Hydro One workers at the Husky Travel Centre in Niagara-on-the-Lake, Ont., in September, 2017. Share prices for Hydro One gained more than 93 per cent over the past five years.Tara Walton/The Canadian Press
Utilities are no longer cheap stocks. But Ottawa’s plan to double Canada’s power grid by 2050 underscores why investors have been paying up for these stalwarts anyway: They can count on attractive growth – and big dividend hikes – for decades.
Toronto-based Hydro One Ltd. H-T certainly resides at the pricier end of the sector.
The share price has gained more than 92 per cent over the past five years, without factoring in dividends, outpacing the S&P/TSX Composite Index by about 18 percentage points.
The spectacular rally has driven the forward price-to-earnings ratio – which uses estimated earnings from analysts – to more than 25, according to data from S&P Global Market Intelligence.
That’s near a record high valuation and well above the 10-year average price-to-earnings ratio for the stock, which is a little more than 20. The current valuation is well above peers like Fortis Inc. and Emera Inc., whose P/E ratios are under 21.
Hydro One’s lofty valuation can be seen in its relatively paltry dividend yield as well, which has fallen as the share price has rallied.
Despite regular increases to the quarterly payout, including a 6-per-cent bump last week, the yield sits at just 2.4 per cent. That’s considerably lower than peers, whose dividend yields can be as high as 4 per cent in the case of Emera.
For investors who prefer their utilities cheap, given the lumbering pace of growth in electricity generation and regulated distribution, it’s tempting to give Hydro One a pass. I did, years ago.
Others may have had reservations as well. The stock has underperformed the TSX by 17 percentage points over the past 12 months. It has gained a ho-hum 7.5 per cent so far this year, as of Thursday, trailing its peers in the Canadian utilities sector.
But enough with the caution. Here’s the argument for giving the expensive stock another look: Electricity is hot, and getting hotter.
We’ve known this for a while, of course. Electric vehicles and heat pumps are just part of a trend toward electrification, which is straining the grid.
Add population growth, rising economic activity and AI data centres to the mix, and you can see why investors have embraced utilities as a sound bet on our future energy needs.
Ottawa’s national electricity strategy, released last week, could take things to another level.
Doubling the size of the country’s grid to keep up with rising electricity demand will reward engineering firms and renewable energy producers. But regulated electric utilities will surely benefit as well, giving the sector a compelling growth profile that should tempt new investors.
Hydro One is focused on electricity transmission and distribution in one area, Ontario, and is in an especially good position.
“Hydro One is entering a period of significant change. Ontario’s growing population, electrification and economic expansion are fundamentally reshaping electricity demand across the province,” chief executive officer David Lebeter said on a call with analysts last week.
Mr. Lebeter, who is retiring from the top job on June 9, declined an interview request to flesh out some of the details here. So did Megan Telford, who has been appointed the next CEO.
But these are hardly state secrets.
Hydro One has a bulletproof balance sheet and a peer-beating investment-grade credit rating from S&P Global Ratings. It expects it can increase its quarterly dividend by 6 per cent a year – a sector-leading pace. Consider that Emera has a larger dividend yield, but increased its quarterly payout by just 1 per cent last year.
Hydro One’s base in Ontario also has its advantages. The province is an economic powerhouse that generates nearly 40 per cent of the country’s gross domestic product. The province’s grid is already 92 per cent clean, which supports electrification efforts.
Hydro One can benefit from another goal of the national electricity strategy: Connect fragmented provincial and territorial grids, which should lead to greater energy efficiency and more transmission investments by Hydro One, given its geographic position.
“There are certainly areas where it does make sense across the country to have stronger ties. The two that come to mind most quickly for me are between Manitoba and Ontario, and between Quebec and Ontario,” Mr. Lebeter said on the call last week.
If betting on electricity demand looks like a winner, why wait around for Ottawa’s national electricity strategy to become actual policy?
Hydro One has a lot going for it, which may justify the stock’s lofty valuation. And what’s coming makes the valuation look downright reasonable.