Morningstar Magazine - August/September 2018 - 67

In the Southeast, utilities have tried to build
new nuclear plants. Southern Company SO
in Georgia has struggled with higher than
expected costs. Scana SCG, a South Carolina utility,
also ran into cost overruns. The budget
for the plant they were trying to build doubled
between when they initially expected
to build it in 2008 and last summer, when they
terminated the project because the cost
just got too high.

Dominion is one of your top defensive picks.

Miller: Some old-time, large-cap, well-known
utilities like Dominion Energy, Southern
Company, and Duke Energy DUK have been beat
down a little bit and are now yielding in the
5% range. These continue to be very steady
utilities with good growth prospects. To
get a 5% yield in this kind of environment, even
after interest rates have gone up so much
in the past year, is still really good for income
investors right now.

Why is Scana is one of your top value picks?

industry's electricity consumption is a good
growth driver for Dominion.
What about renewable energy?

Miller: Renewable energy is still the hottest thing
going right now in the power sector. More
than 30 states have laws that mandate utilities to
invest in renewable energy and, in most cases,
achieve some percentage of usage from renewable
energy. Beyond that, technologies in solar and
wind energy have developed such that they're
now as economic or even more economic than coal
and natural gas. This has both environmental
benefits and benefits for customers as wind and
solar energy prices come down.

Miller: Most utilities stocks are still fairly valued
or slightly overvalued right now. But you
can look for what we call "hairy utilities," where
the market is not necessarily recognizing
the value that is still there because of some
negative development. They either have
cut dividends or there's some kind of risk
in one of their business segments that
the market is overemphasizing. That leads to
buying opportunities.

Dominion in particular is a good opportunity. Most
of its infrastructure is in Virginia and the
mid-Atlantic region, just south of the Marcellus
Shale gas region. Because they're located
between gas demand in Virginia and the Carolinas,
and Marcellus gas supply, Dominion has been
building natural gas pipelines. They've also
invested billions of dollars in natural gas power

Scana is the poster child for that right now.
They abandoned a nuclear plant project
that was going to be about half of their entire
book value. They're trying to recover some
$4 billion that they've invested in the plant, which
is not operational.

Renewable energy is still the hottest thing
going right now in the power sector. ...
technologies in solar and wind energy have
developed such that they're now as
economic or even more economic than coal
and natural gas.

Typically, when utilities build any kind of
infrastructure, they are able to recover the costs
from customers through regulatory rates.
But there is a "used and useful" standard: As long
as the infrastructure is used and useful, then
regulators let customers pay the utility for that.
A half-built nuclear plant is not used and
useful, so there's debate around whether Scana
should be able to recover those costs.

One key issue here is grid reliability. It's very
costly to manage a grid when you rely on the wind
blowing and the sun shining to produce your
electricity. That's one headwind.

Travis Miller

We think they will be allowed to. Otherwise, Scana
faces a bankruptcy situation, and it's in no one's
best interest to let the local utility go bankrupt.
Dominion Energy D, our only wide-moat utility, has
made a bid to acquire Scana, and essentially wipe
clean all the new nuclear issues. This would be
one of the biggest customer rate giveaways: about
$1,000 for every customer if regulators approve
the Dominion acquisition and accept Dominion's
plan to recover nuclear rates.

generation, and they're seeing demand
growth, both on the natural gas side and on the
electricity side. There's a very vibrant technology
area right outside of Washington, D.C.,
in Loudoun County, which is one their largest
service territory regions. It has been reported that
70% of the world's Internet traffic flows
through the county on a daily basis. The tech

Another headwind is that distributed generation,
what people know as rooftop solar, is
essentially putting the generation and the demand
all in one house. That ends up leading to
lower centralized network demand, which is how
utilities earn their revenue. We are seeing
more industrial sector distributed generation
at places such as factories and even server farms

global.morningstar.com/Morningstarmagazine

67
http://global.morningstar.com/Morningstarmagazine
Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018
