Thursday, January 5, 2017

Fortis Inc - 43 Years of Dividend Growth

After reviewing Canadian Utilities, which tops the list of companies on the Canadian Dividend All-Star list with an impressive dividend growth streak of 45 years, the next logical company to look at is Fortis Inc with their 43 year record of raising their payout. Similar to last time, my focus will remain mostly on the qualitative factors that make Fortis an interesting investment, as opposed to the quantitative characteristics which are the focus of many other dividend bloggers.

Company Overview

Fortis characterizes itself as a regulated, low risk and diversified utility company. With approximately 92% of 2015 earnings derived from regulated utilities, the bulk of the company's generated cashflows are indeed low risk. Although Fortis is based in Eastern Canada, their electric and gas regulated and non-regulated operations have customers in five Canadian provinces, nine US states and three Caribbean countries (Turks and Cacos, the Cayman Islands, and Belize).

Dividends

After announcing a 6.7% dividend increase in September 2016, the company's dividend yield is currently ~3.9%. The earnings payout ratio is moderate at 58% of the trailing 12-months EPS.  The 3, 5, and 10 year dividend growth rates are impressive at 7.1%, 5.6%, and 8.6% respectively. Fortis's management has issued guidance that they plan to grow their dividend by an average of 6% per year through 2021.
% annual average growth planned through 2021
Valuation

Fortis's share price was pretty consistent around $40 during 2016 leading to a trailing P/E of 22X. This value is at the higher end of the average P/E of 18-22X range for the past 5 years. Looking at EV/EBITA leads to a similar conclusion, with the company currently trading at 13X in contrast with their 5-year average in the 11-13X range.

Qualitative Catalysts

There are some obvious reasons why you would consider adding Fortis Inc to your investment portfolio

1. Stable Cashflows from Regulated Businesses
- With 92% of Fortis's 2015 earnings coming from regulated businesses and the company reporting that 96% of their assets generate regulated cashflows at Q316, the stable nature of the majority of the company's cashflow is a selling point for investors seeking a low volatility investment.
2. The Dividend Streak and Guidance
- As a dividend investor, you should seek out companies with management who are not only committed to sharing their profits with you, but who realize the importance of raising their payouts over time in-line with business results. With the second longest annual streak of dividend increases of any Canadian company and plans to continue to grow the dividend through 2021 at an average rate of 6%, management clearly puts the interests of income investors at the forefront.
3. Growing Geographical Diversification
- With its roots in  Eastern Canada, I assumed that the majority of company's assets would be based in the maritime provinces. However, I underestimated the growing geographical diversification the company has successfully undertaken in recent years. Only 5% of the company's assets relate to Eastern Canada, with the bulk of assets situated in the US (62%), followed by British Columbia (17%), and Alberta (9%).

Qualitative Drawbacks

Beyond the fact that the current valuation of the company's shares seems on the high end, there are some additional drawbacks for investors to consider before adding Canadian Utilities to their investment portfolio.

1. Regulatory Risk
- With 90%+ of Fortis's earnings depending on regulated business, there is a material risk that future regulatory decisions outside of the company's control could materially impact the company's operations and results. The election of Donald Trump as US President might have increased regulatory risk given Fortis's operations in nine US states and Mr. Trump's protectionist rhetoric during his electoral campaign.
2. Multiple Risks Associated with the Company's Strategy of Growth by Acquisitions 
- Integration Risk: Fortis ($16B market cap) faces integration risk relating to its recent $11B acquisition of ITC Transmission. The degree to which Fortis can successfully integrate ITC into their organization in a timely manner will be key in helping management meet their dividend growth projections in a responsible manner.
- Risk of Overpaying: Given the bull market in North America is long in the tooth, if Fortis continues to look to grow via acquisitions, they face an increasing risk of overpaying for target companies. Investors can gain some confidence in Fortis's management's historic record of paying fair prices for the companies they acquired.
- Dilution Risk: Investors should be cognizant of the fact that as Fortis continues to grow via acquisitions, their investment in shares of the company will be more diluted. Fortis will issue new shares in order to maintain their targeted capital structure.

Conclusions

Most Canadian dividend growth investors have at least one utility in their investment portfolio. Although it might be tempting to include Fortis in your portfolio due to their 43 year streak of raising their dividend and the 6% dividend growth guidance through 2021, I would caution that there will likely be a better time to add the company to your holdings. Given the relatively high current valuation, integration risks associated with the large ITC acquisition, and high regulatory risk, there are better companies to buy at the moment. However, I think Fortis could be an attractive investment at a lower valuation once they integrate ITC into their operations.

Would you consider adding shares of  Fortis Inc. to your portfolio?



2 comments:

  1. Thanks for the comprehensive analysis. Fortis is one of two pure play utilities I own, the other being Algonquin (AQN). I purchased a full position of Fortis in February 2016 at just over $37. I am currently contemplating adding to it, but am looking to get it a little cheaper. If it retraces back under $40, I suspect I will add to my position.

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    1. Thanks for your perspective as a Fortis shareholder. Your plan to add on a dip seems very reasonable. AQN has long been interesting to me, and could be my second utility after Emera.

      I appreciate your comment.

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