Dominion Resources Inc. (D-NYSE)

Transcription

1 January 29, 2010 Dominion Resources Inc. (D-NYSE) Current Recommendation Prior Recommendation UNDERPERFORM Date of Last Change 03/18/2004 Current Price (01/28/10) $37.60 Target Price $39.00 NEUTRAL SUMMARY We continue to like Dominion for its strong regulated growth opportunities, driven by a favorable economic and regulatory environment in Virginia; a solid dividend; and the absence of high-risk oil and gas E&P activities in the hurricane-prone Gulf of Mexico. We believe that the company s strong fundamentals and diverse range of businesses will continue to drive EPS growth going forward. Furthermore, Dominion is expected to benefit from the potential carbon legislation given its nuclearheavy merchant asset base. However, we expect the company s merchant generation and E&P businesses to face downward earnings pressure in the near term due to the roll-off of favorable hedges. We maintain our Neutral recommendation on Dominion. SUMMARY DATA 52-Week High $ Week Low $27.29 One-Year Return (%) Beta 0.52 Average Daily Volume (sh) 1,968,925 Shares Outstanding (mil) 597 Market Capitalization ($mil) $22,456 Short Interest Ratio (days) 5.57 Institutional Ownership (%) 57 Insider Ownership (%) 1 Annual Cash Dividend $1.75 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 0.1 Earnings Per Share (%) 8.3 Dividend (%) 7.4 using TTM EPS 11.5 using 2010 Estimate 11.4 using 2011 Estimate 11.5 Zacks Rank *: Short Term 1 3 months outlook 3 * Definition / Disclosure on last page Risk Level * Low, Type of Stock Large-Blend Industry Util-Elec Pwr Zacks Industry Rank * 160 out of 217 ZACKS ESTIMATES Revenue (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,389 A 3,452 A 4,231 A 4,173 A 16,245 A ,778 A 3,450 A 3,648 A 3,268 A 15,144 A ,471 E ,428 E Earnings Per Share (EPS is operating earnings before non-recurring items) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2008 $1.00 A $0.50 A $0.94 A $0.73 A $3.17 A 2009 $0.97 A $0.68 A $0.99 A $0.63 A $3.27 A 2010 $3.30 E 2011 $3.28 E Zacks Projected EPS Growth Rate - Next 5 Years % Zacks Investment Research, All Rights reserved North Canal Street, Chicago IL 60606

2 OVERVIEW Richmond, Virginia-based Dominion Resources Inc. (D) is a major energy company engaged in the regulated and unregulated electricity distribution, generation, and transmission businesses. Dominion is one of the nation s largest producers and transporters of energy. The company's asset portfolio consists of over 27,500 megawatts of power generation, 6,000 miles of electric transmission, 56,000 miles of electric distribution lines in Virginia and North Carolina, about 1.2 trillion cubic feet equivalent (Tcfe) of proved natural gas reserves, 14,000 miles of natural gas transmission, gathering and storage pipeline, and the nation's largest underground natural gas storage system with 975 billion cubic feet of storage capacity. Dominion manages operations along the following three business lines: Dominion Generation, Dominion Energy and Dominion Virginia Power (DVP), which accounted for 59%, 23%, and 18%, respectively, of 2008 operating earnings. Dominion Generation manages the electric generation operations of Dominion s utility and merchant fleet, as well as the energy marketing and price risk management activities of its generation assets. Dominion Energy manages the company s Ohio regulated natural gas distribution company, regulated gas transmission pipeline and storage operations regulated liquefied natural gas (LNG) operations and its Appalachian natural gas exploration & production (E&P) business. Dominion Virginia Power includes Dominion s regulated electric transmission, distribution and customer service operations, as well as its nonregulated retail energy marketing operations. Through its subsidiaries, Dominion serves approximately 2.4 million retail customer accounts, including governmental agencies, as well as wholesale customers in Virginia and northeastern North Carolina; approximately 1.6 million retail energy customers (residential, and small commercial and industrial customer) in the northeast, mid-atlantic, and Midwest regions of the U.S. and Texas; and approximately 1.7 million residential, commercial, and industrial gas sales and transportation customers in Ohio, Pennsylvania, and West Virginia. REASONS TO BUY Dominion s key strategy is to be a leading provider of electricity, natural gas and related services to customers, primarily in the eastern region of the U.S. In an effort to make its mark, Dominion is primarily focused on expanding its regulated electric generation, electric and natural gas transmission infrastructure within and around its existing footprint. Currently, about 90% of the company s planned $6.5 billion of growth projects for are focused on its regulated or fee-based businesses. In addition to growing its infrastructure, the company also focuses on providing top-tier customer service in all of its operations and delivering earnings per share growth and risk-adjusted returns on invested capital superior to its utility peers. Over the years, Dominion has been focused on its regulated businesses while maintaining upside potential in its well positioned non-regulated businesses. Dominion has successfully transformed its business model from being commodity sensitive to that of being more regulated in the last few years. Dominion has developed a market-leading position in the energy-intensive Midwest, mid-atlantic, and Northeast regions of the U.S. Furthermore, the company owns merchant generation and gas assets in attractive regions. We expect Dominion to be a net beneficiary of potential carbon legislation as a result of its carbon-friendly nuclear and renewable generation asset base. The regulatory framework in Dominion s Virginia is one of the most supportive in the U.S. The state allows for premium return on equity (ROE) and riders for timely recovery of new generation projects. Dominion s service territory continues to prove its relative resilience to recession, largely owing to a favorable customer mix. In addition, Dominion's regulated utility is still adding new customers in spite of the U.S. recession, reflecting moderate economic activity and moderate population growth in its Virginia and North Carolina service areas. Going forward, a favorable settlement of DVP s proposed rate case is Equity Research Page 2

