Home / Business / 3 Great Recession Proof, High-Yield, Blue-Chips – Dominion Energy, Inc. (NYSE: D)

3 Great Recession Proof, High-Yield, Blue-Chips – Dominion Energy, Inc. (NYSE: D)





(Source: imgflip)

My goal is to help income investors find good places to park their money to achieve safe and steadily growing dividends, no matter what the market or economy is doing. Well, unfortunately on March 22 nd the long-dreaded (it is falling for eight years) 10y-3m yield curve inversion finally happened.

According to the San Francisco Federal Reserve, the 10y-3m yield curve is the best recession predictor ever discovered, and according to the Cleveland Fed, since 1966 every inversion save for one (89% accuracy) has resulted in a recession coming within the next 16 months.

That's likely because, according to a survey of banking loan officers by the Dallas Fed, banks use a prolonged moderate inversion of the 10y-3m curve as a sign they need to pull back on landing (and thus cause the recession they fear).

In recent months, the flattening yield curve has been pointing to rising recession risk, which on February 22 nd hit the highest levels in this economic cycle according to the Cleveland Fed's model.



(Source: Cleveland Fed) – Data as or February 22 nd (when the curve was 21 basis points)

Right now the 10y-3m curve sits at -4 basis points, triggering a 10-day window in which, should the curve not rise above zero, the recession clock will start counting down



(Source: MarketWatch, Bianco Research)

This means that a recession is now more likely than not in 2020 (we're on day 3 of that 10-day window), and since WWII now recession has always avoided stocks falling into a bear market.

This is probably a good time to start getting defensive, making sure your asset allocation and portfolio holdings are recession-proof, as I've finished doing with my own retirement portfolio.

But likely with recession now (about 90% probability if yield curve remains inverted), which means mean that investors need to panic. Rather they need to focus on the best quality, undervalued dividend growth stocks, especially recession-resistant sleep-well-at-night or SWAN blue chips.

I've spent the last few weeks crafting a quality scoring system that measures every company on my watchlist by three criteria

  • Dividend safety (balance sheet, cash flow stability, payout ratio)
  • Business model risk (moat, disruption risk, ability to generate returns on invested capital over its cost of capital) [19659014] Management quality (capital allocation track record, dividend friendly corporate culture)

That now gives me 11-point scale for which companies with ratings of 8 or higher are considered blue chips and 9 or above are SWAN stocks. 19659017] So let's look at why Altria (MO), Enbridge (ENB) and Dominion Energy (D) are three of my favorite high-yield SWAN recommendations for income investors today. That's because all three sacrifices

  • High-quality (quality scores of 9 or higher)
  • Safe dividends (with recession-resistant cash flow)
  • Are likely to keep growing their payouts during a recession
  • Low volatility (will likely fall less in a bear market)
  • Each fell less than the S&P 500 during the Great Recession

Best of all, from today's attractive valuations, all three high-yield SWANs are likely to also deliver double -disit total returns that make them not just some of the best defensive stocks you can buy today, but some of the best low-risk investment opportunities of the next few years.

Altria: The American King Of A Wide-Moat, Recession-Proof Business Model

  • Yield: 5.7%
  • Sensei Quality Score: 9/11 (NYSEARCA: SWAN)
  • Beta: 0.51 (generally 49% less volatile than S&P 500)
  • Peak Decline During Great Recession: 20% (vs. 57% for S&P 500)

Altria actually enjoyed 10% sales growth during the Great Recession, showing that even in the worst economic downturn since the Great Depression, addictive cigarettes are a highly stable business and source of rich free cash flow to support the dividend.

This explains why adjusted for spin-offs, Altria has grown its dividend for 49 straight years. That's an amazing track record, which has helped the company become one of the top investments of the last 50 years. Even more impressive is the fact that Altria has been able to achieve steady sales, cash flow, and dividend growth all while facing a myriad of existential threats that bears said to the company to bankruptcy including,

  • 60 years of declining US smoking rates (from 42% in the early 60s to 14% today)
  • A $ 206 billion master settlement when 46 state attorneys general sued big tobacco in the 1990s
  • Never-ending regulatory risks from the FDA
  • Steadily higher state / city tobacco taxes

Morningstar, which is famous for its conservative growth estimates (often lower than other analysts and even management itself), expects cigarette volumes to decline at about 4% in perpetuity



(Source: Investor presentation . It's also roughly the rate management expects to continue (and is built into growth guidance) through 2023.



(Source: Investor presentation)

The key to Altria's impressive growth in the face of never-ending volume declines is its strong brand power, which gives it a wide moat and the ability to raise prices fast enough to keep revenue growing slowly but steadily. The main cash cow is Marlboro. The main cash cow is Marlboro (19659040). The main cash cow is Marlboro. , which at 43.1% market share is the # 1 premium cigarette brand in America. Studies show that premium cigarette smokers are the least likely to quit, and about 80% of the company's operating profits are derived from premium cigarettes.

Morningstar estimates (and I agree) that Altria's core strategy of ongoing price hikes to modestly grow its top line can probably continue for about 20 years. How can that be when a pack of smokes already costs so much? Actually, in Australia, even more draconian anti-smoking laws and much higher taxes mean that the average pack costs about three times as much as in the US.



(Source: Investor presentation)

And believe it or not, in terms of affordability to consumers, Australia is just the 9 th most expensive country. Based on the smoking decline rates in both developed and emerging markets with higher cigarette packs, most analysts remain confident that Altria's core business model will not be in the foreseeable future.

paid for Juul (more on this in a moment) but it was a highly strategic move. That's because Juul commands 75% market share in the booming industry, which has tripled its unit sales volumes over the past five years.



(Source: Investor presentation)

The Juul (and Cronos) investments represent Altria's long-standing tradition of diversifying outside of cigarettes including via wines, cigars, and its 10.2% stake in Anheuser-Busch InBev (BUD). Only time will tell whether or not these recent strategic investments pay off but no one can get into the rapidly growing vaping and global cannabis industry is a smart play (outside of valuations paid) if you are about the future of the cigarette industry.



 

(Source: Investor presentation)

That's why, unlike previous vaping industry leaders, Juul's non-promotional brand loyalty score is equal to Apple's (AAPL) and slightly ahead of other beloved brands alike Trader Joe's and Southwest Airlines (LUV)

So the FDA's threatened doomsday scenario (see risk section) Juul Labs is likely to continue to dominate the US market and is planning on rapid overseas expansion as well



(Source: Investor presentation)

That's why international markets offer an addressable market three times that of North America, so even if Juul can't replicate its dominance overseas It should remain a fast-growing company. What's more, Altria's interest in Juul would mean growing earnings (via the equity method of accounting) that would not be at the expense of its US-based cigarette business.



(Source: Investor presentation)

Why does Altria think Juul's international efforts will be successful? Due to its early attempts to break into the UK, Italian, German and Canadian markets have seen the substantial market share gain. That includes dominating the competition in early Canadian trial stores

What does Juul ultimately mean to Altria? Well, according to management,

  • Dominance in the US vaping market which is expected to grow 15% to 20% CAGR over the next five years
  • Operating margins (at Juul) equal to US cigarettes within five years
  • International revenue equal to US revenue within five years
  • International operating margins equal to cigarettes by 2023
  • Returns on investment above its 8% cost within five years

Basically, Altria is saying that it expects Juul to pay off big time, and become a dominant global player in the rapidly growing vaping market.

Now it's true that Altria recently had to issue a ton of debt ($ 16.3 billion) at an average interest rate of 4.1% (its average interest cost is now 4.4%). That led to several credit downgrades (more on this in the risk section). However, management is confident that 2019's planned cost-cutting (including shutting down its business now that it owns 35% of Juul) will effectively pay for the added interest expense.

Plus future cost-cutting is expected to generate $ 1 trillion in annual retained cash flow which can be used to pay down debt over time (restoring its credit ratings).



(Source: Investor presentation)

Altria has a good track record of paying down debt after major M&A deals, such as after the bought US Tobacco ( $ 10.4 billion 2008 purchase). And even before the pays down any debt Altria's leverage ratio is the second lowest in the industry and lower than most major consumer staples companies

For 2019, management is guiding for 4% to 7% adjusted EPS growth, which is lower than its long-term guidance (due to acquisition costs and time needed to scale up cost-cutting).



And while 5.5% earnings growth this year might not sound like much, keep in mind that according to FactSet Research, analysts expect the S&P 500's earnings growth this year to be 3.8% and just 1.4% for the consumer staples sector. In other words, Altria, just a rapidly slowing economy and facing all its headwinds, is likely to deliver some of the best earnings growth in corporate America in 2019.

And speaking of guidance, here's what Altria CEO Howard Willard said at the Juul acquisition conference call,

While we'll provide more detailed guidance for 2019 in our fourth quarter earnings release in January, we expect that 2019 adjusted diluted EPS growth will be slightly below the low end of our long term 7% to 9% growth aspiration due to debt incurred from our announced transactions at Cronos and Juul. And we maintain our long-term financial goals to grow adjusted diluted EPS at an average annual rate of 7% to 9% and to maintain a dividend payout ratio target of approximately 80% of adjusted diluted EPS. – Howard Willard (emphasis added)

That long-term earnings and dividend growth guidance (based on payout ratio target) is the lynchpin of Altria's bullish thesis



(Source: Investor presentation)

That guidance was once more at the CAGNY conference in late February

Basically, Altria is a great wide-moat, recession-resistant company whose track record on delivering safe and rapidly growing dividends even in economic downturns, is among the best of any company in the world

That's why it's one of my favorite high-yield, blue-chip recommendations today, ahead of a likely recession in 2020. But while Altria is a low-risk swan, my quality score rubric, that doesn It's mean there aren't plenty of risks To be aware of before investing in the company

Risks To Consider

There are two obvious risks to be aware of with Altria. The first is the regulatory one on tobacco which is a decades-long trend that the industry in general, and Altria in particular, has thus been able to navigate and still deliver strong top and bottom line growth, resulting in the steady dividend growth income investors. crave

However, investors always need to keep in mind that the FDA has recently stepped up its anti-tobacco effort, including via threatening,

These risks are underneath the bearish thesis that "this time is different" and that Altria's run as a big dividend growth stock has come to an end. I consider these risks worth watching but not currently representing a thesis breaker (given that earnings, cash flow, and dividends continue to grow).

