Dominion Resources Analyst Report Gabriel Joanes - (NYSE: D) By
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Dominion Resources
(NYSE: D)
Analyst Report
By
Gabriel Joanes
Manager, Student Managed Fund
MBA Class of 2005
University of ConnecticutDate: 11 November 2004 Sector: Utilities Industry: Electrical Utilities
Business Summary Dominion Resources
(NYSE: D)
Dominion is a safe investment with a good amount of growth stemming P.O. Box 26532, Richmond,
from an active diversification. Dominion’s business mix consists of a VA 23261-6532
regulated electric (third largest US utility company) and gas franchise, http://www.dom.com
exploration and production (E&P), and pipeline assets (eight largest in
US). The combination makes for a well diversified and growing NYSE: D
company with stable dividends. In relation to its electricity generation P/E (ttm) 13.44
business, Dominion has a significant cost advantage over some of its P/E (2005) 12.49
peers because most of its generation, about 50% is nuclear or coal- Shares 330.23million
based. Both sources of fuel allow for cheaper electricity production than Market Cap $ 21.24billion
other fuels. With 24,000MW of electric generation, the company is Price $66.5
within the top five electricity producer in the nation. In terms of its 52 Week $59.27-$66.5
natural gas business, falling natural gas inventories in America and in Low/high
many regions have led to sky-high prices, representing a revenue boost Beta 0.2
for Dominion. About 65% of Dominion's earnings come from the Gas
and Electricity transmission regulated businesses, where rates are fixed. Value line
Beta .85
Share Performance Timeliness 4
Price ($): 66.5 52 Week High: 66.35 Currency: USD Safety 2
Avg. Volume (millions): 1.341 52 Week Low: 59.27 Technical 3
Financial B++
Strength
Analyst Rating
Bernstein Outperform
Lehman Strong Buy
Wachovia Market
Perform
Morgan Equal-weight
Stanley
Morning 3 Stars
Star
CSFB Outperform
S&P Hold
UBS Neutral
I recommend a purchase of 150 shares at the share price of $65 for a Warburg
total of $9,750.00. Stop loss at $55.25 (-15%) and review at $78
(+20%).Investment Rational
We expect Dominion to outperform the S&P 500 by a spread of 5 to 10 percentage-point
in the short term. Because of the non-cyclical and mostly regulated natures of the sector,
this investment would constitute a solid and dependable base for the SMF portfolio. We
recommend investing in Dominion because of its
1. Stock price growth (6% 1 year – 25% 3 years – 35% 5 years) which in line
with the utilities industry average and has significantly outperformed the S&P
500.
2. Low Beta (0.85) and low PE ratio (13.4)
3. Steady dividends yielding more than 4% annually
4. Expected revenues growth (5%) and earning growth (4% to 7.5%) for the
next 5 years
5. Positive changes in the industry stemming from deregulation
6. Aggressive diversification and acquisition programs
7. Current debt reductions and improvements in free cash flows as well as a
resolved determination from management to continue this trend in the future
8. Higher than average profit margins
9. Stable all around growth stemming from its regulated business
10. Nuclear generation capabilities with diversified operations
11. Very lucrative gas production and distribution operations benefiting from
high energy prices
12. Stock price trading at a small premium of its intrinsic value
In addition a weak Dollar should have a positive impact on manufacturing which
in turn will benefit utilities through increased energy demands.
Risks
Nevertheless, Dominion has some areas of concerns. We are somewhat nervous
with Dominion’s 2003 and E2004 negative Free Cash Flow. But, we realize that this
trend is due to high capital expenditure supporting Dominion’s diversification efforts as
well as its acquisition programs. Nevertheless, we remain uncertain as to whether these
investments will yield significant rewards in the future or Dominion’s ability to improve
its Free Cash Flows. In addition, as mentioned above, 65% of Dominion's earnings come
from its regulated businesses. The rates are fixed until 2007. Although the company is
working closely with the Virginia assembly to extend the rates until 2010, we are
concerned that the company may not get all the prior benefits which in turn, will impact
Dominion’s growth.
Financial AnalysisDominion currently boasts revenues close to $13 billion and a market cap of roughly $21
billion, consistently placing it among the top 5 corporations among its peers.
