Hydro One Ltd. is in the right place at the right time: Risk-averse investors are shuffling toward the safety of regulated utilities amid market volatility and a U.S. regulator has rejected the company’s $4.4-billion deal to acquire a U.S. utility, removing an issue that had been hanging over the stock for the past year.
The best part? Hydro One (full disclosure: I own shares) remains a work in progress, offering a lot of upside and a hefty dividend while the market comes around.
Admittedly, it has been a rough ride over the past two years for stubborn investors such as myself. The shares fell 29 per cent from mid-2016 to a record low this summer, as Hydro One – which transmits electricity in Ontario – faced a trio of threats that tarnished its appeal.
Rising interest rates made dividend-generating utilities look ho-hum next to bonds. U.S. tax cuts made Hydro One’s proposed acquisition of Avista Corp., the U.S. utility, look considerably less attractive. If completed, analysts expected that the cross-border deal would drag on Hydro One’s profit.
And lastly, the newly elected Doug Ford-led Ontario government (which owns a 47-per-cent stake in the utility after the previous government privatized it in 2015) decided to make the chief executive officer’s compensation a political issue this past summer, leading to his resignation. Now, the stock has an unfortunate tie to government interference.
One by one, though, these issues are fading.
Last week, a regulator in the state of Washington rejected the Avista deal, making it significantly less likely to succeed. Analysts estimated that scuttling the deal should boost Hydro One’s near-term profit outlook by about 5 cents a share and save its balance sheet from additional debt.
The fact that Hydro One’s share price popped 5.7 per cent on the news last Thursday provided a taste of what can happen when a company’s outlook improves.
But there’s more working in Hydro One’s favour right now. Although rising interest rates had weighed on utilities earlier this year, a number of observers are taking a more skeptical view of the global economy, arguing that trade tensions, stock market volatility, weaker commodity prices and declining long-term bond yields are signalling a slowdown next year.
David Kostin, a strategist at Goldman Sachs, recommended in his 2019 equity outlook last month that investors shift toward economically defensive stocks, including utilities, because of their stable sales and attractive valuations.
U.S. utilities have already rallied 17 per cent from lows in early June, outpacing the S&P 500 by 21 percentage points. Canadian utilities are up just 1.5 per cent over the same period, but the sector is outpacing the S&P/TSX Composite Index by 10.5 percentage points (not including dividends).
Hydro One, then, is in good company, and the stock is capable of breaking out of the pack if the utility can soothe additional investor concerns.
Naming a new CEO will surely help solidify its strategic direction. And maybe, just maybe, Mr. Ford will back off from interfering with a publicly owned corporation (he still wants to cut hydro bills to satisfy an election promise), given the recent backlash.
For example, the Washington Utilities and Transportation Commission, which nixed the Avista deal, pointed to Ontario’s meddling ways in its decision. And the debt-rating agency Standard & Poor’s warned this week that it could downgrade Hydro One’s credit rating if Ontario continues to intervene in the utility’s business decisions.
Is Mr. Ford learning something here? Okay, don’t bet your life savings on that one. But with analysts on the fence with mostly “hold” recommendations and target prices that imply the stock will drift sideways over the next 12 months, the downside seems limited. And with a 4.3-per-cent dividend yield, I’m happy to wait around for better days.