A more immediate concern is the $ 14.6 billion in debt Altria is taking on to its equity stakes in Cronos and Juul Labs.

Company [19659080] Net Debt / EBITDA Interest Coverage Ratio

S&P Credit Rating

Altria 2.5 8.0 BBB
Safe Level 3.0 Or Less 8.0 Or Higher BBB- or higher

(Sources: management guidance, Simply Safe dividends, Moody's)

Moody's has downgraded Altria to A3 negative outlook (A-S&P equivalent) due to the leverage ratio upon the closing of the Juul / Cronos acquisition jumping up to 2.5. S&P and Fitch downgraded the company two notches to BBB from the two deals.

The rating agency says that if Altria doesn't quickly bring its leverage down to 2.5 or less it will get a downgrade. To get an upgrade Moody's wants to see no leverage come down to 2.0 or less (it was 1.3 before the investments).

Mind you, the debt levels are not unsafe in and of themselves and even and downgrade would leave Altria with a rating above S & P's (and firmly investment grade). However, the risky move Altria is taking. In fact, the reason that Altria is a level 9 quality SWAN (while ENB and D are level 10) on my quality scale is purely to do with the higher debt, which lowers its dividend safety from very safe to safe. Altria is responsible for the balance sheet, headed for a recession, and for non-profitable assets that won't boost cash flow for years. Altria plans to maintain both investments via equity financing, meaning that unless Cronos and Juul pay dividends (not for many years) then Altria's higher debt does not contribute to free cash flow which is what dividend investors care about.

And there's a lot of uncertainty around whether or not Altria bought Juul at the top of the cycle, growing at a growth company whose growth is about to a halt.

Late 2018 Altria announced it was investing $ 12.8 billion to acquire 35% of Juul Labs, the most dominant US company which Nielsen estimates has about 75% market share. Numerous analysts downgraded the company for solidly overpaying for Juul, (40 times sales and 150 times EBITDA according to most recently available Pitchbook data). A fairness to Altria, management has said that Juul's sales increased 400% in 2018 to $ 1 billion and some sources think they are closer to $ 1.5 billion (so potentially under 10 hours sales).

Morningstar's Philip Gorham (the analyst I most trust when it comes to covering Altria) downgraded the company's fair value estimate at 3% because the size of the deal returns on invested capital are going to take an 8% hit. Mind you, that means a decline from 29% to 21%, and 15% above is considered good for a tobacco company.

But it certainly is troubling that management would make a big strategic move that might result in a big future write-off, and could never try to get to FCF at all. That's due to the FDA's recent arrest has ramped up to levels that rival its hatred of tobacco itself.

The 2018 National Youth Tobacco Survey shows a 78% increase in vaping among US high-schoolers and a 48% increase among others schoolers, outgoing FDA Commissioner Scott Gottlieb threatened to kill the entire market (or at least drastically reduce their ability to sell their most popular products)

, on top of the dramatic rise in 2018, the entire category will face an existential threat . "- ​​Scott Gottlieb (emphasis added)

Gottlieb has announced he's resigning effective in April, which may be a boon for the industry since vaping has been in Gottlieb's crosshairs over the "epidemic" or against vaping. And it should be pointed out that the commissioner was not a fan of the Juul investment, which he holds a sign that Altria is potentially breaking its promise to the FDA to fight underage vaping sales growth. That's why, as part of its Juul investment, Altria is planning on marketing Juul e-liquid pods next to its cigarettes in retail stores.

Some analysts believe that the Gottlieb resignation could help and reduce the investment risk, however , Gottlieb's successor is National Cancer Institute director Norman Sharpless. It's much too early to tell whether Sharpless will be any more lenient with either Juul or tobacco companies. Morningstar and I believe that the current anti-violence policy will continue under Sharpless.

That's even though a new study published in the New England Journal of Medicine shows that is twice as effective as any other method in helping smokers quit. 19659104] Public Health England (a UK government agency) has even said that it is 95% safer than smoking and that the government should make these products available at taxpayer expense via the National Health Service. The safety assessment is backed up by a study from Philip Morris (NYSE: PM) which was recently released.

