Grandpa Is Buying Canada's Longest Dividend Aristocrat Yielding 4.4% For Income And Diversification.

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About: Canadian Utilities Limited (CDUAF), CNUTF, Includes: CDUTF
by: Nikolaos Sismanis
Summary

CU has the longest track record (47 years) of annual dividend increases of any Canadian publicly-traded company.

The company is trading at a discount against future dividends.

CU is a fantastic retirement stock for income-oriented investors.

In the last article of "Grandpa's Retirement Portfolio," we explored the first option of diversifying away from U.S. securities. Grandpa, therefore, bought the UK's National Grid. You can read my analysis here. Today I am also looking to diversify outside the U.S. Source: Invested Wallet

I was thinking about how many countries should GRP have exposure too. Since we are looking for maximum reliability and low volatility, GRP will only focus on established, mature economies, with stable currencies and low political risk. Therefore throughout the series, GRP stocks will be mainly based in:

  • United States
  • United Kingdom
  • Canada

I am also excited and considering Australia and New Zealand, but I want to make sure it is efficient for American investors regarding dividend withholding taxes. There are some fantastic stocks in those regions too. Today, grandpa is about to buy his first Canadian stock. Canadian Utilities (OTCPK:CDUAF)(OTC:CNUTF)(OTC:CDUTF) has the longest track record (47 years) of annual dividend increases of any Canadian publicly-traded company. That's an incredible feat. To survive and prosper consistently for decades requires dedication and prudence. CU has undoubtedly proven it doesn't lack those two. As always, our rules remain the same.

Every stock chosen for GRP must have:

  • A dividend yield ≥ 4%
  • A payout ratio < 80%
  • A PE ratio < 20
  • A beta < 1

Canadian Utilities is certainly within these bounds. The point of this article is to:

  • Give a brief overview of the company to investors unfamiliar with the stock.
  • Discuss the financials and the dividend.
  • Explain why the stock is trading at a discount based on DDM.
  • Conclude why CU is a fantastic stock for retirees and dividend growth investors.

Canadian Utilities

Canadian Utilities, in which ATCO owns 52.2%, is a $22 billion company with approximately 5,000 employees. Based in Alberta, Canadian Utilities Limited is a diversified global energy infrastructure corporation delivering service excellence and innovative business solutions in Electricity, Pipelines & Liquid, and Retail Energy.

Source: Presentation

The company's operations involve delivering natural gas and electricity to communities throughout Alberta and Northern Canada, keeping the lights on in Mexico with clean hydroelectricity, or developing highly efficient natural gas-fired power plants in Australia. Source: Pexels

When I discussed Royal Dutch Shell and National Grid, I made sure that these companies are actively transitioning to renewables and clean energy infrastructure. Energy transmission will eventually go green, and investors must make sure their holdings follow suit.

I was glad when CU announced the sale of its fossil fuel-based electricity generation portfolio for CAN$835 million. Instead, the company invests, owns and operates non-regulated industrial water, natural gas storage, hydrocarbon storage, and NGL related infrastructure. Their portfolio includes

  • 85,200 m3 /day water infrastructure capacity
  • 400,000 m3 hydrocarbon storage capacity
  • 52 PJ natural gas storage capacity
  • ~ 116 km pipelines

Moreover, their industrial water is signed to a long-term commercial agreement to provide water services commencing in 2020 to Inter Pipeline’s PDH plant.

Moving away from fossil fuels and strengthening their clean energy portfolio, sure looks good to me. Management has proven outstanding performance through the decades, and I trust them to continue so.

The dividend

Canadian Utilities is not just a dividend aristocrat, but the longest one in Canada. The company boasts 47 years of consecutive increases. Through contractionary economic climates, recessions, and the test of time, CU has managed to consistently please its shareholders, who never missed their quarterly payment on time.