Quarterly results
Dominion reported net income for the three months ended Sept. 30, 2004, of $337
million compared to a net loss of $256 million for the same period last year. Operating
earnings were $400 million for the three months ended Sept. 30, 2004, compared to
operating earnings of $430 million for the same period in 2003.
The combined third quarter net income contribution of Dominion's primary operating
segments decreased $30 million, primarily due to:
º A lower contribution from regulated electric generation operations due primarily to the
recognition of fuel expenses in excess of amounts recovered in fixed fuel rates.
º A loss from energy trading and marketing activities, reflecting the effect of unfavorable
price changes on electric trading margins and losses related to certain natural gas
contracts.
The losses in 2003 stemmed from
º $650 million of after-tax losses associated with Dominion's discontinued
telecommunications business;
º $80 million of after-tax costs, representing incremental restoration expenses associated
with Hurricane Isabel; Losses offset by
º A $113 million net after-tax gain representing the cumulative effect of adopting two
new accounting standards.
Dominion business lines results
Dominion Energy:
• Dominion Energy Clearing House
Is the energy trading and marketing operation of Dominion and one of the largest
energy marketers in North America.
• Retail Business
Field services operations, representing aggregation of gas supply and related
wholesale activities related to Appalachian and Canadian areas;
Dominion Energy reported 3Q04 operating earnings of $33.0 million compared with
$77.0 million last year. A majority of the decrease was due to lower contributions from
its energy clearinghouse and lower electric transmission margins. Dominion was required
by accounting rules to recognize its hedges for lost production as trading losses, due to
lower production levels in the Gulf of Mexico.
Dominion Generation:
• Dominion’s electric/gas transmission business
o A regulated interstate gas transmission pipeline and storage system,
serving Dominion’s gas distribution businesses and other customers in the
Midwest, the Mid-Atlantic States and the Northeast.o A regulated electric transmission system principally located in Virginia
and northeastern North Carolina;
Dominion’s electric and gas generation business reported operating earnings of
$193.0 million compared to $221.0 million in the same quarter of last year due to electric
generation fuel expenses, which are no longer recoverable under amended deregulation
legislation.
Dominion Exploration & Production reported a 41.8% increase in operating earnings
from $98.0 million in 3Q03 to $139.0 million in 3Q04 due to the delivery of reserves sold
under a volumetric production payment agreement and higher average realized prices.
Analysis and Ratio
2500 18000
Net Profits 16000 Revenues
2000 14000
12000
1500 10000
8000
1000 6000
4000
500 2000
0
0
E
E
E
99
00
01
02
03
04
05
09
19
20
20
20
20
1999 2000 2001 2002 2003 2004E 2005E 2009E
20
20
20
For the past five years Dominion has consistently maintained revenue and income
growth. We expect this trend to continue.
14.00%
profit margin Competition profit margins
12.00%
15.00%
10.00%
10.00%
8.00%
5.00%
6.00%
0.00%
4.00%
1999 2000 2001 2002 2003 2004E2005E2009E
2.00%
0.00%
D DUK SO FLP
Dominion has been able to maintain solid growth in its profit margin. It also has
outperformed its industry for the past year.16.00%
ROE 14.00% competition ROE
12.00%
16.00%
14.00% 10.00%
12.00%
8.00%
10.00%
6.00%
8.00%
6.00% 4.00%
4.00%
2.00%
2.00%
0.00% 0.00%
1999 2000 2001 2002 2003 2004E 2005E 2009E D DUK SO FLP
Dominion has also demonstrated solid ROE numbers. This mainly stems from its
regulated business where revenues and earnings are fixed. Nevertheless, in 2004,
Dominion has managed to outperformed most of its top competitors who also operate
regulated businesses.
