Renewable Energy Is the New Growth Driver for Dominion Energy

The Atlantic Coast Pipeline is no more. When the United States District Court for the District of Montana overturned a federal permit authority, Dominion Energy (D 1.58%) and Duke Energy decided to scrap their $8 billion natural gas pipeline stretching from West Virginia to North Carolina. 

An argument can be made that the decision will delay American climate progress given the energy insecurity of the mid-Atlantic and Southeast regions. In fact, those regions are home to 46% of the nation's coal-fired power plant capacity and 40% of the national coal fleet's electricity output. Removing the ability of West Virginia, Virginia, and North Carolina to more fully utilize natural gas could slow the region's transition to a low-carbon future, as there's now one fewer tool in the toolbox.

The future of Dominion Energy looks quite a bit different, too. The company announced the cancellation of the Atlantic Coast Pipeline, the sale of its gas transmission and storage operations for $9.7 billion, and a significant reduction in the annual dividend per share. While Wall Street hammered the stock shortly after the news barrage, the long-term future of the business remains healthy. It's a lot greener as well, as renewable energy is now the primary driver of earnings and dividend growth. 

Image source: Getty Images.

Natural gas is out, regulated assets are in 

Dominion Energy agreed to sell its natural gas transmission and storage assets to Berkshire Hathaway for $9.7 billion. The transaction comprises $5.7 billion in debt and $4 billion in cash. The energy giant intends to use $3 billion of the cash proceeds to repurchase shares, with the remainder being applied to transaction costs and a pension fund contribution.

On the one hand, the expected use of proceeds might be a bit disappointing to investors hoping the asset sale would accelerate the transition to a greener Dominion Energy. On the other hand, it's a reminder that renewable energy can only be added so quickly to regional grids.

Nothing has changed for Dominion Energy's ambitious renewable energy portfolio in the immediate aftermath of the asset sale. Not directly, anyway. The company still expects to add 5,200 megawatts of offshore wind and 2,700 megawatts of energy storage by 2035, and own up to 16,100 megawatts of onshore wind and utility-scale solar by 2036 -- all the same as before. The business estimates those efforts will require up to $47 billion in capital investment.

What has changed is the proportional value of regulated utility operations, and therefore renewable power assets, to the business. Before the sale, regulated assets were expected to contribute about 70% of full-year 2020 earnings. After the sale, regulated assets are expected to contribute 85% to 90% of full-year 2020 earnings, including the effects of share repurchases.

Data source: Dominion Energy presentation.

The increased importance of Dominion Energy Virginia is no minor detail. Most of the renewable energy projects in the pipeline will belong to the subsidiary, which provides multiple advantages. It protects future earnings growth inside regulated businesses and aligns the company's power asset investments with the goals of the state of Virginia. But there's one short-term trade off: a reduced dividend beginning in the fourth quarter of 2020.

Freeing up capital for renewable energy investments

A major selling point of the natural gas transmission and storage sale is that the transaction significantly lowers the company's risk profile while freeing up capital to invest in renewable energy assets.

The increasing dependence on regulated assets simplifies overall operations for Dominion Energy and makes long-term earnings and dividend growth more sustainable. The business expects full-year 2021 earnings to grow at least 10% from this year, after which annual earnings will grow at a 6.5% clip. Similarly, the dividend is expected to grow 6% per year from a 2021 base of $2.50 per share. 

Investors might have been disappointed by the reduced dividend. Dominion Energy sported a payout ratio of over 80% and an annual dividend per share of $3.76 prior to the sale, but expects to "rebase" that to roughly 65% and $2.50, respectively, in 2021. In other words, the annual dividend yield of the current share price is only 3.4% when factoring in the rebasing, compared to about 4.4% prior to the sale. 

Dominion Energy's payout ratio of 85% in 2020 was well above the industry average of 64%, so the rebasing makes fiscal sense. It provides a greater cushion against economic uncertainty and frees considerable cash flow to invest in the business, namely toward the $47 billion price tag of the company's renewable energy ambitions through 2035. 

Simply put, Dominion Energy is transitioning to a more economically sustainable business that's more dependent on renewable energy assets for growth. The initial reaction to the sale of natural gas transmission and storage assets and rebased dividend evoked a predictable gasp from Wall Street, but investors with a long-term mindset might be pleased with the reduced risk profile -- spanning financial, political, and social risks -- of the energy giant.