Master of Its Dominion

07/02/2007 12:00 am EST

Focus: COMMODITIES

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of Utility Forecaster and associate editor of Personal Finance, says Wall Street has underestimated the stock of Virginia-based utility Dominion Resources.

Dominion Resources (NYSE: D) now has contracts for 80% to 85% of the natural gas and oil operations it put on the market earlier this year. Results are still out for the remaining properties, but the tally of around $11.7 billion thus far has already been pronounced a disappointment by some on Wall Street, [so] the shares have sold off from the low $90s into the low $80s. (They closed above $86 Friday-Editor.)

We had Dominion on watch to get a read on the sale and what the company would do with the proceeds. Now we know: management plans to cut debt by roughly $3.2 to $3.5 billion and has begun making repurchases. That's roughly 16% to 19% of total debt-enough for S&P to rate the outlook for its BBB rating "positive," though not sufficient for an automatic upgrade.

After taxes, the rest of the [sale] proceeds should come in around $7 billion, which management apparently intends to use to buy back stock. Based on current levels, that would retire nearly 25% of the shares.

The real question is whether or not the rest of the company is worth holding onto at this lower level of capitalization. The answer is yes. Divesting the bulk of the oil and gas operations takes Dominion back to its infrastructure roots. The largest remaining operation will be the Virginia electric utility, which now enjoys one of the most favorable regulatory regimes in the country, including automatic recovery of capital costs as incurred at a rate of return equal to an average of Southeastern states.

The company also continues to run America's largest energy storage system, as well as 6,000 miles of power transmission lines; 7,900 miles of gas pipeline, and natural gas and oil reserves in Appalachia (about 20% of the prior total). It operates the largest power plant fleet in New England (20% of the market) and unregulated nuclear plants in several states.

With natural gas and oil production a volatile and growing portion of earnings, the company's overall profits had become increasingly unstable. In contrast, the post-divestiture company's remaining assets have grown steadily over the years and should be even more profitable with increased management focus. All that adds up to solid growth in earnings, dividends and the share price in coming years. Dominion Resources is again a buy up to 90.

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