Last week, I punted Algonquin Power & Utilities Corp. AQN-T from my model Yield Hog Dividend Growth Portfolio. Today, after I briefly recap that decision, I’ll discuss how I’m reinvesting the proceeds.
With Algonquin’s finances stretched by rising interest rates and its growth plans under review, some analysts say the power producer and utility operator could slash its dividend by 25 to 50 per cent. Even if Algonquin were to maintain its dividend at current levels – which I consider a best-case scenario – it no longer meets the “dividend growth” test for the model portfolio.
In my personal portfolio, I also sold some Algonquin shares to crystallize a tax loss, but I’m still a shareholder of the company. Like many of you, I am hoping management can navigate through the current crisis and emerge in stronger financial shape.
Now, it’s time to redeploy some of the cash.
Fortis Inc. FTS-T and Emera Inc. EMA-T have been part of the model portfolio since its inception on Oct. 1, 2017. They’ve performed like utilities should, with steady performance and few surprises. Fortis’s total return to date, including dividends, is about 7.4 per cent on an annualized basis, and Emera’s total return is about 6.7 per cent.
Granted, these modest returns aren’t going to win any stock-picking contests. But keep in mind that both stocks are down sharply from their 2022 highs, partly in response to rising interest rates, which are a headwind for utilities stocks. The silver lining is that their yields – which move in the opposite direction to their share prices – have climbed, with Fortis now yielding about 4.2 per cent and Emera 5.3 per cent. For investors looking to put new money to work, these yields are attractive. (Emera’s credit ratings, while still investment grade, are not as strong as Fortis’s, which helps to explain the difference in yields.)
What’s more, both companies have a long track record of raising their dividends annually (49 consecutive years for Fortis and 16 for Emera). Most recently, Fortis announced a 5.6-per-cent increase in September and Emera hiked its payout by 4.2 per cent in October. And there’s likely more where that came from: Fortis is forecasting annual dividend growth of 4 to 6 per cent through 2027, and Emera is projecting dividend growth of 4 to 5 per cent through 2025.
If there is one lesson Algonquin taught us, however, it’s that even companies with a history of raising their dividends can stumble. One thing that gives me comfort about Fortis and Emera is that both derive virtually all of their earnings from regulated utilities – specifically, about 99 per cent for Fortis and 95 per cent for Emera.
Algonquin’s regulated operations, on the other hand, account for about 80 per cent of its business (including the pending acquisition of Kentucky Power Co.), with the remaining 20 per cent consisting of non-regulated renewable power operations, whose returns can vary with the weather. Indeed, a key reason Algonquin’s recent results missed estimates was that wind during the third quarter was well below the long-term average.
Pure utilities generally offer fewer surprises, thanks to their regulated operations. David Quezada, an analyst with Raymond James, recently upgraded both Fortis and Emera to “outperform” from “market perform.” He cited their multiyear growth plans and geographically diversified operations, which include a significant presence in the U.S. market where the regulatory environment is generally more favourable than in Canada.
With both Fortis and Emera down by double-digits from their recent highs, they are trading toward the low end of their historical ranges on a price-to-earnings basis, Mr. Quezada said.
“We now see compelling value in these low-risk regulated names with each stock approaching key valuation support levels,” he said in a note. He added that the utilities sector, in general, stands to benefit from “significant tailwinds,” which include the transition to greener forms of generation and the need to build transmission lines to connect renewable power sources to the grid.
With all of the above in mind, I decided to “buy” an additional 35 shares each of Fortis and Emera, bringing the total in my model portfolio to 175 and 190 shares, respectively. The two purchases, which were executed at Tuesday’s closing prices, consumed $3,664.50 of the $4,845.15 in proceeds from the sale of my Algonquin shares. I’ll be reinvesting the rest of the cash in the coming weeks, so stay tuned.
Full disclosure: The author also personally owns shares of FTS and EMA.
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