120% 90.00%
Competition payout ratio
payout ratio 80.00%
100% 70.00%
80% 60.00%
50.00%
60% 40.00%
40% 30.00%
20.00%
20% 10.00%
0.00%
0%
D DUK SO FLP
1999 2000 2001 2002 2003 2004E 2005E 2009E
Dominion is experiencing a decreasing Dividends payout ratio trend. A lower payout
ratio gives the company a greater margin for capital investment and thus will generate
growth without excessive leverage. It is worth noting that Dominion has the lowest
Payout ratio among its top competitors while paying competitive dividends.70% 57.00%
60% LTD 56.00% Competition LTD
50% 55.00%
40%
54.00%
30%
53.00%
20%
52.00%
10%
51.00%
0%
D DUK SO FLP
1999 2000 2001 2002 2003 2004E 2005E 2009E
On the negative side, Dominion Long Term debt ratio is high and has been increasing
over the past years. We expect LTD to decrease for 2004 and in the coming years. A high
LTD is typical in the utilities industry given its high fixed costs and investment
requirements. But, Dominion LTD is higher than its industry peers. This is in part due to
the current expansion and diversification efforts of the company. Dominion management
has promised that in 2004, 2005 and following years it will work greatly to reduce its
debt.
400 $700,000
200 FCF $600,000 Competition FCF (10 year avg)
0 $500,000
-200
1999 2000 2001 2002 20032004E $400,000
-400 $300,000
-600
$200,000
-800
$100,000
-1000
$-
-1200
$(100,000) D DUK SO
-1400
-1600
An other area of concern is Dominion Free Cash flow. It has been have negative for the
past few years, and particularly in 2003 with close to 1.5B negative free cash flow. We
attribute this trend to intense capital expenditure to finance expansion and diversification
and to pay down debt. In terms of its competition, Dominion FCF does not fare well
either. Dominion’s management has made a strong commitment to reducing its debt and
increasing its Free Cash Flow in the future. For 2004, we have already noticed a small
decrease in capital expenditure.
Industry AnalysisUtilities are in a highly regulated industry. Like Dominion, most electric utilities have a
large portion of their revenues and profits fixed. The key determinants for a utilities stock
to outperform its peers are:
1) Active diversification
Utilities can leverage their size and influence by entering none core, less regulated
markets such as marketing and brokerage operations.
2) Active acquisition
As a response to 1) increasing costs stemming from high energy prices 2) environmental
and service regulations and 3) deregulation, large companies need to concentrate their
generation assets among a smaller number of companies.
3) Dividends
An important appeal of utilities is their dividends. Investors will judge utilities stock
looking at their Dividend yield and dividend growth.
4) Environment and Costs awareness
A utility company needs to remain sensitive to environmental issues as well as spark
spreads (Difference between electricity production revenues and energy production
costs). This can be achieved through the use of renewable and nuclear energy.
Business Analysis
I selected Dominion for consideration of the SMF because it meets and exceeds all the
criteria above identifying successful utilities stocks.
1) active diversification
Dominion is one of the largest players in the industry and is well diversified. The
company’s operating segments are generation (30% of operating income), Energy
(20%), Delivery (26%), and exploration and production (24%).
Operating Segments
Generation
Energy
Delivery
Exploration and
Production
Dominion has also interests in the natural gas business consisting of the largest
natural gas storage in the nation with 960 billion feet of capacity and a wide
transmission pipeline with extensive reserves.
2) Active acquisition
Dominion has recently acquired several assets from competitors and is expanding.
These acquisitions have strengthened Dominion prospects in the natural gas market
and electricity generation.
a. Dominion Merged with Consolidated Natural Gas in 2000
b. Dominion Merged with Louis Dreyfus Natural Gas in 2001.c. Dominion bought Maryland liquefied natural gas (LNG) terminal in 2002
d. Acquisition of 545 MW of nuclear capacity in WI in 2003
e. By end of 2004 plans to complete construction of 1,180MW natural-gas
fired plant in PA.
f. Dominion has agreed to acquire USGen Assets In Northeast (2004)
3) Environment and Costs
Dominion produces most of its electricity using a wide variety of generation fuel. It is
worth noting that close to 50% of its generation fuel is derived from atomic and coal
sources which are the most cost efficient resources. In addition nuclear power is
considered one of the most environment friendly sources of energy.
4) Dividends
Dominion has consistently delivered solid dividends and is planning a major increase
for the next five years. The company’s dividends yield is within the range of its
industry. In addition, its low payout ratio gives Dominion some “margin of error”
allowing it to continue paying the same dividends even with temporary reduced
earnings.
