D - Dominion Energy: Still In The Bargain Bin

2023-05-06 10:16:09 ET

Summary

• Dominion Energy reported Q2 guidance much worse than Wall Street analysts' estimates.
• However, selling pressure was discernibly missing after its earnings release. As a result, we assessed that peak pessimism likely occurred in March.
• Investors still need to brace for headwinds relating to its business review, regulatory construct, and a still hawkish Fed.
• D's valuation remains attractive, which should continue to attract dip buyers to add more shares.

Dominion Energy, Inc. ( D ) reported its FQ1'23 earnings release yesterday (May 5), as the Virginia-based integrated energy company posted pretty robust results.

We updated investors in an early March update , highlighting why the opportunity to buy D at its "52-week low" was attractive. However, the recent banking crisis resulted in further volatility in D before dip buyers returned toward the end of March.

As such, D holders have survived the March's onslaught, suggesting peak pessimism could have passed.

Management's outlook for Q2 wasn't pretty. Dominion Energy guided for operating EPS of $0.63 at the midpoint, well below Wall Street analysts estimates of $0.70. As such, it was a significant miss, but the selling pressure was discernibly lacking on Friday.

Furthermore, management gave little clarity over the outcome of its business review. However, they assured investors that the " review timeline is still on track , with an Investor Day planned for Q3 2023." Furthermore, the company accentuated that it remains focused on "creating maximum long-term value" for all stakeholders.

However, the uncertainty emanating from the outcome of Dominion Energy's strategic review could keep buyers from returning aggressively, worried about the potential impact on its forward operating EPS.

Several options could be in play, leading to a " divestiture of natural gas utilities, infrastructure assets, or a minority interest in its offshore wind project."

Furthermore, investors also have to deal with ongoing regulatory uncertainty in Virginia. However, management assured investors that the new regulatory construct "simplifies [the] ratemaking process" for its base business, as "base rate reviews are now on a biannual schedule instead of triennial, improving the timeliness of expense and investment recovery."

Despite the near-term clarity, the regulatory framework could lead to longer-term uncertainty, "with regulators who will decide ratemaking in Virginia beginning in the third biennial review."

Therefore, bearish D investors could stress why it's trading at a discount against its sector peers, given these uncertainties.

Furthermore, management highlighted several headwinds that could hamper an improvement in buying sentiments. It attributed earnings pressure to "higher interest rates," worsened by the negative outlook by S&P (downgraded from stable).

While the Fed could pause its rate hikes at the next FOMC in June, it's still too early to anticipate rapid rate cuts moving forward. Moreover, while the jobs market has moderated further, unemployment rates remain low, suggesting that the economy has yet to roll over.

Hence, Dominion Energy's buying sentiments are expected to experience headwinds from elevated interest rates, worsened regulatory challenges, and an uncertain business review outcome.

However, D's valuation doesn't seem aggressive. Seeking Alpha Quant rated D with a "B+" valuation grade.

In addition, D last traded at an NTM operating EPS of 14.8x, well below its peers (18.7x) represented in the Utilities Select Sector ETF ( XLU ).

However, we assessed that the discount is justified to reflect the abovementioned headwinds.

As such, investors looking to add D should consider accounting for a significant margin of safety.

As seen above, dip buyers returned robustly in March, helping to stanch further downside.

D's NTM dividend yield of 4.8% is above its 10Y average of 4%. Dominion Energy's payout ratio is expected to be about 70% of its FY23 operating EPS.

Therefore, we assessed that the market is likely pricing in dividend risks, but not significantly yet. How the outcome of the business review could impact its capital allocation policy remains unclear for now.

Despite that, D's valuation remains attractive, but investors shouldn't expect a quick recovery toward its April 2022 highs anytime soon. However, the risk/reward is constructive, supported by price action and attractive valuation against its high level of pessimism.

Rating: Buy (Reiterated).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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