Published December 25th, 2016 by Bob Ciura
Utility stocks are popular among income investors because of their high dividend yields. What they are less known for is high dividend growth.
Dominion Resources (D) is a rare mix of both. Not only does it have a 4% dividend yield, which is double the average dividend yield in the S&P 500 Index, but it recently raised its dividend by 8%.
This is unusual, because typically utilities raise their dividends only at a low-single digit rate each year.
The reason why Dominion can grow its dividend at a high-single digit rate is because it is experiencing above-average growth for a utility. The company has modernized its assets and is reaping growth from investments in new energy sources.
Dominion is a Dividend Achiever. It has raised its shareholder payout for the past 14 consecutive years.
You can see the entire list of all 273 Dividend Achievers here.
This article will explain why Dominion could be a truly rare find—a high dividend growth utility stock.
Dominion is not a run-of-the-mill utility. It has a large electric utility business, but it also has a midstream energy transportation business.
Dominion Midstream (DM) had its IPO in 2014. Dominion owns the general partner and 64% of the limited partner interests in Dominion Midstream.
Its operations are split up into three reporting segments:
- Dominion Virginia Power (19% of operating earnings)
- Dominion Energy (25% of operating earnings)
- Dominion Generation (56% of operating earnings)
The company possesses an extensive network across the U.S., which consists of 26,000 megawatts of generation, 14,400 miles of natural gas pipelines, and 6,500 miles of electric transmission lines.
It also has a huge natural gas storage system with capacity for 1 trillion cubic feet of natural gas.
In all, the company services more than 6 million utility and retail energy customers.
Business conditions remain sound. Operating earnings rose 6.5% over the first nine months of 2016. Last quarter was particularly strong for the company.
Source: 3Q Earnings presentation, page 3
The primary drivers of this growth were higher electric sales due to warmer weather, lower expenses, and an increase in revenue from regulated growth projects.
Going forward, Dominion has several major projects in the works that should fuel continued growth.
Dominion has some exciting growth catalysts for the future, both in the U.S. and abroad. It is investing significant resources across its various businesses over the next few years.
Source: 2016 EEI Financial Conference, page 6
One of Dominion’s most significant growth catalysts is expanding its midstream assets, specifically the Cove Point Liquefaction project. This is expected to cost $3.4-$3.8 billion and is one of the largest projects the company has ever undertaken.
It will allow Dominion to liquefy natural gas—meaning cool it down to extremely low temperatures—so that it can be stored on tankers and exported to new customers.
Dominion has already secured long-term contracts with customers in India and Japan, and the project is expected to start up by the end of 2017.
Another growth catalyst is renewable energy.
The company has two wind projects currently in development, in Virginia and in India. The Virginia wind project has capacity for 264 megawatts of electricity, and the India wind project can produce 301 megawatts.
Dominion is also active in solar energy. In 2015, the company purchased an 80-megawatt solar facility in Virginia. It also intends to construct its own 400-megawatt solar plant in Virginia, set to be completed by 2020.
Overall, the company intends to invest $18-$20 billion in growth capital expenditures through 2020.
Source: 2016 EEI Financial Conference, page 5
This investment should help modernize Dominion’s assets and help the company grow moving forward.
Competitive Advantages & Recession Performance
Utilities are typically very stable and generate consistent profits from year to year. One reason for this is that there are significant barriers to entry in the utility industry.
The utility industry is heavily regulated. For example, approximately 90% of Dominion’s annual revenue comes from regulated operations.
While regulated operations can sometimes grow at a slower rate than competitive, market-based utilities, the trade-off is stability.
Regulated utilities typically receive favorable regulatory approvals that allow them to raise rates steadily each year.
These competitive advantages allow Dominion to remain profitable, even during recessions. The company’s financial performance during the Great Recession are shown below:
- 2007 earnings-per-share of $2.13
- 2008 earnings-per-share of $3.04
- 2009 earnings-per-share of $2.64
- 2010 earnings-per-share of $2.89
Dominion’s earnings-per-share fluctuated quite a bit, but nevertheless were higher in 2009 than in 2007. Earnings growth continued in the years since the recession ended.
Valuation & Expected Total Returns
Dominion stock trades for a price-to-earnings ratio of 24. It is slightly cheaper than the S&P 500 Index, which has a price-to-earnings ratio of 26.
However, since 2000 the stock has had an average price-to-earnings ratio of 17.5. From this perspective, it seems the stock is slightly overvalued.
Indeed, Dominion stock has run-up in share price for an extended period of time. The stock has risen 45% in the past five years.
Investors have bid up share prices of quality utility stocks like Dominion. With interest rates still near historic lows, income is hard to find.
As a result, investors may want to wait for a better buying opportunity, particularly if interest rates are set to rise.
That being said, the stock can still generate satisfactory returns moving forward, just from earnings growth and dividends.
A possible breakdown of future returns could be as follows:
- 5%-7% earnings-per-share growth
- 4% dividend yield
As a result, total returns could reach 9%-11% per year.
Dominion is a unique stock in the utility sector. It has a large presence in traditional electricity operations. But it also has a significant midstream business which has helped accelerate the company’s growth.
This has led to very attractive dividend growth rates in recent years.
And, thanks to its growth projects, investors can expect Dominion’s high dividend growth rate to continue. Management has pledged to raise the dividend by 8% per year through the end of the decade.
Assuming Dominion’s strategic initiatives remain on track, it could continue its high dividend growth even beyond 2020.