Snag Dominion Resources for Dividends AND Growth

by Aaron Levitt | September 25, 2013 9:00 am

Home to “widows and orphans,” the utility sector is by its very nature boring, with a capital “B.” Most investors flock to the sector in search of one thing — large, steady dividends. After all, providing essential services like electric power or natural gas isn’t sexy, but people need to heat their homes and keep the water running even in times of economic strife.

However, you can have your cake and eat it too.

In this case we’re talking about Dominion Resources (D[1]) and its recent plans to become an LNG exporter to the world. Now, this boring electric utility is about to be a little less boring and offer something more than dividends.

Critical Approval

While Dominion Resources controls nearly 27,000 megawatts worth of uninteresting generation and 64,000 miles worth of power and transmission lines, the electric utility could be a great income and growth pick.

The reason? A huge facility it purchased back in the early 2000s is getting a facelift.

Before fracking took hold across the U.S., Dominion — like many utilities — faced very high natural gas prices. Remember, at one time, natural gas was priced as high $15 per million BTUs. That was a huge issue given that Dominion needed that gas to run its plants, and regulators aren’t necessarily willing to grant consumer price increases willy-nilly. So like many utilities, Dominion looked for a way to find cheaper sources of supply.

In this case, it sought to import natural gas from faraway places like Qatar or Australia, which was much cheaper on cost. In 2002, Dominion acquired the Cove Point LNG facility from Williams (WMB[2]) and began importing liquefied natural gas the next year.

Well, we all know what happened next. The E&P industry began using advanced drilling techniques and unearthed a virtual ocean of natural gas, which caused prices to plunge. As a result, the Cove Point facility was basically useless as it was now cheaper to pipe in gas from places like the Marcellus shale rather than from overseas sources.

Yet there’s still hope — and money to be made — from Cove Point. That’s because Dominion Resources is undergoing a huge transformation from imports to exports.

Given the significant infrastructure already in place at the facility, Dominion will only need to add liquefaction capability — which the firm estimates will cost between $3.4 billion and $3.8 billion. Construction is slated to begin next year[3] and will be completed date of 2017. Already, Cove Point’s potential export capacity is fully subscribed as firms such as Japan’s Sumitomo have signed 20-year terminal service agreements.

However, the real kicker for Dominion has been its approval to begin exporting that LNG to nations without a free-trade agreement with the U.S. — up to 0.77 billion cubic feet of natural gas a day. That opens Cove Point’s capacity to a whole host of power-hungry countries that need LNG to facilitate growth. In turn, that will help produce large revenues for Dominion over the longer-term.

And the facility’s prospects keep getting better.

Dominion Resources seems to be following fellow LNG exporter Cheniere Energy’s (LNG[4]) lead and tucking the facility inside a master limited partnership. By using the corporate structure, Dominion will be able to gain valuable dividends while avoiding taxation on the assets in the MLP. The company estimates that it will generate $1 billion in EBITDA[5] initially from the new MLP. That number will double as the firm “drops down” more of its natural gas pipeline and infrastructure assets that feed the facility, along with its gathering systems in the Marcellus.

Making a Power Play

Given the growth potential from LNG exports as well as hefty MLP distributions, Dominion looks like an attractive pick right now. While it will be some time before Cove Point really begins churning out cash flows, the beauty of being a boring utility is that its generation assets should help cushion the wait time. Plus, D stock currently is yielding a market-beating 3.6%.

The real issue for Dominion could be current valuation.

The nation’s third-largest utility isn’t cheap, trading at 17 times forward earnings and sporting a price/earnings-to-growth ratio of 2.74 (a PEG ratio above 1 is considered to be overvalued). Those relatively high multiples mean that investors already are betting on a lot of growth from the company and its the prospects for LNG. Not to mention, we also have to factor in the high cost of capex spending needed to convert the facility.

Nonetheless, with Cove Point gaining approval, there’s no reason not to expect Dominion to make good on its promise of 5% to 6% earnings growth[6] — along with dividend increases — over the long run.

So shake up your utility portfolio and buy into Dominion Resources.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. D: http://studio-5.financialcontent.com/investplace/quote?Symbol=D
  2. WMB: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMB
  3. slated to begin next year: http://www.ogj.com/articles/print/volume-111/issue-9c/general-interest/doe-approves-dominion-cove-point-lng.html
  4. LNG: http://studio-5.financialcontent.com/investplace/quote?Symbol=LNG
  5. estimates that it will generate $1 billion in EBITDA: http://www.bloomberg.com/news/2013-09-12/dominion-resources-to-form-master-limited-partnership-1-.html
  6. 5% to 6% earnings growth: http://online.wsj.com/article/BT-CO-20130425-709715.html

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