3 expected to pre-empt another base rate review until at least This leaves Dominion with minimal regulatory risk over the next few years. REASONS TO SELL Dominion s business is sensitive to fluctuations in weather. Weather conditions directly influence the demand for electricity and natural gas, affect the price of energy commodities and can affect the production of electricity at the facilities. Furthermore, severe weather, including hurricanes and winter storms, can be destructive, causing outages and property damage that require additional expenses. Dominion s utility operations are subject to federal, state, and local legislative requirements, as well as extensive environmental regulations, such as, air quality, water quality, greenhouse gas emissions, CO2 emissions, waste management, etc. Changes in regulations could impact the company s earnings. Furthermore, the company expects the cost of compliance with existing and new environmental laws to continue being significant. The company s E&P operations may be affected by uncontrollable factors like damage or suspension of operations caused by weather, fire, explosion, etc. It could also be impacted by fluctuations in natural gas and crude oil prices; results of future drilling and well completion activities; drilling costs; acquisitions; rig availability and geological issues. These factors may ultimately weigh on the company s financial results. RECENT NEWS Fourth Quarter and Fiscal 2009 Earnings January 28, 2010 Dominion Resources fourth quarter 2009 EPS was $0.63, within the guidance range of $0.55 to $0.65 issued by the company and above the Zacks Consensus Estimate of $0.60. However, the quarterly EPS declined from last year s EPS of $0.73. The earnings drag during the quarter is attributed to higher outage costs, unfavorable weather in the regulated electric service territory and higher depreciation and amortization expenses. Dominion reported full-year operating earnings of $3.27 per share, which was within the company s guidance of $3.20-$3.30 and above the Zacks Consensus Estimate of $3.24 and full year 2008 earnings of $3.17. The outperformance was driven by higher contributions from the regulated electric utility and gas transmission businesses, higher merchant generation margins and lower income taxes, partially offset by lower gas and oil production in the company's E&P operations. Segment wise, operating earnings in the fourth quarter at Dominion Virginia Power and Dominion Generation declined, while earnings at Dominion Energy improved over the corresponding period last year. In 2009, earnings at Dominion Virginia Power remained flat, while earnings improved in the Generation and Energy segments. Net operating revenues for the quarter and the year decreased 22% and 7% to $3.3 billion and $15.1 billion, respectively. Segment-wise, Dominion Generation s revenue declined 8% during the quarter but improved marginally by 1% for the full year Segment revenue at Dominion Energy declined 20% for the quarter and 15% for Dominion Virginia Power segment posted a revenue increase of 5% in the quarter and the year. During 2009, the company increased its total generating capacity in the Generation segment by 1.5%, through a combination of new generation and upgrades of existing generating facilities. Dominion also progressed on its two large generating facilities -- Virginia City Hybrid Energy Center and Bear Garden -- which are expected to supply 1,175 megawatts in Virginia when operational in Equity Research Page 3

