Why Should You Buy and Hold Dominion?

Dominion might well be a buy with its strong dividend growth and market position. Its recent success in garnering customer growth with new investment has been rewarded by regulators and investors.

Feb 19, 2014 at 9:08AM

Swinging to higher operating profits of $3.25 earnings per share in its most recent quarter, Dominion Resources (NYSE:D) is showing stronger operational performance with rate base repositioning and customer growth. Dominion's stock return generally tracks the S&P 500 while offering a dividend yield of 3.58% with a 7.64% five-year dividend growth rate that far exceeds industry peer rate of 1.29%.

As of Feb. 4, Dominion's trailing 12-month price-earnings ratio of 55.56 is at a premium to an industry peer market capitalization weighted average of 26.65. Sales have declined just over 2% over the past five years relative to an almost flat industry rate.

Is Dominion operationally strong enough to maintain its dividend growth for investors?

Repositioning the rate base?
On Nov. 25, 2013, the Virginia State Corporation Commission approved improvements in rate base along with a regulated ROE of 10.9%. The ROE included a 10.4% market return plus a mandated 50 basis point adder for Virginia's Renewable Portfolio Standard, or RPS.

In December 2013, Dominion leased Marcellus shale oil mineral rights underneath its West Virginia natural gas storage assets in return for access and transport of natural gas. This facility, along with shale gas and oil assets, allows Dominion to hedge natural gas volumetric and price risk for its natural gas customers and electricity generators. The result is a lower commodity price risk and cost to ratepayers.

Dominion will receive $200 million over the next nine years with a natural gas royalty interest and has contracted to deliver over 500,000 dekatherms (dt) of gas per day to pipeline interconnections in Ohio from fields in West Virginia. It closed with two natural gas producers to lease about 100,000 acres of Marcellus production reached by directional drilling into the shale formation underneath Dominion's storage assets; it will retain these assets. Dominion has been developing the 125,000-dt-per-day Allegheny storage facility in West Virginia for about $115 million. This deal will help offset development costs.

Dominion also grew its customer base with 200,000 new connects. It projects new customer demand of 455 MW by 2017 through data center growth in Northern Virginia. Regional demand has grown 40% during the last 10 years. This is all built on a 500 kV transmission investment of $3.6 billion from 2007 through 2012. Dominion continues to use customer conservation and efficiency incentives as tools to promote ratepayer satisfaction.

Enough cash? Enough earnings?
Dominion generated $3.44 billion in operational cash flow in 2013, which is 16% less than in 2012. This was barely enough to cover its net investment cash flow of $3.46 billion. To pay the $1.3 billion dividend and repay $1.25 billion in long-term debt and other liability obligations, Dominion had to raise $4.135 billion of long-term debt. Another way to look at this is that long-term debt is covering long-term investment.

At a 2.94% return on equity (ROE), Dominion would have to retain over 2.5 times its current earnings to maintain its 2014 6.7% dividend increase. Dominion can only short its earnings by reducing equity additions to retained earnings account to cover the dividend payout. This is a really anomalous accounting situation, but it does end up with Dominion issuing debt to cover its dividend shortfall.

Another way for investors to look at the company's dividend policy and cash payout is to review how operational cash flow funds a dividend first and then into new investments. That means that in 2013, over $3 billion in operational cash flow splits into $1.3 billion in dividends and about $1.7 billion for capital. Additional capital of $1.7 billion is raised through long-term debt. Viewed this way, Dominion's $3.4 capital program seems to have a roughly 50/50 split in relatively inexpensive debt and more costly cash flow equity.

A Fool's bottom line
Customer base growth in new demand segments like data center cloud computing drives some top-line growth for a regulated utility. Dominion has coupled this growth with efficiency improvements, gas storage plays, the repositioning of generation assets, and smart improvement of electrical transmission.

I like to think of the company's dividends as being paid out of operations, not long-term debt. This notion is substantiated by the nature of new capital expenditures, which for Dominion are 40-year life electric and gas transmission, gas storage, and customer connections. Operating income from these long-lived assets tend to match the yield and tenor of long-term debt.

New debt is carrying around a 3%-4% coupon and is relatively cheap in this post-quantitative easing market. It is cheaper to use this source of financing to finance infrastructure. Assuming a cost of debt capital of 4%, 34% of which lowers statutory income tax liability and equally weighted with a cost of equity capital of around 10%, we're looking at a blended after-tax 7% capital cost for all of the improvements needed to support customer demand.

Is this a buy for the long-term investor? Dominion's P/E is high relative to the industry, but dividends and dividend growth are strong. They are also backed by long-term investment in the company's customer base. While a deeper analysis is definitely called for, a provisional "yes" is my answer.

More income investing ideas from The Motley Fool
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.


Bill Foote has no position in any stocks mentioned. The Motley Fool recommends Dominion Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information