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Dominion (NYSE:D) is a large U.S.-based utility with 28.1 GW of power generation capacity and 11,000 miles of natural gas transportation pipelines. Dominion also has valuable transmission and distribution assets, such as 6,300 miles of electric transmission lines, 56,800 miles of electric distribution lines and 21,800 miles of gas distribution pipelines. The company has one of the largest natural gas storage systems in the U.S., with almost 950 billion cubic feet of capacity. The company serves 2.4 million electric customers in Virginia and North Carolina, and 1.3 million natural gas customers in Ohio and West Virginia.

Dominion sold its NG exploration and production business for $17.5 billion to focus on its core utility business. The company is also selling off a number of merchant power plants because of non-remunerative prices in the wholesale market. The company has shut down a nuclear power plant and has put 3 thermal power plants on the block. Additionally, Dominion is planning a capital investment of ~$11.5 billion over the next 5 years, with a 60:40 mix between electricity and natural gas assets.

The company has a nice dividend yield of ~4% along with low volatility, which you would expect from a utility stock. Dominion also has a long history of growing dividends, which is again typical for large U.S. utilities. Dominion depends on a mix of renewable and non-renewable energy sources for generating power. While it has reduced its reliance on coal, almost 46% of its total power is still generated using coal.

Why We Like Dominion Resources

  1. Natural Gas Assets - Dominion Energy operates 20 underground gas storage fields located in New York, Ohio, Pennsylvania and West Virginia, with almost 2,000 storage wells and approximately 349,000 acres of operated leaseholds. The total designed capacity of the underground storage fields operated by Dominion Energy is 947 billion cubic feet. Dominion Energy also has about 15 billion cubic feet of above-ground storage capacity at Cove Point. Dominion has significant NG transportation and storage assets in the Marcellus and Utica shale areas.
  2. LNG Exports - The company is in the process of converting Cove Point LNG facility to a bi-directional plant that can both import and export natural gas (provided that it gets the government go-ahead). This LNG facility has a storage capacity of 14.6 bcf, and was recently expanded.
  3. Growing Dividends - Dominion has consistently raised dividends in the last 10 years, with a five year dividend growth rate of 3.74%. The company's dividends have grown from $1.29 in 2002 to $1.97 in 2011.
  4. Slow and Steady Earnings Growth Rate - Dominion is planning to increase its annual earnings by 5-6%. It gets a good mix of profits from regulated and unregulated power markets. Most of its revenues come from Virginia, while the rest come from its transmission and NG assets. Unlike some of the other large U.S. utilities, Dominion expects good electricity growth from its core territory of Virginia.
  5. Biomass and 3-on-1 hybrid plants - Dominion is preparing itself for a more renewable energy future by converting its AltaVista, Southhampton and Hopewell Power Stations from coal to biomass, with commercial operations to start in 2013. The company completed a $1.8bn 3-on-1 hybrid plant in July 2012, and is planning to build two similar 1300 MW plants.
  6. Offshore Wind Energy - Dominion has partnered with Alstom and KBR to build an offshore wind energy demonstration farm off the coast of Virginia. The company is building a 12 MW wind farm using 6 MW offshore wind turbines from Alstom and $4 million in funds from the U.S. Department of Energy. The company has a good chance of winning $47 million in additional funding from DOE. With an estimated capacity of 5000 GW, offshore wind energy has massive potential. This is enough to power the whole country. However, offshore wind energy is still in its infancy, though Europe has made rapid strides in offshore wind development.

Risks

  1. Merchant Power Plant Sales - Dominion failed to sell its Kewaunee nuclear power plant in the Midwest, and has decided to shut it down in Q1 2013. The company now plans to sell 3 coal powered plants in the Midwest. Dominion is claiming good interest from buyers, however if electricity prices remain low and there is additional anti-coal legislation, then the company will have to shut down these thermal power plants as well.
  2. High Dependence on Coal and Nuclear Energy - The company depends on nuclear and coal energy for almost 87% of its power generation capacity. This is a bit risky, as nuclear energy has significant tail risks in case of a radioactive accident, and coal is one of the dirtiest forms of energy. However, Dominion plans to invest $3.5 billion over the next 3 years to reduce air pollution from its plant by 80%.
  3. Lack of Significant Renewable Energy Assets - Dominion lacks significant renewable energy assets like wind farms and solar energy plants. The company may suffer if major global warming/climate change legislation is passed in the future. However, with most of the major countries putting climate change on to the backburner, the probability of this risk is quite low.
  4. Slowing U.S. Electricity Growth - U.S. electricity demand has started to slow as the general economy slows down. Sales of electricity have hit a roadblock due to a combination of energy efficiency and slower growth.

Stock Performance

Dominion has traded in a range of ~$28 to $55 in the last 5 years, hitting a high of ~$55 in July 2012. The stock has outperformed the Dow Jones, by 10 percentage points in the last 5 years. The company has also outperformed its large cap U.S. based utility peers, such as Southern Company (NYSE:SO) and Duke Energy (NYSE:DUK). The company has returned ~4% in the last year, which is again higher than other U.S. utility stocks.

Valuation

Dominion trades at a relatively inexpensive valuation, with a forward P/E ratio of 13.9, which is at a 10% discount to the S&P 500. Dominion provides a dividend yield of 4%, which is more or less the same as the industry average of 4.2%. The company's margin and earnings have fluctuated, as the company has been restructuring its overall business. However, the normalized gross margins and net margins have been showing an increasing trend over the last 5 years.

Summary

Dominion is a safe dividend paying utility that offers additional upside options through its NG assets. If the U.S. government allows LNG exports, Dominion will be one of the main beneficiaries due to its LNG export terminal. The company's management has performed admirably, getting out of unprofitable areas like low return thermal and nuclear power plants, and divesting the risky natural gas exploration and production business for a tidy sum. Additionally, Dominion is focusing on earnings growth and margin improvement in its core utility business. The company faces some risks due to the slowing U.S. economy and lack of renewable energy assets. Overall, however, we like Dominion Resource over the other large U.S. utilities because of its NG assets, presence in higher growth markets and its management.

Source: Dominion - Well Managed Utility With Natural Gas Upside Option