WEC - Dominion Energy: One Of The Best Deals In Utilities

2023-06-07 10:46:43 ET

Summary

• Dominion Energy, Inc. stock is undervalued and offers a dividend yield of over 5%, making it an attractive option for value investors.
• The company is making progress in renewable energy projects and benefits from supportive legislation in Virginia, providing stable funding for decarbonization efforts.
• Dominion has a strong BBB+ credit rating and is expected to see earnings growth in the coming years, making it a potentially lucrative investment opportunity.

It would seem that investment-grade rated utility stocks should see meaningful upward momentum in a stabilizing interest rate and inflation environment, but that hasn't been the case. This is great for value investors, as some names in this space remain materially undervalued while throwing off a decent yield.

This brings me to Dominion Energy, Inc. ( D ), which just may be the cheapest of them all and which I last covered here , remarking on its bottom line growth and progress towards clean energy.

As shown below, Dominion stock continues to trade cheaply, pushing the dividend yield comfortably past the 5% mark. In this article, I discuss recent developments and why value investors may want to consider the stock at its current level.

Why Dominion?

Dominion Energy is one of the largest utilities in the U.S., serving 7 million customers across 16 states with electricity and natural gas. It has an ambitious plan of achieving net zero emissions by the year 2050, and over the trailing 12 months generated $18.2 billion in total revenue.

To get a full appreciation of how cheap Dominion Energy is, it is now trading at a material discount to its peer utility companies. For purposes of normalization, I use EV/EBITDA, since enterprise value includes both the value of equity and debt.

Dominion trades at an EV/EBITDA of just 10.9, which is lower than that of peers Southwestern utility Pinnacle West ( PNW ), Midwestern utilities WEC Group ( WEC ) and Alliant Energy ( LNT ), Southern California utility Sempra ( SRE ), and close neighbor Duke Energy ( DUK ), whose valuations range from 11.6 to 15.1, as shown below.

Moreover, Dominion is now trading at its highest yield outside of the early pandemic timeframe in 2020, with a 5.2% dividend yield. This is one of the highest in the utility sector, and comes with a 67% payout ratio.

Looking forward, Dominion should see benefits from its renewable energy projects, such as wind power, as they come the lower input costs due to no fossil fuel usage. Management recently noted that its offshore wind project is moving forward on schedule and on budget.

Meanwhile, constructive legislation in Virginia helps to secure visibility into future cash flows while reducing customer bills below the monthly average. This is important for Dominion, as it provides a stable source of funding for its decarbonization projects, which will come will lower input costs due to lower fossil fuel costs. This is expected to be achieved through the securitization of deferred fuel costs while providing a healthy return on equity, as noted during the recent conference call :

In February, I discussed the need for a durable regulatory construct that provides for a competitive and fair return on utility investments to attract low-cost capital and support of our customer-focused programs.

New Virginia law enacted in April and effective July 1, comprehensively addresses both of those needs. It provides significant bill relief for our customers and supports the long-term stability of our utility with nearly unanimous bipartisan support, the legislation provides the certainty we need to fund and execute critical energy investments in support of the Commonwealth's robust electric demand growth.

[The law] establishes an authorized ROE of 9.7%, up from 9.35% currently for purposes of the 2023 biennial review which will determine base rates and rider returns through the next biennial period.

Importantly, Dominion maintains a strong BBB+ credit rating, which should help it to secure below market average interest rates on debt refinancing. It also currently has $1.8 billion in cash on the balance sheet, which is the highest level in at least a decade.

Lastly, I see value in Dominion at the current price of $51.62 with forward P/E of 13.6, sitting below its normal P/E of 17.2. While analysts expect earnings to be flat next year, EPS is expected to rise to the mid single-digit in 2025 and beyond. An analysts from Seaport Research recently noted Dominion's large discount to peers and raised its price target to $59, noting the following potential asset dispositions to improve its balance sheet and fund capital investments in its research report :

Dominion is conducting a business review to find the most efficient sources of capital to improve its balance sheet and fund capital spending, and Storozynski said it could sell its South Carolina electric and gas utility, with Southern ( SO ) and NextEra Energy ( NEE ) the most likely buyers, possibly yielding $17B-$18B and resulting in an EPS hit $0.15 lower than that from the sale of gas utilities.

Sell side analysts who follow the company have an average price target of $61 , representing a potential 23% total return over the next 12 months.

Investor Takeaway

Dominion Energy stock's downward pressure has pushed the dividend yield past 5% and it trades at a material discount to its peers. Furthermore, recent legislation in Virginia should help to secure visibility into future cash flows while reducing customer bills below the monthly average. Analysts expect earnings growth to accelerate over the coming years and renewable projects are progressing well. As such, value investors may want to take a hard look at Dominion Energy, Inc. stock at its current discounted price.

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