John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
As the old saying goes, patience is a virtue.
It hasn't helped me much as a Toronto Maple Leafs fan, mind you, but being patient definitely has its rewards when it comes to investing.
Case in point: Fortis Inc.
Canada's largest investor-owned gas and electric utility has been one of the worst performers in my Strategy Lab model dividend portfolio (I also own the shares personally). Yet I've stuck with the company, because – as I explained in previous columns (tgam.ca/EF5V and tgam.ca/EF5W) – I believe it has a bright future despite its short-term challenges. In fact, I was so confident in Fortis's long-term outlook that I bought more shares for my model portfolio roughly a year ago.
Well, I'm pleased to report that the stock has been rebounding of late, even as the rest of the market struggles.
So far in 2014, the shares have risen about 15 per cent, compared with a gain of about 7 per cent for the S&P/TSX composite index. Fortis's total return – including dividends – has been more than 18 per cent. I try not to predict what a stock will do in the short-term, but I believe there will be more gains in the long run. In the meantime, I'm happy to collect my 3.7-per-cent yield.
Here's why I continue to like the shares:
The company is growing …
From 2014 through 2018, Fortis's capital expenditure plan totals about $9.3-billion, led by investments in its Western Canadian utilities and in recently acquired UNS Energy Co. of Arizona. Fortis's "rate base" – the value of assets on which a utility is permitted to earn a regulated rate of return – is expected to grow at an annualized 7 per cent over this period. Combined with other factors, including the end of a rate freeze at its New York state utility Central Hudson, Fortis's earnings per share are poised to grow at an annualized 12 per cent through 2018, CIBC World Markets analyst Paul Lechem said in a report. Moreover, if Fortis succeeds in gaining approval for a couple of liquefied natural gas (LNG) projects, the rate base could grow at an even faster 8.5 per cent, he said.
… and so is the dividend
Fortis is one of the most consistent dividend growers around. It typically announces increases in December or early January, and in recent years the hikes have averaged between 3 and 4 per cent. With the expected increase in earnings growth, Fortis's dividend could be poised to rise at a faster clip: Mr. Lechem expects the dividend to climb at a five-year annualized rate of 9 per cent.
The company is unlocking value
As announced last month, Fortis is exploring the possible sale of its property portfolio, which consists of 23 hotels in eight provinces and 2.8 million square feet of commercial and retail space, primarily in Atlantic Canada. The properties could fetch an estimated $1-billion, and redeploying the funds into regulated utilities could be worth about $1 a share to the stock price, Scotia Capital analyst Matthew Akman said in a note. As a result, he recently boosted his 12-month target price to $39 from $38. Fortis closed Tuesday at $35.03 on the Toronto Stock Exchange.
"FTS shares have performed well lately but likely still have another leg up," he wrote, citing a "positive shift in earnings momentum and accelerated dividend growth."
Everyone needs what Fortis provides
Unless you live in a shack in the woods, you probably use natural gas and/or electricity to heat your home and keep your lights on. Because Fortis supplies products that everyone needs – and earns a regulated return – its earnings are predictable and insulated from changes in commodity prices. The fact that about 93 per cent of its assets are regulated makes it a suitable choice for conservative investors.
The shares are reasonably priced
Based on discounted cash flow analysis – this involves estimating Fortis's future cash flows and working backward to determine their current value – CIBC's Mr. Lechem has a one-year price target of $37 for the shares. This equates to an EV/EBITDA multiple (enterprise value to earnings before interest, taxes, depreciation and amortization) of 10.3 times, which is "conservatively at the lower end of comparable companies Canadian Utilities (9.6 times) and Emera (11.9 times)."
Final thoughts
Staying focused on the long term is one of the keys to investing success. Had I lost patience with Fortis and sold my shares, I would have missed the rebound. Fortis isn't a slam dunk, mind you: If bond yields rise, the shares – which, like all utilities, are sensitive to changes in interest rates – could take a hit. But the dividend will almost certainly continue to grow. In short, I'd rather put my money on Fortis than a certain hockey team.
John Heinzl