But as an investor know, tobacco / weapon is now a highly political issue and just because vaping is an objectively superior alternative. smoking doesn't mean that the global war on it will look up any time soon. Consider that recently

  • San Francisco has proposed banning entirely
  • India is trying to block Juul from entering the country (international expansion was a big part of Altria's investment thesis)
  • FDA (Gottlieb's final blow against vaping on his way out the door has very new new anti-vaping regulations including potentially withdrawing the most popular flavors from the market entirely.

The point is that the war on vaping, which could potentially decimate Juul's future business, is hardly a one -man crusade that is certain to end now that Gottlieb is leaving.

And while Altria's higher debt levels to pay for Juul and Cronos will not threaten the dividend significantly (because $ 575 million will actually cover the interest costs) ), it is also true that this deal could slow Altria's growth rate. That's because the company will now need to focus on paying down debt with retained cash flow instead of buying back shares.

This lack of buyback induced EPS growth is possibly why analysts currently expect Altria's 5-year adjusted EPS growth to be 5.7% to 6.9%, which is below management's long-term guidance of 7% to 9%.

The thing to remember is that these risks are mostly threatened by the future growth rate of the dividend, and not the dividend itself. However, since my recommendation of Altria is based on the company's total return profile (more on this in a moment), Altria should deliver strong bottom line and dividend growth its thesis (and fair value estimate) would take a hit.

] Enbridge: The Continent's Leading Energy Utility Likely Has Decades Of Steady Dividend Growth Ahead

  • Yield: 6.0%
  • Sensei Quality Score: 10/11 (SWAN)
  • Beta: 0.59 (generally 41% less volatile than S&P 500)
  • Peak Decline During Great Recession: 23% (vs. 57% for S&P 500)

When it comes to midstream blue chips they don't get bigger than Enbridge, which was founded in 1949 and is North America's largest oil & gas storage and transportation infrastructure provider.



(Source: Investor presentation)

You can think of Enbridge as an energy utility that operates in three main businesses.

(Source: Investor presentation)

It owns full or partial stakes in over 200,000 miles of pipelines that carry 25% of the continent crude (including 70 % of Canada's takeaway capacity) and 18% of North America's natural gas. The vertically integrated asset map means that the company connects oil producers in almost all of the major oil producing regions to 9 million barrels per day of refining capacity, as well as export capacity that is the lifeblood of the US shale tree.

Those Widespread assets provide incredibly stable cash flow under long-term volume committed contracts that have allowed it to raise its dividend for 24 consecutive years, and at a double-digit rate. This is also the case with long-term interest rates as high as 7%, showing that Enbridge investors need Don't worry about rising rates threatening Enbridge's growth. According to Enbridge, if long-term interest rates rose to full 1% it would result in a 0.25% decrease to DCF / share (what funds the dividend). Given the state of the economy, such a scenario is all but impossible but the point is that rising rates will never likely be threatened by Enbridge



(Source: Investor presentation)

While all midstream operators try to minimize cash flow sensitivity to commodity prices, Enbridge has the lowest sensitivity in the industry, with 98% of cash flow impervious to the price of oil. That's why its adjusted EBITDA has been stable or rising for the past decade, even with crude prices vacillating wildly.



(Source: Investor presentation)

And the contracts, with an average remaining duration of over 10 years, are almost all with investment grade counterparties, including regulated utilities. That's why the credit rating agencies consider Enbridge one of the lowest risk midstream operators on the continent.

Even more than Enbridge's rapid growth in cash flow and dividends is that the company managed to accomplish this during the 2014-2016 oil crash when many peers were forced to pay their debt due to excessive debt.



(Source: Investor presentation)

Enbridge has steadily reduced its leverage while maintaining one of the best payout growth rates of any midstream blue chip. That's why it's the highest credit rating in the industry. At BBB + stable, Enbridge is on par with other midstream SWANs such as TRP, EPD, and MMP

Company Debt / EBITDA Interest Coverage Ratio S&P Credit Rating

Average Interest Rate [Enbridge

4.7
Industry Average 4.9
4.4 4.5 4.5 NA NA

(Sources: earnings release, Gurufocus, FAST Graphs)

Enbridge finished the year with a leverage ratio of 4.7, which is below the 5.0 considered safe by credit rating agencies and bond investors. Remember this is a utility with incredible stable, recurring cash flow. That's why the absolute debt level isn't dangerous.

But as the low-risk, toll-booth, recession-resistant nature of the utility business model wasn't enough, Enbridge has become even more conservative, by adopting a self-funding business model. That means it's funding all of its future organic growth via retained cash flow (65% payout ratio) and modest amounts of low cost, fixed-rate bonds, with zero reliance on equity markets.



(Source: Investor presentation) – figures a CAD

Enbridge expects to invest $ 3.7 billion to $ 4.5 billion per year beyond 2020, the year its $ 12 billion current growth backlog is completed.