3 8.00%
Dividend Per Share 7.00% Dividend Yield
2.9
6.00%
2.8
5.00%
2.7 4.00%
2.6 3.00%
2.00%
2.5
1.00%
2.4 0.00%
1999 2000 2001 2002 2003 2004E 2005E 2009E 1999 2000 2001 2002 2003 2004E
Analyst RecommendationsThis chart indicates that a majority of analyst’s recommendation trend towards a
Buy/Hold. It is worth noting too that there are no Sell recommendations.
Executive Board
Officers and Directors
Chairman and Chief Executive Officer of
THOS. E. CAPPS Dominion
SUSAN B. ALLEN Independent
PETER W. BROWN Independent
RONALD J. CALISE Independent
GEORGE A. DAVIDSON, JR., Not Independent (CEO of acquired company)
JOHN W. HARRIS Independent
ROBERT S. JEPSON, JR., Independent
BENJAMIN J. LAMBERT, III Independent
RICHARD L. LEATHERWOOD, Independent
MARGARET A. McKENNA Independent
KENNETH A. RANDALL Independent
FRANK S. ROYAL, M.D., Independent
S. DALLAS SIMMONS Independent
ROBERT H. SPILMAN Independent
DAVID A. WOLLARD Independent
As illustrated in the above chart, most of Dominion board is independent.
Recent NewsNovember 9, 2004 Nuclear-Power Industry Sees Signs of a U.S. Revival WSJ Utilities Face Opposition Over Safety and Storage; A GE-Westinghouse Contest The nuclear-power industry is laying the groundwork to build new plants in the U.S. for the first time in more than two decades. Buoyed by the re-election of President Bush, whose administration has pushed to expand nuclear power as part of its national energy plan, the industry sees a window of two to three years in which the political environment could make it easier to win approval for new projects. Late last week, two separate consortiums consisting of power companies and reactor makers received word that the Department of Energy would share in the cost of obtaining regulatory approval for new nuclear reactors. The two groups expect the cost of winning that approval to be about $500 million apiece, due to the detailed engineering and testing required by regulators for new reactors. So far, the proposed new plants would be built at existing facilities. One group, led by Virginia's Dominion Resources Inc., is proposing to build a new reactor, designed by AECL, on a site in Mineral, Va., where a nuclear plant has operated since 1980. A second, much larger consortium led by Exelon Corp. and Entergy Corp., plans to select in 2007 a newly designed reactor from either GE or Westinghouse for a potential new plant. The consortium, NuStart Energy Development LLC, hasn't selected a site but is considering existing locations in Clinton, Ill., and Port Gibson, Miss. November 3, 2004 Dominion E&P Announces Devils Tower Production at Pre-Ivan Levels PR Newswire Houston – Production at Devils Tower has returned to pre-Hurricane Ivan levels, Dominion Exploration & Production, a subsidiary of Dominion (NYSE: D), announced today. Three wells are producing, with a fourth well expected on stream within two weeks. The three wells are currently producing approximately 28,000 barrels of oil equivalent per day gross. Completion work on the four remaining wells is now expected to begin by year-end.
