Fortis: A Solid Dividend Investment

Oct. 18, 2021 6:53 AM ETFortis Inc. (FTS), FTS:CA5 Comments3 Likes
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Summary

  • FTS operates a business characterized by low risk and predictable cash flows. The company has interesting growth prospects, especially in clean energy.
  • FTS pays a quarterly dividend, it has an annual dividend yield of 3.5%, and management expects the dividend to increase at a rate of 6% until 2025.
  • The above characteristics make it an appealing choice for the dividend investor seeking a reliable and regular source of income.

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Investment Thesis

Fortis Inc. (NYSE:FTS) announced some positive developments in the last earnings call, yet the stock price didn't go anywhere over the past six months. It is therefore interesting to take an in-depth look at the business to see if there is a buying opportunity. FTS operates a business characterized by low risk and predictable cash flows. Moreover, the company pays a quarterly dividend, it has an annual dividend yield of 3.5%, and management expects the dividend to increase at a rate of 6% until 2025. The above characteristics make it an appealing choice for the dividend investor seeking a reliable and regular source of income.

Source: Seeking Alpha

Company Details

Fortis is mainly an energy delivery company, with 93% of its assets related to the transmission and distribution of electricity and natural gas. This is a business characterized by low-risk, stable, and predictable cash flows.

The company has a head office in St. John's, Newfoundland, and Labrador and the business units operate on an autonomous basis, with each utility having its own management team and board of directors (including independent directors). Needless to say, given that the company distributes natural gas and electricity, seasonality is impacting each business line. The gas utilities realize most of their annual earnings during the first and fourth quarters of the year due to the heating requirements related to cold weather, whereas earnings for electric utilities are generally highest in the second and third quarters due to the use of air conditioning and other cooling equipment in the summer. As a result of the fact that the two commodities have different peak seasons, seasonality has little impact on FTS. Below is a list of the different regulated and non-regulated subsidiaries:

Source: 2020 Annual Information Form

Business Strategy

FTS has experienced over the past years significant growth in its business operations. To put it into perspective, the total assets have increased from $47.8 billion at the start of 2018 to $55.5 billion at the end of 2020. At the same time, shareholders' equity has grown from $16.7 billion to $20.3 billion while net earnings have increased from $1.1 billion in 2018 to $1.2 billion in 2020. This impressive track record of growth can be explained by the company's strategy. In September 2020, the company launched a $19.6 billion five-year capital plan aiming at investing in a diverse mix of low-risk and highly executable projects with the purpose of maintaining and upgrading the existing infrastructure, as well as expanding the capacity and improving the reliability of the existing infrastructure.

Source: Q2 2021 Earnings Conference Call

In addition to the five-year plan, management is focused on constantly pursuing additional energy infrastructure opportunities in the area of further LNG expansion in British Columbia, electric transmission projects in Ontario, and in the area of clean energy. Fortis targets to reduce carbon emissions by 75% by 2035. In May 2021, the company completed the construction of the Oso Grande Wind Project UNS Energy's 250 MW wind-powered electric generating facility.

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Source: Q2 2021 Earnings Conference Call

In my opinion, the company has been using the debt market very efficiently in order to fuel its growth ambitions. Just in FY21 alone, the company, including its subsidiaries, has been able to raise over $1 billion in debt at very favorable interest rates. To give you an example, UNS Energy raised $325 million at 3.25% for a 30-year period. Given the fact that the company can borrow cheaply, it would be important to keep an eye on the debt level if you plan to invest in FTS. As of Q2 FY21, the debt to equity ratio was standing at 1.3. Nevertheless, FTS has an investment-grade credit rating from Moody's and S&P, as have most of its subsidiaries.

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Source: Q2 2021 EARNINGS CONFERENCE CALL

In addition to the above, another reassuring factor concerning the debt level is the manageable debt maturities in the short term. On average, the company needs to pay back $800 million every year over the next five years, assuming no new debt issuance (the company generates more than CAD 2.5 billion per year in operating cash flow).

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Source: Q2 2021 Earnings Conference Call

Valuation

In this part, we will put a price on the business and compare it to the market valuation. During the Q2 FY21 earnings call, management did not provide any guidance regarding earnings. However, they have provided some guidance regarding the dividend growth until the end of 2025:

Thank you, Jocelyn. To conclude our utilities are performing well positioned in us to deliver on our capital and rate-based growth objectives for the remainder of the year. And with the progress we've made in 2020 to reduce our already low carbon footprint, we are excited to be part of the solution to transition North America to a cleaner energy future. With the combination of our high quality ESG profile, five-year growth outlook and 6% dividend growth guidance through 2025. We have a balanced low risk value proposition with opportunities to extend growth for the foreseeable future.

As a result, we will be using a dividend discount model (DDM) in order to value the company. We have made the following assumptions in our DDM:

  • A dividend of CAD 2.07 per share for FY21.
  • A five-year 6% dividend growth rate until the end of 2025.
  • A dividend terminal growth rate of 4% beyond 2025.

Source: Author's estimates

Given the fact that the stock is currently trading at CAD 56.44 per share, the stock is fairly valued for an 8% return in my opinion. If you are happy with an 8% return, this stock is a buy at the current price.

At the same time, I have decided to run another model with a higher discount rate for those of you that target higher returns. Assuming we are using a 9.5% discount rate, the intrinsic value of the stock is CAD 39.6 per share. Given the fact that the stock is trading at CAD 56.4 per share, FTS is a little overvalued for a 9.5% return.

Source: Author's estimates

That being said, there are many moving pieces to this puzzle that can increase the value of the company based on our DDM. For instance, an increase in the dividend payout ratio or a higher revenue growth rate could lead to a higher growth rate in the dividend. However, one issue that must be highlighted is the fact that FTS is constantly issuing new shares to finance their growth ambitions. Since they have issued new shares every year over the previous 2 years, and if this trend continues going forward, your share of the company's earnings will be diluted. This is in my opinion a risk that is worth considering and you need to make the necessary adjustments to the discount rate to see how that fits your investment goals.

Key Takeaways

FTS operates in the energy delivery business which is characterized by low risk, stable and predictable cash flows. The company has a good geographical diversification, operating in Canada, the US and the Caribbean. The company has embarked on a 5-year plan with the goal of investing in a diverse mix of low-risk and highly executable projects while maintaining and upgrading the existing infrastructure. In addition to this plan, the management is focused on developing adjacent projects in clean energy. From FY15 until the end of FY20 the company was able to grow revenue from CAD 6.76 billion to CAD 8.93 billion, which represents an increase of 32.1% over the six-year period. One of the reasons behind the company's success is its use of debt. The company currently has an investment-grade credit rating, enabling it to borrow at very favorable rates to finance profitable projects. Regarding the company's valuation, investors should expect a return close to 8% over the long term at the current price based on the dividend estimates provided by management. If you're satisfied with 8% for the time being and expect the company to deliver on its growth strategy, this stock is a buy at the current price.

This article was written by

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About me: Value-oriented investor, seeking low-risk investments with the potential to deliver high returns. I like to analyze commodities, ETFs, and cash-flow positive businesses that have a moat and growth opportunities.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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