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Canadian Utilities: Small yield = big returns Add to ...

John Heinzl is the dividend investor for Globe Investor’s Strategy Lab. Follow his contributions here. You can see his model portfolio here.

With dividend stocks, modest yields don’t necessarily lead to modest returns.

Case in point: Canadian Utilities, a stock I own both personally and in my Strategy Lab model dividend portfolio.

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Over the past 10 years, the yield on this diversified utility and energy company has averaged 3.1 per cent – not exactly low, but not high enough for many income-hungry investors to notice. Yet the total return – share price appreciation plus reinvested dividends – over that period was a sizzling 229.2 per cent, or 12.7 per cent annually.

There’s no guarantee such boffo returns will continue, but with CU now yielding 2.7 per cent, investors who pass on the stock based on its middling yield could again be missing out. The company is relatively cheap, has plenty of growth potential and is a conservative choice thanks to the growing contribution from its regulated gas and electricity operations.

“Equity investors have been relentlessly focused on dividend yield, often to their own detriment,” analyst Matthew Akman of Scotia Capital said in a Nov. 21 note. The poor performance of high-yielding power and utilities stocks such as TransAlta, Atlantic Power and Capital Power “could increase market appreciation for quality companies with relatively low but growing dividends” such as CU, he said.

Indeed, although CU’s yield is modest now, its earnings and dividends are expected to climb as the company rolls out $6-billion in capital spending, primarily on its regulated electricity operations in Alberta. In mid-November, for instance, the Alberta Utilities Commission approved CU’s planned $1.6-billion Eastern Alberta Transmission Line between Edmonton and Calgary – one of the company’s largest transmission projects to date.

Fuelled by Alberta’s growing economy, CU’s regulated gas and electric utilities and pipelines are expected to nearly double their regulated asset base between 2011 and 2014, Mr. Akman said. Increasing the rate base – the value of assets on which a utility is allowed to earn a specific rate of return as set by regulators – “is a particularly low-risk way of creating earnings growth,” said the analyst, who expects CU’s earnings to grow about 30 per cent in total between 2011 and 2014.

“With rapid earnings growth should follow rapid dividend growth,” he said.

CU’s dividend has risen at an annualized rate of 7.2 per cent over the past five years, but growth could accelerate over the next few years, say analysts, including Mr. Akman. According to Bloomberg, in January CU is expected to boost its quarterly dividend to 48.25 cents ( $1.93 annually), from 44.25 cents ($1.77) – an increase of 9 per cent.

Even with such a promising growth outlook, the stock is far from expensive. Ben Pham, an analyst with BMO Nesbitt Burns, estimates that CU will earn $4.59 a share in 2014. Based on Tuesday’s closing price of $66, the stock trades at a 2014 price-to-earnings multiple of 14.4, which is “a steep discount to Canadian regulated utility peers,” said Mr. Pham, who has an “outperform” rating and $78 target price on the shares.

Making the stock even more interesting, regulated operations are expected to contribute more than 70 per cent of CU’s earnings by 2015, up from 50 per cent currently, lowering the risk profile of the company, he said. CU’s non-regulated interests include power generation, natural gas gathering and storage, and structures and logistics.

“CU continues to offer one of the most compelling combinations of growth and relative value in our power and utility coverage universe,” Mr. Pham said in a Nov. 2 note.

Mr. Akman also thinks the shares are a bargain. In his note, which he wrote when CU was trading at $64.34, he called CU’s estimated 2014 P/E of 13.5 “astonishingly low in today’s bond yield environment. On a relative basis it stands out like a sore thumb given the 20 [times] P/Es on so many other Canadian energy infrastructure stocks we follow.”

All equity investments carry some risk. Changes in interest rates, electricity prices and the costs of commodities used in power generation could all affect CU’s bottom line. But for investors seeking a reasonably priced stock that will almost certainly throw off growing income, the company is worth a close look.

 

Follow on Twitter: @johnheinzl

 
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