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Dominion is down more than 8% over the past one year and 13.9% YTD. Energy Information Administration expects that generation from natural gas will increase from 27.5% in 2014 to 31.6% in 2016. Utility sector forward P/E valuation has dropped to 14.9x, very close to its historical average of 14.1x. The utility stocks have remained the favorite choice for regular income seeking investors with less risk appetite. The utility stocks have posted some impressive gains over the past several years, and valuations expanded significantly. However, Fed’s indication to hike the interest rate has changed the ground and utility in S&P 500 index is now the second worst performing sector, so far this year. Dominion Resources (NYSE: D ), one of the largest utilities in the U.S., has significantly underperformed, just like other utility stocks, as investors adopted a defensive strategy. As a result, Dominion is down more than 8% over the past one year and 13.9% YTD. (click to enlarge) Source: Yardeni Research Dominion’s portfolio mix is well diversified, and it has the generation capacity of approximately 24,400 megawatts along with 12,200 miles of natural gas transmission. However, the largest natural gas storage system capacity of 928 billion cubic feet distinct Dominion from other utility companies. Dominion’s gas storage and transportation operating revenues have surged 7.3% to $1,221 million, or 13.4% of total revenue, so far this year. The storage and transportation revenue will continue to rise in the fourth quarter and next year as demand for U.S. gas in 2015 is estimated to increase by 4.6%. Coal-fired electricity generation has remained the largest component of power generation in the U.S., but the industry dynamics have changed dramatically in the recent past. In April, gas-fired power generation surpassed coal for the first time. In the near-term, Energy Information Administration (NYSEMKT: EIA ) expects that generation from natural gas will increase from 27.5% in 2014 to 31.6% in 2016 amid low natural gas prices. It bodes well for the company as low natural gas prices will reduce the fuel costs and will help Dominion to deliver 5% – 6% earnings growth in 2016. On the other hand, the significant increase in gas demand will fuel Dominion’s gas storage revenue, which will mute the unfavorable impact from the unregulated business. Currently, Dominion produces approximately 34% electricity from natural gas, and coal generation is 27%. Dominion’s 1,358-megawatt combined-cycle plant in Brunswick County, which is expected to become operational in mid-2016 and three-on-one combined-cycle plant with production capacity of 1,588-megawatt Greensville County will increase the share of natural gas generation to approximately 45% by the end of 2018. The declining cost of generation from natural gas and advanced technology will further strengthen the operating margins in the coming years. Moreover, the anticipated contribution from ongoing growth projects including The Cove Point LNG export facility will start fueling earnings growth from 2018 onwards. Thus, these factors completely justify that Dominion’s earnings will grow at an estimated 3-year CAGR of 7.3%, and growth will pick the pace in 2018 due to the addition to major growth projects. Source: NASDAQ With the low natural gas and power prices, the unregulated utility sector’s revenue stream may tumble in the coming quarters. However, Dominion is pretty secure against this headwind as it generates approximately 68.7% of total operating revenue from regulated business and only 16.5% is unregulated. It bodes well for the company as the supportive regulatory environment will enable Dominion to maintain the profit margins while generating steady cash flows. Thus, the growing gas storage business and stable outlook of regulated business will protect the operating margins on stable operating revenues, and will also improve the cash flow to debt ratio from its current level of 15.5%. However, Dominion’s cash flow to debt ratio may remain lower as compared to estimated industry average of 21% for 2016 primarily due to $8.6 billion CAPEX in 2015 and 2016. Dominion’s management is pretty confident to sustain organic growth as the company is deploying quality assets and major projects are on time and budget. The combined-cycle plants and plan for 400-megawatt utility-scale solar generation will pave the way for achieving 80% to 90% operating revenue from regulated business, which will further stabilize revenue stream. Moreover, the management has indicated the there is no need for a big merger deal as the company is well-positioned to meet the future demand while continuing profitable growth. It is a good sign from investors’ perspective because the leverage ratio will remain in its current range of 1.68 times and shareholders will receive 8% annual dividend increase over the next five years. The dynamics are quite favorable for Dominion except the slight drop in electricity demand in the U.S. Moreover, the industry-wide initiatives to reduce the nuclear power production costs by 30% by 2018 also suggests some margin gains for the major utilities. However, the rising yield on 10-year U.S. Treasury note is putting downward pressure on utility stocks, and the interest rate hike is pending yet. The Philadelphia Utility Index (UTY) is already down approximately 16% from its peak at the start of 2015 and Dominion followed the decline. Resultantly, utility sector forward P/E valuation has dropped to 14.9x , very close to its historical average of 14.1x and significantly lower than S&P 500 index forward PE of 15.6x. It is quite an aggressive reaction from investors. Fed has hinted several times that it will follow the gradual and cautious strategy to hike the rate. That said, if it happens, the rate will start increasing from a very low level that Dominion’s yield will still be attractive. Moreover, the interest rate will also increase the ROE, which will partially offset the additional finance cost burden. (click to enlarge) Source: NASDAQ The drop in stock price has pushed Dominion’s dividend yield to a very attractive level of 3.97%. And, now Dominion is trading at trading at a forward PE of 17.1x, significantly less than the 5-year historical average of 36.2x. Thus, it seems that the market has already incorporated the impact of interest rate hike and Dominion may perform well in 2016 as earnings of the company will sustain long-term growth owing to margin expansions and aggregate growth CAPEX of $14.9 billion from 2016 to 2020. That said, Dominion is still a very attractive dividend stock capable of providing upside potential once the dust settles. Scalper1 News
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