4 In the Energy segment, the company doubled the size of its LNG importation facility with the start-up of its Cove Point Expansion project. Additionally, the company achieved full commercial operation at its USA Storage Project, the Appalachian Gateway, to ensure market access by firming up transportation rights and drilling more than 300 wells in the Appalachian E&P operations without any dry holes. In its Dominion Virginia Power segment, the company is focused on increasing customer reliability by making significant investments. Investments in 2009 included completion of over 400 miles of circuit reconditioning across Virginia and North Carolina. On the transmission front, the company made considerable progress on the 500 KV Meadow Brook to Loudoun and Carson to Suffolk electric transmission line projects, which would commence by mid-year The company s liquidity at year-end remained strong at $3.3 billion, comprising $48 million in cash and $3.27 billion available under its credit facility. Cash flow from operations was $3.8 billion in 2009 compared to $2.7 billion in Given the earnings outperformance and limited sensitivity to commodity price changes, Dominion has reaffirmed its 2010 EPS guidance in the range of $3.20 to $3.40. Dominion guided first quarter 2010 operating earnings in the range of $0.90 to $1.00 per share compared to operating earnings of $0.98 per share in the first quarter of The increase is expected to be driven by higher and wider revenues and the impact of a full quarter s benefit from the Cove Point expansion Furthermore, the company reiterated its target to achieve a 55% dividend payout ratio by The board has also set a 2010 dividend rate of $1.83 per share of common stock, up from $1.75 in 2009, a 4.6% increase. Quarterly Dividend January 22, 2010 The Board of Directors declared a quarterly dividend of $ per share of common stock. The dividend is payable on March 20, 2010, to shareholders of record February 26, PJM Forecasts Increased Demand at DVP January 20, 2010 PJM Interconnection, the regional transmission organization, projected customer demand for electricity at Dominion Virginia Power to increase nearly 28% over the next 10 years (2010 to 2020). This represents the fastest growth rate in a 13-state region that stretches from Chicago to the District of Columbia and the Mid- Atlantic. The growth rate for PJM as a whole is forecast at more than 18% over the same period. Dominion s management is encouraged by the PJM study, which shows sustained economic growth in Virginia. But management stated that this confirms the need to make significant investments in the commonwealth's energy generation, transmission and efficiency infrastructure. Furthermore, the study forecasts a 2.5% annual increase in summer demand for Dominion, slightly higher than 2.2% in last year s study. Over the period, PJM expects Dominion s summer peak demand for electricity to increase by more than 5,600 megawatts, equivalent to the peak need of 1.4 million new homes. Dominion currently serves 2.4 million retail electric customers in Virginia and northeastern North Carolina. Dominion plans to meet the increased demand through a balanced program that includes: construction of new generating facilities, including those using renewable energy sources, and upgrades of existing generating units; programs to help customers use energy more efficiently and reduce their demand for electricity at peak times, including very hot or cold days; and improvements to the electric transmission and distribution system. Equity Research Page 4

5 Dominion expects to spend $4 billion over the next three years in a capital investment program that includes two major generating stations now under construction: a state-of-the-art hybrid power station in Wise County, Virginia, using clean-coal technology and biomass; and a gas-powered generating facility in Buckingham County, Virginia. The two power stations will supply 1,175 megawatts once both are in operation by Even after the addition of those two stations, Dominion will have to meet about 4,450 megawatts of increased peak demand either through construction of new plants or energy-efficient measures. The company is seeking approval of the State Corporation Commission to implement a series of energy efficiency programs. Dominion to Boost Customer Service January 5, 2010 Dominion Virginia Power, a subsidiary of Dominion Resources Inc. announced plans to spend $4 billion over three years to improve and expand its ability to provide reliable electric service to its customers. In a letter to the company's 2.3 million customers, management pointed out that Dominion is focused on areas where service reliability did not meet the company's systemwide average, which reached 99.9% in As part of its efforts to improve service to customers, Dominion said it is adding new gas-fired generating units and a hybrid coal station to meet the growing demand. The company informed its customers that it is focused on making improvements to older stations to reduce their emissions. Dominion's distribution system reliability has improved since 2004, primarily through identifying and focusing on circuits where interruptions are more frequent. Last year, Dominion Virginia Power reconditioned over 350 miles of electrical circuits, including installing more than 1,000 new poles, 3,500 new lightning arrestors and other devices. In its letter to customers, management also stated that the company has invested more than $2 billion in recent years on pollution-control equipment to reduce emissions and meet more-stringent environmental requirements. Management noted that customers continue to use more power, despite the recession, and said it expects the demand for electricity to increase as the economy recovers. Dominion said it is committed to meeting Virginia's goal of achieving 15% of its electricity sales from renewable sources in 2025 and reducing customers demand by 10% over the next 12 years. Last month, parent company Dominion Resources Inc. said it would spend $253 million to upgrade a network of natural gas pipelines in West Virginia that was never designed to handle the gas bonanza uncovered in the region. The work will ease pressure within its system and increase the amount of gas that producers can move out of the state. Dominion to Sell Dominion Peoples January 4, 2010 Dominion has decided to continue with the sale of Dominion Peoples to Peoples Hope Gas Companies (PH Gas). The company had also planned to sell Dominion Hope to PH Gas, but the West Virginia Public Service Commission denied the application for sale in an order issued on December 22, The sale of the natural gas utility to PH Gas, a subsidiary of SteelRiver Infrastructure Fund North America, was approved by the Pennsylvania Public Utility Commission on November 19, The sale price is $780 million and closing is expected in the first quarter of The sale is neutral to Dominion's 2010 operating earnings per share outlook provided in its last earnings call. Equity Research Page 5

