Are These 2 Fast-Growing Dividend Stocks in Trouble?

Dominion Energy Midstream Partners (NYSE: DM) has grown briskly since its formation by utility giant Dominion Energy (NYSE: D) in late 2014. Fueling the bulk of the master limited partnership's growth has been a steady diet of transactions with its parent, as it moved over its midstream assets to this more tax-efficient entity. However, a recent tax policy change has clouded the long-term benefit of this relationship, sending units of Dominion Energy Midstream plunging more than 40% this year. Dominion has also taken a tumble, falling more than 15% for the year. Those declines have pushed the yields of these two energy infrastructure companies up to 4.9% for Dominion and 7.2% for its MLP.

Driving that slide is an increasing lack of confidence by investors in the long-term growth outlook of the two companies. Dominion, however, thinks the market has overreacted, which is why it hasn't altered its plans.

Drilling down into the issue

In mid-March, the Federal Energy Regulatory Commission (FERC) changed its long-standing policy that allowed MLPs to recover an income tax allowance in addition to the rates charged on some federally regulated pipeline systems. Investors sold MLPs off on the news, even though this change wouldn't affect them all the same way. Many made that clear in press releases detailing what impact, if any, it would have on their business. For example, natural gas-focused pipeline MLP Williams Partners (NYSE: WPZ) noted that while a third of its earnings come from regulated pipelines, most wouldn't feel an impact from this ruling because of recently settled rate cases. Because of that, Williams didn't change its guidance for dividend growth. Furthermore, Williams noted that, if the change does affect the company in the future, it's "well positioned to execute on corporate structure changes, which would restore the income tax allowance to the pipeline's cost of service rates." The implication here is that the company could merge with its C-corp parent, Williams Companies (NYSE: WMB), or sell these pipelines back to its parent, to restore this tax allowance since the FERC change affected only MLPs.

Dominion Energy, however, wasn't quite as clear on the impact when it issued a statement commenting on the change. The company said it "believes that FERC's change in policy will take years to implement and, even then, will only impact revenues on a prospective basis from the conclusion of any ratemaking process." As a result, it doesn't anticipate any lost revenue at Dominion Energy Midstream over the next three years and "is still evaluating any long-term impacts and their timing." If Dominion's view is the correct one, then the company should have no problem continuing to drop down midstream assets to its MLP.

Why it matters to investors

Those dropdowns are crucial to both Dominion and Dominion Energy Midstream. In Dominion's case, the company had expected to generate up to $8 billion in proceeds via these asset sales through 2020. That plan would do three things for the company:

  1. Delever the balance sheet to its target level of 30%-40% debt by 2020.
  2. Give it some extra cash to grow dividends at a 10% annual rate through 2020 even as earnings are only on pace to expand at an 8%-plus rate over that timeframe.
  3. Provide it with the funding for expansion projects as well as share repurchases.

That strategy would also benefit Dominion Energy Midstream by giving it the fuel to grow its distribution at a 22% compound annual growth rate through 2020.

The concern with this plan, however, is now twofold. First, while Dominion doesn't anticipate any near-term changes to the cash flow of its MLP from the new FERC policy, at least one other pipeline company sees it having an immediate impact on cash flow. Meanwhile, even if the change doesn't cut into cash flow this year, it could weigh on the valuation of MLP assets. As a result, the math driving the drop-down strategy might not work as favorably as before, according to an analyst at Bank of America, who downgraded the stock on the news. If these concerns come to fruition, both Dominion and Dominion Energy Partners might not grow their high-yielding payouts as quickly as once thought. However, Dominion did note that it has several other options to meet its objectives, such as selling its newly constructed natural gas export terminal to the MLP instead of pipeline assets.

A little cloudier, but still obtainable

An unexpected policy change might have thrown a wrench into Dominion's strategy to increase its dividend while providing even more income growth for investors in its MLP. While it's unclear yet as to how much impact if any, the change will have on the growth strategy, investors have taken a sell first, ask questions later approach, despite Dominion's effort to reassure them. That might have been an overreaction, because even though there are no guarantees in investing, it doesn't look as if these dividend growth plans are in trouble, especially since Dominion does have alternative routes to get to the same destination.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Dominion Energy, Inc. The Motley Fool has a disclosure policy.