Dominion Drops a Bombshell

I have owned Dominion Energy (D) in my Dividend Growth Portfolio (DGP) since 2019. I thought it would be a long-time holding for decades.

But a few days ago, Dominion announced a fundamental strategic change. It is going to sell its gas transmission and storage assets to Berkshire Hathaway (BRK) in a $9.7 billion deal, of which $5.7 billion is assumption of debt.

While that gets Dominion out of pipelines and makes its balance sheet prettier, it significantly changes Dominion’s business model and reduces its earnings.

At the same time, the company decided to pare down its dividend payout ratio from 80% of earnings to 65%.

Taken together, those decisions will result in a 33% dividend cut in the 4th quarter of this year, marked by the arrow on this slide from Dominion’s presentation about the deal. Dominion’s quarterly dividend per share will drop from $0.94 to $0.63.

Dominion’s presentation was Monday morning at 9:00. The two companies had kept everything secret. As soon as the market opened at 9:30, Dominion’s price swooned by more than 10% by the end of the day.

Dominion’s shareholders apparently didn’t like the idea. After thinking about it overnight, I decided that I didn’t like it either. In an instant, Dominion went from a bellwether dividend growth stock to one that has pre-announced a dividend cut.

So, I cut too: Dominion, that is, right out of my portfolio.

My portfolio rules do not require a sell upon hearing of a dividend cut, but according to people who have done the math, it will take Dominion’s dividend around 13 years to recover. And that’s if everything goes according to Dominion’s stepped-up increase plan starting from the new lower dividend level in 2022. (As of now, Dominion’s dividend will be frozen at the lower level for 2021.)

The sale of assets also represents a fundamental change in the company’s business model. An argument can be made that Dominion will emerge as a smaller, stronger, and better-focused company. It might, but I’m not sticking around to find out.

Good-bye Dominion.

Replacing Dominion

I do not often sell out of positions, but when I do, I redeploy the money immediately. Other than accumulating dividends awaiting reinvestment, I don’t hold cash in the DGP. It’s always fully invested.

I frequently say to invest like you’re the CEO of your own business. (See DGI Lesson 12: Run Your Investing Like a Business.) Perhaps the most important decisions a business owner makes are about how to allocate capital.

That’s what I am doing here: Re-allocating capital. I am moving capital from a stock that I have soured on into a stock that now appears to be a better bet to help me reach the main goal of the portfolio, which is to generate reliable, increasing income through dividends.

Happily, I had a ready-made replacement: Pinnacle West Capital (PNW), which was my Dividend Growth Stock of the Month just a month ago. I was already considering PNW for my next dividend reinvestment in August, so I simply moved the purchase up.

The swap lets me exchange a utility for another utility, so my portfolio’s diversification across industries stays the same.

The dividend income stays about the same too. At its current payout and former price, Dominion was yielding about 4.5%. After the cut in December (making a guess as to its price then), it will be yielding 3.4% or so.

Pinnacle West is yielding 4.1% right now, and that doesn’t include its 2020 dividend increase, which will be announced later this year. Plus, PNW is undervalued, as covered in last month’s article about it.

Selling and Buying

I executed the following transactions within a few minutes of each other on Tuesday, July 7, 2020. The following screenshot from E-trade shows the sale of Dominion (bottom) and the purchase of PNW (top).

The proceeds from the sale were $2760. The cost of the purchase was $2811. I took the extra $51 from my dividend kitty. That won’t delay the next reinvestment when the kitty hits $1000 in August.

Portfolio Before and After

Here, from Simply Safe Dividends’ portfolio function, is a snapshot of the portfolio prior to the transactions:

Notice how 3% of my income was designated as “may be unsafe.” That’s because Simply Safe Dividends revised Dominion’s safety score downward as soon as it found out about the surprise asset sale.

Here is the same information after I replaced Dominion with Pinnacle West.

Note the impact on the portfolio’s income:

  • Income drops by $23 per year, or about half of a percent.
  • Current yield stays the same at 3.6% (rounded).
  • Dividend safety improves because Dominion’s dividend, obviously, is no longer safe, while PNW’s dividend has a safety score of 92 out of 100.
  • The portfolio’s diversification stays identical.

Closing Thoughts

On an investing blog that I frequent, someone asked me whether, had I known about Dominion’s sale of assets to Berkshire a week in advance, would I have purchased Dominion?

My answer was “no,” because I require a minimum of five years’ dividend growth just to consider a stock. (See DGI Lesson 3, The Five-Year Rule.)

The portfolio’s name, after all, is “Dividend Growth Portfolio.” So I wouldn’t add a stock that I know is going to cut its dividend in a few months.

When I analyzed Pinnacle West Capital last month, I realized that I had found a fine utility and immediately considered it to be a live candidate to add to my portfolio. The opportunity to do so simply came along a few weeks sooner than I expected. While it took me a day to figure things out, in the end it was a pretty easy decision.

When I report on the portfolio next month, Dominion will be gone, PNW will be aboard, and everything else will look pretty much the same.

— Dave Van Knapp

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Source: Dividends and Income