The phrase "stuck between a rock and a hard place" was invented for the situation that now faces income investors. Interest rates are rising, which weighs on dividend-paying stocks such as utilities, but the Federal Reserve still remains committed to keeping rates low in the face of a still-fragile recovery.
In this era of 1% CDs and slowing dividend growth, stocks once considered ironclad income generators are struggling. Latest case in point: the utility Dominion Resources (D) , which reported fourth-quarter earnings Monday morning that fell compared with the same period a year earlier.
Some analysts are now calling for investors to dump this long-time income stalwart and look for other, more promising income choices this year. Is the rap against Dominion justified? Let's take a look as to whether it still belongs in your dividend portfolio.
Rate-sensitive investments such as utility stocks get hammered when interest rates are rising, because utilities must borrow large sums of money for capital expenditures. As rates go up, utilities' rising cost of capital dampens their share prices. In addition, safer interest-rate pegged investments such as U.S. Treasuries become more enticing from a risk-reward calculation.
The Federal Reserve in December hiked interest rates for the first time since 2006. The move has hurt utility stocks, as investors dump them in favor of less-risky Treasuries, which offer better yields.
The benchmark Utilities SPDR ETF (XLU) , which invests about 8% of its holdings in Dominion, has fallen 5% over the past year. Dominion performed even worse, falling 7.5% over the past year. Not all of Dominion's peers have suffered as badly. For example, American Electric Power (AEP) has fallen less than 1% over the past year.
Dominion's cause wasn't helped on Monday morning before the markets opened, when it announced that earnings had declined to $416 million, or earnings per share (EPS) of 70 cents, compared with earnings of $490 million, or EPS of 84 cents, in the same period a year ago. The Wall Street consensus had called for EPS in the most recent quarter of 89 cents. The unexpectedly poor performance represented year-over-year declines of 15% in earnings and 17% in EPS.
Based in Richmond, Va., Dominion operates via three divisions: Dominion Virginia Power (DVP), Dominion Generation, and Dominion Energy. DVP is focused on regulated electric transmission and distribution that serve residential, commercial, industrial and governmental customers in Virginia and North Carolina. Dominion Generation generates electricity through coal, nuclear, gas, oil, hydro and renewable sources. Dominion Energy centers around regulated natural gas distribution and storage.
In our view, the company possesses several inherent strengths that will hold it in good stead in future quarters.
First, the company's disappointing earnings results should be placed in the context of an unseasonably mild winter, which lessens demand for power. Moreover, the company has been boosting its capital expenditures to grow its electric and natural gas businesses and is extending operations throughout the Mid-Atlantic. The company also has been beefing up its renewable energy portfolio.
And in a huge strategic reach to the West, Dominion Resources announced on Feb. 1 that it would spend about $4.4 billion to acquire Questar (STR) , a utility based in Salt Lake City that's a primary distributor of natural gas to Western states.
The merged business entity would serve about 4.8 million electric and gas customers in seven states. The Questar deal is a shrewd and far-sighted move on Dominion's part that will generate economies of scale and add new revenue streams, to offset weakening demand and plummeting energy prices.
Dominion's trailing 12-month price-to-earnings ratio of 24 looks a bit pricey, compared with the trailing P/E of 16 for its peers. But the Questar merger should help the stock outperform in a year that some analysts say will usher in a bear market. With the stock now trading at about $71.40, the average analyst estimate is $77, which suggests the stock could still gain 7.8%. Meanwhile, the dividend yield of 3.9% is enticing for investors who remain desperate for decent yields.
The verdict: Despite Monday's negative operating results and a subpar performance over the past year, Dominion remains a solid bet for both income and capital appreciation.
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