(Source: Investor presentation) – figures in CAD

For context, $ 12 billion in growth projects is the second largest backlog in the industry (behind only TransCanada (NYSE: TRP)) and that's just about the next two years and after putting $ 5.2 billion of projects into service in 2018. Those projects helped drive 20% growth in dividend 10% in 2019, living up to its guidance of 10% payout growth through 2020.



Next year's 10% hike, which is coming late 2019, marks Enbridge's 25 consecutive year of dividend raises, with father the best payout growth record in the industry.

Beyond 2020 management believes its self-funding business model and about $ 4.2 billion in annual growth investment can drive about 6% long-term DCF / share growth. And since the payout ratio is expected to remain stable at about 65%, that means long-term dividend growth that matches closely with that figure.

That might be a lot less than recent years, but remember that Enbridge is essentially a utility . But one that yields far more and offers long-term dividend growth that virtually no regulated utility can match

The key to Enbridge's growth thesis is supporting North America's epic energy boom, which is expected to last for decades.


(Source: Investor presentation)

Enbridge plans to spend about half its capex budget on expanding its existing crude system which consists of 17,000 miles of pipeline that carries 70% of Canada's oil, including 65% of its export capacity to the US. This is designed to serve the rapidly growing Western Canadian Sedimentary Basin which is not just ocean of oil, but the largest natural gas reserves on the continent.

Enbridge is also getting into the Permian Basin, which is potentially the largest oil formation ever discovered, with Rystad Energy estimating a further 250 billion barrels of recoverable oil equivalents.



(Source: Rystad Energy, Rattler Midstream S-1)

The Permian is now producing over 3 million barrels per day and expected to double production over the next five years.



 

(Source: Investor presentation)

Enbridge's first foray into the Permian is a small joint venture project, connecting the Permian to export facilities on the Texas Gulf Coast. But given the US oil exports are expected to grow from 2 million bpd to as much as 10 million by 2040, you can see the enormous future growth opportunities Enbridge (and all midstream giants) potentially have servicing that export growth.



( Source: US Energy Information Administration)

And that's just Enbridge's key growth catalysts on the business side of the business.



(Source: Investor presentation)

We can't forget about 200,000 miles of natural gas pipelines that the company plans to expand to cash in on the massive secular trend of rising gas usage, especially in LNG exports and Mexican gas exports (via pipelines with 25-year volume of committed contracts on 100% of capacity).



(Source: Investor presentation)

But let's not forget that Enbridge is also the largest gas utility in Ontario, whose population is expected to increase by 32% over the next 21 years. Enbridge estimates the Ontario utility segment alone can drive 1% to 2% long-term cash flow per share growth after 2020.

Basically, Enbridge is one of my favorite midstream blue chips because it takes the low-risk nature of this industry and cranks it up to 11 thanks to

  • The most diversified customer base
  • The strongest contract profile / lowest commodity sensitivity
  • A fortress-like balance sheet (that's getting stronger over time)
  • One of the lowest payout ratios in the industry
  • A self-funding business model with $ 2.6 trillion in annual retained cash flow to fund future growth
  • Numerous growth catalysts in nearly every part of the midstream capex boom ($ 1 + trillion in new spending needed through 2050)

With Enbridge, you do not just get a high-yield SWAN with a recession-proof business model, but a decade-long growth runway that makes it one of the finest blue chips in its industry and one of the best high-yield s tocks you can buy before an economic downturn.

But as with any company, low-risk doesn't mean no risk and here's what investors need to know before investing in Enbridge.

Risks To Consider

The biggest risks to keep in mind with any pipeline giant is execution risk. Enbridge recently suffered a one year delay on its most important growth project, the Line 3 replacement, which at $6.8 billion, makes up nearly 50% of the current growth backlog.



(Source: Investor presentation)

The good news is that management has learned from earlier mistakes, such as when it failed to secure the approval of native tribes in Canada (which killed the Northern Gateway oil pipeline, which it spent 12 years trying to build but had to cancel in 2016).

This time Enbridge dotted all its Is and crossed all its Ts by meeting with officials over 2,600 times, holding dozens of open houses with the public and most importantly, obtaining full cooperation of all native tribes over which the pipeline runs.

This final delay is not due to court cases (regulators have rejected the final appeals by environmentalists) but merely the timing of final state approvals. Federal approvals come 30 to 60 days later and by the time they will arrive it will be too late to begin construction. Line 3 is expected to be fully in service by the end of 2020 and the delay doesn't change 2019's DCF guidance or plans for the final 10% dividend hike for 2020.

However, the point is that, as we'll see with Dominion next, major midstream projects often get delayed (or even canceled) by an endless stream of court battles from environmentalists who seek to kill North America's energy boom.

