John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Even good companies with long records of dividend growth will test the patience of investors from time to time.
Case in point: Canadian Utilities Ltd.
When I "bought" the shares for my Strategy Lab model dividend portfolio in September, 2012, they were trading at $33.92. They rose steadily, peaking at more than $44 in January of this year, but have since given back much of those gains. On Tuesday, they closed at $36.91.
Why the pullback? A few reasons.
First, Calgary-based Canadian Utilities took a hit of $46-million in the first quarter related to Alberta Utilities Commission regulatory decisions affecting returns from Jan. 1, 2013, through March 31, 2015. Excluding adjustments for 2013 and 2014, first-quarter earnings in the utility division would have been $22-million higher than a year earlier.
Second, mild weather and increased supply contributed to a 52-per-cent drop in Alberta power prices during the first quarter compared with a year earlier, hitting the company's independent electricity generating operations. Canadian Utilities was also affected by lower "frac" spreads in its natural-gas processing business.
This all culminated with a 30-per-cent drop in first-quarter adjusted earnings, to $130-million or 49 cents a share from $186-million or 71 cents a year ago.
As tough as the quarter was, I'm not giving up on Canadian Utilities that easily. In fact, I'm doing the opposite: With the share price down more than 15 per cent from its recent peak, I'm using some of the cash in my model portfolio to purchase another 15 shares, bringing my total to 155.
Here's why:
It's a dividend growth machine
Certainly, the downturn in Alberta's economy creates headwinds for Canadian Utilities, but this isn't the company's first rodeo. It has increased its dividend every year since 1972 – one of the longest streaks for a Canadian company – including a 10.3-per-cent increase announced in January. That stellar record demonstrates its ability to navigate the ups and downs of the business cycle. What's more, the payout ratio is conservative at less than 60 per cent of estimated 2015 earnings, which gives the dividend plenty of protection and leaves room for future increases. In a recent note, RBC analyst Robert Kwan estimated that the dividend will grow to $1.30 annually in 2016, up from $1.18 currently – a projected increase of more than 10 per cent. That's not guaranteed, of course, but you can bet the company will do everything in its power to keep its dividend growth record intact.
The yield and valuation are attractive
Reflecting the lower share price and recent dividend hike, Canadian Utilities' yield has climbed to about 3.2 per cent currently from 2.6 per cent at the start of the year. That's attractive, considering the dividend will almost certainly continue to grow. The price-to-earnings multiple, meanwhile, has slipped to about 17.3 (based on 2015 earnings estimates), down from 18.6 in January. It's not a dirt-cheap valuation, but it's reasonable for a company that produces most of its earnings from regulated gas and electricity transmission and distribution utilities, which throw off relatively predictable cash flows and are insulated from competition.
The bad news is baked in
Canadian Utilities isn't the sort of stock that's going to double in a short period of time. But given the stable nature of its earnings, it likely won't plunge in price, either – particularly since the stock is well off its highs. Mr. Kwan's "base case" target price is $42, with an "upside scenario" of $52 and a "downside scenario" of $34. But the bearish case assumes a 2-percentage-point increase in long-term interest rates, which seems unlikely.
The company is investing in its future
To keep its earnings and dividends growing, Canadian Utilities is pouring money into new transmission lines in Alberta, a gas pipeline in Mexico and numerous other projects. From 2015 through 2017, it plans capital investments of $5.1-billion in its regulated utilities. The company, whose controlling shareholder is ATCO Ltd., is also exploring new avenues for growth, such as a $200-million investment to develop salt caverns for hydrocarbon storage. These projects will bear fruit for investors in the coming years, and if energy prices recover, that will work in Canadian Utilities' favour, too.
The balance sheet is strong
Even as Canadian Utilities' assets grew to $17-billion in 2014 from $9-billion in 2010, the company maintained a single-A credit rating that allows it to borrow at attractive rates to fund future expansion.
Closing thoughts
No stock is risk free. A prolonged slump in the energy sector and in Alberta power prices would likely exert a drag on Canadian Utilities' earnings and dividend growth, but its regulated utility operations and capital investments should help to counter the damage. A faster-than-expected rise in interest rates would also likely be negative for the stock. Be sure to do your own due diligence before investing in any security.
Disclosure: The author owns shares of CU personally and in his Strategy Lab model dividend portfolio.