6 Dominion Hope will rejoin Dominion East Ohio to make up Dominion's natural gas distribution business within Dominion Energy, the natural gas segment which also includes natural gas production, transmission and storage. Dividend Increase and Board Appointments December 17, 2009 The board of directors of Dominion reaffirmed its dividend policy established in October 2007 to achieve a 55% payout ratio by The board also increased the 2010 dividend rate by 4.6% to $1.83 per share, up from $1.75 paid this year. Dominion expects to declare its first quarterly dividend of $ per share in January 2010, which will be payable in March The board has also elected two new directors William P. Barr and Robert H. Spilman Jr. who will join the board effective December 18, Thus, Dominion s board expands from 10 to 12 members. Dominion Expands Operations December 16, 2009 Dominion Resources Inc. announced plans to expand its natural gas gathering, processing and liquids facilities in West Virginia. Dominion plans to spend $253 million for its expansion project, which is called the Gathering Enhancement Project. The expansion project is designed to increase the efficiency and reduce high pressures in its gathering system, thus increasing the amount of natural gas local producers can transfer through Dominion's West Virginia system. The expansion includes nine new units totaling approximately 7,000 horsepower for compressing gas over the next three years, 25 miles of new and replacement pipeline, and two new processing plants in Pleasants (10 million cubic feet per day capacity) and Lewis counties (40 million cubic feet per day). Daily capacity is expected to increase approximately 50 million cubic feet to 280 million cubic feet. It also includes a 60,000 gallon per day expansion of the Hastings Extraction Plant in Wetzel County. The project is expected to be completed by the fourth quarter of 2012 and will be paid for by producers at their rates. VALUATION We believe that the company s strong fundamentals and diverse range of businesses will continue to drive EPS growth. Going forward, we expect significant earnings growth at Dominion s regulated businesses, driven by Virginia s constructive regulatory structure and strong regulated growth opportunities. However, Dominion's competitive generation business is expected to be challenged over the next couple of years by lower power prices and rising fuel costs. Nevertheless, as one of the nation s largest utilities, Dominion still offers an attractive long-term investment opportunity. Shares are presently trading at 11.5x trailing 12-month EPS compared to the 14.4x average for the peer group and 27.7x for the S&P 500. The trailing 12-month EV/EBITDA multiple is above the industry average. Our target price of $39.00 is based on 2010 multiple of 11.8x. We maintain our Neutral recommendation for the stock. Equity Research Page 6

7 Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Dominion Resources Inc. (D) Industry Average S&P Enersis S. A. ADR (ENI) N/A 12.5 Constellation Energy Group Inc. (CEG) Southern Company (SO) FPL Group Inc. (FPL) TTM is trailing 12 months; F1 is 2010 and F2 is 2011, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Dominion Resources Inc. (D) Industry Average S&P Equity Research Page 7

8 Earnings Surprise and Estimate Revision History Equity Research Page 8

9 If you do not agree with our NEUTRAL recommendation for D Read why professional investors may have a different recommendation on the stock Go to: DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of D. Zacks EPS and revenue forecasts are not consensus forecasts. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1066 companies covered: Outperform- 14.2%, Neutral- 79.1%, Underperform 6.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 217 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 217. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research Page 9