Dominion Energy Third Quarter Results: Valuation Affected by Near-Term Risks (NYSE:D)

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domain energy (New York Stock Exchange 😀) shares fell 3% on November 4, even as the company reported better-than-expected earnings for the third quarter of 2022.

Dominion Energy Third Quarter Results

The Virginia-based company reported adjusted earnings of $1.11 per share, from revenue of $4.39 billion. This compares with the consensus forecast for non-GAAP earnings of $1.08 per share and revenue of $3.98 billion.

Meanwhile, the third quarter of last year posted adjusted earnings of $1.11 per share and revenue of $3.18 billion.

Looking ahead to the next quarter, management expects similar earnings for the fourth quarter of 2022, with operating earnings expected to fall between $0.98 and $1.13 per share. This is somewhat higher than the analyst consensus forecast of $1.07 per share.

Management also lowered its full-year 2022 operating earnings guidance range to $4.03 to $4.18 per share, from a range of $3.95 to $4.25 previously, and against the consensus forecast of $4.11.

Overall, this seemed like a pretty strong set of results, with updated guidance for the coming quarter in line with or slightly above previous targets and analyst expectations.

Business Review Announced

However, the disappointing news came from a warning that macroeconomic challenges, coupled with increased investment needs, could affect the company’s ability to meet its medium-term goals.

Management announced a “top-to-bottom business review” with the goal of ensuring that Dominion Energy continues to be in the best position to create significant long-term value for shareholders. And in the absence of a new capital allocation strategy, the company could miss its medium-term EPS growth target of 6.5%.

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Dominion Energy Mid-Term EPS Growth Business Review

Dominion Energy Third Quarter Results Presentation

By 2023, we see paths to achieving our existing goals as we expect to be able to overcome macroeconomic challenges with increased non-regulated investment activities and other initiatives.

However, these unregulated profit drivers, among other parts of our business, are subject to the review we announced this morning. Therefore, I caution that results consistent with our existing guidance can only be achieved in a status quo result for our review.”

CEO Bob Blue, Dominion Energy Third Quarter 2022 Earnings Call

The company has so far provided scant details about what actions it is planning, but confirmed that it remains committed to its current regulated business profile. Management also added that it was not considering any proposals that could affect the dividend. Other than that, we can only wait for more details, which the company hopes to provide in early 2023.

Regulated Assets

More alignment with state-regulated assets could make sense. Dominion Energy’s capex portfolio is growing at its fastest pace, with the utility giant planning to spend some $37 billion in growth capex between 2022 and 2026. Investments in zero-carbon electricity generation, energy storage, electricity transmission and gas distribution have resulted in a spending spree that has Dominion Energy moving even further into clean energy and state-regulated assets.

The operating segments of Dominion Energy, the utility regulated by the state of Virginia, had distribution assets in contact

Dominion Energy Third Quarter Results Presentation

State-regulated utility operations now contribute 90% of its operating profit, up from 65% in 2018. The remaining 10% comes from contracted assets, which includes its 50% stake in the Cove Point LNG terminal, which it is currently operated by Berkshire Hathaway Energy. Subsidiary BHE GT&S.

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Dominion Energy is a natural monopoly in much of what it offers, with no effective competition. Therefore, a focus on regulated operations should translate into predictable revenues and low borrowing costs. In turn, lower business risks, including reduced exposure to commodity prices, are expected to underpin attractive risk-adjusted returns for shareholders.

It could put Dominion Energy in a unique position to potentially enjoy faster growth as well, due to long-term secular growth drivers, including growing adoption of electric vehicles, data center demand growth and accelerating of decarbonization efforts. Dominion Energy’s rate base is forecast to grow about 9% annually over the next five years, slightly more than its EPS growth target.

double edged sword

However, the regulatory environment can be a double-edged sword, as the company must work closely with regulators to approve the fees it can charge consumers; this ultimately determines what they can earn.

Regulators are required to strike a balance between keeping consumer rates affordable and adequately attracting enough private capital to sufficiently finance the capital spending required to meet infrastructure needs.

We can see this in play with Dominion Energy’s regulated offshore wind farm in the Virginia shield. The state regulator has been insisting on a performance guarantee for the CVOW project, which would require Dominion to finance the cost of replacement power if the wind farm’s output falls below its expected net capacity factor of 42%, measured on a three-year moving average.

Dominion has said that insisting on collateral will prevent the project from moving forward as it may not account for unusual weather patterns or events. In a proposal for a transaction agreement, presented on October 28, it has sought to replace this guarantee with a shared cost approach that would make the company share the responsibility for the cost overruns of its construction.

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Now it is up to the Virginia SCC to decide whether to approve this settlement. But whatever the outcome, it’s clear that Dominion Energy’s fortunes are not entirely in its own control.

Ratings

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Uncertainty surrounding the CVOW project has played a role in the recent underperformance of Dominion Energy shares. Investors now also have to deal with additional risks stemming from their upcoming trade review.

Until around September, its stock performance over the past year largely tracked the rest of the utilities sector. Since then, Dominion Energy has distanced itself from its peers in the sector, posting a total return of -8.0% over the last 52 weeks, compared to +3.7% for the sector.

But earnings expectations have barely budged. The EPS consensus forecast for the current fiscal year is down just 0.2% over the past 6 months to $4.11, while the figure for 2023 is down 0.7% at $4.37. Meanwhile, EPS for 2024 was revised up 0.1% to $4.68.

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Data by YGraphics

Dominion Energy is now trading at a significant discount to the sector, with a forward P/E of 16.3 and a dividend yield of 4.0%. This compares favorably to the industry average forward P/E of 18.8 and average dividend yield of 3.0%.

final thoughts

Despite medium-term macroeconomic and regulatory risks, I believe Dominion Energy is in an attractive position to benefit from changing energy trends. The shift to regulated infrastructure assets, particularly electricity generation and transmission, is expected to benefit its long-term earnings outlook, as well as improve revenue reliability.

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