Dominion Energy's 88% Data Center Demand Spike Could Get the Dividend Growing Again

Dominion Energy (NYSE: D) is one of the largest regulated utilities in the United States. At the moment, it's offering a lofty 4.8% dividend yield at a time when the average utility's yield is just 2.8%. And yet it is still a hard stock to love because the company's performance around dividends has disappointed on occasion.

News last month of an 88% spike in demand for energy from data centers could help get this high-yield stock back on its dividend feet. Here's why.

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What happened to Dominion Energy's dividend?

Dominion Energy has radically changed its business over the past few decades. Management's long-term goal has been to reduce risk. Early on, that included selling off investments in the oil production space in favor of more reliable cash-generating assets. The list was eventually whittled down to include electric utilities, natural gas utilities, and energy pipelines. But things changed in a big way in 2020.

Image source: Getty Images.

That was the year in which Dominion sold its energy pipeline business to Warren Buffett's Berkshire Hathaway. In some ways, the 2020 transaction made sense, since pipelines were deeply out of favor at the time, and they were creating unneeded headaches for the rest of the utility's business. The only problem is that the sale required a dividend cut since it meant jettisoning income-producing assets.

Management promised that it would quickly get back to dividend growth, which it did ... for one year. After that one dividend hike, management told investors it was performing a strategic review of the business. The review took about a year to complete, with little information provided to investors along the way, other than a key goal was to maintain the dividend at its then-current level. At the end of the review, management agreed to sell its natural gas utilities to Enbridge and completed the sale in September 2023.

D data by YCharts

To management's credit, the dividend was maintained after the transaction. But the now pure-play regulated electric utility was clear that the dividend would remain static until it had shored up its balance sheet, and the dividend payout ratio had been reduced to a more sustainable level. This is where things still stand today.

Where to from here for Dominion Energy?

Dominion's balance sheet is pretty solid, noting that it carries an investment-grade rating. There's still some work to be done to shore up that rating, but it is highly likely that the company achieves this goal. The dividend payout ratio, however, is still a bit on the high side.

In 2024, the payout ratio using adjusted earnings was a lofty 96%. To be fair, that was a transition year, given the asset sales. If management hits its earnings targets in 2025, the payout ratio will drop to a touch below 80% at the midpoint of guidance. That's a much more comfortable figure, but the company is probably looking for a payout ratio below 70% before a dividend increase is in the cards.

This is where artificial intelligence (AI) and the data centers that support this technology come into play. One of Dominion's strongholds is Virginia, which happens to be a vital technology hub. Over the next decade, commercial power demand, which includes data centers, is expected to grow from around 48% of the utility's business to 62%. This is a massive change, and the core driver is the data centers that power AI.

This is highlighted by Dominion's huge 88% increase in contracted capacity from data centers, one that occurred over less than six months in 2024. This surge demonstrates the immense power demand to support AI technology and underscores Dominion's strategic positioning to benefit from this growing data center need.

Dominion's dividend has nowhere to go but up

While it is possible that Dominion shocks investors again with another company overhaul (and dividend change), this would be surprising, given that it has now whittled itself down to just a regulated electric utility. What is far more likely is that Dominion builds back investor trust by hitting its financial targets, including restoring dividend growth.

Given the huge demand from AI, it looks increasingly like a dividend hike could happen sooner rather than later. But the really exciting piece is what Dominion's management stated on its fourth-quarter 2024 earnings call: "Data center growth in Virginia is not slowing down. In fact, it's accelerating, and we're taking every step to meet this opportunity." The good news on the AI front may not be over for this high-yield utility.

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Reuben Gregg Brewer has positions in Dominion Energy and Enbridge. The Motley Fool has positions in and recommends Berkshire Hathaway and Enbridge. The Motley Fool recommends Dominion Energy. The Motley Fool has a disclosure policy.