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On Sept. 14, NextEra Energy and Dominion announced an expanded benefits package for Virginia customers to secure regulatory approval for NextEra's proposed $100 billion acquisition, including debt.

Why it matters: Stakeholders have raised bill affordability as a key issue in the proposed merger. Virginia Gov. Abigail Spanberger has requested to intervene, and more than a dozen lawmakers have sought local hearings. Most public comments have opposed the merger. The parties will double customer bill credits to $10 per month for four years. When the merger was announced, NextEra Energy proposed $2.25 billion of customer bill credits over two years. The companies also announced they would extend employee protections to five years, add 1,000 jobs in Virginia, and accelerate clean energy development. Merger opponents identified all as key issues.

The bottom line: We are reaffirming our $88 fair value for NextEra Energy, $73 fair value for Dominion Energy, and narrow moat ratings for both companies. NextEra Energy trades at a 6% discount to our fair value estimate, in line with our sector view as of Sept. 14. We previously expected the companies would have to offer additional bill credits to achieve regulatory approval, leaving our fair value estimate unchanged. We continue to view the transaction in the best interest of Dominion shareholders. We increased our Dominion fair value estimate by $14 per share when the transaction was announced and lowered our NextEra fair value estimate by $2 per share.

Long view: NextEra has filed for key state and federal regulatory approvals. We continue to view Virginia as the most difficult regulatory approval to obtain, as evidenced by the company's enhanced customer benefits announced today. In our view, the recent announcement increases the probability of Virginia regulatory approval. Ultimately, we expect regulatory approval given NextEra's track record of operating efficiency and relatively lower bills in Florida.

Our fair value estimate is $73 per share after incorporating year-to-date financial, operational, and regulatory updates.

Dominion Energy has agreed to be acquired by NextEra Energy. Dominion Energy shareholders will receive 0.8138 shares of NextEra Energy, plus a one-time $360 million payment upon the deal closing.

On a stand-alone basis, our fair value estimate is $59 per share. Over the next five years, we expect Dominion to invest $65 billion, primarily focused on decarbonization. We expect Dominion's significant capital investment needs and electricity growth will support earnings at the high end of management's 5%-7% annual growth target for 2026-30.

In our discounted cash flow valuation, we use a 5.9% cost of capital based on a 7.0% cost of equity. This is lower than the rate of return we expect investors to demand for a diversified equity portfolio, reflecting Dominion's lower sensitivity to the economic cycle and lower operating leverage.

We assign Dominion Energy a Narrow Morningstar Economic Moat Rating.

We don't expect the proposed acquisition of NextEra Energy to affect our moat rating. NextEra Energy operates regulated utilities with a competitive advantage and a highly contracted energy portfolio.

Service territory monopolies and efficient scale advantages are the primary sources of economic moats for a regulated utility like Dominion, which derives nearly all its income from rate-regulated utilities in three states.

Dominion Energy Virginia generates and distributes electricity in Virginia and North Carolina. Dominion's regulated natural gas distribution utilities have service territories in North and South Carolina. Service territory monopolies and efficient scale advantages are the primary moat sources for these regulated utilities.

State and federal regulators grant regulated utilities like Dominion exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their power generation, transmission, and distribution networks. In exchange for regulated utilities’ service-territory monopolies, state and federal regulators set returns to minimize customer costs while offering fair returns to capital providers.

This implicit contract between regulators and capital providers should, on balance, allow regulated utilities like Dominion to achieve at least their cost of capital, though observable returns may vary in the short run due to demand trends, investment cycles, operating costs, and access to financing. Intuitively, utilities should have an economic moat based on efficient scale, but in some cases, regulation offsets this advantage, preventing excess returns on capital.

The risk of adverse regulatory decisions precludes regulated utilities from a wide moat. However, the threat of material destruction of value is low, and normalized returns exceed the cost of capital in most cases, leaving us comfortable assigning narrow moats to many regulated utilities.

Dominion Energy operates in high-growth Virginia, which should provide investment opportunities.

Growth capital investments focused on renewable energy, carbon reduction, and electricity demand growth provide significant investment opportunities for Dominion.

Management has completed its strategic review, providing needed clarity for investors.

Political and regulatory pressure has increased in Virginia, Dominion's most important service territory.

Management's decision to initiate a strategic review in late 2022 without providing a desired outcome or direction resulted in a loss of confidence in the executive team.

We expect minimal dividend growth for investors over our five-year forecast period.