Dominion Energy is a relatively boring utility with a high yield, but there's one important thing it is lacking that will turn some off.
The S&P 500 index is yielding a paltry 1.2% today. The average utility, using Utilities Select SPDR ETF as a proxy, is yielding 3%. Dominion Energy's (D 0.81%) dividend yield is a far more hefty 4.7%. That will probably catch the eye of most income-oriented investors. But before you jump aboard, you'll want to understand a couple of caveats that come with owning Dominion Energy.
What does Dominion Energy do?
Dominion Energy is a fairly simple regulated electric utility today, but it hasn't always been like this. At one point it owned oil and natural gas production assets, pipelines, and natural gas utilities. The company has spent the past couple of decades trimming down its business to become more simple and less risky.
Image source: Getty Images.
The most recent change came in 2023, when the company announced plans to sell three regulated natural gas utilities to Enbridge (ENB 1.57%). The last of the three sales is likely to be completed in the third quarter of 2024. After that point, Dominion expects to grow earnings at a strong 5% to 7% rate through 2029. That's an attractive growth rate for a utility. The growth is going to be driven by a $43 billion capital investment plan that notably includes a huge offshore wind development project.
If you're an income investor looking for a high-yield utility stock to add to your portfolio, Dominion Energy is definitely worth a closer look. But there are a couple of additional issues to consider before you buy it.
Dominion hasn't been the best dividend stock
Before Dominion decided to sell the natural gas utility operations, it agreed to sell its pipeline business to Berkshire Hathaway (BRK.A 1.85%) (BRK.B 1.61%) in 2020. That was a very large sale, which materially reduced the company's cash flow, and necessitated a dividend cut. After that cut, management said dividend growth would resume, which it did for one year. And then Dominion announced it was examining its business with the intent of overhauling it -- again.
Management has stated repeatedly that the current dividend is safe, but now that the review is over -- the outcome being the sale of the natural gas utilities, among other things -- the company is focused on debt reduction and improving its payout ratio. In other words, until Dominion's balance sheet is stronger and its payout ratio is in line with the payout ratio of its peers, there aren't going to be any dividend increases here.
D Payout Ratio data by YCharts
It could take several years before the dividend starts to grow again, noting that the payout ratio will probably have to dip below 70% before a dividend increase is considered. So buying now gets you a higher yield, but you won't see any dividend growth. If that trade-off isn't OK with you, you won't want to own Dominion Energy until dividend growth resumes.
In all, Dominion is kind of a special-situation investment. It isn't a turnaround, exactly, since the company is actually operating fairly well and has an exciting business future. It operates in one of the most in-demand locations for data centers in the world. But the business overhaul is still a real issue to consider, because it will leave the company trailing its peers in a way that will turn off a lot of dividend-focused investors.
Dominion is for contrarians with long investment horizons
If you're looking at Dominion because of its above-average dividend, yield make sure you understand what comes along with that yield -- notably, an ongoing business overhaul and a lack of dividend growth. That won't be acceptable to a lot of dividend investors, and understandably so.
However, if you think in decades, Dominion might still be a good option, particularly if you're in a position to reinvest dividends today. Assuming the company successfully lowers the payout ratio, by the time you want to use the dividend to pay for living expenses the dividend could be growing again. And you'll have compounded that hefty yield in the meantime, materially increasing your position in the stock.
Reuben Gregg Brewer has positions in Dominion Energy and Enbridge. The Motley Fool has positions in and recommends Berkshire Hathaway and Enbridge. The Motley Fool recommends Dominion Energy. The Motley Fool has a disclosure policy.
