The world is shifting toward increased use of electricity, often of the clean variety. Against that backdrop, investors looking to invest in an electric stock should take a closer look at boring old utilities. One worth a deep dive today is Dominion Energy (D 0.76%), as it, too, works to refocus its business around electricity. Here's what you need to know.
Getting out of the oil patch
Dominion Energy started a transformation process more than a decade ago when it sold its oil & gas exploration and production business. The goal at that point was to get out of volatile sectors, and focus on more steady, regulated utilities and fee-based midstream energy assets. Since that point, it has been increasingly building up its utility business, most recently with the opportunistic purchase of SCANA. That utility ran into financial trouble when its contractor on a nuclear project went bankrupt, leading it to cancel the entire investment. But the acquisition allowed Dominion to expand into higher-growth regions of the country.
Dominion's most recent move is a plan to divest most of its midstream business, selling it to Berkshire Hathaway. There are a couple of reasons for this shift, including a tax law change that made midstream assets a less desirable investment for Dominion. However, the final decision likely boiled down to increased regulatory and environmental scrutiny of pipelines, which made it difficult to operate and build new assets.
There's only one problem: Dominion's midstream business was a big piece of the company's top line, at about 25% of operating earnings. Divesting this business is going to lead to a dividend cut of around 28% once the deal is consummated, likely in late 2020. This transaction basically represents the completion of Dominion's shift to a focused utility company -- but it will be far from a boring name in the space.
Growth comes next
The proceeds from the midstream asset sale, which will be around $4 billion, are largely slated to go toward stock repurchases to offset lost revenue on the earnings per share front. In addition, Berkshire Hathaway will be taking on $5.7 billion of Dominion's debt, reducing the company's leverage. The dividend cut, meanwhile, is expected to drop the company's payout ratio -- which, at around 80%, had been at the high end of the industry -- to a conservative 65%. All in all, Dominion expects to be in better financial shape following the sale.
And it will still have a number of growth opportunities ahead of it. That includes spending to upgrade its utility assets, which regulators generally like to see, and building a huge offshore wind farm in the waters off of Virginia. The exciting piece is that Dominion expects that it will be able to increase earnings by a roughly 6.5% clip after the sale is complete, which is good for a utility. In turn, it believes that the dividend will begin growing at 6%, which is also a pretty good number. Investors are likely to reward the stock as management proves its ability to meet these targets.
The risk here is that Dominion's future is a little up in the air right now as it works to complete the transaction with Berkshire Hathaway. And then there will be that dividend cut, which investors might not be happy to see. However, Dominion is definitely becoming a more focused electric company, and one with a better growth profile. In the end, it's likely to be worth stepping in a little early.
The final makeover
Dominion's stock has lagged behind that of the average utility in recent years, using Vanguard Utilities ETF as a proxy. With the changes it has in the works, it looks like the company is set to complete a decades-long transition, and at the same time reposition itself for stronger earnings and dividend growth. That should get investors excited about the stock again, and likely close the gap with the broader utility group performance-wise. And that should turn out to be a compelling opportunity for long-term investors looking to invest in the electric space.