Hydro One Ltd. shares have been walloped by rising interest rates and political uncertainty, but this double-whammy of bad news looks like a gift for investors buying the stock at today’s beaten-up price.
Or at least that’s what I keep telling myself. I’ve owned this stock for a couple of years, and I have been adding to my holdings in three different accounts (a registered retirement savings plan, a tax-free savings account and – apologies to my daughter − a registered education savings plan), under the belief that electricity distribution is a solid business.
But doubling down has only added to my pain as Hydro One’s share price has tumbled below $20 over the past month, from a high above $26 in 2016 – a 30-per-cent belly flop.
Despite nursing losses, I remain convinced that the risks weighing on the stock will soon blow away. And the Ontario provincial election on Thursday should get the winds moving.
That’s right, I’m calling the populist bluffs of the New Democrats and the Progressive Conservatives. Both parties have had colourful things to say about the utility − 47 per cent owned by the province − as they appeal to voters outraged over rising electricity prices.
One of these parties will prevail in the election now that Liberal leader Kathleen Wynne has conceded defeat, putting their respective platforms to the test.
The PCs, under leader Doug Ford, want to replace Hydro One’s board and fire its chief executive officer, Mayo Schmidt. For some reason, Mr. Ford believes Mr. Schmidt’s paycheque is connected to electricity rates.
The NDP, under leader Andrea Horwath, wants to return Hydro One to provincial ownership, reversing the utility’s privatization through an initial public offering in 2015.
You can certainly understand why risk-averse investors might want to avoid this stock until political clarity emerges. But whichever leader becomes Ontario’s next premier, it seems unlikely that either will follow through on their bluster.
Why? The PC’s plan would make the pro-business party look like silly corporate meddlers: Even if they succeeded, they would end up removing a highly regarded CEO and replacing him with − what? – a highly regarded bargain CEO?
And the NDP’s plan to nationalize Hydro One, just three years after privatization, would cost the indebted province an estimated $10-billion, and it would need to get around an agreement reached during the IPO process that restricts provincial ownership.
“Ultimately, we believe the attempt for an incoming government to purchase the entirety of Hydro One is a very unlikely scenario. In any event, this type of situation is impermissible under the existing governance agreement,” Andrew Kuske, an analyst at Credit Suisse, said in a recent note to clients.
What’s more, neither plan would have any significant impact on electricity rates: Rates are set by the Ontario Energy Board, not the distribution utility. And if either plan continues to linger over the share price after the election, the uncertainty will most hurt the utility’s single biggest shareholder: Ontario.
So betting that the next provincial government will leave Hydro One more or less unchanged looks like a reasonable approach. And if the next premier backs off, the political nonsense weighing on the share price will disappear.
Beneath this overhang is a compelling investment.
Yes, the shares have also been hit by rising interest rates, which tends to lower the valuations of utilities that are prized for their stable dividends. The utilities sector within the S&P/TSX Composite Index has slumped more than 10 per cent this year.
But as the share price has declined, Hydro One's dividend yield has risen to a compelling 4.7 per cent.
As a publicly traded company, Hydro One has already raised its quarterly payout three times, most recently by 5 per cent. And investors can expect additional hikes as management transforms a lumbering government division into a more efficient operation that can take advantage of consolidation within the North American electricity sector.
Robert Kwan, an analyst at RBC Dominion Securities, expects the shares will rebound to $25 within a year, underpinned by Hydro One’s efforts to update aging infrastructure and streamline its operations.
“We expect a high-single-digit total return profile (i.e., yield plus growth) plus upside into the low-double digits, which we see as attractive for a stock with a below-average risk profile,” Mr. Kwan said in a recent note.
The stock trades at just 15 times estimated 2018 profit, according to Bloomberg, which is below the valuations for utility stocks in the S&P/TSX Composite and the S&P 500.
Clearly, Ontario’s politicians need to play along here. But until they do, the stock is cheap.