Utilities recover

By Gordon Pape, Editor and Publisher

Utility stocks are normally unpretentious workhorses in a portfolio. They aren’t flashy and don’t generate large capital gains. But they usually provide stability and cash flow, which is a combination that appeals to many investors in uncertain times.

Last year was an exception. Although the dividends continued to flow, the rapid run-up in interest rates by the central banks hit utility stocks hard. The S&P/TSX Capped Utilities Index (total returns) began 2022 at 881.48. It finished at 788.38 for a loss of 10.6%. Suddenly, utility stocks didn’t look quite so stable.

All of Canada’s major utilities were hit. Rising interest rates raised borrowing costs for these capital-intensive companies. At the same time, share prices fell as investors demanded higher yields for holding risky, interest-sensitive stocks.

We’ve continued to see interest rates rise this year, but there’s been a turnaround in the performance of utilities. As of the close on May 11, the TSX total returns capped utilities index was ahead 9.52% year to date. Investors had almost recovered the losses of 2022 in less than four and a half months.

What happened? Here’s how I see it.

Interest rate expectations. Looking ahead, it appears the latest rate hike cycle is over, or close to it. Inflation is edging down with each passing month, reducing the need for more rate hikes to bring it under control. That doesn’t mean there won’t be a few more, but we’re unlikely to return to the intensity we experienced last year.

Oversold stocks. The utilities pendulum swung too far to the downside last year. It was due to correct itself – which it has.

Attractive yields. In early March, Fortis shares were yielding 4.2%. Canadian Utilities was paying 5.1%, and Emera was yielding 5.2%. Those are attractive returns from rock-solid companies and investors started to take notice.

Although other utility stocks have higher yields, my go-to choice in this sector has long been Fortis Inc. Here’s an update on the stock.

Fortis Inc. (TSX, NYSE: FTS)

Originally recommended on Aug. 15/05 (#2531) at $20.80. Closed Friday at C$61.55, US$45.42.

Background: Fortis is an electricity and natural gas distribution utility based in St. John’s, Newfoundland and Labrador. It has total assets of about $65 billion and generated revenue of $11 billion in 2022. The company serves about 3.4 million utility customers in five Canadian provinces, nine US states, and three Caribbean countries. It has 9,100 employees.

Performance: The shares touched a 52-week low of $48.45 in mid-October but have been gradually working their way up since. After a setback in early March, the price took off and the shares are now trading at over $61.

Recent developments: The company released first quarter results earlier this month and they came in ahead of expectations. Net earnings attributable to shareholders were $437 million ($0.90 per share). That compares to $350 million ($0.74 per share) in the first quarter of 2022. Adjusted net earnings were $439 million ($0.91 per share). That was up $70 million ($0.13 per share) from the same period in 2022.

Management said the profit increase reflected rate base growth, higher retail electricity sales, and lower depreciation expense.

Fortis invested $995 million in capital expenditures in the quarter and said the company is on track to spend $4.3 billion on capex in 2023. Projects include construction of the Eagle Mountain Woodfibre Gas Line in British Columbia.

Divestiture: The company is selling its 93.8% ownership interest in the Aitken Creek Natural Gas Storage Facility to Enbridge for approximately $400 million. Management says the proceeds will be used to strengthen the balance sheet and support the financing of its regulated utility growth strategy.

Dividend: The quarterly dividend is $0.565 per share ($2.26 per year). The shares yield 3.7% at the current price. The company expects annual dividend increases of 4-6% through 2027.

Outlook: The company’s $22.3 billion five-year capital plan is expected to increase the midyear rate base from $34.1 billion in 2022 to $46.1 billion by 2027. This translates into a five-year compound annual growth rate of 6.2%.

Action now: Buy for yield and modest capital growth.

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