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The 1 Thing to Watch at Dominion Energy in 2020

By Reuben Gregg Brewer – Feb 1, 2020 at 11:19AM

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Dominion is up 23% over the past year, a good run for a utility. But there's a cloud on that silver lining that could derail this giant.

Dominion Energy (D -0.88%), one of the largest utilities in the United States, has been much loved by Wall Street over the past year or so. That's not unusual, with the broader utility sector, as measured by Vanguard Utility ETF, actually inching ahead of the S&P 500 Index's gain over the past 12 months. Investors have been seeking out safe havens, and utility stocks like Dominion fit that bill. However, anyone looking at buying today needs to go in with their eyes open here. 

A good company, overall

For starters, Dominion is generally considered a well-run utility. And it has done a fairly good job of late getting big projects done on time and on budget, boosting its long-term prospects. The most notable success on this front came with its Cove Point natural gas export terminal. It was a multi-billion-dollar, multi-year project backed by long-term contracts, and it should provide years of stable cash flow to Dominion and its shareholders. 

A man standing with power lines in background

Image source: Getty Images.

That said, big projects cost lots of money. The original plan was to use a controlled master limited partnership called Dominion Energy Partners to raise cash. Cove Point, specifically, was going to be sold to Dominion Energy Partners upon its completion so Dominion Energy could put the cash it raised to work elsewhere in the company. A government rule change surrounding limited partnership taxation made that unfeasible, and Dominion ended up buying its controlled partnership and rethinking its funding plans.

The company has rejiggered over the past year or so, leaning more on its balance sheet than it had originally hoped. For example, its financial debt-to-EBITDA ratio of roughly 6.6 times is toward the high end of its peer group. Its payout ratio, which reached nearly 90% at one point, is too high for comfort (around 70% is the norm for its closest peers). So Dominion is slowing down its dividend growth rate until that payout ratio comes down and has been working to ensure that leverage doesn't get out of hand (by selling a portion of Cove Point, for example). Based on the stock advance, investors appear to be increasingly comfortable with the steps Dominion is taking on the finance front.   

More issues to come

That said, this giant utility also has a big project that's not going so well right now. The Atlantic Coast Pipeline, like Cove Point, is a multi-year, multi-billion-dollar construction effort. It is a 600-mile underground natural gas pipeline that starts in West Virginia and ends in North Carolina, with offshoots along the way that connect to Dominion power plants. It will also provide natural gas to other utilities, with Duke Energy and The Southern Company being two notable partners on the project.   

The Atlantic Coast Pipeline has faced notable environmental pushback. At this point, the project's completion has been delayed and the cost estimate has increased by as much as $1 billion, or roughly 17%. That's actually the good news, based on the expectation that things work out as planned from here on out.  

D Chart

D data by YCharts

The bad news is that a mid-year 2020 decision to be handed down by the U.S. Supreme Court will end up being a key tipping point on the project. The Court is deciding whether or not the U.S. Forest Service has the authority to approve the pipeline crossing underneath the Appalachian Trail. The total distance in dispute is roughly 0.1 miles on a 600-mile project, but it is an increasingly important section of the pipeline. Dominion is confident it will win, but a loss would be a big blow to the project and investor sentiment.   

Since much of the pipeline has already been built, it is unlikely that Dominion would simply drop the project if it lost. However, losing would likely require rethinking much about the company's current plans. More importantly, it could add even more time and cost to the already delayed and over-budget project. Investors would likely, and rightly, see a loss at the Supreme Court as a major negative. It wouldn't change the core of Dominion's business, of course, but it would cloud the utility's growth outlook, perhaps negatively affect its ability to keep debt in check, and hamper its plans to bring its dividend payout ratio back in line with peers.

Pins and needles

Dominion isn't sitting still. It's already got another big project lined up (a giant offshore wind farm). However, in 2020, the big news is going to come from the U.S. Supreme Court. And there's no way to tell which way things will go until that decision is actually handed down. If Dominion wins, the Atlantic Coast Pipeline probably comes in close to its current expectations and investors breathe a sigh of relief. If Dominion loses, well, management hasn't really discussed what happens at that point in too much detail -- but it won't be nearly as good an outcome. If you own Dominion or are thinking about buying it, you'll want to keep an eye on the Supreme Court in 2020.

Reuben Gregg Brewer owns shares of Dominion Energy, Inc and Southern Company. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy.

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