Dominion Energy (D 0.53%) is one of the largest utilities in the United States. It also has one of the highest dividend yields in the sector at around 4.4%. That isn't a market oddity -- investors have looked at the utility's balance sheet and correctly surmised that Dominion has a leverage problem. That said, the U.S. utility giant is working hard to fix that. Here's the lowdown on what's going on, including a recent deal that will result in a $2 billion cash inflow.
It's got problems
There's no way to sugarcoat Dominion's current financial state. Its financial debt to equity ratio isn't out of line with those of its closest peers at around 0.65 times. However, its financial debt to EBITDA ratio of more than 6.5 times is well above those of similarly sized utilities. Meanwhile, as you might expect, its ability to pay its interest expenses is among the weakest of its peers, with the company sporting a times interest earned ratio of less than two. And, to add to the list of problems, its payout ratio in 2019 is expected to be close to 90%, compared to an average of around 70% for peers.
Although operationally speaking Dominion is a fairly boring company, its financial state is anything but. However, the company is well aware of the issue. It recently announced that dividend growth would slow into the low single digits until the payout ratio is more in line with those of its peers. After a series of 10% annual hikes that's a bit of a let down for dividend investors, but it will preserve the company's 16-year streak of annual increases, while also bringing its payout ratio down to more comforting levels. And, of course, it will free up cash for other uses, like strengthening the balance sheet.
Making things better after making things worse
Mending its balance sheet is a good move, but it was something that Dominion pretty much forced on itself. It has been aggressively building assets over the past couple of years, notably including the recently completed Cove Point liquefied natural gas facility (more on this in a second). That spending was already stretching the company's finances. Then the bankruptcy of contractor Westinghouse forced utility peer SCANA to scrap a nuclear power plant it was building. That pushed SCANA into financial disarray. Dominion saw an opportunity and stepped in to help, eventually buying the smaller, troubled, utility.
Strategically speaking, Dominion made a good move. SCANA's business added exposure to higher-growth regions of the country. But it did little to help Dominion's strained financial condition. Now add to that the company's decision to buy back a master limited partnership it controlled, largely because of tax regulation changes that reduced its value as a funding vehicle. And also keep in mind that Dominion still has more construction plans on the books, notably the contentious Atlantic Coast Pipeline.
That's why Dominion has been getting more creative to raise cash, including selling assets outright. In late 2018 it agreed to sell some non-core power plants for around $1.25 billion. At roughly the same time it also found a buyer for its 50% stake in the Blue Racer pipeline, raising another $1.5 billion. And it took on debt at the Cove Point facility, pushing cash up to Dominion to use (it was originally planning to sell Cove Point to the controlled partnership it had to buy back).
The most recent move was the sale of a 25% stake in Cove Point to Canadian infrastructure giant Brookfield Asset Management (BN 0.20%). This allowed the company to raise another $2 billion from this asset that it can use to further strengthen its balance sheet. And, as you would expect, all of these moves have had an impact, with long-term debt levels falling of late. However, after long-term debt more than doubled over the past decade, there's still a lot of work to be done.
In fact, the recent step lower looks like a tiny blip compared to the long-term trend. Worse, as the utility sells assets it also loses the associated cash flows. So these sales may help whittle down the debt pile, but they may not be as helpful in correcting the leverage issue, at least not in the near term. Still, when you step back, Dominion is making the right decisions today to help improve its financial condition.
And as a utility, Dominion has a highly regulated business with locked in customers and a fairly reliable recurring income stream. So it can likely handle its debt-heavy balance sheet for now. (Bankruptcy isn't exactly something investors need to be too worried about here.) However, Dominion appears to have a long way to go before its balance sheet and dividend are back on solid ground.
Is the high yield worth it?
While Dominion offers investors one of the higher yields in the utility space, it really isn't a great choice for particularly conservative income investors right now. Put simply, the yield is high for a good reason. For more aggressive sorts willing to keep a close eye on their portfolios, however, Dominion might be worth a deep dive. Yes, it has a leverage issue. But it sees the problem, and is working to address it. If you can stomach some uncertainty while it does that, the risks here seem worth the reward if you are looking to buy a utility stock today.