Dominion Energy: Recession-Proof Business Model From One Of The Best Utilities In The Country

  • Yield: 4.8%
  • Sensei Quality Score: 10/11 (SWAN)
  • Beta: 0.25 (generally 75% less volatile than S&P 500)
  • Peak Decline During Great Recession: 34% (vs. 57% for S&P 500)



(Source: Investor presentation)

Dominion is one of the largest regulated utilities in America with 7.5 million gas and electric customers in 18 states. What makes them my second favorite utility in the country (behind NextEra Energy) is the quality management team has spent the past decade transforming its business model into a low-risk one that's ideal for conservative high-yield investors.



(Source: investor presentation)

The company sold off its cyclical businesses (such as oil & gas production) and has focused like a laser on achieving industry-leading growth rate while focusing on maximizing stable and regulated cash flow.



(Source: investor presentation)

Today 95% of the company's earnings are in regulated and wide-moat businesses that are recession-resistant.

By 2020 the company plans to generate 65% to 70% of operating earnings from regulated utility businesses in its core five states.



(Source: Investor presentation)

Those are located in some of the most constructive (ie profitable) regulatory environments.

These are where returns on equity are above average and allow for rapid earnings growth. Dominion's location in fast-growing states (with rapidly expanding economies) plus its ability to get 35% of its power from non-carbon sources today keep its regulatory relationships favorable, with regulators eager for it to continue rapidly expanding its infrastructure.

  • Virginia electric utility: 1% customer growth, 2.4% sales growth, 10.2% returns on equity (vs. 9.7% national average)
  • Gas utility business (four states, 6th largest gas utility in America): 1.4% annual customer growth, 10.1% ROE
  • South Caroline gas & electric businesses: 2% annual customer growth, 10.2% ROE

By the end of next year, another 25% to 30% of operating earnings will come from its midstream gas transmission/storage business (FERC regulated) located in 15 states.

Less than 10% of earnings will be from contracted electrical generation. 55% of that cash flow is under long-term (10 years or longer) contract, with 45% being market-based with hedges in place to smooth out cash flow. This includes 1.1 GW of solar power under PPAs with other regulated utilities.

In 2018 Dominion grew its earnings 12.5%, its dividend 10% and most importantly improved its balance sheet significantly via $8 billion in corporate level debt reduction.

Company Debt/ EBITDA Interest Coverage Ratio S&P Credit Rating Average Interest Cost Return On Invested Capital
Dominion Energy 4.5 3.3 BBB+ 4.0% 7%
Industry Average 3.8 4.9 NA NA NA

(Sources: Gurufocus, F.A.S.T.Graphs, Simply Safe Dividends, earnings supplement)

A strong balance sheet is essential, not just for a safe dividend, but also maintaining access to low-cost capital that is the lifeblood of the utility industry.



(Source: Investor presentation)

In 2018, Dominion, despite having to acquire SCANA and its MLP, Dominion Midstream Partners, was able to achieve its deleveraging targets two years early, resulting in a credit rating outlook upgrade that reduces the risk of downgrades in the future.



(Source: Investor presentation)

Today the credit rating agencies view the company's strong investment grade ratings favorably which is great going into a recession when credit markets are likely to tighten.

That strong balance sheet, when combined with the regulated, wide-moat nature of its business and highly stable cash flow, means that Dominion is likely to continue its impressive track record of steady dividend growth in all economic conditions.



 

(Source: Simply Safe Dividends)

But Dominion's balance sheet strengthening (at just the right time) wasn't just about surviving the next recession with its dividend intact, it was made with a long-term view on cashing in on some major secular macroeconomic trends.



(Source: Investor presentation)

That includes the rapid replacing of coal with natural gas-fired power plants, which will provide the baseload power to recharge electric cars. By 2050, millions of EVs in its core markets will need low-carbon power that Dominion expects to provide, both through new natural gas plants (some supplied by its own gas pipelines) as well as its rapidly growing solar/wind operations.



(Source: Investor presentation)

In Virginia alone, the company plans to spend $17 billion over the coming five years which will grow its rate base (on which it obtains permitted ROEs) by 7% to 8% CAGR.



(Source: Investor presentation)

The midstream gas storage and transmission business is under long-term contracts, with 73% of sales contracted with regulated US and international utilities. These "take-or-pay" contracts have firm volume commitments ensuring Dominion gets paid in full, even if actual gas demand were to fall during a recession (same as Enbridge).



(Source: Investor presentation)

Over the next five years, Dominion plans to invest $3.6 billion into expanding its midstream business, growing its rate base by double-digits.



(Source: Investor presentation)

The gas utility business plans to invest $3.5 billion to better serve the needs of 3 million customers in North Carolina, Ohio, West Virginia and Utah.

And now that the $14.6 billion acquisition of SCANA is finally complete, Dominion is one of the biggest electric and gas suppliers to the state (with 1.1 million customers), including its largest, richest and fastest growing cities.



(Source: Investor presentation)

Through 2023, Dominion is budgeting $2.1 billion in growth capex which will grow its SC rate base 5% annually.



