How Dominion Energy Inc Makes Money

MarketsMotley Fool

At first blush, the way U.S. utility giant Dominion Energy Inc (NYSE: D) makes money is pretty easy to understand -- it provides customers with energy. But there's so much more to know than that if you really want to understand this company, which owns both regulated and unregulated assets, and actually handles several different kinds of energy. Here's a primer on the key facts that'll help you get a feel for how Dominion Energy makes the money it needs to support its fast-growing dividend and 4.6% dividend yield.

The basics of the business

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Dominion breaks its operations down into three main segments: power generation, power delivery, and gas infrastructure. Looking from the top down, each is pretty simple to understand. But when you start to dig in a little, you see there are nuances that are important.

For example, power generation is where the company places all of its facilities that generate electricity. Its total generating capacity of nearly 27 gigawatts, however, is broken down between utility operations (21.5 gigawatts) and merchant power (4.7 gigawatts). These are two very different businesses, and the generating assets in each are also drastically different.

The utility segment primarily generates power using coal (24% of 2016 power production and 20% of capacity), natural gas (30%, 35%), and nuclear (31%, 16%). Renewables (primarily hydroelectric), oil, and purchased power/nonutility production make up the rest of production and capacity. Most of the energy generated is used to supply Dominion's end customers, which are served by the company's power delivery business. Delivery and production are broken out because of the changing structure of the power industry, where utilities like Dominion are increasingly passing through the cost of energy and charging customers for the use of their power lines.

That said, another key shift taking place in the electricity space is an increasing focus on renewable power. Although Dominion holds some renewable assets in its utility segment, most of its efforts in this space are on the merchant side. Here, the utility is building solar and wind farms, but also owns a collection of natural gas and nuclear facilities. The power generated by these assets are largely sold under long-term contracts to other companies.

Dominion's power delivery group, meanwhile, serves around 2.6 million residential and business customers in its North Carolina and Virginia service territories. But it also contains roughly 6,600 miles of high-voltage transmission lines that get power from one part of the country to another.

The natural gas business, meanwhile, also contains multiple parts. For example, the company provides natural gas to over 2.3 million end customers in Ohio, Utah, Wyoming, Idaho, and West Virginia. But within this segment is also a midstream business that is increasingly housed in the company's controlled limited partnership Dominion Energy Midstream Partners LP (NYSE: DM). The pipes and other midstream assets here help move energy from where it's brought out of the ground to where it's processed and eventually used.

Dominion Energy has been selling, or dropping down in industry speak, midstream assets to its partnership. That allows it to monetize the assets while still retaining control of them and benefiting from them financially. So as Dominion builds new midstream assets, like the Cove Point LNG export facility, it can drop those down to Dominion Energy Midstream Partners to generate cash that it can use to pay down debt or reinvest in its business. It's something of a virtuous cycle for Dominion Energy.

The future is about building

Roughly 90% of Dominion Energy's business is regulated. Although the exact impact of that regulation is different depending on which business is being discussed, the big-picture impact is largely the same. Dominion has to ask permission from regulators when it wants to raise prices.

The end result is that the best way for the company to grow its business is to invest in its business, which provides a solid justification for higher rates. And in the parts of its business were rate approval is less of an issue, capital investment expands its collection of revenue-generating assets. Good examples on the regulated side are the company's Greensville power station, which is roughly 75% complete (and on-time and on-budget), and storm-hardening power lines. The Cove Point LNG facility is an example of a growth-minded capital investment meant to expand Dominion's revenue generating asset base.

All in, Dominion Energy has plans to spend roughly $4 billion a year on capital projects through 2020 that will help it increase earnings between 6% and 8% a year. That spending will span its entire business. That bottom-line growth is expected to fuel dividend growth of as much as 10% a year over that time span, further extending the company's 15-year streak of annual dividend hikes. So it's not only important for you to understand each of the company's three core segments, but also the capital investment plans that go along with each business.

It's bigger than it looks

If you are looking at utilities, Dominion should be on your list for a deep dive. That said, looking at Dominion Energy as an electric utility is way too simple an approach here. It really is so much more than that. And even when you dig into the operation a little bit, you start to see that there are nuances within each of the three main segments of the business.

This, meanwhile, doesn't even take into account the company's efforts to grow its top and bottom lines via capital spending, a key issue to watch if you are considering an investment here. At this point, however, you should have enough grist to get yourself familiar with Dominion, one of the largest and highest-yielding U.S. utilities -- and one that plans to be toward the head of the pack when it comes to growth over the next few years.

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