FERC Ruling Casts Doubts On Dominion's Dropdown Ambitions, BofA Says In Downgrade

The Federal Energy Commission recently ruled that MLPs will no longer be allowed to recover an income tax allowance in cost-of-service rates.

The Analyst

In the wake of the ruling, Bank of America Merrill Lynch analyst Julien Dumoulin-Smith downgraded shares of Dominion Energy Inc D from Buy to Neutral and reduced the price target from $79 to $72, reflecting lower multiples for gas transmission assets plus the mark to market of the MLP shares.

The Thesis

The FERC ruling casts doubts on Dominion's dropdown ambitions into Dominion Energy Midstream Partners LP DM, Dumoulin-Smith said in a Tuesday note. The ruling could affect the valuation of midstream assets, making the accretion math on the acquisitions potentially more challenging, the analyst said. 

The incentive distribution rights at the MLP complicate the cost of capital arbitrage, Dumoulin-Smith said.

The company's decision not to file for an involuntary rate reduction will prompt a Section 5 investigation at FERC, delaying any effect on rates, according to BofA. Since a large portion of the MLP is owned by Dominion, the MLP assets can continue to collect taxes at a lower rate of 21 percent, thereby impacting earnings per share by 10 cents, the analyst said. 

"The uncertainty around how the new rule would apply to MLPs majority-owned by a C-Corp (in this case D) remains a key unresolved issue," Dumoulin-Smith said. 

Although the Dominion story is not entirely dependent on the possibility of the MLP drops, alternative monetization options could prove less accretive, according to BofA. 

The Price Action

Dominion shares are up about 18 percent over the past year.

At the time of publication, the stock was slipping nearly 1 percent to $68.51.

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