I’ve been looking at what is happening to natural gas/LPG and seeing the beginnings of acknowledgement that gas is not much different to coal in terms of greenhouse gas emissions. Given the climate emergency and with coal under threat, the focus is coming on to gas, especially as it is facing competition from renewables and storage. In that context, I was interested to see that Dominion Energy (D) recently made two significant decisions to exit most of its gas infrastructure assets. And then, I saw Equanimity Investing’s article indicating disappointment with Dominion as an investment proposition. Here, I provide another view of Dominion from the perspective of the challenges companies have as they reposition from a fossil fuel energy base to renewables. In times of great change, legacy companies like Dominion have challenges as they adapt their businesses. One can take the view that Dominion is on the front rather than the back foot. My impression is more “front” than “back” foot.
Dominion to sell most of its gas infrastructure assets to Berkshire Hathaway
Dominion is selling most of its gas transmission and storage assets in a ~$9.7 billion transaction, involving ~$4 billion cash and assumption of ~$5.7 billion debt. A significant part of the cash (~$3 billion) will be used to repurchase shares.
This transaction means that between $1.12 and $1.21/share will disappear from 2020 guidance (slide 10 recent presentation), reducing midpoint guidance from $4.43 to $3.50. For 2021, estimated earnings after full-year impact of planned share repurchases are $3.85-$3.90 (10-11% growth), with ~6.5% annual growth anticipated going forward.
The dividend will fall from ~$3.45 in 2020 to ~$2.50 in 2021 at a 65% payout ratio (down from ~80% payout ratio) and there are plans for accelerated dividend growth of 6% annually. This will bring Dominion from being an outlier in payout ratio to be in line with best in class peers.
The sale of these assets by Dominion means that the buyer (Berkshire Hathaway (BRK.A) (BRK.B)) must be confident that it can benefit from consolidation of these assets with its own asset base. Whether Berkshire Hathaway’s decision to double down on gas at this time is a good idea is another story. I’m sceptical about Berkshire Hathaway’s decision, but George Fisher has provided a counter view for those interested.
Dominion and Duke Energy abandon the Atlantic Coast Pipeline project
The Atlantic Coast Pipeline project was announced in 2014 at a time when gas was seen to be the next big play in the energy transition. Some still see gas as a bridge fuel and so abandonment of the pipeline is likely to be an issue for these parties. Dominion seems less wedded to gas than Duke Energy (DUK), although both parties focus strongly on carbon-free energy and emissions reductions.
Hence Dominion and Duke Energy position the exit from this project in terms of the need for energy provision to be decarbonised, with specific mention of renewables, energy storage, nuclear license renewals, electric vehicles infrastructure, energy delivery infrastructure, energy efficiency measure, and demand management programs. The parties decided that continuing delays (at least 3.5 years behind schedule) and cost blowout from an original estimate of $4.5-5.0 billion to $8 billion finally made the project unviable. In addition to the delays and cost blowouts, there were also a series of ongoing legal challenges despite a recent Supreme Court victory.
Dominion points specifically to the need to be net zero emissions (both CO2 and methane) by 2050.
Note that the sale of the gas infrastructure assets to Berkshire Hathaway means ~$5.7 billion debt reduction, which no doubt helps as the abandonment of the Atlantic Coast Pipeline means up to $3.2 billion in pre-tax charges.
The big news: Dominion making the switch to renewables
Most of the commentary on Dominion’s gas exits focuses on the near-term change in earnings, dividend reduction, and share buybacks. The big news seemed to mostly fly under the radar. My take home from the recent Dominion presentation was on slide 9, which indicated the anticipated change in the structure of the business between now and 2035. Most notable is that capital investment between 2020 and 2035 is dominated by zero-carbon generation and storage (solar, wind, batteries and nuclear re-licensing), accounting for up to $47 billion, with just $6 billion dedicated to gas line replacement and up to $2 billion spend on Renewable Natural Gas. The company also plans to retire more than 4 GW of coal- and oil-fired electricity generation between 2018 and 2025.
Dominion Energy is a company that is serious about the Paris Agreement and the need to decarbonise. The transactions described above mean that Dominion is narrowing its business to provide investors with a pure-play focus on low carbon state-regulated utility operations.
Unless one is a trader when investing in big conservative power suppliers, one needs to look to how the company is positioning itself for the future. The planned substantial divestment by Dominion Energy of its gas transmission and storage assets reflects more than just getting out of a (large) segment of its business. It also heralds a major investment into zero carbon generation and storage. And Dominion suggests that this will drive its long-term profitability. This is a company with a clear vision about how it is going to make the transition to a zero carbon future. I suggest that taking a narrow view of the company’s exit from gas assets misses the point for investors interested in the long term. However, Ramani has a good point when he suggests that perhaps it is time to sell and buy back later when the dust has settled. There is also the additional issue as to what will happen in the short term as the COVID-19 crisis finally gets to be faced. So, if one decides that Dominion is of interest, the timing of investment might be addressed. However, in summary, Dominion has not lost the plot and it is positioning itself for the future early rather than being caught with stranded assets and the wrong business model. Dominion is worth considering when an investor considers what to do about his/her investment in oil and gas companies (e.g. Exxon Mobil (XOM) who are yet to seriously engage with the need to decarbonise).
I am not a financial advisor, but I do pay close attention to the big changes underway as energy and transport exit fossil fuels and get electrified. If my commentary helps give you and your financial advisor perspective about investment in Dominion, please consider following me.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.