Investing requires balancing risk with reward, which is just as true for individual investors as it is for the companies they own. Giant U.S. utility Dominion Energy (NYSE:D) is a prime example of this today, as it works to complete a large natural gas project that has faced material environmental pushback. In fact, despite a case being heard by the U.S. Supreme Court about the Atlantic Coast Pipeline, Dominion just increased its ownership stake in the project. Here's what you need to know about this deal and the project.
A little money, a notable decision
The Atlantic Coast Pipeline is intended to bring natural gas from West Virginia to Virginia and South Carolina. It is an underground pipeline that Dominion says is needed because current natural gas capacity won't be enough to satisfy growing demand in the regions it will serve. There are three main utility customers for the project: Dominion, Duke Energy, and The Southern Company (NYSE:SO). The multi-billion dollar investment was originally owned by all three, with Dominion controlling 48% of the project, Duke 47%, and Southern 5%.
When Dominion released its fourth-quarter 2019 earnings, however, it noted that it had bought Southern's 5% stake. That brings its control of the project to more than 50%, effectively giving it complete control over the investment. The cost of this acquisition was roughly $175 million and included some other natural gas assets. To be fair, that's a relatively tiny cost compared to the entire project, which has already spent $3.4 billion on construction efforts and it isn't close to done yet (the total cost is expected to be about $8 billion at this time, but it could go higher). However, when you consider the increased control it gives Dominion, it is a notable move. And it comes at an interesting time.
Environmental pushback against the Atlantic Coast Pipeline has been intense. In fact, the increasing difficulty of getting projects like this done was one of the key reasons why Southern chose to sell its stake. During Southern's fourth-quarter 2019 earnings conference call, it noted that the pipeline was simply too small a position for the utility to bother with because the financial payoff didn't justify the uncertainty and complexity the project added to the utility's business. That complexity today includes a date with the U.S. Supreme Court to decide a somewhat arcane issue.
Who controls this forest?
The big question in front of the court is who can grant approval for the pipeline to cross the Appalachian Trail. At this point, the U.S. Forest Service has given its stamp of approval, but the trail is actually a multi-state entity effectively run by the Appalachian Trail Conservancy. That group, however, isn't the one bringing the case, it is outside environmental groups that are championing the fight. In fact, the Conservancy has decided to not oppose the pipeline.
The outcome of the case is notable for the Appalachian Trail. Control of the trail is something of a loose affiliation involving tacit approvals that's been left alone because so far it has worked relatively well. It is hardly a formal setup and it could be set asunder if Dominion loses. For Dominion, the Supreme Court case is notable because despite being just a small piece of the pipeline, it's an important connection point.
If Dominion isn't victorious, and the U.S. Forest Service isn't the rightful approving entity, the utility may have to seek approval from Congress to grant the crossing. That's something that it is already working on, but it makes completing the pipeline much more difficult and, frankly, uncertain. A Supreme Court loss wouldn't be the end of the road, but it would be a big roadblock. So why increase the ownership position right now?
The answer is likely two-fold. Although neither Southern nor Dominion stated this as a fact, during Dominion's fourth-quarter 2019 earnings call it made clear that Southern remained a key customer. It is possible that buying Southern's 5% share of the project was at least partly meant to assuage a key customer. Secondly, and likely more importantly, Dominion's current projection is that the Atlantic Coast Pipeline could add up to $0.25 per share to earnings starting in 2022, assuming it gets completed on time. Given that full-year operating earnings in 2020 are projected to be between $4.25 and $4.60 a share, that would represent a roughly 5% earnings boost. Although that may not sound like a huge deal, for a utility that's a big number -- especially since it is tied to just one investment.
In other words, Dominion is making a calculated bet that it can complete the project, and that the added cost of buying Southern out will be well worth the expense if it keeps things moving full steam ahead. But a lot is riding on the Supreme Court case outcome, since a loss would probably push the project's cost higher and the completion date even further out.
Probably worth it
When all is said and done, Dominion appears to be making the right move here. The cost of increasing its stake by 5% relative to the total project is modest, and it will help to keep the Atlantic Coast Pipeline moving forward. Meanwhile, the possible earnings upside for the utility is pretty compelling. And even if the Supreme Court doesn't decide in Dominion's favor, there are still alternatives. Right now this project is the issue to watch at Dominion, but its increased stake in the pipeline isn't something to get too upset over. It's a trade-off and, at this point, the potential reward seems worth it.