Does This Utility Have the Best Position in the Business?


Investing in a utility should be simple: Just look at what company you pay to keep the lights on and buy its stock. Unfortunately, that is not the case, especially in our more environmentally conscious society. Now you need to find a utility that's going green so that it keeps your portfolio flowing with green.

Here's the rub: In order for that utility to generate the kind of returns you expect, it needs to generate its electricity from the cleaner sources that actually help boost the bottom line. Given the return differentials among the generating options, natural gas is the clean source offering the most bang for your utility's buck at the moment.

With its prime position to profit from natural gas, Dominion Resources is, in my opinion, one of the best-positioned utilities. Not only does the company generate a lot of energy from natural gas, it also generates a lot of profit from transporting it. That's right, Dominion has strategically positioned a growing midstream business inside its sleepy utility segments.

Its this midstream business embedded within Dominion's energy subsidiary that has some very intriguing pieces being laid as the foundation for the company's growth. While the segment houses two gas utilities located in Ohio and West Virginia that serve more than a million customers, there is much more here than I think investors realize.

Among the jewels are over 10,000 miles of gathering and transmission pipeline, a massive natural gas storage business and a good amount of processing capacity. Also, in what could be a real hidden gem, Dominion's Cove Point LNG facility in Maryland has the potential to be used to export natural gas. What's more, all of these assets are located in the heart of the natural-gas-rich Marcellus and Utica shales.

What else is nice about Dominion is that there is more to the company outside of natural gas. Its electricity generation fleet is pretty balanced between coal at 31%, natural gas at 28%, nuclear at 21%, and oil, renewables, and others representing the remaining capacity.

While renewables are a smaller portion, that's not to say that Dominion isn't planning to expand its portfolio, as it just announced its first foray into solar energy last week. The company also boasts of hydro, wind, and biomass among its generating assets. So, while it doesn't have as clean a fleet as its wind-powered peer NextEra Energy , that's only because its attention is elsewhere at the moment.

Having a diversified generation portfolio is important -- many in the industry have shifted their generation mixes toward cleaner sources. Duke Energy for example has gone from 55% coal and 5% natural gas generation in 2005 to a planned mix of 38% coal and 24% natural gas by 2015.

That's still nowhere near as clean as NextEra, which already has a mix of 56% natural gas, 13% wind, and just 6% coal. For arguably the cleanest portfolio in the business, investors can turn to Atlantic Power , which offers a portfolio that's 96% clean and a dividend yield near 7%. No matter where you look, the industry is working hard to clean up its generating capabilities.

That being said, I still like the balance at Dominion. We've seen an over-reliance on one type of generating fleet working against nuclear kingpin Exelon . The company, which generates more than half its power from nuclear, recently cut its dividend as returns have been held back by low natural gas prices. Instead, Exelon has turned to diversify its fleet by taking on smaller renewable projects which it hopes will have a quick payback.

Dominion is making its own investments in cleaner forms of energy generation, but not in the same way as its peers. It recently completed the Virginia City Hybrid Energy Center which cost $1.8 billion and will have 585 MW of capacity. What's interesting to note here is that Dominion is using another very inexpensive fuel -- coal -- but with a renewable twist: 20% of the facility's fuel will be wood waste. There's more on the way as company has several other coal-fired stations that it's converting to take wood waste with plans to spend more than $150 million to convert 150 MW of baseload capacity.

This is but a small sample from the impressive list of expansion projects across the company's portfolio. Between 2013 and 2017 the company could spend upwards of $3 billion each year on growth projects. That capital is expected to generate earnings growth of 5%-6% annually.

These projects are designed to move the company's business mix to generate much more stable regulated earnings. As it does, Dominion plans to be able to increase its dividend payout ratio to between 65% and 70% of earnings, up from a range of 60%-65%. Right now that's enough to generate a dividend right around 4% which the company now expects to grow by 6%-7% per year.

When you add it all up -- the generation growth, the midstream opportunities, and the financial profile -- its easy to see that Dominion has a lot to offer income-seeking investors. There's also more potential upside in the future from Cove Point and even an eventual sale or MLP IPO of some of its midstream assets, especially in the Utica. That's why I think Dominion just might be the best-positioned utility to generate market-beating returns over the next few years, and to show my confidence in this call, I'm giving Dominion the thumbs-up in my CAPS profile.

If Dominion's generation mix isn't clean enough for you as the nation moves increasingly toward clean energy, consider Exelon, which is perfectly positioned to capitalize on having the largest nuclear fleet in North America. This strength combined with an increased focus on renewable energy, along with its recent merger with Constellation, puts Exelon and its best-in-class dividend on a short list of top utilities. To determine if Exelon is a good long-term fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for instant access.

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Matt DiLallo has the following options: Short Apr 2013 $35 Puts on Exelon. The Motley Fool recommends Dominion Resources and Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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