Since I launched my Strategy Lab model dividend portfolio a year and a half ago, most of the stocks have produced double-digit returns.
That’s the good news.
The bad news? There have been a few clunkers, too.
Case in point: Fortis.
Shares of Canada’s largest investor-owned gas and electric utility have produced a whopping total return, including dividends, of about 0.3 per cent since I “bought” them in September, 2012. (Disclosure: I also own the shares personally.)
Why the lousy performance? For one thing, during the bull market investors have gravitated to higher-growth names, leaving conservative stocks such as Fortis behind. For another, worries about rising interest rates have pressured interest-sensitive companies in general, and utilities in particular.
On top of that, financing tied to Fortis’s proposed $4.3-billion (U.S.) acquisition of UNS Energy of Arizona may also be weighing on the stock.
The deal, which is expected to close by the end of 2014, is being funded in part by $1.8-billion (Canadian) of debentures which are convertible into Fortis common shares after conditions of the acquisition have been satisfied. The worry is that a lot of investors will sell their newly acquired shares, and that “equity overhang” is keeping a lid on Fortis’s stock price.
Am I concerned? Not really.
The fact is, despite the short-term headwinds, Fortis’s long-term outlook is still solid. I’m not selling my shares and would even consider adding to my position if the price were to weaken further. Here are five reasons:
The dividend is growing
Fortis’s annual dividend has increased for 41 consecutive years – the longest such streak for any public corporation in Canada. I’ll go out on a limb here and predict that the company will raise its dividend again this year. And next year, and the year after that, and … you get the idea.
Moreover, because of the recent weakness in the share price, Fortis’s dividend yield is now a juicy 4.1 per cent – well above the five-year average of 3.6 per cent.
The business is conservative
You don’t buy a company such as Fortis in the hope of doubling your money. Not going to happen. You buy it for slow but steady growth in earnings and dividends, lower volatility compared with the market and a business model that provides some protection from economic swings.
About 90 per cent of Fortis’s $18-billion in assets (at Dec. 31, 2013) are regulated electric or gas utilities in Canada, the United States and the Caribbean. These operations earn a regulated return that insulates the company from fluctuating commodity prices and provides predictable cash flows.
It’s not standing still
The UNS deal marks the second major U.S. acquisition for Fortis, following last year’s $1.5-billion (U.S.) purchase of New York State gas and electric utility CH Energy Group. Together, UNS and CH will add more than one million customers, bringing Fortis’s total customer base to three million.
Acquisitions are only part of Fortis’s growth strategy. From 2014 through 2018, the company plans to invest more than $6.5-billion (Canadian) across various capital projects, mainly in Western Canada. These include the Waneta Dam hydroelectric expansion south of Trail, B.C., investments in the electricity network of subsidiary FortisAberta and expansion of a liquefied natural gas facility in Delta, B.C.
Acquisitions and capital investments will boost earnings per share “in 2015 and beyond … which will support continuing growth in dividends,” the company says.
The downside is probably limited
Fortis’s shares are down about 11 per cent from their 52-week high. That’s a good thing. Why? Because it suggests that the stock has already “baked in” a weak short-term outlook. The recent pullback, plus the stock’s attractive yield, should put a floor under the shares.
I’m not saying the stock won’t fall from here; it could. But it’s hard to imagine a big drop, particularly when most analysts agree that 2015 – when both UNS and Waneta are expected to start contributing to Fortis’s earnings – will bring an improvement in Fortis’s bottom line.
It’s reasonably priced
Fortis trades at about 15.7 times estimated 2015 earnings, which is slightly higher than Canadian Utilities’ forward price-to-earnings ratio of 15.4 but below Emera’s P/E of 16.8, according to Globeinvestor.com. (Disclosure: I own both of those stocks, as well). So it’s not especially cheap, but it’s not expensive either.
Although utilities are relatively low-risk stocks, Fortis’s shares could struggle if bond yields rise. Regulatory decisions, currency exchange rates and delays or costs associated with acquisitions and developments could also affect the share price.
That said, the company’s earnings and dividends will almost certainly rise in the years ahead, which is why I’m not panicking about the current soft patch and plan to hold the shares for the long run.