John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
There are enough unpredictable things in life: the weather, traffic, the Leafs....
That's why, when it comes to investing, I like to focus on the one thing that is predictable: dividends. Even as share prices rise and fall with every economic headline, dividends are remarkably consistent – especially if you choose the right companies.
That brings us to Fortis Inc., whose gas and electric utilities serve more than three million customers in Canada, the United States and the Caribbean. I've personally owned Fortis for years and held it in my model dividend portfolio since the launch of Strategy Lab in 2012.
The reason is simple: The St. John's-based parent of Newfoundland Power has paid higher dividends annually for 43 consecutive years. The most recent increase came on Sept. 27 when the company raised its dividend by 6.7 per cent to 40 cents a quarter, or $1.60 annually – for a yield of 3.9 per cent.
How predictable are Fortis's dividend increases? Well, because the vast majority of its earnings are from regulated utilities that churn out reliable and growing cash flows, the company can project dividend increases many years into the future. When Fortis announced the latest rise, it also extended its 6-per-cent annual dividend growth forecast by a year to 2021.
Dividend hikes aren't official until the board approves them, but for Fortis to make such a projection signals a high degree of confidence in the outlook for its business.
Fortis is "abundantly capable of meeting this guidance," Raymond James analyst David Quezada said in a note, citing expected earnings-per-share growth of more than 8 per cent annually over the next few years and a conservative, expected payout ratio of about 65 per cent.
I'm also counting on Fortis to make good on its pledge. That's one reason that today I'm using some of the cash in my Strategy Lab model dividend portfolio to purchase an additional 10 Fortis shares, bringing my total to 160.
Fortis's predictable earnings make it a defensive holding. But the company is also charting an aggressive expansion that should appeal to investors looking for some extra sizzle.
Complementing its extensive Canadian utility operations, the company has made a string of U.S. acquisitions in recent years, expanding into New York with the purchase of CH Energy Inc. in 2013 and scooping up Arizona's UNS Energy Corp. in 2014.
Now, it's poised to complete the $11.3-billion (U.S.) acquisition of Michigan-based ITC Holdings Corp., which owns about 25,000 kilometres of regulated electricity transmission lines in the U.S. Midwest. The deal – which will make Fortis one of the 15 largest utilities in North America – recently received approval from the U.S. Federal Energy Regulatory Commission and is expected to close by the end of the year, with Singapore's sovereign wealth fund taking a 19.9-per-cent equity interest in ITC for $1.23-billion.
The ITC acquisition will provide Fortis with "another major footprint in the U.S. Midwest [and] a transmission business with both premium returns and a solid growth platform," CIBC World Markets analyst Robert Catellier said in a recent note.
Acquisitions aren't the only source of growth for Fortis. Through 2020, the company has about $9-billion (Canadian) of capital expenditures planned for its existing operations that will increase Fortis's total rate base – the value of assets on which a regulated utility is permitted to earn a specified return. Most of these investments are "relatively small and highly executable," Mr. Quezada said. What's more, the company stands to benefit as recent regulatory decisions will likely lead to higher rates at some of its U.S. utilities, he said.
For all of its positives, Fortis still trades at a discount to its utility peers, with a 2017 price-to-earnings multiple of about 16.5 compared to the industry average of about 17.7. But this may not last.
"In light of the company's low risk, highly diversified business and solid growth outlook, we believe this discount is unwarranted and see it narrowing over time," said Mr. Quezada, who has an "outperform" rating and $50 price target on the shares.
Bay Street is generally bullish on the stock. Of the 13 analysts who follow the company, there are nine "buys" or equivalent, four "holds" and zero "sells," according to Bloomberg. The average 12-month price target is $48.15 – 17-per-cent higher than Tuesday's close of $40.98.
Is Fortis a slam dunk? No. Every stock comes with risks. For utilities, these include potentially unfavourable regulatory decisions, rising interest rates and uncertainties associated with completing and integrating major acquisitions. But given Fortis's long track record of creating value, I'm willing to accept these risks.
While nobody can predict what will happen to Fortis's share price in the short run, over the long run, I'm confident that the dividend will continue to rise and that, ultimately, investors will be rewarded with capital gains as well. That's a prediction I'm willing to make.