Investing is full of uncertainties: Will the market rise on Monday? Will the Nasdaq Composite Index rebound to new highs this year? Will the yield on the 10-year Government of Canada bond get back above 1 per cent in 2021?
Beats me.
But some investments are actually quite predictable.
Consider the utility Fortis Inc. I’ve owned the stock personally for years and also hold in my model Yield Hog Dividend Growth Portfolio (tgam.ca/dividendportfolio). Fortis doesn’t provide exhilarating gains or terrifying drops; it just chugs along, rewarding investors with growing dividends and a share price that slowly marches higher.
For the 10 years through Sept. 30, the owner of regulated gas and electric utilities in Canada, the United States and the Caribbean has posted an annualized total return – including dividends – of 9.4 per cent. Sure, that pales next to the returns of some high-flying tech stocks, but it handily beats the annualized total return – also including dividends – of 5.8 per cent for the S&P/TSX Composite Index over the same period.
And we can expect more where that came from. Here’s why I believe Fortis deserves a place in every well-balanced dividend portfolio.
Predictable – and sustainable – dividend hikes
Fortis’s dividend yield of 3.7 per cent may look modest, but it doesn’t tell the full story. Fortis has raised its dividend for 47 consecutive years – including a 5.8-per-cent increase announced on Sept. 23 – and it’s not about to stop now. Citing its new five-year capital investment plan of $19.6-billion, the company extended its average annual 6-per-cent dividend growth projection by a year to 2025. So, when you buy Fortis, you’re getting a dividend that will almost certainly grow for years to come – and a share price that will likely go along for the ride. What’s more, the dividend is well protected thanks to a conservative payout ratio of about 71 per cent of projected earnings for 2021, according to analysts' estimates.
Regulated – and rising – returns
Because utilities are monopolies, their returns are regulated by public utility commissions. Regulation is good for customers, because it prevents them from getting gouged. It’s also good for investors, because it makes utility earnings relatively stable and predictable. In Fortis’s case, investors stand to benefit because the company’s “rate base” – the value of assets on which it is allowed to earn a regulated return – is expected to grow to $40.3-billion by 2025 from $30.2-billion in 2020, driven by infrastructure upgrades. The rising rate base, in turn, will lead to higher earnings and dividends.
A focus on renewables
When Fortis unveiled its updated five-year plan, renewable energy was a key focus. Chief operating officer David Hutchens – who will succeed Barry Perry as chief executive officer at the end of 2020 – said the company stands to benefit from “gale force tailwinds as we go into the clean energy future.” At its Tucson Electric Power subsidiary in Arizona, for example, Fortis aims to exit coal-fired generation by 2032 and replace it with wind, solar and energy storage initiatives. Other projects include building transmission lines to bring renewable energy to more customers. By 2035, Fortis aims to reduce carbon emissions company-wide by 75 per cent compared with 2019 levels. This is not only good for the planet, but could attract more capital from “ESG” investors who evaluate companies based on environmental, social and governance factors.
A reasonable valuation
Fortis currently trades at about 19 times estimated 2021 earnings, which is slightly above the mid-point of its historical price-to-earnings (P/E) range of 14 to 22. But David Quezada, an analyst with Raymond James, said in a recent note that Fortis deserves a higher multiple given that bond yields – which typically have a negative correlation with utility P/E multiples – are near historical lows. The coronavirus pandemic “has weighed on the utility sector overall. However, we believe the impact in Fortis’ case is minimal and … we believe this represents a compelling opportunity to add to positions,” Mr. Quezada said.
Closing thoughts
Is everything about Fortis predictable? No. Unfavourable regulatory decisions and the uncertain economic outlook are among the risks the company faces. In the short run, it’s impossible to predict the direction of Fortis or any other stock. But over the long run, Fortis will almost certainly continue to raise its dividend – as it’s done for nearly half a century – and the stock will likely reward investors with continued capital growth.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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