.76/share (4.7% yield) to an estimated $2.50/share starting in 2021 (a 3.1% yield at the current stock price).
Although Dominion Energy operates in several states besides Virginia, Virginia is its core. The hostile governmental (Executive Order 43), judicial, regulatory and environmental (cancellation of the well-subscribed Atlantic Coast pipeline) conditions necessitating an asset sale to Berkshire Hathaway and upcoming dividend reduction suggests investors should wait out Dominion’s retrenchment.
Second-Quarter 2020 Results
Pandemic shutdown effects on electricity use in Dominion’s service areas were less than expected. For the March-July 2020 period, electricity use in the mainly (87%) Virginia-North Carolina service territory was actually up by 0.2% compared to the 2018-2019 average for the same period. However, between March and July 2020, electricity use in the South Carolina service territory was down by -3.9% compared to the 2018-2019 average.
The difference between the two service areas reflects different mixes between higher residential demand and lower combined commercial/industrial demand that has been experienced from the coronavirus-caused shutdowns.
Overall, the Energy Information Administration expects U.S. electricity use to be lower by a huge -4.2% for full-year 2020 relative to 2019, implying a very large decline in the second quarter and subsequent recovery in the third and fourth quarters.
For the second quarter of 2020, Dominion Energy’s net loss was -$1.2 billion, or -$1.41/share, compared to a net gain of $54 million for the same period a year ago. Operating earnings for the quarter were $706 million, compared to $619 million for the second quarter of 2019.
In 2Q20, the -$2.8 billion impairment charge for the Atlantic Coast Pipeline and Supply Header project was only somewhat offset by a $400 million gain from the company’s nuclear decommissioning trust and a $550 million income tax benefit.
Dominion expects 2020 operating earnings of $3.37-3.63/share (down from a pre-COVID-19 estimate of $4.25-4.60/share).
The company’s operating earnings by segment for 2Q20 were:
- Dominion Energy Virginia, +$437 million (62% of net total);
- Gas Transmission and Storage, +$184 million;
- Gas Distribution +$87 million;
- Dominion Energy South Carolina, +$75 million;
- Contracted Generation, +$21 million;
- Corporate and Other, -$98 million.
Asset Sale to Berkshire Hathaway
In early July 2020, Dominion announced it was selling gas transmission and storage assets to Berkshire Hathaway for $4 billion and the assumption of $5.7 billion in debt, or almost $10 billion. This includes 7700 miles of natural gas transmission lines and 900 billion cubic feet (BCF) of storage: specifically, Dominion Energy Transmission, Questar Pipeline, Carolina Gas Transmission, 50% of the Iroquois Gas Transmission System, and 25% of the Cove Point liquefied natural gas (LNG) facility in Maryland. Dominion will retain 50% of Cove Point and Brookfield Asset Management owns the remaining 25%.
As noted above, in the second quarter of 2020, the gas transmission and storage segment being sold to Berkshire Hathaway contributed $184 million in operating earnings, or 26%. Gas transmission and storage earnings for the first six months of the year was similar at $405 million in operating earnings out of $1.64 billion, or a 25% share.
The sale is expected to close in the fourth quarter of 2020. Once closed, with earnings from these assets no longer going to Dominion, the company expects to cut its dividend to 65% of remaining operating earnings, or about $2.50/share.
The Net-Zero Initiative and Virginia Executive Order 43
Dominion’s Net Zero initiative aligns with Virginia Executive Order 43 for decarbonization throughout the state.
Several states, including Virginia, (but not North Carolina or South Carolina, also both served by Dominion), are targeting partial or full decarbonization by 2030-2050. The primary carbon fuels to generate electricity have been coal and natural gas. Virginia has not legislated a goal, but it has implemented an executive order targeting 30% clean generation fuels by 2030 and 100% clean generation fuels by 2050. Clean fuels are defined as hydropower, solar, wind, (aka “renewables”) and nuclear. As the graphs below show, because of the sizable contribution of nuclear, Dominion is already reaching this goal.
Another near-term goal specific to the state government: “The Commonwealth shall procure at least 30 percent of the electricity under the statewide electric contract with Dominion Energy from renewable energy resources by 2022.”
Electricity Fuel Generation Sources
In its earnings call slides, Dominion notes that in 2019 natural gas was 42% of its electric generation fuel and renewables were 4%. The company expects a significant ramp-up by 2035 of renewables to 33% and a ramp-down (at least on a percentage basis) of natural gas to 26%. This is illustrated below.