(Source: Investor presentation)

In total, Dominion's $26 billion growth backlog will grow the rate base by 7% annually ($19 billion in total) and help drive some of the fastest earnings growth of any regulated utility, much less one of Dominion's impressive size.



(Source: Investor presentation)

That's expected to drive long-term earnings growth of 5% to 6%, which is above average for a large-cap utility.



(Source: Investor presentation)

Basically, Dominion Energy is a high-yielding regulated utility with a growing empire of profitable markets, that is poised to benefit from decades of steady and industry-leading growth rates. That means it's one of the best low-risk, high-yield names in its sector, and one of my favorite defensive SWANs to recommend going into a recession.

But while Dominion is low-risk, that doesn't mean there aren't important factors to consider before investing.

Risks To Consider

While Dominion's cash flow is protected by an empire of regulated monopolies and long-term contracted assets, just like any highly regulated company it can face setbacks.

One such recent problem is the Atlantic Coast Pipeline, which it owns 48% of and is now likely to be completed in 2021, two years behind schedule, and at a cost of close to $8 billion.



(Source: Investor presentation)

That project, like many long interstate pipelines, has faced never-ending challenges from environmentalists suing to block it. The 4th Circuit Court of appeals recently ruled against Dominion and so now it's taking its case all the way to the Supreme court.



(Source: Investor presentation)

Given the current composition of the court (5/4 conservative) and the numerous affidavits from regulated utilities explaining why they absolutely need this project to be completed, analysts believe Dominion will ultimately prevail.

However, it's important to remember that in the courts nothing is guaranteed, and even if the ACP (which represents pretty much all of Dominion's midstream growth backlog) isn't killed off, it will end up being two years late and costing roughly $3 billion more than expected. Should Dominion lose the case ACP might have to be abandoned, with billions in capex already spent amounting to nothing. Worse still, its long-term growth guidance might prove unattainable.

Another thing to remember is that while Dominion has access to $6 billion in theoretical liquidity to complete its growth plans, in reality, it can't borrow that much.



(Source: Investor presentation)

Not without leveraging the balance sheet to dangerous levels that would threaten its investment grade credit rating and access to low-cost debt. This is why over the coming three years the company plans to rely on about $1.2 billion in equity issuances.



 

(Source: Investor presentation)

Selling stock to fund growth is a natural part of the sector's business model, but it does mean that Dominion's future EPS growth is partially at the mercy of fickle equity markets. While utilities are low volatility by nature, share prices still tend to fall during recessions and so if the bear market is longer and more severe than expected, higher shareholder dilution could result in weaker-than-expected EPS growth.

Finally, there's the dividend growth to consider. While Dominion expects to grow earnings 5% to 6% over time, the dividend growth rate is going to fall off a cliff for the next few years.



(Source: Investor presentation)

After growing the payout at 9% CAGR over the past five years, Dominion's payout ratio is now at 87% which is far higher than most regulated utilities. Management wants to bring that down over time, both to improve its dividend safety, and to retain more earnings to fund growth in the future (further deleveraging the balance sheet).



(Source: Investor presentation)

But that means the dividend is likely to grow at slightly less than half the earnings growth rate until the payout ratio declines to the low 70s. That will still be roughly in line with the dividend growth rate of most utilities, but prove extremely disappointing to anyone who expected double-digit dividend growth to continue.

My point is that anyone considering investing in Dominion needs to have a realistic expectation for future payout growth and remember that the stock price is likely to track earnings higher over time.

Total Return Profile: Defensive High-Yield Stocks With Double-Digit Return Potential

What ultimately determines my recommendations is a company's dividend profile which is composed of yield, dividend safety, long-term growth potential, and valuation. Together, these tend to determine total returns and whether or not I consider a dividend stock to make a good long-term investment.

Company Yield Payout Ratio Sensei Quality Score (Out Of 11) Expected Long-term Cash Flow Growth Total Return Expected (No Valuation Change)

Valuation-Adjusted Total Return Potential

Altria 5.7% 69% 9 (SWAN) 5.7% to 9% 11% to 14.7% 12% to 18.1%
Enbridge 6.0% 58% 10 (SWAN) 5% to 7% 11% to 13% 13.6% to 17.4%
Dominion Energy 4.8% 87% 10 (SWAN) 5% to 6% 9.8% to 10.8% 10.9% to 13.1%
S&P 500 1.8% 33% 6.4% 8.2% 2% to 8%

(Sources: Simply Safe Dividends, F.A.S.T. Graphs, Morningstar, analyst estimates, Moneychimp, Multpl.com, Yardeni Research, Gordon Dividend Growth Model, Dividend Yield Theory)

All three of these defensive, low-volatility and recession-resistant SWANs offer very attractive yields that are up to three times what the S&P 500 is offering. More importantly, all of the dividends are safe, thanks to dividend well covered by cash flow that won't decline in a recession.

The balance sheets are also strong enough to avoid payout cuts, even during the Financial Crisis. The coming recession is likely to be far milder and give these blue-chips little trouble.

