Watch Dominion, but Wait

 | Dec 10, 2012 | 5:30 PM EST  | Comments
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Dominion Resources (D) is one of the nation's best managed utilities. But buying now could be a mistake. Two challenges Dominion faces are its price-to-earnings ratio and its dividend. At 25.0, Dominion's P/E ratio is the highest in its peer group. Its dividend yields 4.08%, which is in line with the company's risk profile. To increase Dominion's market valuation would require higher earnings or increased dividends, both of which will be difficult to achieve in the near term. The long term is another story.

Almost 60% of Dominion's revenue is derived from 28,200 megawatts of power-generating facilities. On the merchant side, Dominion has been disposing of unprofitable facilities. It retired an unprofitable nuclear power plant that had been operating outside its service territory in Wisconsin. It announced plans to sell its interests in three coal-fired power plants -- two in Illinois and one in Massachusetts. It sold two other coal plants -- one in Illinois (State Line) and the other in Massachusetts (Salem Harbor).

After all the retirements and sales, Dominion's merchant fleet is left with a two-unit nuclear facility in Connecticut (Millstone), some natural gas-fired plants, a couple of wind power plants and a minority interest in a tiny cogeneration biomass/coal unit operating in Maine.

On the regulated side, Dominion has earned a stable relationship with its state overseers. Unlike its neighbors Duke Energy (DUK) and Pepco Holdings (POM), Dominion collaborates with state regulators to develop safe, economic and reliable power. All parties are motivated, because the Virginia is short energy capacity and is a net importer of electric power. So it's not a surprise that the state is encouraging the company to expand its regulated fleet of coal, nuclear, hydroelectric and gas turbines to include additional combined cycle gas turbines, solar and other power-production facilities.

The culling of the company's merchant fleets and the expansion of its regulated fleets should provide improved margins and earnings. Unlike Exelon (EXC), Dominion should reduce its exposure to declining power markets.

Helping reduce Dominion's risk is its four regulated distribution utilities. It owns Dominion North Carolina Power and Dominion Virginia Power, which serve retail electric customers in portions of North Carolina and Virginia. It also owns Dominion East Ohio and Dominion Hope, which are retail natural gas utilities operating in Ohio and West Virginia.

Servicing these distribution utilities are Dominion's wholesale operations, which are largely regulated by the Federal Energy Regulatory Commission (FERC). Dominion owns 6,300 miles of electric transmission lines. It also owns 11,000 miles of natural gas transmission, gathering and storage pipelines. Included is one of the nation's largest natural-gas storage systems with 947 billion cubic feet of storage capacity, serving energy customers in 15 states. Most are regulated by the FERC.

Connected to Dominion's wholesale gas operations is a liquefied natural gas (LNG) import facility in Maryland. Dominion plans to convert their idle LNG facility into an import/export facility.

By converting its Cove Point LNG facility, Dominion's objective is not to generate windfalls from the LNG export market but to restore an asset that is currently stranded.

Currently, Dominion has hundreds of millions in capital expenditure tied up in a facility that can longer import LNG economically. To keep the facility in operational readiness, Dominion has been incurring significant operations and maintenance expenses without any offsetting revenue. By reversing the flow of natural gas, Dominion hopes to capture enough revenue to cover its expenses and contribute something toward earnings.

From the broader perspective, for investors to realize short-term gains, Dominion's earnings or dividends have to improve. Today, both appear to be challenges, because year-over-year revenues are down and so are earnings.

The longer view looks more positive. Dominion's management sharpened its focus to rely on regulated assets. It has diversified its regulated assets to include power and natural gas. About 25% of Dominion's consolidated revenue comes from gas sales, transportation and storage. Going forward, that percentage should increase, particularly if natural gas prices increase and power prices decrease. More directly, long-term earnings and dividends should grow.

The long-term is measured in months and years. Over the last several decades, Dominion rewarded their shareholders with growth in market valuation and dividends.

Now that Dominion exiting coal, some commentators are now recommending Dominion. But before jumping, it might be a good idea to wait a few weeks to see how Congress addresses fiscal-cliff issues, particularly new taxes on dividends. On the other hand, if investors believe taxes will remain unchanged, now is as good as any to jump in.

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