Want to get defensive? D is an undervalued Utility stock you should pay attention to

September 20, 2018

Want to get defensive? D is an undervalued Utility stock you should pay attention to

A basic tenet of economic and market analysis asserts that the longer a bull market lasts, the more likely it becomes to experience a significant reversal. It may seem strange to some to be writing about a potential downturn when most reports indicate that the U.S. economy continues to be healthy and strong; but one of the early indications that a significant shift from expansion to contraction, and consequent bearish conditions in the financials market often comes when risks begin to increase and appear in unexpected areas.

One of those risks comes from the simple, extremely extended state of the current market and U.S. economy, which is now well into its ninth year and beginning to move into historically unprecedented territory. No bull market lasts forever; it will inevitably shift to the bearish side just as bearish markets will eventually, and inevitably swing back to the upside. Another potential risk that most did not anticipate before the beginning of 2018 was the threat of global trade war; and yet the Trump administration announced a new set of $200 billion worth in tariffs against China. And while the government continues to negotiate with Canada and the European Union, it is also true that tariffs against those governments and Mexico persist as the U.S. maintains its hard line. The effects of tariffs against those countries, and the retaliatory tariffs they have imposed on the U.S., still hasn’t been seen, but that doesn’t mean the threat isn’t real, only that it could take longer to become apparent.



A smart investor takes steps to stay engaged in the market while bullish conditions persist, while at the same time looking for ways to minimize risk exposure. One method is to focus on industries whose businesses aren’t subject to the same cyclicality most pockets of the economy experience. One of those industries is the Electric Utilities industry, where the largest and most-established companies continue to maintain healthy revenue streams even when the economy suffers. The industry has been one of the strongest performers in the market of late, increasing about 15% from a February bottom and staging what is now an intermediate upward trend from that point.

One of the largest players in the industry is Dominion Energy Inc. (D), a company that has followed that broader trend to an increase of about 12% over the same period. The really interesting part of this stock’s story is that despite its bullish performance so far this year, the stock remains significantly undervalued, offering a sizable value-oriented opportunity over the long term on a high-dividend stock with a solid financial base.



Fundamental and Value Profile

Dominion Energy, Inc., formerly Dominion Resources, Inc., is a producer and transporter of energy. Dominion is focused on its investment in regulated electric generation, transmission and distribution and regulated natural gas transmission and distribution infrastructure. It operates through three segments: Dominion Virginia Power operating segment (DVP), Dominion Generation, Dominion Energy, and Corporate and Other. The DVP segment includes regulated electric distribution and regulated electric transmission. The Dominion Generation segment includes regulated electric fleet and merchant electric fleet. The Dominion Energy segment includes gas transmission and storage, gas gathering and processing, liquefied natural gas import and storage, and nonregulated retail energy marketing. As of December 31, 2016, Dominion served utility and retail energy customers, and operated an underground natural gas storage system with approximately one trillion cubic feet of storage capacity. D’s current market cap is $46.2 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased by more than 23% while revenues posted an increase of almost 10%. In the last quarter, earnings declined 24% versus the quarter prior, while revenues dropped about 11%. The company operates with an impressive margin profile, with Net Income running at about 22.5% of Revenues for the last twelve months, and 14.5% in the last quarter.
  • Free Cash Flow: D’s free cash flow has been negative for more than four years, but has been increasing steadily since mid-2016, when it bottomed at more than -$2 billion to its current level at about $110 million in the last quarter. That’s a positive increase of nearly $1.9 billion, or 95% in the last two years. Negative free cash flow generally isn’t a positive, but it also hasn’t been unusual for the industry in the last few years. The more important point is the upward direction D’s free cash flow trend.
  • Debt to Equity: D has a debt/equity ratio of 1.6, which is higher than I normally prefer to see, but is also not unusual for utility stocks. The company’s balance sheet demonstrates their operating profits are more than adequate to service their debt.
  • Dividend: D pays an annual dividend of $3.34 per share, which translates to an annual yield of about 4.72% at the stock’s current price. That’s better than the average yield of the S&P 500 or even of 30-year Treasury notes, which investors also like to gravitate to when they perceive greater risk in the marketplace.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for D is $30.65 per share and translates to a Price/Book ratio of 2.3 at the stock’s current price. Their historical average Price/Book ratio is 3.36, which suggests the stock is trading right now at a discount of about 46%, and that puts the stock’s long-term target at nearly $103 per share. That is well above the stock’s all-time high, reached earlier this year a bit above $85 per share, but is also makes that high – which translates to a long-term upside opportunity of more than 20%.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from December 2017 to its low in June of this year; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. Since finding that bottom at around $61.50, the stock has increased about 15%. Since August, the stock has moved into a narrow, sideways range that technical traders like to consider a consolidation range. Support is around $70, and resistance is about $72.50.
  • Near-term Keys: The thing about a narrow trading range such as that maintained right now by D is that it makes defining technical signal points pretty easy. A break above $72.50 could mark an interesting opportunity to buy the stock or to work with call options for a short-term bullish trade, while a drop below $70 could provide a good opportunity for a bearish trade by shorting the stock or working with put options. If you like the stock’s value proposition right now, the sideways range also provides a good opportunity to take a long position and take advantage of the passive income offered by its healthy dividend yield.