Source: Fact Sheet

For the following calculations regarding the DDM, I will be using the original numbers corresponding to the Canadian listing of the stock. I initially calculated each year's Δ change of dividend increases. The average for the past three years ends up being 0.09- aka 9%

Source: Author

In my opinion, the rate at which the company increases its dividend is very impressive. Not only maintaining such an excellent track record of payouts but also growing the actual annual dividend so fast is astonishing. I am going to calculate the present value of the stock through DDM, using the formula below.

I will be using a 6% dividend growth rate (well below the current dividend growth rate so that we are prudent.) I am also going to be using a discount rate of 10%. I believe that a 10% discount rate is in line with our "Grandpa's Retirement Portfolio" expectations.

Source: Jason Greene

*Warning*: These calculations reflect the dividend growth and discount rate that I think suit GRP. Other investors may have different needs and expectations and adjust their numbers accordingly.

With the help of Excel and some simple math, we end up with a present value of the company of CAD 43.74.

Source: Author

The stock's current MP is 38.85, which represents a ~12.6% discount to our "fair" PV.

Regarding the earnings, the company reported $607 million in 2018, up only 0.8% from 2017's $602 million. However, what's interesting is the energy infrastructure segment's growth. Even though the company's main Utilities segment saw a small decline in earnings, the energy infrastructure business more than doubled within a year. The latter not only compensated for the core segments setback but also shows hyper-growth capabilities. Its activities were listed earlier in the article.

Source: Presentation

Moreover, the 2019-2021 expansion plan for the company projects the deployment of $3.6 billion, in every energy infrastructure segment possible. Operational diversification, as well as regional diversification, will help CU to withstand potential currency headwinds. The company receives turnover from Canada, U.S., Mexico, and Australia.

Source: Presentation

All in all, I believe that Canadian Utilities is indeed trading at a discount against future cash flows. I think that our 6% future dividend growth rate is a quite conservative estimate. Remember, the company's average dividend growth rate over the past years has been close to 10%. Moreover, you can see how well the growth in earnings supports that growth. Over the past three years, net income has been growing at ~21.5%, while diluted EPS by an even higher percentage.

Source: Morningstar

The risks

The most significant risk I see in CU is its massive pile of long-term debt. As you can see, Total Liabilities have gone up by nearly 50% in 2018 since 2014. Especially noteworthy is the spike in long-term debt that has occurred between 2017 & 2018. Source: Morningstar

However, all liabilities, including the long-term debt, are well covered by the operating cash flow. Source: Morningstar

Therefore, the company is left with enough free cash flow, to not only have its debt and dividends paid but also build a robust cash position. Source: Morningstar

Another potential risk could be currency headwinds. As I have mentioned, CU receives sales by more than four continents. While this could be seen as income diversification, as well as less need to buy futures and manually hedge against currencies, it could also be a potential risk.

While the USD/CAD has been long over the past decade, the trend seems to have been stabilized over the past five years. The risk here is that older CU investors now receive fewer dividends than ten years ago (excluding dividend growth) because of the increased dominance of the USD over the CAD.

Source: XE

In any case, I believe that owning Candian stock could diversify your retirement portfolio not only geopolitically but also currency wise. After all, in the scenario that the trend reverses investors will be receiving more income and vice-versa. Remember than the goal of grandpa is to be receiving his beloved dividends continually. I believe that diversifying amongst three or four currencies is vital to withstand short-term geopolitical and trade risk.

Conclusion

Grandpa's goal is to sleep well at night, every night. When I pick stocks, I am trying to make sure, that no matter how the economy is doing, what's the state of the trade war, or if a recession is on the way, grandpa will be receiving his dividends every quarter.

I believe that Canadian Utilities stock fulfills all of grandpa's needs. Besides passing our initial "rules," CU is also trading at a discount against future dividends. The stock's diversified sources of income, geological and operational variety, as well as management's plans to embrace the new energies, making it an excellent pick for our grandpa. After all 47 years of consecutive dividend increases and the current 9% dividend growth is hard to leave anybody not impressed and tempted to buy.

I am looking forward to all of your comments and suggestions, that have been incredibly helpful in deciding what the next GRP picks will be. Thank you!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.