D - Dominion Energy: Load Up On The Battering That Has Taken It To A 52-Week Low

2023-03-09 15:09:31 ET

Summary

• Dominion Energy's renewable energy projects faced significant execution challenges compounded by legislative uncertainties, prompting investors to flee the scene.
• Income investors are likely not prepared for more headwinds, as the company couldn't provide more clarity pending the completion of its business review.
• Another wave of uncertainty hit D's investors as the CEO of NextEra Energy criticizes the cost-effectiveness of offshore wind projects, casting doubt on the company's strategy.
• Dominion Energy braces for another potential setback as the Fed contemplates a more hawkish approach, potentially dealing a blow to the company's earnings.
• However, D has been so well-battered that it's hard to be so bearish now.

Dominion Energy, Inc. ( D ) has failed to convince investors that the worst was over in mid-December, even as buyers returned momentarily. However, sellers quickly took control in late January, sending D into another tailspin as it spiraled further down, dropping more than 15% to form its recent March lows.

As such, Dominion investors have likely fled once more, as the leading integrated energy player faced significant uncertainties over its business review.

The company's plans are also pending legislative uncertainty awaiting the decision of Virginia Governor Glenn Youngkin. The General Assembly reached a tentative agreement to subject Dominion Energy to " tighter regulatory oversight — reversing years of actions that loosened the reins over the powerful company."

Investors are likely worried about the impact of the agreement and the impact on the company's forward earnings. Accordingly, Dominion would need to "undergo more frequent rate reviews by state regulators, refund excess profits to customers, and lower its allowed rate of return."

At its Q4 earnings conference , the company highlighted that it would not be able to complete its business review until the final decision, including legislation on its offshore wind project.

Hence, investors will likely have to bear with these uncertainties until April or May, which was clearly not welcomed by income investors seeking dividend security.

At its Q4 earnings call, Dominion Energy stressed its commitment to maintaining its dividend policy, which was recently maintained at $0.6675 per share per quarter.

Notably, the company emphasized that it intends to conduct its business review with the intention "without reducing the dividend." As such, while a near-term impact could lift its payout ratio above its 65% target rate, it remains confident in returning it "back to 65% without cutting the dividend."

However, given its recent underperformance relative to the S&P 500 ( SPX ) since our late December update, it appears that investors weren't convinced about the company's position.

Moreover, NextEra Energy ( NEE ) CEO John Ketchum downplayed the cost-effectiveness of offshore wind projects at the recent CERAWeek conference.

Keen investors should recall that Dominion Energy articulated that its 2.6 GW " is on track and on budget," with completion slated by the end of 2026.

However, Ketchum accentuated that "offshore wind is a 'bad bet' in the fight against climate change." He added "complications in installing and maintaining infrastructure at sea and high cost of transmitting electricity back to shore" as daunting challenges.

Therefore, not everyone is on the same side as Dominion Energy, even as the company navigates the challenges of the energy transition.

Coupled with significant regulatory uncertainties, we believe naysayers could justify the battering, as the market needs to reflect these execution headwinds.

Moreover, the company added that its floating rate debt (20% of portfolio) could face higher costs due to a hawkish Fed. The company highlighted that its initial interest rate assumptions were well understated as the Fed went on a hiking rampage.

With the market pricing in an even more hawkish Fed following Chair Powell's recent senate testimony, investors must be prepared for potential earnings disappointment.

As such, we aren't surprised that D's dividend yield has surged to 4.9%, close to the two standard deviation zone over its 10Y average of 4%.

With the 2Y Treasury yield printing more than 5% recently, income investors likely have a much safer option, even though D's valuation seems to have priced in significant pessimism.

We had anticipated D's bottom to hold in December. However, the recovery in January was quickly rejected, as the sellers forced another steep selloff to form its March lows.

However, D's price action appears to have stabilized recently, although it could be premature to be sure.

With December lows decisively taken out, the usual guideline should be to maintain a cautious posture while waiting for buyers to demonstrate sufficient conviction.

However, we are confident that the Fed is on track toward hitting peak rates in 2023, suggesting that the spread between the 2Y and D's NTM dividend yield should narrow moving forward.

With its price action and valuations well-battered, the reward/risk is likely still skewed to the upside.

However, investors should consider adding progressively. The current levels look highly appealing if they have high conviction over the legislative outcome in favor of Dominion Energy.

Rating: Buy (Reiterated).

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