As a long-term dividend investor, I prefer boring stocks with attractive dividend growth prospects. The last thing I want is excitement. But that's exactly what I just got when Dominion Energy (D -0.82%) announced a "business review" along with its third-quarter 2022 earnings.
Investors didn't appreciate that news or the uncertainty they were left with, and sent shares sharply lower. I completely understand that reaction, but what is the real risk? Let's look closer.
A long and winding path
Dominion Energy has changed a great deal over the years. At one point, it was a highly diversified business that even included oil drilling assets. But management set about simplifying things and sold off those assets, while shifting toward regulated utility businesses. It arguably completed this transition in 2020 when it sold most of its midstream division to Berkshire Hathaway.
Image source: Getty Images.
The downside of this deal was that the company's pipeline operations were sizable, so it ended up cutting the dividend by roughly 33% (about the contribution of the business it sold). The positives from the move included shifting to an almost completely regulated utility model and a promise of 6.5% annual earnings growth through at least 2025, accompanied by roughly 6% dividend growth. Basically, given enough time, the dividend would grow back to where it was before the cut.
I was willing to accept that trade-off because the simplified business would be more consistent and reliable. And management has so far lived up to the promises it made. The stock, however, hasn't really been a huge winner. In fact, after headwinds with a major offshore wind project took center stage earlier in the year, shares are down more than 25% in 2022 alone. They also trade well below where they started out in 2020, before the asset sale and dividend cut.
What's gone wrong?
Management has watched the stock performance and appears to think that something has to change, which is why it announced a strategic review when it reported third-quarter earnings. Here's the interesting thing: The company highlighted that it still sees a path to its long-term growth targets in 2023, and is tracking as expected for 2022. It has even put forward a workaround for the offshore wind issue that it believes will address regulator concerns and allow the project to move forward.
In other words, based on the company's results, there doesn't appear to be a business reason for the business review. It appears to be driven by the fact that the stock price has been weaker than management would like. It's a little disconcerting that a company would judge its long-term business plans by the short-term whims of investors. Sometimes you just have to stick it out until Wall Street realizes that things are actually going as projected.
Although analysts worked hard to get more information about the review and the potential for change, management explained that it was too early to give any indication of where things were going. That said, the key goals of the review were provided, including remaining a regulated utility, capitalizing on the clean energy transition, and maintaining Dominion's "current" credit profile and dividend. So at first blush dividend investors don't need to worry about a dividend cut.
However, I put "current" in quotes because that suggests there is a possibility that the dividend growth plans previously provided will be given up. This is a problem for investors like me who stuck around after the dividend cut because of the potential for strong dividend growth (for a utility). With the renewed uncertainty, Dominion Energy is no longer a boring dividend stock. It is now a name that investors have to watch closely, at least until the business review is complete. Given the dividend pledge, there's no reason to rush for the exits. But without dividend growth, Dominion may not be attractive enough to own despite having a roughly 4% dividend yield.
Where to from here?
Analyst questions suggested that there was an opportunity for earnings growth to accelerate, and management didn't argue against that viewpoint -- but it also didn't support it either. So there's no clear indication of what could happen from here. My fear is that dividend growth gets pushed to the wayside as the company looks to spend more on clean energy investments. That could potentially attract ESG investors and lead to a higher share price. But I'm a dividend investor, and dividend growth was an expressly stated part of a story that business developments suggest doesn't actually need to change.
I'm not exactly worried, but I'm not thrilled with the uncertainty either. Dominion just went on my "problem list," earning it extra scrutiny. It should probably get extra attention from you too if you are a shareholder. My big fear is that management is trying to prepare dividend investors like me for a change that they won't appreciate, even if the dividend is sustained at current levels.