(Data Source: Company website)
Natural Gas Prices
Low natural gas prices (shown above) benefit Dominion’s electricity customers due to lower costs for gas-fueled generation. This cost advantage will dissipate in Virginia as natural gas use becomes increasingly limited in the state’s electricity generation due to Executive Order 43.
However, do note that post-Berkshire sale, generation in North Carolina, in Dominion’s South Carolina operations – which will comprise 15% of its earnings – and the six states shown below in its gas distribution segment – which will comprise another 15% of its earnings – have not enacted policies requiring Dominion to reduce either the direct sale of natural gas for heating and other applications or the use of natural gas for electricity generation. This energy flexibility will benefit the natural gas and electricity consumers of those states.
(Image Credit: Seeking Alpha)
Institutional Shareholder Services (ISS) recently ranked Dominion Energy’s overall governance as 8, with sub-scores of audit (1), board (6), shareholder rights (7), and compensation (9). On the ISS scale, 1 represents lower governance risk and 10 represents higher governance risk.
At July 15, 2020, shorted shares were only 1.3% of floated shares. Insiders own a fractional 0.28% of outstanding shares.
Dominion’s beta is 0.43: its stock moves directionally with the overall market but with less volatility, as is typical for utilities.
Senior management changes effective October 1, 2020: current chairman, president, and chief executive officer Tom Farrell will become executive chair; Bob Blue will become president and CEO; and Diane Leopold will become the chief operating officer.
Competitors and Dow Jones Utility Index Comparison
Utilities have no exact competitors – they have a monopoly on their service areas in exchange for regulation – but they can be compared to one another, especially in the 15-stock Dow Jones Utility Index (DJU).
Nor are utilities uniform in approach. They vary by their regional economies’ growth, by level of non-regulated businesses, and by whether their state governments and public utility commissions are limiting their generating fuel sources, as many – including Virginia – are.
With the sale of its natural gas transportation and storage, Dominion will become much more focused (about 90%) on regulated utilities.
By contrast, utilities with revenue from non-regulated merchant sales include Exelon Corp. (EXC) and NextEra Energy (NEE).
Other Financial and Stock Highlights
At June 30, 2020, Dominion had $72.84 billion in liabilities and $103.73 billion in assets, resulting in a steep-but-utility-standard liability-to-asset ratio of 70%. Again, the sale of assets to Berkshire Hathaway will reduce debt by $5.7 billion.
Market capitalization is $67.4 billion at an August 3, 2020 closing stock price of $80.33 per share. Dominion’s 52-week price range is $57.79-90.89 per share, so its August 3, 2020 closing price is 88% of the high.
The company expects 2020 operating earnings per share of $3.50 for a current price-to-earnings ratio of 23.0. Analysts’ average estimate for 2021 EPS is $3.86 for a forward P/E of 20.8.
Market value per share is two and a half times book value per share of $31.53, indicating positive investor sentiment.
The current dividend of $3.76/share represents a 4.7% yield. However, the company’s new dividend of an estimated $2.50/share starting in 2021 would represent a dividend of 3.1%/share at today’s stock price.
The mean overall rating from eighteen analysts is 2.7, or “Hold” leaning slightly toward “Buy.”
Data by YCharts
Positive and Negative Risks
In addition to the pandemic recovery and Virginia regulatory risks, with a liability-to-asset ratio of 70%, Dominion is more exposed to interest rate increases than companies in other sectors. However, interest rate increases appear unlikely for now.
Recommendations for Dominion Energy
I do not recommend Dominion Energy to growth-seeking or dividend-hunting investors. Although the company has surfed the pandemic shutdowns without a terrible demand loss, the extreme resistance it encountered in trying to build the Atlantic Coast pipeline – despite its Supreme Court win – resulting in the cancellation and the company’s $2.8 billion write-off of its shares speak to the negative environment in which it operates in the Virginia part of its service territory.
The sale of gas assets to Berkshire and follow-on expected dividend cut reduces the attractiveness of a stock in a sector in which investors expect healthy dividends. It is possible the company’s stock price will fall to align with the lower expected operating earnings, an unappealing prospect for growth investors.
It is also disappointing to see the company not pushing back on Virginia’s unrealistic executive guidance to replace all (cheap) hydrocarbon-fueled electricity generation – especially given nearby plentiful natural gas – with nuclear and intermittent, more-expensive renewables.
Those interested in Dominion should wait for the post-Berkshire sale shakeout of lower dividends and likely lower price after the fourth quarter.
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Disclosure: I am/we are long NEE. 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.