Utility stocks are normally unpretentious workhorses in a portfolio. They aren’t flashy and don’t generate large capital gains. But they usually provide stability and cash flow, which is a combination that appeals to many investors in uncertain times.
Last year was an exception. Although the dividends continued to flow, the rapid run-up in interest rates by the central banks hit utility stocks hard. The S&P/TSX Capped Utilities Index (total returns) began 2022 at 881.48. It finished at 788.38 for a loss of 10.6 per cent. Suddenly, utility stocks didn’t look quite so stable.
All of Canada’s major utilities were hit. Rising interest rates raised borrowing costs for these capital-intensive companies. At the same time, share prices fell as investors demanded higher yields for holding risky, interest-sensitive stocks.
We’ve continued to see interest rates rise this year, but there’s been a turnaround in the performance of utilities. As of the close on May 12, the TSX total returns capped utilities index was ahead 10.71 per cent year-to-date. Investors had recovered most of the losses of 2022 in less than 4½ months.
What happened? Here’s how I see it.
Interest-rate expectations. Looking ahead, it appears the latest rate-hike cycle is over, or close to it. Inflation is edging down with each passing month, reducing the need for more rate hikes to bring it under control. That doesn’t mean there won’t be a few more, but we’re unlikely to return to the intensity we experienced last year.
Oversold stocks. The utilities pendulum swung too far to the downside last year. It was due to correct itself – which it has.
Attractive yields. In early March, Fortis Inc. (FTS-T) shares were yielding 4.2 per cent. Canadian Utilities Ltd. (CU-T) was paying 5.1 per cent, and Emera Inc. (EMA-T) was yielding 5.2 per cent. Those are attractive returns from rock-solid companies and investors started to take notice. The resulting price increases mean the yields are lower now, but still appealing.
Although other utility stocks have higher yields, my go-to choice in this sector has long been Fortis Inc. Here’s an update on the stock.
Closed May 12 at $61.55.
Background: Fortis is an electricity and natural gas distribution utility based in St. John’s. It has total assets of about $65-billion and generated revenue of $11-billion in 2022. The company serves about 3.4 million utility customers in five Canadian provinces, nine U.S. states and three Caribbean countries. It has 9,100 employees.
Performance: The shares touched a 52-week low of $48.45 in mid-October but have been gradually working their way up since. After a setback in early March, the price took off and the shares are now trading at over $61.
Recent developments: The company released first-quarter results earlier this month and they came in ahead of expectations. Net earnings attributable to shareholders were $437-million (90 cents a share). That compares with $350-million (74 cents a share) in the first quarter of 2022. Adjusted net earnings were $439-million (91 cents a share). That was up $70-million (13 cents a share) from the same period in 2022.
Management said the profit increase reflected rate base growth, higher retail electricity sales, and lower depreciation expense.
Fortis invested $995-million in capital expenditures in the quarter and said the company is on track to spend $4.3-billion on capex in 2023. Projects include construction of the Eagle Mountain Woodfibre Gas Line in British Columbia.
Divestiture: The company is selling its 93.8-per-cent ownership interest in the Aitken Creek Natural Gas Storage Facility to Enbridge for approximately $400-million. Management says the proceeds will be used to strengthen the balance sheet and support the financing of its regulated utility growth strategy.
Dividend: The quarterly dividend is 56.5 cents a share ($2.26 per year). The shares yield 3.7 per cent at the current price. The company expects annual dividend increases of 4 per cent to 6 per cent through 2027.
Outlook: The company’s $22.3-billion five-year capital plan is expected to increase the midyear rate base from $34.1-billion in 2022 to $46.1-billion by 2027. This translates into a five-year compound annual growth rate of 6.2 per cent.
If you want a higher yield, check out some of the other companies in this sector. Emera Inc. (EMA-T) is currently paying 4.7 per cent.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe