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Duke Scraps Major Pipeline Project But Remains Committed to Dividend

On Sunday, Duke Energy and its building partner Dominion Energy announced plans to scrap construction of the Atlantic Coast Pipeline (ACP) following years of delays, cost overruns, and regulatory headaches.

Duke Energy owned 47% of this $8 billion natural gas pipeline project and expects to record a multibillion-dollar charge this year as a result of the cancellation.

The utility will also no longer receive any earnings contributions from the project.

Is this financial setback enough to jeopardize Duke Energy's dividend? We don't think so.

First, Duke Energy is a very large utility, and the ACP was just one part of its expansive operations.

The company previously announced a 2020 EPS target of $5.25, which included projected contributions from the ACP of $0.20, or less than 4% of total profits.

The ACP's contribution was expected to grow to $0.30 to $0.35 per share in 2021, but even then we estimate it would only account for a mid-single-digit percentage of Duke Energy's overall earnings.

With the ACP scrapped and some lingering impact from the pandemic, Duke Energy said it now expects results for 2020 to trend to the low end of its EPS guidance range of $5.05 to $5.45.

Coupled with the utility's dividend of $3.86 per share, Duke Energy's updated guidance implies a forward payout ratio near 75%.

While that's at the high end of Duke Energy's 65% to 75% long-term payout ratio target, we believe it's still a reasonably safe level for a regulated utility.

Losing future earnings from the ACP isn't expected to materially alter Duke Energy's credit profile or financing plans either.

Management affirmed that the company has no incremental equity issuance needs as a result of the discontinuation of the ACP, and Duke Energy's $2.5 billion equity forward, which was priced in November 2019, is expected to provide "sufficient balance sheet support."

Standard & Poor's maintains an A- investment grade rating with a stable outlook for the firm, too.

However, many of the same supportive comments could have been said about Dominion Energy's dividend, which was reduced on Sunday after management decided to exit the natural gas transmission and storage business to focus on Dominion's faster-growing utilities.

But unlike Dominion, which derived nearly 25% of its earnings from these midstream operations, Duke Energy is already nearly a pure-play state-regulated utility.

Duke Energy generated 85% of its 2019 adjusted EPS from regulated electric utilities and infrastructure. Gas utilities and infrastructure added another 9%, with pipeline investments (including the ACP) accounting for a relatively small piece of the business.

In other words, even if Duke Energy followed Dominion by exiting its gas pipelines to focus further on regulated utilities and a cleaner energy profile (wind, solar, and energy storage accounted for 6% of 2019 EPS), we estimate the firm's payout ratio would remain under 80%.

Coupled with management's ongoing commitment to the dividend, we are maintaining Duke Energy's Safe Dividend Safety Score.

"Finally, we understand the value of the dividend to our investors. Approximately 40% of whom are retail investors and many of whom count on our dividend as a source of income during these uncertain times. 2020 marks the 94th consecutive year of paying a quarterly cash dividend.

"Throughout the past 9 decades, including during the financial crisis of 2008 and 2009, we have protected our quarterly cash dividend. Our excellent businesses that operate in some of the best jurisdictions in the country give us confidence to continue paying and growing the dividend, consistent with our long-term target payout ratio of 65% to 75%."

– CFO Steve Young, 5/12/20 Earnings Call

That said, investors should probably expect Duke Energy's earnings and dividend growth to fall below the firm's targets (4-6% for EPS and 4% for the dividend) over the next year or two due to the loss of the ACP and the pandemic's impact.

In fact, on July 6 management announced a 2% dividend increase. Duke Energy will provide a more detailed financial and business update when it reports earnings in early August.

We will continue monitoring the situation and plan to keep holding our Duke Energy shares in our Conservative Retirees portfolio.

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