John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Utility operator Fortis Inc. is one of the original members of my Strategy Lab model dividend portfolio, and I've been pleased with its performance.
The company has delivered exactly what a regulated utility should: steady growth in earnings and dividends, with gradual increases in the share price, too.
Since the model dividend portfolio's inception on Sept. 13, 2012, shares of St. John's-based Fortis have posted a total return (through May 26) of 60.6 per cent, or 10.6 per cent on an annualized basis. That compares with an annualized gain of 6.6 per cent for the S&P/TSX composite total return index.
Total return is a theoretical measure that assumes all dividends were reinvested in additional shares. Although I don't automatically reinvest my dividends from Fortis – or any of the other 11 securities in the model portfolio – I do use the cash that accumulates to increase my position in certain stocks when I consider them attractive.
Since Strategy Lab started, I've raised my stake in Fortis on three occasions, and today I've decided to acquire another 10 shares, bringing my total to 170 shares. Reinvesting dividends is one of the keys to building wealth because it harnesses the power of compounding – the secret sauce in a long-term investing plan.
Here's why I continue to like Fortis, whose shares I also own personally.
Predictable dividend growth
Fortis has one of the longest dividend-growth records for a Canadian company, having increased its annual payment for 43 consecutive years. And there's more to come: The company has said it aims to raise its dividend at an annual rate of 6 per cent through 2021.
I'm especially fond of stocks, such as Fortis, that raise their dividends faster than the rate of inflation – currently less than 2 per cent – because the purchasing power of my income continues to grow. Fortis currently pays $1.60 a share annually, for a yield of 3.62 per cent based on Tuesday's closing share price of $44.24.
Assuming the company achieves its growth target, the dividend will climb to $2.14 by 2021. If the pattern of the past couple of years continues, the next dividend hike will come in September.
A history of acquisitions
Fortis has a long record of successful acquisitions, including Terasen Inc. (2007), CH Energy Group Inc. (2013), UNS Energy Corp. (2014) and ITC Holdings Corp. (2016).
The $11.3-billion (U.S.) acquisition of Michigan-based ITC, a regulated electric-transmission utility that operates in seven Midwest U.S. states, was Fortis's largest deal yet and positions the company to take advantage of growth in renewable generation as transmission lines will be required to get that green electricity to market.
"There are always concerns with large acquisitions, but … we believe Fortis has added value here and we see the addition of future development projects at ITC turning this into a solid deal," Accountability Research Corp. analysts Michael Ruggirello and Mark Rosen said in a note. The firm has a "buy" rating and a $50 (Canadian) target price on the shares.
A solid capex plan
In addition to growing through acquisitions, Fortis also invests in its existing operations to raise its rate base – the value of assets on which a utility is permitted to earn a regulated rate of return.
Over the next five years, the company plans capital expenditures of about $13-billion across its regulated gas and electric operations in Canada, the United States and the Caribbean to support a growing customer base and to maintain its existing generation, transmission and distribution infrastructure.
"Given that a regulated utility is allowed to earn a return on its asset base, we expect these investments to translate into solid earnings growth," Edward Jones analyst Andy Smith, who has a "buy" rating on the shares, said in a note.
Rising earnings, in turn, will support Fortis's dividend-growth plans.
Good diversification
Fortis's operations are well diversified geographically, spanning five provinces, nine U.S. states and four Caribbean countries. Following the ITC acquisition, the U.S. market now accounts for more than half of Fortis's operating earnings. "We view the company's diversification as a positive as it helps reduce the volatility in earnings due to unusual weather and the potential impact of adverse regulatory rulings," Mr. Smith said. What's more, about 97 per cent of Fortis's assets are regulated, with only a small contribution of earnings from unregulated power-generation assets that are largely contracted on a long-term basis. That asset mix should appeal to conservative investors. "We prefer more regulated companies due to the greater consistency and stability in earnings and dividends they produce," Mr. Smith said.
Reasonable valuation
"Because of their predictable earnings, utilities that are primarily regulated tend to trade at higher price-to-earnings multiples than those with large unregulated operations. But Fortis is still reasonably valued, trading at about 17 times estimated 2017 earnings – slightly below the peer group average of closer to 18. Analysts are generally bullish on the shares, with nine "buys," four "holds," no sells and an average price target of $48.92, according to Thomson Reuters.
No stock is without risks, of course: Interest rates, regulatory decisions and general market conditions, among other factors, could all affect the shares in the short run. But over the long run, I believe that Fortis's earnings, dividends and share price will continue to grow. That`s why I consider it a core holding.