And in terms of long-term dividend growth potential, all three are likely to deliver similar or superior growth to the S&P 500's 20-year median rate of 6.4%. For Dominion that faster growth won't come until the payout ratio falls to management's new target range.

Even if you assume no valuation changes over time, the combination of yield and long-term growth would likely deliver double-digit returns, and all in a high-yield, recession-proof, low volatility package.

But adjusting for valuations (return to fair value) and you find that MO, ENB and D are likely to outperform the market by a wide margin, at least based on the current range of forward return targets most analysts/financial firms have (according to Morningstar).

Valuations: All 3 Blue-Chips Are Good To Great Buys Today



(Source: Ycharts)

It's been a great year for Dominion and Enbridge with only Altria underperforming the market, though rallying hard off recent lows (I last recommended it around $44). But even with strong rallies in recent weeks all three blue-chips are still good to great buys today.

That's based on my favorite valuation method for blue-chip dividend stocks, dividend yield theory or DYT. This is the only strategy that asset manager/newsletter publisher Investment Quality Trends has used since 1966.



(Source: Investment Quality Trends)

Decades of market-beating returns (and the best risk-adjusted track record of any newsletter over the past 30 years according to Hulbert Financial Digest) give credence to this approach. DYT simply compares a stock's yield to its historical yield, because unless the thesis breaks, yields tend to cycle around a relatively stable level that approximates fair value.

Company Yield 5-Year Average Yield Estimated Discount To Fair Value Long-Term Valuation Boost
Altria 5.7% 4.0% 29% 3.4%
Enbridge 6.0% 3.9% 35% 4.4%
Dominion Energy 4.8% 3.8% 21% 2.3%

(Sources: Simply Safe Dividends, Dividend Yield Theory, Moneychimp)

Keep in mind that interest rates are not likely to go much higher, even should the yield curve un-invert and the US avoid a recession. Thus I fully expect each stock to return to its five-year average yield, as long as management is able to deliver on its long-term guidance. And if I didn't have confidence in each of these companies' management teams I wouldn't recommend them.

A return to their historical yields would potentially give significant valuation boosts to each company, which could send long-term total returns to between 13% (for Dominion) and 18% (for Altria).

But in case you think I'm being overly bullish let's also consider Morningstar's highly conservative three-stage discounted cash flow models.

Company Morningstar Fair Value Estimate Discount To Fair Value

Long-Term Valuation Boost

Altria $62 9% 1.0%
Enbridge $47 22% 2.6%
Dominion Energy $84 10% 1.1%

(Source: Morningstar)

Indeed, Morningstar considers these blue-chips to be trading at lower margins of safety than dividend yield theory, but each is still at a modest to significant discount to its estimated fair value. Thus investors will likely, over time, see shares appreciate slightly faster than cash flow growth rates.

Splitting the difference between DYT and Morningstar's DCF models, I fully comfortable recommending Altria, Enbridge, and Dominion as strong to very strong buys under my blue-chip valuation scale.



  • Altria: 19% undervalued: strong buy
  • Enbridge: 29% undervalued: very strong buy
  • Dominion Energy: 16% undervalued: strong buy

Remember that undervalued blue-chips do not necessarily go up in a bear market (almost no stock does). Nor does a SWAN rating under my 11 point quality scale mean "no risk" (no such company exists), or that a stock might not fall significantly if the market were to crash like in 2008 (which it's not likely to).

Rather SWAN just refers to the quality of the company and the safety of the dividend. All three of these SWANs are likely to deliver generous, safe and rising income over time, no matter what the market or economy does, which is why I'm recommending them ahead of 2020's likely recession.

Bottom Line: These Are 3 High-Yield Blue-Chips You Can Trust To Deliver Safe And Growing Dividends Even In A Recession

With a recession now looking likely in 2020, it's more important than ever for conservative high-yield income investors (like retirees or near retirees) to know what blue-chips they can buy that will provide safe and rising income even in an economic downturn.

While none of these SWANs are likely to avoid share price declines, their low volatility, recession-resistant cash flow, and safe and rising dividends make them some of the best pre-recession blue-chips you can buy.

Altria and Enbridge might not be for everyone, depending on your personal comfort with investing in tobacco/energy industries. But if you don't mind their business models, all three of these high-yield giants makes for an attractive buy right now, both in terms of valuation and as a defensive holdings for your diversified dividend portfolio ahead of a likely bear market.

Best of all, all three are likely to deliver double-digit, market-beating total returns, making them not just great choices for conservative income-focused investors, but anyone looking to a solid, low-risk way to likely outperform the market in the coming years.

Just remember that proper asset allocation is crucial going into a bear market. So make sure you have enough cash/bonds available to meet expenses (along with dividends, SS and any pension you may have) to avoid selling quality stocks at firesale prices.

Disclosure: I am/we are long ENB, MO, D. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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