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Rising interest rates have pummelled shares of Fortis Inc., but the utility operator has projects on the go and dividend should keep rising. (Marcel Pelletier/iStockphoto)
Rising interest rates have pummelled shares of Fortis Inc., but the utility operator has projects on the go and dividend should keep rising. (Marcel Pelletier/iStockphoto)

YIELD HOG

Why I’m not giving up on Fortis 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.

As mentioned in last week’s column, I used some of the “cash” in my Strategy Lab model dividend portfolio to purchase additional shares of both Fortis and the iShares REIT Index Fund (XRE).

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These are two of the worst-performing securities in my portfolio, yet the underlying businesses remain sound and, because the share prices have tumbled, the yields have jumped.

Today I’ll elaborate on my reasons for adding to my Fortis position. In a future column, I’ll discuss why I still like real estate investment trusts and XRE in particular.

Why Fortis has stumbled

I’ve owned Fortis personally for years. It’s the country’s largest investor-owned gas and electric utility, with 2.4 million customers in Canada, New York State and the Caribbean. In addition to its regulated utilities, which account for 90 per cent of its assets and provide a predictable earnings stream, the company also owns nonregulated hydro generating assets, hotels and commercial real estate.

People need electricty and gas to power their homes and keep them warm in the winter, so it’s a stable business that’s easy to understand. What’s more, the company has a long history of raising its dividend, which is one of the qualities I look for in a stock.

However, after years of impressive shareholder returns – thanks to a combination of acquisitions and organic growth – Fortis has hit a rough patch. Falling regulated rates of return on its utilities, weak mergers and acquisitions activity and the expropriation of its electric utility in Belize all took a toll on the stock.

Then came rising bond yields, which are like kryptonite to interest-sensitive stocks such as Fortis. The shares have skidded about 9 per cent this year, including dividends, and the price is back to where it was three years ago.

Trouble spells opportunity

When a stock gets clobbered, the knee-jerk reaction of some investors is to sell. But with Fortis, the recent weakness presents an opportunity to buy a solid, low-risk company at a discount – just when its outlook is improving.

“Bad news is largely behind it now and the stock is attractively valued,” Matthew Akman, an analyst with Scotia Capital, said in a June note in which he upgraded Fortis to “sector outperform” from “sector perform.”

Fortis’s fortunes won’t change overnight, mind you, but there are several potential sources of growth on the horizon.

Growth set to resume

In June, the company completed the acquisition of CH Energy Group, which serves 300,000 electricity and 75,000 gas customers in New York State. The $1.5-billion (U.S.) deal wasn’t a slam dunk: To obtain regulatory approval, Fortis had to offer inducements, including a rate freeze until 2015, job guarantees for four years and $50-million of financial benefits to customers.

Because of those sweeteners, Fortis now expects that the deal will be accretive to earnings in 2015 instead of 2014. “Over the longer term, we do not believe that this difference will have a material impact on the value of [Fortis’s] shares,” Jeremy Rosenfield, an analyst with Desjardins Securities, said in an August note.

Another growth driver is the $900-million (Canadian) Waneta hydroelectric dam expansion in British Columbia, which is expected to come into service in spring, 2015. Fortis, which holds a 51-per-cent stake in the nonregulated project, stands to receive a boost of 5 to 10 cents a share to its bottom line when Waneta comes on line, Mr. Akman estimated.

In addition, Fortis has about $500-million in infrastructure growth opportunities in B.C. tied to liquefied natural gas exports, he said.

Dividend still growing

Analysts expect Fortis, which currently yields 4.1 per cent, to continue raising its dividend at a modest pace. Paul Lechem of CIBC World Markets forecasts that the annual dividend will grow to $1.28 in 2014 from $1.24 in 2013 – an increase of 3.2 per cent or 1 cent a share on a quarterly basis. Fortis typically raises its dividend in December or January.

Keep in mind that Fortis’s shares could come under pressure if bond yields continue to climb. However, the rising dividend – and the prospect of growing earnings in coming years – should help to limit the downside.

If you’re looking for a stock that will double or triple in value, Fortis isn’t for you. However, for long-term investors who want a relatively stable source of dividends with a dash of growth thrown in, the beaten-down shares of Fortis may be worth a look.

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