Dominion Energy Inc. (NYSE: D) as we await a more positive fundamental picture. On the 3Q20 conference call, management indicated that it would use the fourth-quarter earnings call to provide investors with a ‘mini-investor day style refresh.’ During the upcoming call, we look for the company to provide new strategic guidance and capex projections.
The past few quarters have been eventful for Dominion. In early July, the company announced that it would sell its midstream gas business to Berkshire Hathaway. It also abandoned work on its Atlantic Coast Pipeline (ACP) project. As a result, management lowered its 2020 guidance and announced a 33% cut in the dividend. Dominion will now focus entirely on its regulated utilities in Virginia, South Carolina and North Carolina.
Dominion also recently underwent a management change. Thomas Farrell stepped down as CEO on October 1, 2020. Mr. Farrell previously maintained dual responsibilities as executive chairman and CEO. The new CEO is Robert M. Blue. Mr. Farrell remains executive chairman. Mr. Blue previously served as COO. D shares have declined 4% since our downgrade in August, while utility shares have generally rallied on improved industrial demand and continued strong residential utility usage. We would consider returning Dominion to our BUY list if it is able to provide a positive revenue and EPS growth outlook at its investor day.
Dominion shares have underperformed the S&P 500 over thepast three months, falling 7%, compared to a 10% gain for the index. They have also underperformed over the last year, falling 7%, versus a 16% gain for the S&P. The shares have underperformed the industry TF, IDU, over the past year and the past five years. The stock’s beta is 0.32.
On November 5, Dominion reported 3Q20 operating earnings of $916 million or $1.08 per share, down from $946 million or $1.15 per share in 3Q19. The decrease was attributable to weakness in the Virginia and South Carolina segments, partially offset by favorable weather and stronger results in the Gas Distribution and Contracted Assets businesses. On a GAAP basis, the company reported net income of $356 million or $0.41 per share, down from $975 million or $1.17 per share a year earlier. The decrease was attributable to an impairment charge on certain merchant solar generation facilities, and a charge on the sale of Fowler Ridge, partly offset by gains in nuclear decommissioning trust funds. On the top line, third-quarter operating revenue fell 5% to $3.6 billion due to lower energy prices. Net revenue, however, increased 4% to $3.0 billion, due to lower fuel cost expense and the Virginia Power rate adjustment.
In July 2020, the company agreed to sell its gas transmission and storage business to Berkshire Hathaway Energy, a subsidiary of Warren Buffett’s conglomerate, for $9.7 billion. The price includes the assumption of $5.7 billion in debt and a cash payment of about $4.0 billion, of which $3.0 billion will be used to repurchase stock in late 2020. The deal is expected to close in 4Q20. The sale reflects Dominion’s efforts to shift to a higher-growth business model focused on regulated utilities and renewable energy. In 2Q20, Dominion and partner Duke Energy canceled their Atlantic Coast Pipeline (ACP) project. Management cited cost and regulatory uncertainty, including environmental litigation risks, and in-service delays, as primary factors. The company has billions of dollars in sunk costs related to the project.
The company projects 2020 operating EPS of $3.37-$3.63, unchanged from its prior projection. The results exclude operating earnings from the transmission segment. Management also projects 2021 EPS of $3.85-$3.90 and long-term EPS growth of 6.5%. Positive drivers include lower financing costs, lower depreciation, and increased earnings stability due to the gas transmission and storage asset sale.
EARNINGS & GROWTH ANALYSIS
Reflecting the above-mentioned asset sale, Dominion now reports results for four operating segments: Dominion Energy Virginia, Gas Distribution, Dominion Energy South Carolina and Contracted Assets. (The results exclude ‘corporate’ and ‘other.’) We summarize 3Q segment results below.
Dominion Energy Virginia: Third-quarter net income decreased 2.5% from the prior year to $613 million. The decrease was primarily attributable to renewable energy investment credits in 3Q19 that did not recur in 3Q20 and unfavorable weather. Gas Distribution: Third-quarter net income increased 48.8% from the prior year to $64 million, as interest expense and other expenses were lower. These positive drivers were partially offset by lower depreciation and amortization expense and higher rate adjustment returns.
Dominion Energy South Carolina: Third-quarter net income fell 5.4% from the prior year to $157 million. The decline was the result of higher other expenses, unfavorable weather, and a lower regulatory rider equity return. These negatives were partially offset by lower interest expense and a 3% increase in gas distribution customer accounts.
Contracted Assets: Third-quarter net income increased 30.2% from the prior-year period to $112 million. The increase was the result of better margins and lower interest expense, partially offset by planned outage costs.
We are maintaining our 2020 operating EPS estimate of $3.61 and increasing our 2021 forecast to $3.91 from $3.88.
FINANCIAL STRENGTH & DIVIDEND
Moody’s and Standard & Poor’s rate the company’s credit as Baa2/stable and BBB+/positive, respectively. As a result of its business divestiture and ACP termination, management cut the quarterly dividend by 33% to $0.63 per share to reflect the revised business model. The new yield is about 3.3%.
MANAGEMENT & RISKS
Dominion recently underwent a management change. Thomas Farrell stepped down as CEO on October 1, 2020. Mr. Farrell previously maintained dual responsibilities as executive chairman & CEO. The new CEO is Robert M. Blue. Mr. Blue previously served as COO.
The company plans to support future earnings growth by investing in what it terms ‘foundational’ projects as well as in large-scale ‘transformational’ projects. These projects include rate base spending on distribution and transmission lines, the replacement of aging gas pipelines, solar projects, and natural gas-fired generation plants. Altogether, at the foundational level, the company projects total growth capex of $26.0 billion through 2023. At the transformational level, it will continue work on the Cove Point liquefaction plant (in which it will retain a 50% interest after the sale to Berkshire Hathaway). However, as noted above, it has abandoned work on the Atlantic Coast Pipeline due to regulatory hurdles. It will also sell the Dominion Midstream MLP business to Berkshire Hathaway.
Specific risks to the share price involve liquidity and credit issues. Key risks for electric and gas utility stocks include commodity price fluctuations, a decline in the rate of kilowatt-hour sales growth, the effect of adverse weather on revenues, potential environmental and safety liabilities, policy or market structure changes that could jeopardize long-term earnings growth, and higher-than-expected interest rates. Utilities also face the potential for unfavorable regulatory proceedings, especially regarding construction cost recovery.
Dominion Energy is one of the nation’s largest regulated utility companies, with a portfolio of 30,700 megawatts of generation capacity; gas distribution pipelines; and 10,400 miles of electric transmission lines. Dominion serves almost 7 million utility and retail energy customers, with significant utility operations in Virginia, North Carolina and South Carolina.
Taking into account the company’s recent divestitures, dividend cut, and energy production mix (notably the less than 5% of total production that comes from renewables), we believe that shares are fully valued at current levels and that a HOLD rating remains appropriate.
On December 18 at midday, HOLD-rated D traded at $76.02, up $0.09.