TSX utility stocks saw major drawdowns, as interest rates rose rapidly last year. Higher rates made Treasury yields more attractive, making bond proxies — utilities — less appealing. But as we might see the rate hike cycle slowing by mid-2023, it’s time to put utility stocks on our watchlists.
What’s next for Fortis stock?
Canada’s largest utility stock Fortis (TSX:FTS) lost 25% between August to October 2022. While that’s a normal drawdown for a growth stock, it’s a massive value erosion for utilities. But FTS has seen a decent up move of late and has recovered 16% since October.
If you are okay with relatively lower returns and value stability, Fortis is an apt bet. Stocks like FTS might underperform broader markets in the short term, but its stable dividends and the less-volatile stock have beaten broader markets in the long term.
To be precise, FTS stock has returned 50% in the last five years and 140% in the last decade, including dividends. In comparison, the TSX Composite Index has returned 26% and 60% in the same period, respectively.
Utilities like Fortis grow their earnings very slowly relative to broader markets. In the last decade, its per-share earnings increased by 4%, compounded annually. However, some riskier options, like tech stocks, grow their earnings quite rapidly compared to this. And that’s why tech stock substantially outperforms utilities in bull markets. So, if you have a higher risk appetite, growth stocks, tech, or biotech names might be suitable bets for you instead of utilities.
Earnings and dividend stability
Fortis operates as an electric and gas utility and serves over three million customers in Canada, the U.S., and the Caribbean. It generated almost the whole of its profits from regulated operations, facilitating stable financial growth. Unlike tech or other risky sectors, utilities have stable cash flows in almost all economic cycles. And that’s why Fortis has increased its shareholder payouts for the last 49 consecutive years through years of recessions and even the pandemic.
And it’s not just Fortis; many utilities have such long payment histories because of their stable earnings. For example, peer Canadian Utilities (TSX:CU) has increased its dividend for 50 consecutive years.
Fortis intends to raise its dividend by 5% annually through 2027. This dividend growth visibility also stands strong in these uncertain times. Its low-risk business operations and earnings stability will drive this dividend growth in the long term.
Moreover, utilities pay a significant portion of their profits to shareholders as dividends. So, while other sectors pay out around 20% of their earnings, utilities give away more than 60% of their profits as dividends. Fortis’s payout ratio was 53% in the last 12 months, while Canadian Utilities’s was 81%.
Valuation
FTS stock saw a steep fall last year amid its rich valuation. However, it is currently trading 20 times its earnings and looks relatively fairly valued. It might not see a significant recovery soon, as rate hikes continue, at least in the first half of 2023. But the downside also looks limited, as the damage has already been done. Its stable dividends and less-volatile stock make it an appealing stock in volatile markets.
