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Dominion, Southern dividend metrics may raise questions if recession deepens

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Dominion, Southern dividend metrics may raise questions if recession deepens

While not a material issue currently, a deeper or more prolonged COVID-19 driven recession than currently anticipated could impact the dividend growth plans of some utilities with comparatively low cash flow coverage of the dividend and high dividend payout ratio metrics. Based on recent data, Dominion Energy Inc. and Southern Co. appear to be among the companies whose dividend growth policies could be impacted. We emphasize that dividend cuts would not be expected, but rather the possibility of a decline in dividend growth.

Other companies with a low cash flow coverage of the dividend include South Jersey Industries Inc.New Jersey Resources Corp.Eversource Energy and OGE Energy Corp. These utilities, however, with the exception of South Jersey Industries, may be lower risks to modify their dividend growth rates than the two companies mentioned above since their payout ratios are more in line with the industry averages.

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The table at the conclusion of this report includes the year-end 2019 cash flow coverage of the dividend and 2019 dividend payout metrics for the energy and water companies included in the Financial Focus coverage universe. The reader may to refer to this table for information regarding specific energy and water companies. The data included in this report is derived from Financial Focus' April 9 analysis of several utility financial quality measures. Please see the tables attached to the April 9 article for explanations of the calculations of the cash flow coverage of the dividend and dividend payout metrics.

We note that CenterPoint Energy Inc. announced on April 1 a 48% reduction in its common dividend and a $300 million planned capital expenditures reduction primarily due to problems tied to Enable Midstream Partners; CenterPoint owns a 53.7% limited partner interest and a 50% general partner interest. Problems at Enable have been nagging for some time and we consider CenterPoint as somewhat of a special situation.

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Dominion Energy

Dominion Energy posted the second lowest 2019 cash flow coverage of dividend at 2.22x and second highest year-end 2019 dividend payout of 86.7%. In addition, the cash flow coverage of the dividend declined by 10.8% in 2019 compared to 2018. In its recent first quarter 2020 earnings presentation, Dominion indicated it is "well positioned" with regard to COVID-19 related demand impacts but the company continues to monitor the situation carefully. Dominion affirmed its 2020 operating EPS guidance range of $4.25-$4.60, and affirmed a 5% plus post-2020 operating EPS annual growth rate. It also affirmed a 2.5% annual dividend growth rate, subject to the approval of its Board of Directors.

With its anticipated dividend growth rate at about 50% of its expected EPS growth rate, Dominion has established a path to reduce its very high payout ratio. With its low cash flow coverage of the dividend, however, the company's financial plans may be pressured if the COVID-19 recession impacts revenues and costs to a greater magnitude and for a longer period of time than currently anticipated. The company noted that its Gas Distribution, Gas Transmission and Storage, and Contracted Generation segments, which together account for about 40% of 2020 expected operating EPS guidance, have significant mitigants that reduce exposure to near-term COVID-related financial impacts. Dominion's electric utility operations in Virginia, North Carolina and South Carolina, however, do not utilize electric revenue decoupling mechanisms. The company conceivably could receive approval from regulatory commissions in these three states to defer and ultimately recover COVID-19 related lost electric revenues from ratepayers, effectively accomplishing what a revenue decoupling mechanism would have accomplished.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

Southern Company

Southern's 2019 cash flow coverage of dividend measure is the sixth-lowest among the energy companies at 2.81x, while its 79.2% dividend payout ratio is well above average. On April 20, the company announced an eight-cent annual dividend increase, the same increase as in 2019, 2018 and 2017, so if any change in dividend policy were to occur, it likely would take place in early 2021. In its first quarter earnings presentation, Southern reiterated projected 2020 adjusted EPS guidance of $3.10 to $3.22, and indicated its expected long-term EPS growth rate remains 4% to 6%.

Regarding COVID-19 impacts for 2020, Southern's baseline projections indicate an overall 2020 weather normal annualized impact on retail sales of 2% to 5%, with an estimated total impact on base revenues of $250 million to $400 million. This scenario assumes stay-at-home policies phased out in mid-summer and modest economic recovery over the balance of the year. Actual impact will be highly dependent upon the duration of stay-at-home policies and the pace of recovery. Southern noted, "while the current situation is unprecedented, we have previously demonstrated significant cost management during economic downturns, including the 2008/2009 recession."

Southern's situation is uniquely complicated by its nuclear expansion project, Vogtle Units 3 and 4. Not only does the company have to work through the economic effects of the recession, but also the financial impacts of any further construction delays and cost increases regarding the two units. Southern recently reaffirmed that it expect to meet November 2021 and November 2022 regulatory-approved in-service dates for units 3 and 4, respectively, and indicated that the Unit 3 aggressive site work plan target in-service date remains May 2021, while the Unit 4 aggressive site work plan target in-service date shifted back two months to May 2022.

In mid-April, Southern implemented a workforce reduction of about 20% at the Vogtle construction site intended to mitigate COVID-19 impacts but did not change the total project capital cost forecast. The company noted that the "next few months are pivotal as we adjust to a smaller, more streamlined workforce and seek to stabilize and increase productivity." In sum, while the final phases of the Vogtle expansion project appear to be on track and within the current budget, they represent another area of uncertainty, in addition to the COVID-19 economic fallout, that could stress Southern's finances and possibly even its dividend growth plans.

Possible economic recovery scenarios

While notable uncertainty exists regarding the future timing and magnitude of the economic recovery, the current consensus among utility management appears to be that the worst economic effects of the COVID-19 pandemic likely will occur in the second quarter of 2020 with a recovery to commence in the second half of the year. A recent presentation by Xcel Energy Inc. management serves to highlight possible recovery scenarios.

Xcel has provided an analysis, which we believe is applicable, with the exception of the specific numeric sales and EPS effects, to the general utility industry. The analysis presents three scenarios outlining the potential impact of the pandemic on electric and natural gas sales and EPS, based on various assumptions of the duration of the stay-at-home provisions and the speed and magnitude of the economic recovery.

In the Mild Scenario, which has a severe impact through May with a V-shaped economic recovery, the following change in 2020 electric sales would result: an increase of approximately 1% in residential; a decline of approximately 4% in commercial and industrial, or C&I; and a decline in total retail electric sales of approximately 2%. This sales decline would reduce 2020 EPS by approximately 11 cents.

The Base Case Scenario, which envisions a severe impact through the second quarter with slower U-shaped recovery with lingering effects throughout 2020, would result in the following change in 2020 electric sales: an increase of approximately 1% in residential; a decline of approximately 6% in C&I; and a decline in total retail electric sales of approximately 4%. This sales decline would reduce 2020 EPS by approximately 17 cents.

In the Severe Scenario, which includes severe impact through the third quarter followed by a protracted, challenged L-shaped recovery, the following change in 2020 electric sales would occur: an increase of approximately 1% in residential; a decline of approximately 12% in C&I; and a decline in total retail electric sales of approximately 8%. This sales decline would reduce EPS by approximately 37 cents.

The Mild, Base Case and Severe scenarios include a decrease in natural gas sales of 0%, 1% and 2%, respectively. The company also noted that potential impacts due to other items could have negative EPS impact of $0.02 to $0.05, assuming constructive regulatory treatment. Xcel recently reaffirmed its 2020 EPS guidance of $2.73 to $2.83 per share, which assumes the implementation of contingency plans that will be sufficient to offset the negative impacts of the COVID-19 pandemic under the Base Case scenario.

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