Despite facing a big new obstacle, investors should be taking a longer look at Fortis
From this morning Globe and Mail
Fortis Inc. has navigated through the pandemic almost unscathed, raising its quarterly dividend in September and delivering a slight increase in annual adjusted profits in 2020, a year that most businesses would rather forget.
But now the St. John’s-based regulated utility is facing a new obstacle in early 2021: Rising bond yields. Should long-term investors take another look at Fortis, which has energy delivery operations throughout North America, as the share price slips back to 2019 levels?
What’s clear here is that the bond market is to blame as bond prices slump in anticipation of higher inflation, stronger economic growth and sooner-than-expected rate hikes by central banks.
The yield on the 10-year U.S. Treasury bond (bond prices and yields move inversely) rose to nearly 1.5 per cent on Wednesday, up from about 0.9 per cent at the start of the year. That’s a big jump from recent ultralow levels, and it makes dividend yields on stocks look less attractive by comparison.
Other government bond yields have also shot higher, including yields on Government of Canada bonds. The rise has triggered a downturn in economically defensive, slow-growing utilities that are so sensitive to the bond market that they are widely known as bond proxies.
Fortis shares have slipped more than 5 per cent over the past four weeks and are now trading at levels seen nearly two years ago.
FORTIS INC
49.86-1.63 (-3.17%)
YEAR TO DAT.49
The retreat is part of a broader trend. The S&P/TSX utilities index, which includes Emera Inc. and Hydro One Ltd. (full disclosure: I own Hydro One shares), has fallen nearly 8 per cent over the same period. Even renewable power companies with relatively upbeat growth prospects are stumbling: Algonquin Power and Utilities Corp. has fallen 10 per cent over the past month.
The slump resembles other times when bond yields have risen. Brian Belski, chief investment strategist at BMO Capital Markets, used data going back to 1990 to illustrate that utilities have been the worst performing sector within the S&P/TSX Composite Index when the yield on the 10-year U.S. Treasury bond is rising.
“Our work shows the faster the rise in interest rates, the greater the level of underperformance,” Mr. Belski said in a recent note.
That’s a good reason to avoid utilities if you think that bond yields will continue to rise as the global economy emerges from the pandemic this year and central banks withdraw extraordinary stimulus measures.
But there’s a compelling argument for staying put or even buying shares during the slump: Utilities are already down, trailing the TSX by about 9 percentage points so far this year and making dividend yields pop next to what are – even after the recent gains – paltry bond yields.
Fortis has a dividend yield of 4.1 per cent. Analysts expect the utility can raise its dividend by about 6 per cent each year, funded by low-but expected steady profit growth as the utility expands, invests in renewable energy and benefits from rate base increases of about 6 per cent.
What’s more, the stock looks relatively cheap at current levels. Robert Hope, an analyst at Bank of Nova Scotia, noted that the stock trades at 17.5-times estimated 12-month earnings from a consensus of analysts. The valuation hasn’t been that low, Mr. Hope said, since early 2019, when the Government of Canada 10-year bond yield was about 2 per cent.
Right now, the Canadian 10-year bond yield is about 1.4 per cent, suggesting that the recent decline in Fortis’ share price is reflecting a considerably greater upturn in bond yields that might not arrive for some time – if it ever does.
Is Fortis the only name worth considering among utilities? No. But it’s a shining example of an attractive stock when the broader market is looking increasingly overextended and vulnerable to pullbacks.
Note Bossu is in at $ 49,75 and would add on at discount ....