Dominion E&P owns 75 percent of Devils Tower production and is the operator of the platform. Pioneer Natural Resources Company (NYSE:PXD) owns the remaining 25 percent of production. Oil and natural gas from Devils Tower flows through a spar floating production facility owned by a unit of The Williams Companies, Inc. Devils Tower is located about 140 miles southeast of New Orleans on Mississippi Canyon block 773 in the deepwater Gulf of Mexico. Dominion has a comprehensive insurance program to reimburse for delayed production beyond an estimated $9 million after-tax loss of income October 15, 2004 Dominion Initiates First Dividend Increase in a Decade by Declaring Fourth-Quarter Payout of 66.5 Cents Per Share PR Newswire RICHMOND, Va. - The board of directors of Dominion (NYSE: D) initiated its first dividend increase in 10 years today by declaring a fourth-quarter dividend of 66.5 cents per share of common stock. The declaration represents a 2-cent increase over Dominion’s previous quarterly dividend of 64.5 cents per share. This will boost Dominion’s 2004 annual dividend rate to $2.60 per share of common stock. Dividends are payable on Dec. 20, 2004, to shareholders of record Nov. 29, 2004. For dividends payable in 2005, the quarterly rate is expected to rise again, from 66.5 cents per share to 67 cents per share, for an annual rate of $2.68 in 2005. Under current financial projections, the company believes that additional 8-cent-per-share annual increases in the dividend rate are appropriate. September 7, 2004 Dominion Agrees To Buy USGen Assets In Northeast PR Newswire Acquisition Will Add 2,839 Megawatts of Coal, Gas and Oil Capacity to Dominion Portfolio Acquisition Expected to Be Immediately Accretive Under terms of the agreement, Dominion will purchase the 1,599-megawatt coal- and oil- fired Brayton Point Station and the 745-megawatt coal- and oil-fired Salem Harbor Station, both in Massachusetts. Dominion will also acquire the 495-megawatt combined- cycle natural gas-fired Manchester Street Station in Rhode Island. At takeover, about 30 percent of the combined output from the three stations will be sold under contracts to unidentified buyers. The balance will be sold into the NEPOOL wholesale market.
Valuation
Dominion's weighted average cost of capital
Inputs
(all dollar fig in thousands)
Calculation for Ks(Stock)
Risk Free Rate(10 yr T-bond Rate)= 4.07%
Beta = 0.85 (VL)
Historical Risk Premium= 5.90%
From CAPM
Ks= 9.09%
Calculation for Kd(Debt)
Interest Expense $ 1,071,000
Amount of LT debt $ 16,033,000
Kd= 6.68%
Kd(1-T) 4.35%
Calculation for Kp(Pref. Stock)
Dividend Paid on Pref. Stock $ 16,000 (VL)
Amount of Pref. Stock $ 257,000 (VL)
Kp= 6.23%
Market Value Wts Wts*K
Stock
OUTSTANDING SHARES 325,000
Price $ 65
Market Cap $ 21,004,750 0.55867 0.050755
Debt
10 yr Bond issued Aug 2004
Maturity 3/15/2013
Issued 9/15/2003
Coupon 5.00%
Price $ 102
Book Value(debt) $ 16,033,000
Market Value(debt) $ 16,336,024 0.434494 0.018895
Pref. Stock
Value $ 257,000 0.006836 0.000426
Total Mkt. Value $ 37,597,774
WACC= 7.01%Earning Discount Model Intrinsic Value Calculation
(all dollar fig in thousands)
Initial Earning $ 947,640
first stage earning growth rate 4.00%
second stage earning growth rate 3.50%
WACC 7.01%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
947,640 985,546 1,024,967 1,065,966 1,108,605 1,152,949 1,199,067 1,247,030 1,296,911 1,348,787
Terminal Value 39,771,930
Earnings Flows 985,546 1,024,967 1,065,966 1,108,605 1,152,949 1,199,067 1,247,030 1,296,911 41,120,718
PV of Flows 956,748 965,943 975,226 984,599 965,014 974,289 983,652 993,106 30,567,985
SUM= $38,366,561
Long Term Debt $16,033,000
Shares
outstanding $325,000
share price $68.72
Dividend Discount Model
DDM
Dividends
2000 2001 2002 2003 2004
2.58 2.58 2.58 2.58 2.6
%increase 0.00% 0.00% 0.00% 0.78%
Assumptions* 2005 2006 2007 2008 2009 2010 2011onwards
Dividend Growth 2% 2% 2% 2% 2% 2% 3.0%
*Dividend Growth as estimated by ValueLine
WACC 7.01%
2004 2005 2006 2007 2008 2009 2010
2.6 2.652 2.705 2.75914 2.81432 2.8706 2.92802
Terminal Value 73.0179
Dividend Flows 2.652 2.705 2.75914 2.81432 2.8706 75.9459
PV of Flows $2.53 $2.45 $2.38 $2.31 $2.25 $56.63968
Price= $68.56Based on the figures above, Dominion stock intrinsic value using DDM and Earnings Discount model is between 68 and 69. It is slightly above its current price of $66.57.
You can also read
